Form 10-K
2008 ANNUAL REPORT
FINANCIAL CONTENTS
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 and weakening in the economy, specifically the real estate market, 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) deteriorating credit quality; (3) political developments, wars or other
hostilities may disrupt or increase volatility in securities markets or other economic conditions; (4) changes in the interest rate environment reduce interest margins; (5) prepayment speeds, loan origination and sale volumes, charge-offs
and loan loss provisions; (6) Fifth Thirds ability to maintain required capital levels and adequate sources of funding and liquidity; (7) maintaining capital requirements may limit Fifth Thirds operations and potential growth;
(8) changes and trends in capital markets; (9) problems encountered by larger or similar financial institutions may adversely affect the banking industry and/or Fifth Third (10) competitive pressures among depository institutions
increase significantly; (11) effects of critical accounting policies and judgments; (12) changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board (FASB) or other regulatory agencies;
(13) 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; (14) ability to maintain favorable ratings from rating agencies; (15) fluctuation of Fifth Thirds stock price; (16) ability to attract and retain key personnel; (17) ability to receive
dividends from its subsidiaries; (18) potentially dilutive effect of future acquisitions on current shareholders ownership of Fifth Third; (19) effects of accounting or financial results of one or more acquired entities;
(20) difficulties in combining the operations of acquired entities; (21) lower than expected gains related to any potential sale of businesses; (22) loss of income from any potential sale of businesses that could have an adverse
effect on Fifth Thirds earnings and future growth; (23) ability to secure confidential information through the use of computer systems and telecommunications networks; and (24) 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) |
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2008 |
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2007 |
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2006 |
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2005 |
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2004 |
Income Statement Data |
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Net interest income (a) |
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$3,536 |
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3,033 |
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2,899 |
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2,996 |
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3,048 |
Noninterest income |
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2,946 |
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2,467 |
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2,012 |
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2,374 |
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2,355 |
Total revenue (a) |
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6,482 |
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5,500 |
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4,911 |
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5,370 |
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5,403 |
Provision for loan and lease losses |
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4,560 |
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628 |
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343 |
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330 |
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268 |
Noninterest expense |
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4,564 |
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3,311 |
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2,915 |
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2,801 |
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2,863 |
Net income (loss) |
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(2,113) |
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1,076 |
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1,188 |
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1,549 |
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1,525 |
Net income (loss) available to common shareholders |
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(2,180) |
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1,075 |
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1,188 |
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1,548 |
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1,524 |
Common Share Data |
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Earnings per share, basic |
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$(3.94) |
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2.00 |
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2.14 |
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2.79 |
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2.72 |
Earnings per share, diluted |
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(3.94) |
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1.99 |
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2.13 |
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2.77 |
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2.68 |
Cash dividends per common share |
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.75 |
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1.70 |
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1.58 |
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1.46 |
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1.31 |
Book value per share |
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13.57 |
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17.18 |
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18.00 |
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16.98 |
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15.99 |
Financial Ratios |
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Return on assets |
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(1.85) |
% |
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1.05 |
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1.13 |
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1.50 |
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1.61 |
Return on average common equity |
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(23.0) |
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11.2 |
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12.1 |
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16.6 |
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17.2 |
Average equity as a percent of average assets |
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8.78 |
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9.35 |
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9.32 |
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9.06 |
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9.34 |
Tangible equity |
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7.86 |
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6.05 |
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7.79 |
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6.87 |
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8.35 |
Tangible common equity |
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4.23 |
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6.14 |
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7.95 |
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7.22 |
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8.50 |
Net interest margin (a) |
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3.54 |
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3.36 |
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3.06 |
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3.23 |
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3.48 |
Efficiency (a) |
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70.4 |
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60.2 |
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59.4 |
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52.1 |
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53.0 |
Credit Quality |
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Net losses charged off |
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$2,710 |
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462 |
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316 |
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299 |
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252 |
Net losses charged off as a percent of average loans and leases |
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3.23 |
% |
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.61 |
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.44 |
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.45 |
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.45 |
Allowance for loan and lease losses as a percent of loans and leases |
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3.31 |
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1.17 |
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1.04 |
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1.06 |
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1.19 |
Allowance for credit losses as a percent of loans and leases (b) |
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3.54 |
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1.29 |
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1.14 |
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1.16 |
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1.31 |
Nonperforming assets as a percent of loans, leases and other assets, including other real estate owned
(c) |
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2.96 |
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1.32 |
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.61 |
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.52 |
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.51 |
Average Balances |
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Loans and leases, including held for sale |
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$85,835 |
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78,348 |
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73,493 |
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67,737 |
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57,042 |
Total securities and other short-term investments |
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14,045 |
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11,994 |
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21,288 |
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24,999 |
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30,597 |
Total assets |
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114,296 |
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102,477 |
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105,238 |
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102,876 |
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94,896 |
Transaction deposits (d) |
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52,584 |
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50,987 |
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49,678 |
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48,177 |
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43,260 |
Core deposits (e) |
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63,719 |
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61,765 |
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60,178 |
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56,668 |
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49,468 |
Wholesale funding (f) |
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36,357 |
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27,254 |
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31,691 |
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33,615 |
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33,629 |
Shareholders equity |
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10,038 |
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9,583 |
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9,811 |
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9,317 |
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8,860 |
Regulatory Capital Ratios |
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Tier I capital |
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10.59 |
% |
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7.72 |
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8.39 |
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8.35 |
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10.31 |
Total risk-based capital |
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14.78 |
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10.16 |
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11.07 |
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10.42 |
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12.31 |
Tier I leverage |
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10.27 |
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8.50 |
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8.44 |
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8.08 |
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8.89 |
(a) |
Amounts presented on a fully taxable equivalent basis (FTE). The taxable equivalent adjustments for years ending December 31, 2008, 2007, 2006, 2005 and 2004 were $22
million, $24 million, $26 million, $31 million and $36 million, respectively. |
(b) |
The allowance for credit losses is the sum of the allowance for loan and lease losses and the reserve for unfunded commitments. |
(c) |
Excludes nonaccrual loans held for sale. |
(d) |
Includes demand, interest checking, savings, money market and foreign office deposits. |
(e) |
Includes transaction deposits plus other time deposits. |
(f) |
Includes certificates $100,000 and over, other foreign office deposits, federal funds purchased, short-term borrowings and long-term debt. |
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TABLE 2: QUARTERLY INFORMATION (unaudited) |
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2008 |
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2007 |
For the three months ended ($ in millions, except per share data) |
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12/31 |
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9/30 |
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6/30 |
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3/31 |
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12/31 |
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9/30 |
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6/30 |
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3/31 |
Net interest income (FTE) |
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$897 |
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1,068 |
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744 |
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826 |
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785 |
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760 |
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745 |
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742 |
Provision for loan and lease losses |
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2,356 |
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941 |
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719 |
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544 |
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284 |
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139 |
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121 |
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84 |
Noninterest income |
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642 |
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717 |
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722 |
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864 |
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509 |
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681 |
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669 |
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608 |
Noninterest expense |
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2,022 |
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967 |
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858 |
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715 |
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940 |
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853 |
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765 |
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753 |
Net income (loss) |
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(2,142) |
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(56) |
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(202) |
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286 |
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16 |
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325 |
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376 |
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359 |
Net income (loss) available to common shareholders |
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(2,184) |
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(81) |
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(202) |
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286 |
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16 |
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325 |
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376 |
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359 |
Earnings per share, basic |
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(3.82) |
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(.14) |
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(.37) |
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.54 |
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.03 |
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.61 |
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.69 |
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.65 |
Earnings per share, diluted |
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(3.82) |
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(.14) |
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(.37) |
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.54 |
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.03 |
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.61 |
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.69 |
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.65 |
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, results of operations and cash flows.
The Bancorp is a diversified financial services company headquartered in
Cincinnati, Ohio. At December 31, 2008, the Bancorp had $119.8 billion in assets, operated 18 affiliates with 1,307 full-service Banking Centers including 92 Bank Mart® locations open
seven days a week inside select grocery stores and 2,341 Jeanie® ATMs in the Midwestern and Southeastern regions of the United States. The Bancorp reports on five business segments:
Commercial Banking, Branch Banking, Consumer Lending, Fifth Third Processing Solutions (FTPS) and Investment Advisors.
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 dependent on both net interest income and noninterest
income. For the year ended December 31, 2008, net interest income, on a fully taxable equivalent (FTE) basis, and noninterest income provided 55% and 45% of total revenue, respectively. 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 incurred on liabilities such as deposits, short-term borrowings and long-term debt. 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 pays 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 due to a weakening economy within the Bancorps footprint.
Net interest income, net interest margin 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. Noninterest expense is
primarily driven by personnel costs and occupancy expenses, in addition to expenses incurred in the processing of credit and debit card transactions for its customers and merchant and financial institution clients.
On May 2, 2008, the Bancorp completed the purchase of nine branches located in Atlanta and deposits of $114 million from First
Horizon National Corporation (First Horizon). On June 6, 2008, the Bancorp completed its acquisition of First Charter Corporation (First Charter), a regional financial services company with assets of $4.8 billion that operated 57 branches in
North Carolina and 2 in suburban Atlanta, paying $31.00 per First Charter share, or approximately $1.1 billion. On October 31, 2008, the Bancorp assumed approximately $257 million of deposits from the Federal Deposit Insurance Corporation
(FDIC) acting as receiver for Freedom Bank in Bradenton, Florida.
Earnings Summary
During 2008, the Bancorp continued to be affected by the economic slowdown and market disruptions. The Bancorps net loss was $2.2 billion, or $3.94
per diluted share, which included $67 million in preferred stock dividends. Net income was $1.1 billion, or $1.99 per diluted share, for 2007. Results for both years reflect a number of significant items.
Items affecting 2008 include:
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$965 million of noninterest expense due to a goodwill impairment charge reflecting the decline in estimated fair values of certain of the Bancorps business
reporting units below their carrying values and the determination that the implied fair values of the reporting units were less than their carrying values; |
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$339 million and $19 million of net interest income due to the accretion of purchase accounting adjustments related to loans and deposits, respectively, from
acquisitions during 2008; |
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$273 million of other noninterest income related to the redemption of a portion of Fifth Thirds ownership interests in Visa, Inc. (Visa) and $99 million in
net reductions to noninterest expense to reflect the recognition of the Bancorps proportional share of the Visa escrow account, partially offset by additional charges for probable future Visa litigation settlements;
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$229 million after-tax impact of charges relating to a change in the projected timing of cash flows relating to income taxes for certain leveraged leases. This
charge consisted of approximately $130 million pre-tax, reflected as a reduction in interest income, and an increase of approximately $140 million in tax expense required for interest; |
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$215 million reduction to other noninterest income to reflect the lower cash surrender value of one of the Bancorps Bank Owned Life Insurance (BOLI)
policies; |
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$104 million reduction to noninterest income due to other-than-temporary impairment (OTTI) charges on Federal National Mortgage Association (FNMA) and Federal
Home Loan Mortgage Corporation (FHLMC) preferred stock and certain bank trust preferred securities; |
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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$76 million of other noninterest income, partially offset by $36 million in related litigation expense, due to the successful resolution of a court case related
to goodwill created in the 1998 acquisition of CitFed (the CitFed litigation); and |
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Preferred stock dividends increased from $1 million to $67 million in 2008 due to the issuance of Series G preferred stock in the second quarter of 2008 and
repurchase of Series D and Series E preferred stock in the fourth quarter of 2008. The repurchase of Series D and Series E preferred stock resulted in preferred stock dividends of $19 million, which was the amount of the repurchase price in excess
of the par value of the preferred stock. |
For comparison purposes, items affecting 2007 include:
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$177 million reduction to other noninterest income to reflect the lower cash surrender value of one of the Bancorps BOLI policies;
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$172 million of other noninterest expense relating to the indemnification of estimated current and future Visa litigation settlements;
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$16 million of noninterest income from the sale of non-strategic credit card accounts; and |
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$15 million of other noninterest income from the sale of FDIC deposit insurance credits. |
Net interest income (FTE) increased to $3.5 billion, from $3.0 billion in 2007. The primary reason for the 17% increase in net interest
income was an 11% increase in average interest-earning assets. Additionally, the benefit from the accretion of purchase accounting adjustments related to the second quarter acquisition of First Charter, totaling $358 million, was largely offset by
$130 million in charges relating to leveraged leases and the cost of carrying higher balances of nonaccrual loans and leases. Net interest margin was 3.54% in 2008, an increase of 18 basis points (bp) from 2007.
Noninterest income increased 19%, from $2.5 billion to $2.9 billion, in 2008. The increase in noninterest income was impacted by a $273
million gain related to the redemption of a portion of Fifth Thirds ownership interests in Visa, offset by $104 million due to OTTI charges on FNMA and FHLMC preferred stock and certain bank trust preferred securities. Growth occurred in
several categories compared to 2007. Electronic payment processing revenue increased 11% due to higher transaction volumes. Service charges on deposits grew 11% due to decreased earnings credits and higher customer activity. Corporate banking
revenue increased 21% as the Bancorp realized growth from the buildout of its suite of commercial products in 2007. Mortgage banking net revenue increased 50% due to higher sales margins, increased volume of portfolio loans sold and the impact of
Statement of Financial Accounting Standards (SFAS) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115.
Noninterest expense increased $1.3 billion compared to 2007. Noninterest expense in 2008 included $965 million of noninterest expense
due to a goodwill impairment charge, the aforementioned $99 million reduction to expenses related to Visa litigation reserves and Visas funding of an escrow account, $65 million increases in salaries and benefits from the
adoption of SFAS No. 159, and $36 million in litigation expense due to the successful resolution of the CitFed litigation. Noninterest expense in 2007
included $172 million related to the indemnification of estimated current and future Visa litigation settlements. The growth in noninterest expense can also be attributed to increased FDIC insurance due to the depletion of the Bancorps prior
FDIC insurance premium credits in 2008, a higher provision for unfunded commitments, increases in the credit component of fair value marks on counterparty derivatives, increases in loan and lease processing costs from higher collection activities
over the past year and increased volume-related processing expenses.
The Bancorp does not originate subprime mortgage
loans, does not hold credit default swaps and does not hold asset-backed securities backed by subprime mortgage loans in its securities portfolio. However, the Bancorp has exposure to disruptions in the capital markets and weakening economic
conditions. The housing markets continued to weaken during 2008, particularly in the upper Midwest and Florida. Additionally, economic conditions deteriorated throughout 2008, putting significant stress on the Bancorps commercial and consumer
loan portfolios. Consequently, the provision for loan and lease losses increased to $4.6 billion for the year ended December 31, 2008 compared to $628 million during 2007. Net charge-offs as a percent of average loans and leases were 3.23% in
2008 compared to .61% in 2007. At December 31, 2008, nonperforming assets as a percent of loans, leases and other assets, including other real estate owned (excluding nonaccrual loans held for sale) increased to 2.96% from 1.32% at
December 31, 2007. During the fourth quarter of 2008, the Bancorp sold or transferred to held-for-sale $1.3 billion in carrying value of commercial loans and incurred $800 million in charge-offs on those loans, in order to address some of the
more problematic loan portfolios, specifically real estate loans in Florida and Michigan. Refer to the Credit Risk Management section in Managements Discussion and Analysis for more information on credit quality.
In response to the current economic operating environment and uncertain future trends, the Bancorp took actions to strengthen its
capital position in 2008. During the second quarter of 2008, management raised its capital target to an eight to nine percent Tier 1 capital ratio and issued approximately $1.0 billion in Tier 1 capital in the form of convertible preferred shares.
During 2008, the Bancorp reduced its common dividend due to the outlook for a continued negative credit environment, preserving over $580 million of capital in 2008 relative to the prior level, and nearly $1.0 billion in 2009. On December 31,
2008, the Bancorp received $3.4 billion as part of the U.S. Department of Treasury (U.S Treasury) Capital Purchase Program (CPP) and issued senior preferred stock and ten-year warrants under the terms of the program - impacting the Bancorps
Tier 1 capital ratio and total risk-based capital ratio by approximately 3.00%. 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, 2008, the Tier 1 capital ratio was 10.59%, the Tier 1 leverage ratio was 10.27% and the total risk-based capital ratio was 14.78%.
RECENT ACCOUNTING STANDARDS
Note 1 of the Notes to
Consolidated Financial Statements provides a discussion of the significant new accounting standards adopted by the Bancorp during 2008 and 2007 and the expected impact of significant accounting standards issued, but not yet required to be adopted.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
The Bancorps Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States of
America. Certain accounting policies require management to exercise judgment in determining methodologies, economic assumptions and estimates that may materially affect the value of the Bancorps assets or liabilities and results of operations
and cash flows. The Bancorp has six critical accounting policies, which include the accounting for allowance for loan and lease losses, reserve for unfunded commitments, income taxes, valuation of servicing rights, fair value measurements and
goodwill. No material changes have been made during the year ended December 31, 2008 to the valuation techniques or models described below.
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 determined based on managements estimate of the borrowers ability to repay the loan given the availability of collateral and other sources of cash flow, as well as an evaluation of legal options available to the
Bancorp. 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, the fair value of the underlying collateral or readily observable secondary market values. The Bancorp evaluates the collectibility of both principal and interest
when assessing the need for a loss accrual. Historical loss rates are applied to commercial loans that are not impaired or are impaired but smaller than an established threshold and thus not subject to specific allowance allocations. The loss rates
are derived from a migration analysis, which tracks the historical net charge-off experience sustained on loans according to their internal risk grade. The risk grading system currently utilized for allowance analysis purposes encompasses ten
categories.
Homogenous loans and leases, such as consumer installment and residential mortgage loans, 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. 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, are necessary to reflect
losses inherent in the portfolio. Factors that management considers in the analysis include the effects of the national and local economies; trends in the
nature and volume of delinquencies, charge-offs and nonaccrual loans; changes in loan mix; credit score migration comparisons; asset quality trends; risk management and loan administration; changes in the internal lending policies and credit
standards; collection practices; and examination results from bank regulatory agencies and the 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 above
specified thresholds 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 credit impairment at acquisition. Reductions to
the carrying value of the acquired loans as a result of credit impairment are 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 increase
by approximately $190 million at December 31, 2008. 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 increase by 10%, the
allowance for residential and consumer loans would increase by approximately $100 million at December 31, 2008. 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 estimated loss rates and
do not imply any expectation of future deterioration in the risk ratings or loss rates. Given current processes employed by the Bancorp, management believes the risk grades and estimated loss rates currently assigned are appropriate.
The Bancorps primary market areas for lending are the Midwestern and Southeastern regions of the United States. When evaluating
the adequacy of allowances, consideration is given to these regional geographic concentrations and the closely associated effect changing economic conditions have on the Bancorps customers.
Reserve for Unfunded Commitments
The reserve for unfunded commitments is maintained at a level believed by management to be sufficient to absorb estimated probable losses related to unfunded credit facilities and is included in other liabilities in the Consolidated Balance
Sheets. The determination of the adequacy of the reserve is based upon an evaluation of the unfunded credit facilities, including an assessment of historical commitment utilization experience, credit risk grading and credit grade migration. Net
adjustments to the reserve for unfunded commitments are included in other noninterest expense in the Consolidated Statements of Income.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Income 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.
Deferred income tax assets and liabilities are determined using the balance sheet method and are reported in either other assets or
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. As described in greater detail in Note 16 of the Notes to Consolidated Financial Statements, the Internal Revenue Service (IRS) has challenged the Bancorps tax
treatment of certain leasing transactions. For additional information on income taxes, see Note 22 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 obtains servicing rights. Servicing rights resulting from loan sales are initially recorded at fair value and subsequently amortized in proportion to, and over the period of,
estimated net servicing income. Servicing rights are assessed for impairment monthly, based on fair value, with temporary impairment recognized through a valuation allowance and permanent impairment recognized through a write-off of the servicing
asset and related valuation allowance. Key economic assumptions used in measuring any potential impairment of the servicing rights include the prepayment speeds of the underlying loans, the weighted-average life, the discount rate, 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 impairment
in the servicing portfolio. For purposes of measuring impairment, the servicing rights are stratified into classes based on the financial asset type and interest rates. Fees received for servicing loans owned by investors are based on a percentage
of the outstanding monthly principal balance of such loans and are included in noninterest income in the Consolidated Statements of Income as loan payments are received. Costs of servicing loans are charged to expense as incurred.
The
change in the fair value of mortgage servicing rights (MSRs) at December 31, 2008 due to immediate 10% and 20% adverse changes in the current prepayment assumptions would be approximately $33 million and $63 million, respectively, and due to
immediate 10% and 20% favorable changes in the current prepayment assumptions would be approximately $37 million and $78 million, respectively. The change in the fair value of the MSR portfolio at December 31, 2008 due to immediate 10% and 20%
adverse changes in the discount rate assumption would be approximately $15 million and $30 million, respectively, and due to immediate 10% and 20% favorable changes in the discount rate assumption would be approximately $16 million and $34 million,
respectively. The 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, changes 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 the change in fair value may not be linear. Also, the effect of a
variation in a particular assumption on the fair value of the servicing rights 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.
Fair Value Measurements
Effective January 1, 2008, the Bancorp adopted SFAS No. 157, Fair Value Measurements, which provides a framework for measuring fair value under accounting principles generally accepted in the United States of America.
SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 addresses the valuation
techniques used to measure fair value. These valuation techniques include the market approach, income approach and cost approach. The market approach uses prices or relevant information generated by market transactions involving identical or
comparable assets or liabilities. The income approach involves discounting future amounts to a single present amount and is based on current market expectations about those future amounts. The cost approach is based on the amount that currently
would be required to replace the service capacity of the asset.
SFAS No. 157 establishes a fair value hierarchy,
which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the
lowest priority to unobservable inputs (Level 3). A financial instruments categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the instruments fair value measurement. The three
levels within the fair value hierarchy are described as follows:
Level 1 - Quoted prices (unadjusted) in active
markets for identical assets or liabilities that the Bancorp has the ability to access at the measurement date.
Level
2 - Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include: quoted prices for similar assets or liabilities in active markets; quoted prices
for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by
correlation or other means.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Level 3 - Unobservable inputs for the asset or liability for which there is little, if any, market activity at the measurement date. Unobservable
inputs reflect the Bancorps own assumptions about what market participants would use to price the asset or liability. The inputs are developed based on the best information available in the circumstances, which might include the Bancorps
own financial data such as internally developed pricing models, discounted cash flow methodologies, as well as instruments for which the fair value determination requires significant management judgment.
The Bancorp measures financial assets and liabilities at fair value in accordance with SFAS No. 157. These measurements involve
various valuation techniques and models, which involve inputs that are observable, when available, and include the following significant financial instruments: available-for-sale and trading securities, residential mortgage loans held for sale and
certain derivatives. The following is a summary of valuation techniques utilized by the Bancorp for its significant financial assets and liabilities measured at fair value on a recurring basis.
Available-for-sale and trading securities
Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are
estimated using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. Such securities would generally be classified within Level 2 of the fair value hierarchy. In certain cases where there is limited
activity or an absence of observable market data around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. A significant portion of the Bancorps available-for-sale securities are agency
mortgage-backed securities that are fair valued using a market approach and the Bancorp has determined them to be Level 2 in the fair value hierarchy. A significant portion of the Bancorps trading securities are variable rate demand notes
(VRDNs), that are fair valued using a market approach, and the Bancorp has determined them to be Level 2 in the fair value hierarchy.
Residential mortgage loans held for sale
For residential mortgage loans held for sale, fair value is
estimated based upon mortgage backed securities prices and spreads to those prices. Residential mortgage loans held for sale are fair valued using a market approach and the Bancorp has determined them to be Level 2 in the fair value hierarchy.
Derivatives
Exchange-traded derivatives valued using quoted prices are classified within Level 1 of the valuation hierarchy. However, few classes of derivative contracts are listed on an exchange. Most derivative contracts are measured using discounted
cash flow or other models that incorporate current market interest rates, credit spreads assigned to the derivative counterparties and other market parameters. Derivative positions that are valued utilizing models that use as their basis readily
observable market parameters are classified within Level 2 of the valuation hierarchy. Derivatives that are valued based upon models with significant unobservable market parameters are classified within Level 3 of the valuation hierarchy. A majority
of the derivatives are fair valued using an income approach and the Bancorp has
determined them to be Level 2 in the fair value hierarchy.
Valuation techniques and parameters used for measuring financial assets and liabilities are reviewed and validated by the Bancorp on a quarterly basis. Additionally, the Bancorp monitors the fair values of significant
assets and liabilities using a variety of methods including the evaluation of pricing runs and exception reports based on certain analytical criteria, comparison to previous trades and overall review and assessments for reasonableness.
In addition to the financial assets and liabilities measured at fair value on a recurring basis, the Bancorp measures servicing
rights and certain loans at fair value on a nonrecurring basis. Refer to Note 25 of the Notes to Consolidated Financial Statements for further information.
Goodwill
Business combinations entered into by the Bancorp typically include the acquisition
of goodwill. SFAS No. 142, Goodwill and Other Intangible Assets requires goodwill to be reported at and tested for impairment at the Bancorps reporting unit level on an annual basis and more frequently in certain
circumstances. These circumstances include significant declines in the Bancorps stock price that result in a market capitalization below book value. The Bancorp has determined that its segments qualify as reporting units under the guidance of
SFAS No. 142. Impairment exists when a reporting units carrying amount of goodwill exceeds its implied fair value, which is determined through a two-step impairment test. The first step (Step 1) compares the fair value of a reporting unit
with its carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds its fair value, the second step (Step 2) of the goodwill impairment test is performed to measure the impairment loss amount, if any.
The fair value of a reporting unit is the price that would be received to sell the unit as a whole in an orderly transaction between
market participants at the measurement date. To determine the fair value of a reporting unit, the Bancorp employs an income-based approach, utilizing the reporting units forecasted cash flows (including a terminal value approach to estimate
cash flows beyond the final year of the forecast) and the reporting units estimated cost of equity as the discount rate. Additionally, the Bancorp determines its market capitalization based on the average of the closing price of the
Bancorps stock during the month including the measurement date, incorporating an additional control premium, and allocates this market-based fair value measurement to the Bancorps reporting units in order to corroborate the results of
the income approach.
When required to perform Step 2, the Bancorp compares the implied fair value of a reporting
units goodwill with the carrying amount of that goodwill. If the carrying amount exceeds the implied fair value, an impairment loss equal to that excess amount is recognized, not to exceed the goodwill carrying amount. Consistent with SFAS
No. 142, during Step 2, the Bancorp determines the implied fair value of goodwill for a reporting unit by assigning the fair value of the reporting unit to all of the assets and liabilities of that unit (including any unrecognized intangible
assets) as if the reporting unit had been acquired in a business combination. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. This assignment process
is only performed for purposes of testing goodwill for impairment. The Bancorp does not adjust the carrying values of recognized assets or liabilities (other than goodwill, if appropriate), nor recognize previously unrecognized intangible assets in
the Consolidated Financial Statements as a result of this assignment process. Refer to Note 8 of the Notes to Consolidated Financial Statements for further information regarding the Bancorps goodwill.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RISK FACTORS
Weakness in the economy and in the real estate market, including specific weakness within Fifth Thirds geographic footprint, has adversely
affected Fifth Third and may continue to adversely affect Fifth Third.
If the strength of the U.S. economy in general and the
strength of the local economies in which Fifth Third conducts operations continues to decline, this could result in, among other things, a deterioration in credit quality or a reduced demand for credit, including a resultant effect on Fifth
Thirds loan portfolio and allowance for loan and lease losses. A significant portion of Fifth Thirds residential mortgage and commercial real estate loan portfolios are comprised of borrowers in Michigan, Northern Ohio and Florida, which
markets have been particularly adversely affected by job losses, declines in real estate value, declines in home sale volumes, and declines in new home building. These factors could result in higher delinquencies and greater charge-offs in future
periods, which would materially adversely affect Fifth Thirds financial condition and results of operations.
Deteriorating
credit quality, particularly in real estate loans, has adversely impacted Fifth Third and may continue to adversely impact Fifth Third.
Fifth Third has experienced a downturn in credit performance and expects credit conditions and the performance of its loan portfolio to continue to deteriorate in the near term. This caused Fifth Third to increase its allowance for loan and
lease losses, driven primarily by higher allocations related to residential mortgage and home equity loans, commercial real estate loans and loans of entities related to or dependant upon the real estate industry. If the performance of Fifth
Thirds loan portfolio does not improve or stabilize, additional increases in the allowance for loan and lease losses may be necessary in the future. Accordingly, a decrease in the quality of Fifth Thirds credit portfolio could have a
material adverse effect on earnings and results of operations.
Fifth Thirds results depend on general economic conditions
within its operating markets.
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 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 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.
Fifth Thirds ability to maintain required capital levels and adequate sources of funding and liquidity.
Fifth
Third is required to maintain certain capital levels in accordance with banking regulations. Fifth Third must also maintain adequate funding sources in the normal course of business to support its operations and fund outstanding liabilities. Fifth
Thirds ability to maintain capital levels, sources of funding and liquidity could be impacted by changes in the capital markets in which it operates. Additionally, if Fifth Third sought additional sources of capital, liquidity or funding,
those additional sources could dilute current shareholders ownership interests.
Each of Fifth Thirds
subsidiary banks must remain well-capitalized for Fifth Third to retain its status as a financial holding company. In addition, failure by Fifth Thirds bank subsidiaries to meet applicable capital guidelines could subject the bank to a variety
of enforcement remedies available to the federal regulatory authorities. These include limitations on the ability to pay dividends, the issuance by the regulatory authority of a capital directive to increase capital, and the termination of deposit
insurance by the FDIC.
As a regulated entity, Fifth Third must maintain certain capital requirements that may limit its operations and potential
growth.
Fifth Third is a bank holding company and a financial holding company. As such, Fifth Third is subject to the
comprehensive, consolidated supervision and regulation of the Board of Governors of the Federal Reserve System, including risk-based and leverage capital requirements. Fifth Third must maintain certain risk-based and leverage capital ratios as
required by its banking regulators and which can change depending upon general economic conditions and Fifth Thirds particular condition, risk profile and growth plans. Compliance with the capital requirements, including leverage ratios, may
limit operations that require the intensive use of capital and could adversely affect Fifth Thirds ability to expand or maintain present business levels.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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.
Problems encountered by financial institutions larger or similar to Fifth Third could adversely affect financial markets generally and have indirect adverse effects
on Fifth Third.
The commercial soundness of many financial institutions may be closely interrelated as a result of credit, trading,
clearing or other relationships between the institutions. As a result, concerns about, or a default or threatened default by, one institution could lead to significant market-wide liquidity and credit problems, losses or defaults by other
institutions. This is sometimes referred to as systemic risk and may adversely affect financial intermediaries, such as clearing agencies, clearing houses, banks, securities firms and exchanges, with which the Bancorp interacts on a
daily basis, and therefore could adversely affect Fifth Third.
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.
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 uncertainty of estimates involved, Fifth Third may have to significantly increase the allowance
for loan and lease losses and/or sustain credit losses that are significantly higher than the provided allowance and could recognize a significant provision for impairment of its mortgage servicing rights. If Fifth Thirds allowance for loan
and lease losses is not adequate, Fifth Thirds business, financial condition, including its liquidity and capital, and results of operations could be materially adversely
affected. For more information on the sensitivity of these estimates, please refer to the Critical Accounting Policies section.
Fifth Third regularly reviews its litigation reserves for adequacy considering its litigation risks and probability of incurring losses
related to litigation. However, Fifth Third cannot be certain that its current litigation reserves will be adequate over time to cover its losses in litigation due to higher than anticipated settlement costs, prolonged litigation, adverse judgments,
or other factors that are largely outside of Fifth Thirds control. If Fifth Thirds litigation reserves are not adequate, Fifth Thirds business, financial condition, including its liquidity and capital, and results of operations
could be materially adversely affected. Additionally, in the future, Fifth Third may increase its litigation reserves, which could have a material adverse effect on its capital and results of operations.
Changes in accounting standards could impact Fifth Thirds reported earnings and financial condition.
The accounting standard setters, including FASB, U.S. Securities and Exchange Commission (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 cases, 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.
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 Thirds business, financial condition and results of operations are highly regulated and could be adversely affected by new or changed regulations and by
the manner in which such regulations are applied by regulatory authorities.
Current economic conditions, particularly in the
financial markets, have resulted in government regulatory agencies placing increased focus on and scrutiny of the financial services industry. The U.S. Government has intervened on an unprecedented scale, responding to what has been commonly
referred to as the financial crisis. In addition to participating in the U.S. Treasurys CPP, the U.S. Government has taken steps that include enhancing the liquidity support available to financial institutions, establishing a commercial paper
funding facility, temporarily guaranteeing money market funds and certain types of debt issuances, and increasing insured deposits. These programs subject Fifth Third and other financial institutions who have participated in these programs to
additional restrictions, oversight and/or costs that
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
may have an impact on Fifth Thirds business, financial condition, results of operations or the price of its common stock.
New proposals for legislation continue to be introduced in the U.S. Congress that could further substantially increase regulation of the
financial services industry. Federal and state regulatory agencies also frequently adopt changes to their regulations and/or change the manner in which existing regulations are applied. Fifth Third cannot predict whether any pending or future
legislation will be adopted or the substance and impact of any such new legislation on Fifth Third. Additional regulation could affect Fifth Third in a substantial way and could have an adverse effect on its business, financial condition and results
of operations.
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 could 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:
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Actual or anticipated variations in earnings; |
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Fifth Thirds announcements of developments related to its businesses; |
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New technology used or services offered by traditional and non-traditional competitors; and |
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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.
The financial services industry is highly competitive and creates competitive pressures that could adversely affect Fifth Thirds revenue and profitability.
The financial services industry in which Fifth Third operates is highly competitive. Fifth Third competes not only with commercial
banks, but also with insurance companies, mutual funds, hedge funds, and other companies offering financial services in the U.S., globally and over the internet. Fifth Third
competes on the basis of several factors, including capital, access to capital, products, services, transaction execution, innovation, reputation and price.
Over time, certain sectors of the financial services industry have become more concentrated, as institutions involved in a broad range of financial services have been acquired by or merged into other firms. In fiscal 2008, this trend accelerated
considerably, as several major U.S. financial institutions consolidated, were forced to merge, received substantial government assistance or were placed into conservatorship by the U.S. Government. These developments could result in Fifth
Thirds competitors gaining greater capital and other resources, such as a broader range of products and services and geographic diversity. Fifth Third may experience pricing pressures as a result of these factors and as some of its competitors
seek to increase market share by reducing prices.
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.
Pursuant to the standardized terms of the CPP described previously, among other things, Fifth Third has agreed to institute certain restrictions on the compensation of certain senior management positions, which could
have an adverse effect on Fifth Thirds ability to hire or retain the most qualified senior management. It is possible that the U.S. Treasury may, as it is permitted to do, impose further requirements on Fifth Third. If Fifth Third is unable to
attract and retain qualified employees, or do so at rates necessary to maintain its competitive position, or if compensation costs required to attract and retain employees become more expensive, Fifth Thirds performance, including its
competitive position, could be materially adversely affected.
If Fifth Third is unable to grow its deposits, it may be subject to
paying higher funding costs.
The total amount that Fifth Third pays for funding costs is dependent, in part, on Fifth Thirds
ability to grow its deposits. If Fifth Third is unable to sufficiently grow its deposits, it may be subject to paying higher funding costs. This could materially adversely affect Fifth Thirds earnings and results of operations.
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 typically
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.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Fifth Thirds ability to pay or increase dividends on its common stock or to repurchase its capital stock is restricted by the terms of the U.S.
Treasurys preferred stock investment in Fifth Third.
In December 2008, Fifth Third sold $3.4 billion of its Series F
Preferred Stock to the U.S. Treasury pursuant to the terms of the CPP. For so long as any preferred stock issued under the CPP remains outstanding, those terms prohibit Fifth Third from increasing dividends on its common stock, and from making
certain repurchases of equity securities, including its common stock, without the U.S. Treasurys consent until the third anniversary of the U.S. Treasurys investment or until the U.S. Treasury has transferred all of the preferred stock
it purchased under the CPP to third parties. Furthermore, as long as the preferred stock issued to the U.S. Treasury is outstanding, dividend payments and repurchases or redemptions relating to certain equity securities, including Fifth Thirds
common stock, are prohibited until all accrued and unpaid dividends are paid on such preferred stock, subject to certain limited exceptions.
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 stock to pay for those acquisitions, which would dilute current shareholders ownership interests. Acquisitions
also could require Fifth Third to use substantial cash or other liquid assets or to incur debt. In those events, Fifth Third 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 when integrating the operations of an acquired entity. Fifth Third may not be
able to fully achieve its strategic objectives and planned 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.
After completing an acquisition, Fifth Third may find certain items are not accounted for
properly in accordance with financial accounting and reporting standards. Fifth Third may also not realize the expected benefits of the acquisition due to lower financial results pertaining to the acquired entity. For example, Fifth Third could
experience higher charge offs than originally anticipated related to the acquired loan portfolio.
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.
Fifth Third may sell or consider selling one or more of its businesses. Should it determine to sell such a business, it may not be able to generate gains on sale or
related increase in shareholders equity commensurate with desirable levels. Moreover, if Fifth Third sold such businesses, the loss of income could have an adverse effect on its earnings and future growth.
Fifth Third owns several non-strategic businesses that are not significantly synergistic with its core financial services businesses. Fifth Third has,
from time to time, considered the sale of such businesses, which could supplement its capital by an estimated additional $1 billion or more. If it were to determine to sell such businesses, Fifth Third would be subject to market forces that may make
completion of a sale unsuccessful or may not be able to do so within a desirable time frame. If Fifth Third were to complete the sale of non-core businesses, it would suffer the loss of income from the sold businesses, and such loss of income could
have an adverse effect on its future earnings and growth.
Fifth Third is exposed to operational and reputational 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 third party 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.
Fifth Third and other financial institutions have been the subject of increased litigation which could result in legal liability and damage to its reputation.
Fifth Third and certain of its directors and officers have been named from time to time as defendants in various class actions and
other litigation relating to Fifth Thirds business and activities. Past, present and future litigation have included or could include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages.
Fifth Third is also involved from time to time in other reviews, investigations and proceedings (both formal and informal) by governmental and self-regulatory agencies regarding its business. These matters also could result in adverse judgments,
settlements, fines, penalties, injunctions or other relief. Like other large financial institutions and companies, Fifth Third is also subject to risk from potential employee misconduct, including non-compliance with policies and improper use or
disclosure of confidential information. Substantial legal liability or significant regulatory action against Fifth Third could materially adversely affect its business, financial condition or results of operations and/or cause significant
reputational harm to its business.
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 (includes transaction deposits and other time deposits) and
wholesale funding (includes certificates $100,000 and over, other deposits, federal funds purchased, short-term borrowings and long-term debt). 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 typically greater than net interest rate spread due to the interest
income earned on those assets that are funded by non-interest-bearing liabilities, such as demand deposits, or shareholders equity.
Table 4 presents the components of net interest income, net interest margin and net interest spread for 2008, 2007 and 2006. 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.
During 2008, a number of market forces impacted net interest
income. The decreasing rate environment, spurred by the Federal Reserve monetary policies throughout the year, initially allowed deposits to reprice further than loans due to increased credit spreads on new originations. This effect was muted during
the second half of 2008 as disruptions in the credit markets created a highly competitive deposit rate environment. Loan yields came under further downward pressure due to the increased levels of nonperforming loans and leases. Other adjustments
included the accretion of discounts on acquired loans, primarily as a result of the second quarter 2008 acquisition of First Charter, which increased net interest income by $339 million during 2008. The purchase accounting accretion reflects the
high discount rate in the market at the time of the acquisition; the total loan discounts are being accreted into net interest income over the remaining period to maturity of the loans acquired. During the second quarter of 2008, the Bancorp
recognized a reduction of approximately $130 million to interest income on commercial leases as a result of the recalculation of cash flows on certain leveraged leases. More information on the leveraged lease adjustment can be found in Note 16 of
the Notes to Consolidated Financial Statements.
Overall, net interest income (FTE) was $3.5 billion for 2008, compared to
$3.0 billion earned in 2007. The increase in
net interest income compared to the prior year is the result of an 11% increase in average interest-earning assets combined with a 49 bp increase in net
interest spread that was partially reduced by the increase in nonperforming loans. In 2008, $282 million in additional interest income would have been recorded if nonaccrual loans had been current compared to $144 million in 2007. Exclusive of the
purchase accounting and leveraged lease adjustments, net interest income increased by $291 million, or 10%, over the prior year.
Reported net interest margin was 3.54% in 2008, compared to 3.36% in 2007. For the year, the negative effects of the leveraged lease adjustment, a reduction to net interest margin of 13 bp, and increase in nonperforming loans were offset by
the positive impact from the accretion of the discounts on acquired loans, which increased net interest margin approximately 34 bp in 2008. Exclusive of the purchase accounting and leveraged lease adjustments, net interest margin was flat on a
year-over-year basis as widening credit spreads were offset by higher nonaccrual loans and leases and a greater concentration in lower yielding commercial loans.
Total average interest-earning assets increased 11% from 2007. Average total commercial loans increased 19% and the investment portfolio increased 17%, while consumer loans decreased modestly.
Commercial mortgage and commercial construction loans increased primarily as a result of acquisitions during the past year. Commercial and industrial loans increased due to the origination for portfolio of loans that historically were sold to the
Bancorps off-balance sheet commercial paper conduit, coupled with the use of contingent liquidity facilities related to certain off-balance sheet programs that were drawn upon in 2008. These commercial loans have the effect of lowering the
overall yield on commercial loans. Increases in the investment portfolio relate to both the Bancorps desire to keep an appropriately sized investment portfolio given the growth in loans and leases, which occurred primarily from acquisitions,
coupled with the purchase of securities as part of the Bancorps non-qualifying hedging strategy related to mortgage servicing rights.
Interest income (FTE) from loans and leases decreased $481 million compared to 2007. Exclusive of the accretion of discounts on acquired loans and the leveraged lease adjustment during the second quarter of 2008,
interest income (FTE) from loans and leases decreased $694 million, or 13%, compared to the prior year. The year-over-year decrease in interest income is a result of the repricing of variable rate loans in a declining rate environment, partially
offset by the increase in average loan and lease balances. At the end of 2008, the Bancorps prime rate was 3.25% compared to 7.25% at the end of 2007. Interest income (FTE) from investment securities and short-term investments
TABLE 3: CONDENSED CONSOLIDATED STATEMENTS OF INCOME
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions, except per share
data) |
|
2008 |
|
2007 |
|
2006 |
|
2005 |
|
2004 |
Interest income (FTE) |
|
$5,630 |
|
6,051 |
|
5,981 |
|
5,026 |
|
4,150 |
Interest expense |
|
2,094 |
|
3,018 |
|
3,082 |
|
2,030 |
|
1,102 |
Net interest income (FTE) |
|
3,536 |
|
3,033 |
|
2,899 |
|
2,996 |
|
3,048 |
Provision for loan and lease losses |
|
4,560 |
|
628 |
|
343 |
|
330 |
|
268 |
Net interest income (loss) after provision for loan and lease losses (FTE) |
|
(1,024) |
|
2,405 |
|
2,556 |
|
2,666 |
|
2,780 |
Noninterest income |
|
2,946 |
|
2,467 |
|
2,012 |
|
2,374 |
|
2,355 |
Noninterest expense |
|
4,564 |
|
3,311 |
|
2,915 |
|
2,801 |
|
2,862 |
Income (loss) before income taxes and cumulative effect (FTE) |
|
(2,642) |
|
1,561 |
|
1,653 |
|
2,239 |
|
2,273 |
Fully taxable equivalent adjustment |
|
22 |
|
24 |
|
26 |
|
31 |
|
36 |
Applicable income taxes |
|
(551) |
|
461 |
|
443 |
|
659 |
|
712 |
Income (loss) before cumulative effect |
|
(2,113) |
|
1,076 |
|
1,184 |
|
1,549 |
|
1,525 |
Cumulative effect of change in accounting principle, net of tax |
|
- |
|
- |
|
4 |
|
- |
|
- |
Net income (loss) |
|
(2,113) |
|
1,076 |
|
1,188 |
|
1,549 |
|
1,525 |
Dividends on preferred stock |
|
67 |
|
1 |
|
- |
|
1 |
|
1 |
Net income (loss) available to common shareholders |
|
($2,180) |
|
1,075 |
|
1,188 |
|
1,548 |
|
1,524 |
Earnings per share, basic |
|
($3.94) |
|
2.00 |
|
2.14 |
|
2.79 |
|
2.72 |
Earnings per share, diluted |
|
(3.94) |
|
1.99 |
|
2.13 |
|
2.77 |
|
2.68 |
Cash dividends declared per common share |
|
0.75 |
|
1.70 |
|
1.58 |
|
1.46 |
|
1.31 |
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TABLE 4: CONSOLIDATED AVERAGE BALANCE SHEETS AND ANALYSIS OF NET INTEREST INCOME
(FTE) |
|
For the years ended December 31 |
|
2008 |
|
|
2007 |
|
|
2006 |
|
($ 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 |
|
$28,426 |
|
$1,520 |
|
5.35 |
% |
|
$22,351 |
|
$1,639 |
|
7.33 |
% |
|
$20,504 |
|
$1,479 |
|
7.21 |
% |
Commercial mortgage |
|
12,776 |
|
866 |
|
6.78 |
|
|
11,078 |
|
801 |
|
7.23 |
|
|
9,797 |
|
700 |
|
7.15 |
|
Commercial construction |
|
5,846 |
|
342 |
|
5.85 |
|
|
5,661 |
|
421 |
|
7.44 |
|
|
6,015 |
|
460 |
|
7.64 |
|
Commercial leases |
|
3,680 |
|
18 |
|
0.49 |
|
|
3,683 |
|
158 |
|
4.29 |
|
|
3,730 |
|
185 |
|
4.97 |
|
Subtotal - commercial |
|
50,728 |
|
2,746 |
|
5.41 |
|
|
42,773 |
|
3,019 |
|
7.06 |
|
|
40,046 |
|
2,824 |
|
7.05 |
|
Residential mortgage |
|
10,993 |
|
705 |
|
6.41 |
|
|
10,489 |
|
642 |
|
6.13 |
|
|
9,574 |
|
568 |
|
5.94 |
|
Home equity |
|
12,269 |
|
701 |
|
5.71 |
|
|
11,887 |
|
897 |
|
7.54 |
|
|
12,070 |
|
900 |
|
7.45 |
|
Automobile loans |
|
8,925 |
|
566 |
|
6.34 |
|
|
10,704 |
|
674 |
|
6.30 |
|
|
9,570 |
|
552 |
|
5.77 |
|
Credit card |
|
1,708 |
|
167 |
|
9.77 |
|
|
1,276 |
|
133 |
|
10.39 |
|
|
838 |
|
99 |
|
11.84 |
|
Other consumer loans and leases |
|
1,212 |
|
64 |
|
5.28 |
|
|
1,219 |
|
65 |
|
5.36 |
|
|
1,395 |
|
68 |
|
4.87 |
|
Subtotal - consumer |
|
35,107 |
|
2,203 |
|
6.27 |
|
|
35,575 |
|
2,411 |
|
6.78 |
|
|
33,447 |
|
2,187 |
|
6.54 |
|
Total loans and leases |
|
85,835 |
|
4,949 |
|
5.77 |
|
|
78,348 |
|
5,430 |
|
6.93 |
|
|
73,493 |
|
5,011 |
|
6.82 |
|
Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable |
|
13,082 |
|
643 |
|
4.91 |
|
|
11,131 |
|
566 |
|
5.08 |
|
|
20,306 |
|
904 |
|
4.45 |
|
Exempt from income taxes (a) |
|
342 |
|
25 |
|
7.35 |
|
|
499 |
|
36 |
|
7.29 |
|
|
604 |
|
45 |
|
7.38 |
|
Other short-term investments |
|
621 |
|
13 |
|
2.15 |
|
|
404 |
|
19 |
|
4.80 |
|
|
396 |
|
21 |
|
5.27 |
|
Total interest-earning assets |
|
99,880 |
|
5,630 |
|
5.64 |
|
|
90,382 |
|
6,051 |
|
6.70 |
|
|
94,799 |
|
5,981 |
|
6.31 |
|
Cash and due from banks |
|
2,490 |
|
|
|
|
|
|
2,275 |
|
|
|
|
|
|
2,477 |
|
|
|
|
|
Other assets |
|
13,411 |
|
|
|
|
|
|
10,613 |
|
|
|
|
|
|
8,713 |
|
|
|
|
|
Allowance for loan and lease losses |
|
(1,485) |
|
|
|
|
|
|
(793) |
|
|
|
|
|
|
(751) |
|
|
|
|
|
Total assets |
|
$114,296 |
|
|
|
|
|
|
$102,477 |
|
|
|
|
|
|
$105,238 |
|
|
|
|
|
Liabilities and Shareholders Equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing core deposits: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest checking |
|
$14,095 |
|
$126 |
|
0.89 |
% |
|
$14,820 |
|
$318 |
|
2.14 |
% |
|
$16,650 |
|
$398 |
|
2.39 |
% |
Savings |
|
16,192 |
|
224 |
|
1.38 |
|
|
14,836 |
|
456 |
|
3.07 |
|
|
12,189 |
|
363 |
|
2.98 |
|
Money market |
|
6,127 |
|
118 |
|
1.92 |
|
|
6,308 |
|
269 |
|
4.26 |
|
|
6,366 |
|
261 |
|
4.10 |
|
Foreign office deposits |
|
2,153 |
|
34 |
|
1.60 |
|
|
1,762 |
|
73 |
|
4.15 |
|
|
732 |
|
29 |
|
3.93 |
|
Other time deposits |
|
11,135 |
|
411 |
|
3.69 |
|
|
10,778 |
|
495 |
|
4.59 |
|
|
10,500 |
|
433 |
|
4.12 |
|
Total interest-bearing core deposits |
|
49,702 |
|
913 |
|
1.84 |
|
|
48,504 |
|
1,611 |
|
3.32 |
|
|
46,437 |
|
1,484 |
|
3.20 |
|
Certificates - $100,000 and over |
|
9,531 |
|
324 |
|
3.40 |
|
|
6,466 |
|
328 |
|
5.07 |
|
|
5,795 |
|
278 |
|
4.80 |
|
Other foreign office deposits |
|
2,163 |
|
52 |
|
2.42 |
|
|
1,393 |
|
68 |
|
4.91 |
|
|
2,979 |
|
148 |
|
4.97 |
|
Federal funds purchased |
|
2,975 |
|
70 |
|
2.34 |
|
|
3,646 |
|
184 |
|
5.04 |
|
|
4,148 |
|
208 |
|
5.02 |
|
Other short-term borrowings |
|
7,785 |
|
178 |
|
2.29 |
|
|
3,244 |
|
140 |
|
4.32 |
|
|
4,522 |
|
194 |
|
4.28 |
|
Long-term debt |
|
13,903 |
|
557 |
|
4.01 |
|
|
12,505 |
|
687 |
|
5.50 |
|
|
14,247 |
|
770 |
|
5.40 |
|
Total interest-bearing liabilities |
|
86,059 |
|
2,094 |
|
2.43 |
|
|
75,758 |
|
3,018 |
|
3.98 |
|
|
78,128 |
|
3,082 |
|
3.94 |
|
Demand deposits |
|
14,017 |
|
|
|
|
|
|
13,261 |
|
|
|
|
|
|
13,741 |
|
|
|
|
|
Other liabilities |
|
4,182 |
|
|
|
|
|
|
3,875 |
|
|
|
|
|
|
3,558 |
|
|
|
|
|
Total liabilities |
|
104,258 |
|
|
|
|
|
|
92,894 |
|
|
|
|
|
|
95,427 |
|
|
|
|
|
Shareholders equity |
|
10,038 |
|
|
|
|
|
|
9,583 |
|
|
|
|
|
|
9,811 |
|
|
|
|
|
Total liabilities and shareholders equity |
|
$114,296 |
|
|
|
|
|
|
$102,477 |
|
|
|
|
|
|
$105,238 |
|
|
|
|
|
Net interest income |
|
|
|
$3,536 |
|
|
|
|
|
|
$3,033 |
|
|
|
|
|
|
$2,899 |
|
|
|
Net interest margin |
|
|
|
|
|
3.54 |
% |
|
|
|
|
|
3.36 |
% |
|
|
|
|
|
3.06 |
% |
Net interest rate spread |
|
|
|
|
|
3.21 |
|
|
|
|
|
|
2.72 |
|
|
|
|
|
|
2.37 |
|
Interest-bearing liabilities to interest-earning assets |
|
|
|
|
|
86.16 |
|
|
|
|
|
|
83.82 |
|
|
|
|
|
|
82.41 |
|
(a) |
The fully taxable-equivalent adjustments included in the above table are $22 million, $24 million and $26 million for the years ended December 31, 2008, 2007 and 2006,
respectively. |
increased 10% compared to 2007. The increase in interest income from investment securities was a result of the 17% increase in the average investment portfolio offset by a decrease in the weighted-average yield.
Core deposits increased $2.0 billion, or three percent, compared to last year. The cost of interest-bearing core deposits
was 1.84% in 2008, which was a decrease of 148 bp from 3.32% in 2007. The year-over-year decrease is a result of the decrease in short-term market interest rates as, over the past year, the federal funds target rate decreased 400 bp to a target of
0.25% at December 31, 2008 compared to 4.25% at December 31, 2007. Partially offsetting the decrease in the market rates was the highly competitive rate environment for core deposits, which was created by disruptions in the credit markets.
Some relief from the highly competitive deposit pricing was experienced at the end of the fourth quarter as a number of bank consolidations were completed. The relief in competitive deposit pricing is expected to be somewhat muted in 2009, as
customers began moving balances into higher yielding time deposits
during the fourth quarter of 2008. Interest expense on wholesale funding decreased 16% compared to the prior year, despite a 33% increase in average
balances. Overall, the growth in average loans and leases since 2007 outpaced core deposit growth by $5.5 billion. In 2008, wholesale funding represented 42% of interest-bearing liabilities, up from 36% in 2007. The Bancorp issued $750 million of
senior notes in April 2008 and $400 million of trust preferred securities in May 2008. The Bancorps equity funding position increased approximately $500 million compared to 2007 from the issuance of $1.1 billion in preferred shares during the
second quarter of 2008. Additionally, on December 31, 2008 the Bancorp sold $3.4 billion of senior preferred shares and related warrants to the U.S. Treasury under its CPP. For more information on the Bancorps interest rate risk
management, including estimated earnings sensitivity to changes in market interest rates, see the Market Risk Management section of Managements Discussion and Analysis of Financial Condition and Results of Operations.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
|
|
|
|
|
|
|
|
|
|
|
|
TABLE 5: CHANGES IN NET INTEREST INCOME (FTE) ATTRIBUTED TO VOLUME AND YIELD/RATE (a) |
For the years ended December 31 |
|
2008 Compared to 2007 |
|
2007 Compared to 2006 |
($ in millions) |
|
Volume |
|
Yield/Rate |
|
Total |
|
Volume |
|
Yield/Rate |
|
Total |
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
Increase (decrease) in interest income: |
|
|
|
|
|
|
|
|
|
|
|
|
Loans and leases: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
$385 |
|
(504) |
|
(119) |
|
$135 |
|
25 |
|
160 |
Commercial mortgage |
|
117 |
|
(52) |
|
65 |
|
93 |
|
8 |
|
101 |
Commercial construction |
|
13 |
|
(92) |
|
(79) |
|
(27) |
|
(12) |
|
(39) |
Commercial leases |
|
- |
|
(140) |
|
(140) |
|
(2) |
|
(25) |
|
(27) |
Subtotal - commercial |
|
515 |
|
(788) |
|
(273) |
|
199 |
|
(4) |
|
195 |
Residential mortgage |
|
32 |
|
31 |
|
63 |
|
56 |
|
18 |
|
74 |
Home equity |
|
28 |
|
(224) |
|
(196) |
|
(14) |
|
11 |
|
(3) |
Automobile loans |
|
(113) |
|
5 |
|
(108) |
|
68 |
|
54 |
|
122 |
Credit card |
|
42 |
|
(8) |
|
34 |
|
47 |
|
(13) |
|
34 |
Other consumer loans and leases |
|
- |
|
(1) |
|
(1) |
|
(9) |
|
6 |
|
(3) |
Subtotal - consumer |
|
(11) |
|
(197) |
|
(208) |
|
148 |
|
76 |
|
224 |
Total loans and leases |
|
504 |
|
(985) |
|
(481) |
|
347 |
|
72 |
|
419 |
Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
Taxable |
|
96 |
|
(19) |
|
77 |
|
(452) |
|
114 |
|
(338) |
Exempt from income taxes |
|
(11) |
|
- |
|
(11) |
|
(8) |
|
(1) |
|
(9) |
Other short-term investments |
|
8 |
|
(14) |
|
(6) |
|
(1) |
|
(1) |
|
(2) |
Total interest-earning assets |
|
597 |
|
(1,018) |
|
(421) |
|
(114) |
|
184 |
|
70 |
Cash and due from banks |
|
|
|
|
|
|
|
|
|
|
|
|
Other assets |
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan and lease losses |
|
|
|
|
|
|
|
|
|
|
|
|
Total change in interest income |
|
$597 |
|
(1,018) |
|
(421) |
|
$(114) |
|
184 |
|
70 |
Liabilities and Shareholders Equity |
|
|
|
|
|
|
|
|
|
|
|
|
Increase (decrease) in interest expense: |
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing core deposits: |
|
|
|
|
|
|
|
|
|
|
|
|
Interest checking |
|
$(15) |
|
(177) |
|
(192) |
|
$(41) |
|
(39) |
|
(80) |
Savings |
|
39 |
|
(271) |
|
(232) |
|
81 |
|
12 |
|
93 |
Money market |
|
(7) |
|
(144) |
|
(151) |
|
(2) |
|
10 |
|
8 |
Foreign office deposits |
|
13 |
|
(52) |
|
(39) |
|
43 |
|
1 |
|
44 |
Other time deposits |
|
16 |
|
(100) |
|
(84) |
|
12 |
|
50 |
|
62 |
Total interest-bearing core deposits |
|
46 |
|
(744) |
|
(698) |
|
93 |
|
34 |
|
127 |
Certificates - $100,000 and over |
|
125 |
|
(129) |
|
(4) |
|
34 |
|
16 |
|
50 |
Other foreign office deposits |
|
28 |
|
(44) |
|
(16) |
|
(78) |
|
(2) |
|
(80) |
Federal funds purchased |
|
(29) |
|
(85) |
|
(114) |
|
(25) |
|
1 |
|
(24) |
Other short-term borrowings |
|
127 |
|
(89) |
|
38 |
|
(55) |
|
1 |
|
(54) |
Long-term debt |
|
71 |
|
(201) |
|
(130) |
|
(97) |
|
14 |
|
(83) |
Total interest-bearing liabilities |
|
368 |
|
(1,292) |
|
(924) |
|
(128) |
|
64 |
|
(64) |
Demand deposits |
|
|
|
|
|
|
|
|
|
|
|
|
Other liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
Total change in interest expense |
|
368 |
|
(1,292) |
|
(924) |
|
(128) |
|
64 |
|
(64) |
Shareholders equity |
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity |
|
|
|
|
|
|
|
|
|
|
|
|
Total change in net interest income |
|
$229 |
|
274 |
|
503 |
|
$14 |
|
120 |
|
134 |
(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 and lease portfolio
that is based on factors previously 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 to cover losses inherent in the
portfolio. 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 on previously charged-off loans and leases.
The provision for loan and lease losses
increased to $4.6 billion in 2008 compared to $628 million in 2007. The primary factors in the increase were the increase in impaired commercial loans which are individually reviewed and reserved for, higher losses, increased estimated loss factors
due to negative trends in overall delinquencies, increased loss estimates once a loan becomes delinquent related to the deterioration in real estate collateral values in certain of the Bancorps key lending markets and declines in general
economic conditions that are used
to determine an economic factor adjustment. As of December 31, 2008, the allowance for loan and lease losses as a percent of loans and leases increased
to 3.31% from 1.17% at December 31, 2007.
Refer to the Credit Risk Management section for more detailed information
on the provision for loan and lease losses including an analysis of the loan portfolio composition, non-performing assets, 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
For the year ended December 31, 2008, noninterest income increased by $479 million, or 19%, on a year-over-year basis. The components of noninterest income are shown in Table 6.
Electronic payment processing revenue increased $86 million, or 11%, in 2008 compared to the 2007 as the Bancorp continued to realize
growth in each of its three main product lines. The components of electronic payment processing revenue are shown in Table 7.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 6: NONINTEREST INCOME
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2008 |
|
2007 |
|
2006 |
|
2005 |
|
2004 |
Electronic payment processing revenue |
|
$912 |
|
826 |
|
717 |
|
622 |
|
521 |
Service charges on deposits |
|
641 |
|
579 |
|
517 |
|
522 |
|
515 |
Corporate banking revenue |
|
444 |
|
367 |
|
318 |
|
299 |
|
228 |
Investment advisory revenue |
|
353 |
|
382 |
|
367 |
|
358 |
|
363 |
Mortgage banking net revenue |
|
199 |
|
133 |
|
155 |
|
174 |
|
178 |
Other noninterest income |
|
363 |
|
153 |
|
299 |
|
360 |
|
587 |
Securities gains (losses), net |
|
(86) |
|
21 |
|
(364) |
|
39 |
|
(37) |
Securities gains, net non-qualifying hedges on mortgage servicing rights |
|
120 |
|
6 |
|
3 |
|
- |
|
- |
Total noninterest income |
|
$2,946 |
|
2,467 |
|
2,012 |
|
2,374 |
|
2,355 |
Merchant processing revenue increased 11%, to $341 million, compared to 2007 as the growth in the number of merchants and transaction
volumes compared to 2007 was partially offset by lower average dollar amounts per transaction due to lower consumer spending in the fourth quarter of 2008. Financial institutions revenue increased to $324 million, up seven percent, compared to 2007
due to higher transaction volumes as a result of continued success in attracting financial institution customers. Card issuer interchange increased 16%, to $247 million, compared to 2007 due to continued growth related to debit and credit card
usage. The Bancorp processed approximately 28.4 billion transactions during 2008 compared to approximately 26.7 billion transactions during 2007 and handles electronic processing for over 169,000 merchant locations worldwide.
TABLE 7: COMPONENTS OF ELECTRONIC PAYMENT PROCESSING REVENUE
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2008 |
|
2007 |
|
2006 |
Merchant processing revenue |
|
$341 |
|
308 |
|
255 |
Financial institutions revenue |
|
324 |
|
305 |
|
279 |
Card issuer interchange |
|
247 |
|
213 |
|
183 |
Electronic payment processing revenue |
|
$912 |
|
826 |
|
717 |
Service charges on deposits increased to $641 million, up $62 million, or 11%, in
2008 compared to 2007. Commercial deposit revenue, net of earnings credits, increased $44 million, or 18%, compared to 2007. Gross commercial deposit revenue grew six percent, to $534 million, compared to 2007. The overall increase was primarily
impacted by a decrease in earnings credits of $35 million, or 54%, on compensating balances resulting from the decline in short-term interest rates. Commercial customers receive earnings credits to offset the fees charged for banking services on
their deposit accounts such as account maintenance, lockbox, ACH transactions, wire transfers and other ancillary corporate treasury management services. Earnings credits are based on the customers average balance in qualifying deposits
multiplied by the crediting rate. Qualifying deposits include demand deposits and interest-bearing checking accounts. The Bancorp has a standard crediting rate that is adjusted as necessary based on competitive market conditions and changes in
short-term interest rates. Retail deposit revenue increased five percent, to $348 million, in 2008 compared to 2007. The increase in retail service charges was attributable to higher customer activity. Deposit generation and growth in the number of
customer deposit account relationships continue to be a primary focus of the Bancorp.
Corporate banking revenue increased
$77 million, or 21%, in 2008 over 2007, and reflects benefits from the broadening of the Bancorps suite of commercial products. Foreign exchange derivative income of $106 million, increased $46 million compared to 2007 due to volume increases.
Growth also occurred in fees associated with business lending and asset securitizations, which grew $13 million and $12 million, respectively, compared to 2007. The Bancorp is committed to providing a comprehensive range of financial services to
large and middle-market businesses.
Investment advisory revenue decreased $29 million, or eight percent, from 2007 due to the significant decline in equity markets in 2008 as the Bancorp experienced broad-based decreases in several categories. Brokerage
fee income, which includes Fifth Third Securities income, decreased 11%, or $12 million, in 2008 as investors migrated balances from stock and bond funds to money markets funds due to market volatility. Mutual fund revenue decreased 12%, to $53
million, in 2008 due to a shift to lower yielding investments and lower asset values. As of December 31, 2008, the Bancorp had approximately $179 billion in assets under care and managed $25 billion in assets for individuals, corporations and
not-for-profit organizations.
Mortgage banking net revenue increased to $199 million in 2008 from $133 million in 2007.
The components of mortgage banking net revenue for the year ended December 31, 2008 and 2007 are shown in Table 8.
TABLE 8: COMPONENTS OF MORTGAGE BANKING NET REVENUE
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2008 |
|
2007 |
|
2006 |
Origination fees and gains on loan sales |
|
$260 |
|
79 |
|
92 |
Servicing revenue: |
|
|
|
|
|
|
Servicing fees |
|
164 |
|
145 |
|
121 |
Servicing rights amortization |
|
(107) |
|
(92) |
|
(68) |
Net valuation adjustments on servicing rights and free-standing derivatives entered into to
economically hedge MSR |
|
(118) |
|
1 |
|
10 |
Net servicing revenue (expense) |
|
(61) |
|
54 |
|
63 |
Mortgage banking net revenue |
|
$199 |
|
133 |
|
155 |
Mortgage banking net revenue increased $66 million compared to 2007 due to higher
sales margins on loans sold, higher sales volume of portfolio loans, and the impact of the adoption of SFAS No. 159 for residential mortgage loans held for sale, offset by lower net valuation adjustments. Mortgage originations decreased three
percent, from $11.9 billion to $11.5 billion, in comparison to 2007 as application volumes decreased during the second half of 2008 as a result of market disruptions. Mortgage originations rebounded during the fourth quarter of 2008 as a result of
the declining interest rate environment. The increase in sales margins on loans sold and sales volume of portfolio loans contributed $151 million and $13 million, respectively, to the increase in mortgage banking net revenue. The adoption of SFAS
No. 159 on January 1, 2008 for residential mortgage loans held for sale also contributed approximately $65 million to the increase in mortgage banking net revenue. Prior to adoption, mortgage loan origination costs were capitalized as part
of the carrying amount of the loan and recognized as a reduction of mortgage banking net revenue upon the sale of the loans. Subsequent to the adoption, mortgage loan origination costs are recognized as expense when incurred and included in
noninterest expense within the Consolidated Statements of Income.
Mortgage net servicing revenue decreased $115 million
compared to 2007. 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
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
adjustments on both settled and outstanding free-standing derivative financial instruments. Temporary impairment on servicing rights, partially offset by
gains on derivatives economically hedging the mortgage servicing rights (MSRs), resulted in lower mortgage net servicing revenue compared to 2007. The Bancorps total residential mortgage loans serviced at December 31, 2008 and 2007 was
$50.7 billion and $45.9 billion, respectively, with $40.4 billion and $34.5 billion, respectively, of residential mortgage loans serviced for others.
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 10 of the Notes to Consolidated Financial Statements. The Bancorp maintains a non-qualifying hedging strategy to
manage a portion of the risk associated with changes in impairment on the MSR portfolio. The Bancorp recognized a gain from MSR derivatives of $89 million, offset by a temporary impairment of $207 million, resulting in a net loss of $118 million for
the year ended December 31, 2008 related to changes in fair value and settlement of free-standing derivatives purchased to economically hedge the MSR portfolio. For the year ended December 31, 2007, the Bancorp recognized a gain from MSR
derivatives of $23 million, offset by a temporary impairment of $22 million, resulting in a net gain of $1 million. See Note 10 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 acquires various securities as a component of its non-qualifying hedging strategy. A gain on non-qualifying hedges on mortgage servicing
rights of $120 million and $6 million in 2008 and 2007, respectively, was included in noninterest income within the Consolidated Statements of Income, but are shown separate from mortgage banking net revenue.
Other noninterest income increased $210 million in 2008 compared to 2007. The components of other noninterest income are shown in Table
9. The increase was primarily due to a $273 million gain from the redemption of a portion of the Bancorps ownership interest in Visa, Inc. and a $76 million gain related to the satisfactory resolution of the CitFed litigation. This increase
was offset by higher losses from the sale of both other real estate owned properties and loans in addition to higher charges in 2008 to lower the current cash surrender value of one of the Bancorps BOLI policies. Charges related to one of the
Bancorps BOLI policies were $215 million and $177 million, respectively, for the years ended December 31, 2008 and December 31, 2007.
Net securities losses totaled $86 million in 2008 compared to $21 million of net securities gains during 2007. The net securities losses in 2008 include OTTI charges of $38 million and $29 million relating to FHLMC
and FNMA preferred stock, respectively, along with OTTI charges of $37 million related to certain bank trust preferred securities. The FHLMC and FNMA preferred stock, combined, are carried at approximately $1 million at December 31, 2008 with a
par value of $68 million. The bank trust preferred securities with OTTI charges had a carrying value of $79 million with a par value of $116 million at December 31, 2008.
TABLE 9: COMPONENTS OF
OTHER NONINTEREST INCOME
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2008 |
|
2007 |
|
2006 |
Gain on redemption of Visa, Inc. ownership interests |
|
$273 |
|
- |
|
- |
CitFed litigation settlement |
|
76 |
|
- |
|
- |
Cardholder fees |
|
58 |
|
56 |
|
49 |
Consumer loan and lease fees |
|
51 |
|
46 |
|
47 |
Operating lease income |
|
47 |
|
32 |
|
26 |
Insurance income |
|
36 |
|
32 |
|
28 |
Banking center income |
|
31 |
|
29 |
|
22 |
(Loss) gain on loan sales |
|
(11) |
|
25 |
|
17 |
Loss on sale of other real estate owned |
|
(60) |
|
(14) |
|
(8) |
Bank owned life insurance (loss) income |
|
(156) |
|
(106) |
|
86 |
Other |
|
18 |
|
53 |
|
32 |
Total other noninterest income |
|
$363 |
|
153 |
|
299 |
Noninterest Expense
Total noninterest expense increased $1.3 billion, or 38%, in 2008 compared to 2007. The components of noninterest expense are shown in Table 10. Noninterest expense in 2008 included a $965
million charge to record goodwill impairment, $99 million in net reductions to noninterest expense to reflect the recognition of the Bancorps proportional share of the Visa escrow account, partially offset by additional charges for probable
future Visa litigation settlements, $65 million in mortgage origination costs from the adoption of SFAS No. 159, $36 million in legal expenses related to the CitFed litigation and $20 million in acquisition related expenses. Noninterest expense
in 2007 included charges of $172 million related to the indemnification of estimated current and future Visa litigation settlements and $8 million in acquisition related costs. Excluding these items, noninterest expense increased $444 million, or
14%, due to increased volume-related processing expenses, higher FDIC insurance, increases in the credit component of fair value marks on counterparty derivatives, increased provision for unfunded commitments and higher loan processing costs. For
more information pertaining to the goodwill impairment charge, see Note 8 of the Notes to Consolidated Financial Statements.
Total personnel costs (salaries, wages and incentives plus employee benefits) increased 6% in 2008 compared to 2007 due primarily to approximately $65 million in mortgage origination costs that prior to the adoption of SFAS No. 159 on
January 1, 2008, were included as a component of mortgage banking net revenue. Total personnel expense in 2008 and 2007 included $9 million and $7 million, respectively, in severance related costs. Excluding these items, personnel expense
increased two percent compared to 2007. As of December 31, 2008, the Bancorp employed 22,423 employees, of which 6,678 were officers and 2,578 were part-time employees. Full-time equivalent employees totaled 21,476 as of December 31, 2008
compared to 21,683 as of December 31, 2007.
TABLE 10: NONINTEREST EXPENSE
|
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2008 |
|
|
2007 |
|
2006 |
|
2005 |
|
2004 |
Salaries, wages and incentives |
|
$1,337 |
|
|
1,239 |
|
1,174 |
|
1,133 |
|
1,018 |
Employee benefits |
|
278 |
|
|
278 |
|
292 |
|
283 |
|
261 |
Net occupancy expense |
|
300 |
|
|
269 |
|
245 |
|
221 |
|
185 |
Payment processing expense |
|
274 |
|
|
244 |
|
184 |
|
145 |
|
114 |
Technology and communications |
|
191 |
|
|
169 |
|
141 |
|
142 |
|
120 |
Equipment expense |
|
130 |
|
|
123 |
|
116 |
|
105 |
|
84 |
Goodwill impairment |
|
965 |
|
|
- |
|
- |
|
- |
|
- |
Other noninterest expense |
|
1,089 |
|
|
989 |
|
763 |
|
772 |
|
1,081 |
Total noninterest expense |
|
$4,564 |
|
|
3,311 |
|
2,915 |
|
2,801 |
|
2,863 |
Efficiency ratio |
|
70.4 |
% |
|
60.2 |
|
59.4 |
|
52.1 |
|
53.0 |
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net occupancy expenses increased $31 million, or 11%, in 2008 compared to 2007 due to the addition of 80 new banking centers. Growth in the number of banking
centers was primarily driven by acquisitions, which added 69 banking centers since 2007.
Payment processing expense,
which includes third-party processing expenses, card management fees and other bankcard processing, increased 12% in 2008 compared to 2007 due to higher network charges of $24 million from increased processing volumes for both the merchant and
financial institutions businesses.
Total other noninterest expense increased by $100 million, or 10%, in 2008 compared to
2007. The components of other noninterest expense are shown in Table 11. Loan processing expense was higher in comparison to 2007 as a result of increased collection activities. Increased professional service fees compared to 2007 resulted from
legal expenses of $36 million stemming from the CitFed litigation. FDIC insurance and other taxes were higher due to the depletion of the Bancorps prior FDIC insurance premium credits in 2008. The provision for unfunded commitments increased
$82 million compared to 2007 due to higher estimates of inherent losses resulting from deterioration in the credit quality of the underlying borrowers. The credit component of fair value marks on counterparty derivatives increased due to
deterioration in the credit quality of the Bancorps customers.
In December 2008, the FDIC approved a final rule on
deposit assessment rates for the first quarter of 2009. The rule raised assessment rates uniformly by 7 bp (annually) for the first quarter of 2009 only. The FDIC issued another final rule during the first quarter of 2009 changing the way the
FDICs assessment system differentiates for risk, makes corresponding changes to assessment rates beginning with the second quarter of 2009, and makes certain technical and other changes to the assessment rules. In addition, the FDIC issued an
interim rule that provides for a 20 bp special assessment on June 30, 2009. The increase in assessment rates effective January 1, 2009 will approximately double the Bancorps expected assessment for 2009s first quarter. The Bancorp
believes the assessment rates subsequent to the first quarter 2009 will be significantly higher than the first quarter of 2009. As a result, the Bancorp expects that increased FDIC insurance expense in 2009 will have an adverse impact on its results
of operations.
In addition to the standard deposit insurance assessments, as noted above, in the third quarter of 2008,
the FDIC announced the Temporary Liquidity Guarantee Program (TLGP), which temporarily guarantees the senior debt of participating FDIC- insured institutions and certain holding companies, as well as deposits in noninterest-bearing deposit
transaction accounts.
The Bancorp expects assessments related to the TLGP to have an adverse impact on its results of operations.
|
|
|
|
|
|
|
TABLE 11: COMPONENTS OF OTHER NONINTEREST EXPENSE |
For the years ended December 31
($ in millions) |
|
2008 |
|
2007 |
|
2006 |
Loan processing |
|
$188 |
|
119 |
|
93 |
Marketing |
|
102 |
|
84 |
|
78 |
Professional services fees |
|
102 |
|
54 |
|
41 |
Provision for unfunded commitments and letters of credit |
|
98 |
|
16 |
|
5 |
FDIC insurance and other taxes |
|
73 |
|
31 |
|
39 |
Affordable housing investments |
|
67 |
|
57 |
|
42 |
Intangible asset amortization |
|
56 |
|
42 |
|
45 |
Travel |
|
54 |
|
54 |
|
52 |
Postal and courier |
|
54 |
|
52 |
|
49 |
Recruitment and education |
|
33 |
|
41 |
|
51 |
Operating lease |
|
32 |
|
22 |
|
18 |
Supplies |
|
31 |
|
31 |
|
28 |
Visa litigation (accrual) settlement |
|
(99) |
|
172 |
|
- |
Debt termination |
|
- |
|
- |
|
49 |
Other |
|
298 |
|
214 |
|
173 |
Total other noninterest expense |
|
$1,089 |
|
989 |
|
763 |
The efficiency ratio (noninterest expense divided by the sum of net interest
income (FTE) and noninterest income) was 70.4% and 60.2% for 2008 and 2007, respectively. Excluding the goodwill impairment charge of $965 million in 2008, the efficiency ratio was 55.5% (comparison being provided to supplement an understanding of
fundamental trends). The Bancorp continues to focus on efficiency initiatives, as part of its core emphasis on operating leverage and on expense control.
Applicable Income Taxes
The Bancorps income (loss) before income taxes, applicable
income tax expense and effective tax rate for each of the periods indicated are shown in Table 12. 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. The effective tax rate for the year ended December 31, 2008 was primarily impacted by the pre-tax loss in 2008, partially offset by tax expense of approximately $140 million in
the second quarter of 2008 required for interest related to the tax treatment of certain of the Bancorps leveraged leases for previous tax years and the nondeductible portion of the charge of $965 million to record impairment of goodwill.
|
|
|
|
|
|
|
|
|
|
|
|
TABLE 12: APPLICABLE INCOME TAXES |
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2008 |
|
|
2007 |
|
2006 |
|
2005 |
|
2004 |
Income (loss) before income taxes and cumulative effect |
|
$(2,664) |
|
|
1,537 |
|
1,627 |
|
2,208 |
|
2,237 |
Applicable income tax expense (benefit) |
|
(551) |
|
|
461 |
|
443 |
|
659 |
|
712 |
Effective tax rate |
|
(20.7) |
% |
|
30.0 |
|
27.2 |
|
29.9 |
|
31.8 |
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, Processing Solutions and Investment Advisors. 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 accounting 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.
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 serving 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 London Interbank Offered Rate (LIBOR) swap curve. Matching duration 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 the 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 is captured in General Corporate and Other.
The business segments are charged provision expense based on the actual net charge-offs experienced by the loans owned by each segment. Provision expense attributable to loan growth and changes
in factors in the allowance for loan and lease losses are captured in General Corporate and Other. The financial results of the business segments include allocations for shared services and headquarters 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 (loss) available to common shareholders by business segment is summarized in Table 13.
|
|
|
|
|
|
|
TABLE 13: BUSINESS SEGMENT NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS |
For the years ended December 31 ($ in millions) |
|
2008 |
|
2007 |
|
2006 |
Income Statement Data |
|
|
|
|
|
|
Commercial Banking |
|
$(697) |
|
698 |
|
693 |
Branch Banking |
|
568 |
|
620 |
|
563 |
Consumer Lending |
|
(108) |
|
130 |
|
180 |
Processing Solutions |
|
182 |
|
163 |
|
139 |
Investment Advisors |
|
93 |
|
99 |
|
90 |
General Corporate and Other |
|
(2,151) |
|
(634) |
|
(477) |
Net income (loss) |
|
(2,113) |
|
1,076 |
|
1,188 |
Dividends on preferred stock |
|
67 |
|
1 |
|
- |
Net income (loss) available to common shareholders |
|
$(2,180) |
|
1,075 |
|
1,188 |
Commercial Banking
Commercial Banking offers banking, cash management and financial services to large and middle-market businesses, government and professional customers. In addition to the traditional lending and
depository offerings, Commercial
Banking products and services include, among others, foreign exchange and international trade finance, derivatives and capital markets services, asset-based
lending, real estate finance, public finance, commercial leasing and syndicated finance. Table 14 contains selected financial data for the Commercial Banking segment.
|
|
|
|
|
|
|
TABLE 14: COMMERCIAL BANKING |
For the years ended December 31
($ in millions) |
|
2008 |
|
2007 |
|
2006 |
Income Statement Data |
|
|
|
|
|
|
Net interest income (FTE) (a) |
|
$1,645 |
|
1,311 |
|
1,318 |
Provision for loan and lease losses |
|
1,864 |
|
127 |
|
99 |
Noninterest income: |
|
|
|
|
|
|
Electronic payment processing |
|
(2) |
|
(6) |
|
(5) |
Service charges on deposits |
|
186 |
|
154 |
|
146 |
Corporate banking revenue |
|
414 |
|
341 |
|
292 |
Investment advisory revenue |
|
5 |
|
3 |
|
3 |
Mortgage banking net revenue |
|
- |
|
- |
|
- |
Other noninterest income |
|
52 |
|
66 |
|
40 |
Securities gains (losses), net |
|
- |
|
- |
|
- |
Noninterest expense: |
|
|
|
|
|
|
Salaries, incentives and benefits |
|
299 |
|
264 |
|
245 |
Net occupancy expense |
|
17 |
|
15 |
|
14 |
Payment processing expense |
|
1 |
|
- |
|
- |
Technology and communications |
|
(2) |
|
4 |
|
- |
Equipment expense |
|
4 |
|
3 |
|
2 |
Goodwill impairment |
|
750 |
|
- |
|
- |
Other noninterest expense |
|
599 |
|
514 |
|
467 |
Income (loss) before taxes |
|
(1,232) |
|
942 |
|
967 |
Applicable income tax expense (benefit) |
|
(535) |
|
244 |
|
274 |
Net income (loss) |
|
$(697) |
|
698 |
|
693 |
Average Balance Sheet Data |
|
|
|
|
|
|
Commercial loans |
|
$43,213 |
|
35,666 |
|
32,714 |
Demand deposits |
|
6,208 |
|
5,930 |
|
6,300 |
Interest checking |
|
4,536 |
|
4,107 |
|
3,875 |
Savings and money market |
|
4,047 |
|
4,461 |
|
5,053 |
Certificates $100,000 and over & other time |
|
2,293 |
|
1,855 |
|
1,774 |
Foreign office deposits |
|
1,932 |
|
1,486 |
|
515 |
(a) |
Includes taxable equivalent adjustments of $15 million for 2008, $14 million for 2007 and $13 million for 2006. |
Comparison of 2008 with 2007
Commercial Banking incurred a net loss of $697 million compared to net income of $698 million in 2007 as solid growth in net interest income and corporate banking revenue was more than offset by increased provision for loan and lease losses
and impairment to goodwill. The impairment charge of $750 million was taken in the fourth quarter of 2008 due to the decline in the estimated fair value of the Commercial Banking segment below its carrying value and the determination that the
implied fair value of the goodwill was less than its carrying value. Net interest income increased $334 million, or 25%, compared to the same period last year. The accretion of purchase accounting adjustments, totaling $204 million, primarily
related to the second quarter acquisition of First Charter drove the increase in net interest income with the remainder attributed to the growth in loans, partially funded by an increase in deposits. Average commercial loans and leases increased
21%, to $43.1 billion, over 2007 due to increased loan production within the Bancorps footprint during 2008, acquisitions since 2007, and the purchase of assets from an unconsolidated Qualified Special Purpose Entity (QSPE) under a liquidity
asset purchase agreement with the Bancorp. See Note 10 of the Notes to Consolidated Financial Statements for further information on the unconsolidated QSPE. Excluding the impact of $1.0 billion from acquisitions and $243 million from the use of
contingent liquidity facilities, average commercial loans increased approximately 17% compared to 2007. Average core deposits increased four percent due to growth in interest checking and foreign office deposits.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net charge-offs as a percent of average loans and leases increased to 436 bp from 36 bp in 2007. Net charge-offs increased in comparison to 2007 due to weakening economies and the continuing deterioration of credit within the Bancorps
footprint, particularly in Michigan and Florida, involving commercial loans and commercial mortgage loans. Additionally, in the fourth quarter of 2008, the Bancorp sold or transferred to held-for-sale $1.3 billion in commercial loans and commercial
mortgage loans, resulting in $800 million in charge-offs on those loans, or 185 bp.
Noninterest income increased $97
million compared to 2007 due to corporate banking revenue growth of $73 million and increased service charges on deposits of $32 million, both up 21%. Corporate banking revenue increased as a result of growth in foreign exchange derivative income,
which increased $38 million, to $90 million, during 2008 and in business lending fees, which increased $16 million, or 26%, compared to 2007. The increase in service charges on deposits was a result of higher volume-related business service charges
(net of discounts) and a reduction in the amount of offsetting earnings credits as short-term rates were lower in 2008 than 2007.
Noninterest expense increased $868 million compared to 2007 primarily due to goodwill impairment of $750 million in 2008. The impairment charge was taken in the fourth quarter of 2008 due to the decline in the estimated fair value of the
Commercial Banking segment below its carrying value and the determination that the implied fair value of the goodwill was less than its carrying value. Also contributing to the growth in noninterest expense was sales incentives, which increased 22%
to $106 million compared to 2007 as a result of increased revenues, especially foreign exchange derivative income. Additionally, other noninterest expense increased due to growth in loan expenses of $33 million, to $65 million, during 2008 from
increased collection activities.
Comparison of 2007 with 2006
Net income increased $5 million compared to 2006 as a result of continued success in the sale of corporate banking services, offset by a higher provision for loan and lease losses and growth in
noninterest expense.
Net interest income was modestly lower in comparison to 2006 due to a 32 bp decline in the spread
between loan yields and the related FTP charge. Average loans and leases increased nine percent over 2006, to $35.7 billion, with growth concentrated in C&I loans and commercial mortgage loans. The increase in commercial mortgage loans can be
attributed to loans acquired from R-G Crown Bank (Crown) in November 2007 and to the conversion of construction loans to permanent financing throughout 2007. Average core deposits increased modestly to $15.9 billion in 2007 compared to 2006. Net
charge-offs as a percent of average loans increased from 31 bp in 2006 to 36 bp in 2007 as the segment experienced an increase in charge-offs of commercial mortgage loans in parts of its footprint, specifically eastern Michigan and northeastern
Ohio.
Noninterest income increased $82 million, or 17%, compared to 2006 largely due to an increase in corporate banking
revenue of $49 million, or 17%. Increases in corporate banking revenue occurred in all subcaptions as a result of a build-out of its commercial product offerings by the Commercial Banking segment.
Noninterest expense increased $72 million, or 10%, in 2007 compared to 2006 primarily due to higher sales related incentives expense and
a volume-related increase in affordable housing investments expense.
Branch Banking
Branch Banking provides a full range of deposit and loan and lease products to individuals and small businesses through 1,307 full-service banking
centers. Branch Banking offers depository and loan products, such as checking and savings accounts, home equity loans and lines of credit, credit cards and loans for automobile and other personal financing needs, as well as products designed to meet
the specific needs of small businesses, including cash management services. Table 15 contains selected financial data for the Branch Banking segment.
|
|
|
|
|
|
|
TABLE 15: BRANCH BANKING |
For the years ended December 31 ($ in millions) |
|
2008 |
|
2007 |
|
2006 |
Net interest income |
|
$1,662 |
|
1,464 |
|
1,300 |
Provision for loan and lease losses |
|
352 |
|
162 |
|
108 |
Noninterest income: |
|
|
|
|
|
|
Electronic payment processing |
|
189 |
|
174 |
|
159 |
Service charges on deposits |
|
447 |
|
421 |
|
365 |
Corporate banking revenue |
|
12 |
|
13 |
|
15 |
Investment advisory revenue |
|
84 |
|
90 |
|
87 |
Mortgage banking net revenue |
|
13 |
|
7 |
|
5 |
Other noninterest income |
|
67 |
|
73 |
|
80 |
Securities gains (losses), net |
|
- |
|
- |
|
- |
Noninterest expense: |
|
|
|
|
|
|
Salaries, incentives and benefits |
|
517 |
|
479 |
|
455 |
Net occupancy expense |
|
159 |
|
136 |
|
121 |
Payment processing expense |
|
6 |
|
6 |
|
15 |
Technology and communications |
|
16 |
|
14 |
|
13 |
Equipment expense |
|
44 |
|
37 |
|
32 |
Goodwill impairment |
|
- |
|
- |
|
- |
Other noninterest expense |
|
503 |
|
450 |
|
398 |
Income before taxes |
|
877 |
|
958 |
|
869 |
Applicable income tax expense |
|
309 |
|
338 |
|
306 |
Net income |
|
$568 |
|
620 |
|
563 |
Average Balance Sheet Data |
|
|
|
|
|
|
Consumer loans |
|
$12,665 |
|
11,838 |
|
11,461 |
Commercial loans |
|
5,596 |
|
5,169 |
|
5,289 |
Demand deposits |
|
6,006 |
|
5,756 |
|
5,839 |
Interest checking |
|
7,845 |
|
8,692 |
|
10,578 |
Certificates $100,000 and over & other time |
|
13,749 |
|
13,729 |
|
13,031 |
Savings and money market |
|
16,184 |
|
14,623 |
|
11,886 |
Comparison of 2008 with 2007
Net income decreased $52 million, or eight percent, compared to 2007 as increases in net interest income and service fees were more than offset by a higher provision for loan and lease losses and
increased salaries & incentives and net occupancy expense. Net interest income increased 14% compared to 2007 due to the increase in volume of higher yielding credit cards coupled with the FTP impact for increases in deposit balances. Also
impacting net interest income was the accretion of purchase accounting adjustments, totaling $43 million, primarily related to the second quarter acquisition of First Charter. Average loans and leases increased seven percent compared to 2007 as home
equity loans grew five percent due to acquisitions since 2007. The segment grew credit card balances by $396 million, or 36%, resulting from an increased focus on relationships with its current customers through the cross-selling of credit cards.
Average core deposits were up three percent compared to 2007 primarily due to acquisitions since 2007.
Net charge-offs as
a percent of average loan and leases increased in 2008 to 194 bp from 95 bp in 2007. Net charge-offs increased in comparison to 2007 as the segment experienced higher charge-offs involving brokered home equity lines and loans, commercial loans and
credit cards. The increase of $63 million in charge-offs on home equity reflected borrower stress and a decrease in home prices primarily within the Bancorps footprint. Commercial loan charge-offs increased $41 million compared to 2007 due to
the weakening economy and the
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
continuing deterioration of commercial credit, particularly in Michigan and Florida. Charge-offs involving credit cards increased $44 million compared to
2007 due to higher card balances and the resulting increase in losses upon the maturation of the portfolio.
Noninterest
income increased $34 million, or four percent, compared to 2007 primarily due to an increase in service charges on deposits of $26 million, or six percent. The increase in deposit fees, including consumer overdraft fees, is attributed to higher
customer activity in comparison to 2007.
Noninterest expense increased $123 million, or 11%, compared to 2007 as salaries
and incentives increased eight percent due to higher incentives paid from increased revenues in 2008. Additionally, net occupancy and equipment costs increased 17% as a result of additional banking centers. Since 2007, the Bancorps banking
centers have increased by 80 to 1,307 as of December 31, 2008, mainly due to acquisitions, which contributed 69 banking centers. Other noninterest expense increased 12%, which can be attributed to higher loan cost associated with collections.
Comparison of 2007 with 2006
Net income increased $57 million, or 10%, compared to 2006 as the segment benefited from increased interest rates through the majority of 2007 and increased service charges on deposits. Net interest income increased
$164 million as increases in total deposits were partially offset by a deposit mix shift toward higher paying deposit account types. Average core deposits increased three percent, to $39.9 billion, compared to 2006. Average loans and leases
increased two percent to $17.0 billion, led by growth in credit card balances of 56%.
The provision for loan and lease
losses increased $54 million over 2006 due to the deteriorating credit environment involving home equity loans, particularly in Michigan and Florida. Net charge-offs as a percent of average loans and leases increased significantly from 64 bp to 95
bp, with much of the increase occurring in the fourth quarter of 2007. The Bancorp experienced growth in charge-offs on home equity lines and loans with high loan-to-value (LTV) ratios, reflecting borrower stress and lower home prices.
Noninterest income increased nine percent from 2006 as service charges on deposits grew 15% compared to the prior year due to growth
in consumer deposit fees driven by new account openings and higher levels of customer activity.
Noninterest expense
increased eight percent compared to 2006. Net occupancy and equipment expenses increased 13% compared to 2006 as a result of the continued opening of new banking centers.
Consumer Lending
Consumer Lending includes the Bancorps mortgage, home equity,
automobile and other indirect lending activities. Mortgage and home equity lending activities include the origination, retention and servicing of mortgage and home equity loans or lines of credit, sales and securitizations of those loans or pools of
loans or lines of credit and all associated hedging activities. Other indirect lending activities include loans to consumers through mortgage brokers, automobile dealers and federal and private student education loans. Table
16 contains selected financial data for the Consumer Lending segment.
|
|
|
|
|
|
|
TABLE 16: CONSUMER LENDING |
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2008 |
|
2007 |
|
2006 |
Income Statement Data |
|
|
|
|
|
|
Net interest income |
|
$497 |
|
404 |
|
409 |
Provision for loan and lease losses |
|
425 |
|
149 |
|
94 |
Noninterest income: |
|
|
|
|
|
|
Electronic payment processing |
|
- |
|
- |
|
- |
Service charges on deposits |
|
- |
|
- |
|
- |
Corporate banking revenue |
|
- |
|
- |
|
- |
Investment advisory revenue |
|
- |
|
- |
|
- |
Mortgage banking net revenue |
|
184 |
|
122 |
|
148 |
Other noninterest income |
|
38 |
|
69 |
|
76 |
Securities gains (losses), net |
|
124 |
|
6 |
|
3 |
Noninterest expense: |
|
|
|
|
|
|
Salaries, incentives and benefits |
|
134 |
|
74 |
|
87 |
Net occupancy expense |
|
8 |
|
8 |
|
7 |
Payment processing expense |
|
- |
|
- |
|
- |
Technology and communications |
|
2 |
|
2 |
|
2 |
Equipment expense |
|
1 |
|
1 |
|
1 |
Goodwill impairment |
|
215 |
|
- |
|
- |
Other noninterest expense |
|
224 |
|
167 |
|
167 |
Income (loss) before taxes |
|
(166) |
|
200 |
|
278 |
Applicable income tax expense (benefit) |
|
(58) |
|
70 |
|
98 |
Net income (loss) |
|
$(108) |
|
130 |
|
180 |
Average Balance Sheet Data |
|
|
|
|
|
|
Residential mortgage loans |
|
$10,699 |
|
10,156 |
|
9,523 |
Home equity |
|
1,143 |
|
1,328 |
|
1,311 |
Automobile loans |
|
7,989 |
|
9,712 |
|
8,560 |
Consumer leases |
|
797 |
|
917 |
|
1,328 |
Comparison of 2008 with 2007
Consumer Lending incurred a net loss of $108 million compared to net income of $130 million in 2007 as the increases in net interest income and mortgage banking net revenue and securities gains
were more than offset by growth in provision for loan and lease losses and goodwill impairment. The impairment charge of $215 million was taken in the fourth quarter of 2008 due to the decline in the estimated fair value of the Consumer Lending
segment below its carrying value and the determination that the implied fair value of the goodwill was less than its carrying value. The growth in net interest income compared to 2007 was primarily driven by a rebound in mortgage rate spreads,
partially offset by the decrease in interest-earning assets. Net interest income was also impacted by the accretion of purchase accounting adjustments, totaling $60 million, primarily related to the second quarter acquisition of First Charter.
Average residential mortgage loans increased six percent compared to 2007 due to acquisitions, including Crown in the fourth quarter of 2007 and First Charter in the second quarter of 2008. Average automobile loans decreased 18% compared to 2007 due
to securitizations totaling $2.7 billion in 2008. Net charge-offs as a percent of average loan and leases increased from 73 bp in 2007 to 221 bp in 2008. Net charge-offs, primarily in residential mortgage loans, increased in comparison to 2007 due
to the weakening economy and continuing deterioration of real estate values within the Bancorps footprint, particularly in Michigan and Florida. The segment continues to focus on managing credit risk through the restructuring of certain
residential mortgage and home equity
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
loans in addition to careful consideration of underwriting and collection standards. As of December 31, 2008, the Bancorp had restructured approximately
$462 million and $248 million of residential mortgage loans and home equity loans, respectively, to mitigate losses due to declining collateral values.
Mortgage originations decreased to $11.2 billion in 2008 from $11.4 billion in 2007 due to lower application volumes in the second half of 2008 resulting from market disruptions. The increase in sales margins on loans
held for sale and sales volume of portfolio loans were the primary reasons for increased mortgage banking net revenue compared to 2007. Also contributing to the increase in mortgage banking net revenue in 2008 was the $65 million impact from the
adoption of SFAS No. 159, as of January 1, 2008, on residential mortgage loans held for sale. Prior to adoption, mortgage loan origination costs were capitalized as part of the carrying amount of the loan and recognized as a reduction of
mortgage banking net revenue upon the sale of the loans. Subsequent to the adoption, mortgage loan origination costs are recognized in earnings when incurred, which primarily drove the increase in salaries and incentives in comparison to 2007. The
increase in other noninterest expense compared to 2007 can be attributed to higher loan processing costs from increased collection activities.
Comparison of 2007 with 2006
Net income decreased $50 million, or 28%, compared to 2006 despite increased
originations, due to an increase in provision for loan and lease losses and decreased gain on sale margins. Average residential mortgage loans increased seven percent compared to 2006 due to increased mortgage originations and loans acquired from
Crown. Net charge-offs increased to 73 bp in 2007, an increase from 47 bp in 2006, due to greater severity of loss on residential mortgages and automobile loans related to declining real estate prices and a market surplus of used automobiles,
respectively.
Noninterest income decreased 14% compared to 2006 due to a decline in mortgage banking net revenue. The
Bancorps mortgage originations were $11.4 billion and $9.4 billion in 2007 and 2006, respectively. Despite the increase in originations, gain on sale margins decreased due to widening credit spreads in the residential mortgage market,
resulting in a decrease in mortgage banking net revenue of $26 million, or 18%.
Processing Solutions
Fifth Third Processing Solutions provides electronic funds transfer, debit, credit and merchant
transaction processing, operates the Jeanie® ATM network and provides other data processing services to affiliated and unaffiliated customers. Table 17 contains selected financial data for
the Processing Solutions segment.
|
|
|
|
|
|
|
TABLE 17: PROCESSING SOLUTIONS |
For the years ended December 31 ($ in millions) |
|
2008 |
|
2007 |
|
2006 |
Net interest income |
|
$7 |
|
(6) |
|
(3) |
Provision for loan and lease losses |
|
16 |
|
11 |
|
9 |
Noninterest income: |
|
|
|
|
|
|
Electronic payment processing |
|
796 |
|
700 |
|
601 |
Service charges on deposits |
|
1 |
|
(1) |
|
(1) |
Corporate banking revenue |
|
- |
|
3 |
|
1 |
Investment advisory revenue |
|
- |
|
- |
|
- |
Mortgage banking net revenue |
|
- |
|
- |
|
- |
Other noninterest income |
|
46 |
|
41 |
|
35 |
Securities gains (losses), net |
|
- |
|
- |
|
(1) |
Noninterest expense: |
|
|
|
|
|
|
Salaries, incentives and benefits |
|
80 |
|
75 |
|
70 |
Net occupancy expense |
|
4 |
|
4 |
|
3 |
Payment processing expense |
|
265 |
|
237 |
|
169 |
Technology and communications |
|
42 |
|
31 |
|
32 |
Equipment expense |
|
2 |
|
4 |
|
4 |
Goodwill impairment |
|
- |
|
- |
|
- |
Other noninterest expense |
|
161 |
|
123 |
|
130 |
Income before taxes |
|
280 |
|
252 |
|
215 |
Applicable income tax expense |
|
98 |
|
89 |
|
76 |
Net income |
|
$182 |
|
163 |
|
139 |
Comparison of 2008 with 2007
Net income increased $19 million, or 12%, compared to 2007 as the segment continues to increase its presence in the electronic payment processing business. The segment continues to realize
year-over-year growth in transaction volumes and revenue growth, despite the negative effect of the slowdown in consumer spending, due to the addition and conversion of large national clients over the past year and current initiatives involving
merchant pricing and sales. Financial institutions processing revenues increased $50 million, or 16%, driven by higher transaction volumes. Merchant processing revenue increased $29 million, or nine percent, over 2007 as growth in the number of
merchants and overall transaction volume was partially offset by lower average dollar amounts per transaction. Growth in card issuer interchange of $17 million, or 25%, can be attributed to organic growth in the Bancorps credit card portfolio.
Payment processing expense increased $28 million, or 12%, from 2007 due to higher network charges of $189 million, an
increase of $23 million, or 14% from 2007. The increase in network charges is a result of increased transaction volumes as financial institution transactions and merchant transactions processed both increased in comparison to 2007. Noninterest
expense also increased due to higher volume-related technology and communications expense.
Comparison of 2007 with 2006
Net income increased $24 million, or 17%, versus the prior year as electronic payment processing revenues continued to produce double-digit
increases. Merchant processing increased $55 million due to the addition and conversion of large national clients throughout 2007. Card issuer interchange revenues increased primarily due to new customer additions and the resulting higher card sales
volumes from the success in the Bancorps initiative to increase credit card penetration of its customer base.
The
strong increase in noninterest income was mitigated by a 19% increase in noninterest expense due to network charges resulting from increased transaction volume in addition to expenses related to the conversion of large merchant contracts.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Investment Advisors
Investment
Advisors provides a full range of investment alternatives for individuals, companies and not-for-profit organizations. The Bancorps primary services include investments, private banking, trust, asset management, retirement plans and custody.
Fifth Third Securities, Inc., (FTS) an indirect wholly-owned subsidiary of the Bancorp, offers full service retail brokerage services to individual clients and broker dealer services to the institutional marketplace. Fifth Third Asset Management,
Inc., an indirect wholly-owned subsidiary of the Bancorp, provides asset management services and also advises the Bancorps proprietary family of mutual funds. Table 18 contains selected financial data for the Investment Advisors segment.
|
|
|
|
|
|
|
TABLE 18: INVESTMENT ADVISORS |
For the years ended December 31 ($ in millions) |
|
2008 |
|
2007 |
|
2006 |
Income Statement Data |
|
|
|
|
|
|
Net interest income |
|
$183 |
|
153 |
|
138 |
Provision for loan and lease losses |
|
49 |
|
12 |
|
4 |
Noninterest income: |
|
|
|
|
|
|
Electronic payment processing |
|
2 |
|
1 |
|
1 |
Service charges on deposits |
|
9 |
|
7 |
|
7 |
Corporate banking revenue |
|
18 |
|
10 |
|
7 |
Investment advisory revenue |
|
354 |
|
386 |
|
367 |
Mortgage banking net revenue |
|
1 |
|
2 |
|
2 |
Other noninterest income |
|
2 |
|
1 |
|
2 |
Securities gains (losses), net |
|
- |
|
- |
|
- |
Noninterest expense: |
|
|
|
|
|
|
Salaries, incentives and benefits |
|
159 |
|
167 |
|
172 |
Net occupancy expense |
|
10 |
|
10 |
|
10 |
Payment processing expense |
|
- |
|
- |
|
- |
Technology and communications |
|
2 |
|
2 |
|
2 |
Equipment expense |
|
1 |
|
1 |
|
1 |
Goodwill impairment |
|
- |
|
- |
|
- |
Other noninterest expense |
|
204 |
|
215 |
|
196 |
Income before taxes |
|
144 |
|
153 |
|
139 |
Applicable income tax expense |
|
51 |
|
54 |
|
49 |
Net income |
|
$93 |
|
99 |
|
90 |
Average Balance Sheet Data |
|
|
|
|
|
|
Loans |
|
$3,527 |
|
3,206 |
|
3,067 |
Core deposits |
|
4,666 |
|
4,959 |
|
4,651 |
Comparison of 2008 with 2007
Net income decreased $6 million, or six percent, compared to 2007 as higher net interest income and decreased operating expenses were more than offset by a higher provision for loan and lease
losses and lower investment advisory income. The segment grew loans by 10% and benefited from an overall decrease in interest rates to increase net interest income $30 million, or 20%, as spreads widened due to decreases in funding costs. Average
core deposits declined six percent compared to 2007. The decrease in core deposits was primarily due to a 16% decline in interest checking balances.
Noninterest income decreased $22 million, or five percent, compared to 2007, as investment advisory income decreased eight percent, to $354 million. Included in the decrease of investment advisory income was a decline
in broker income of $11 million, or nine percent, driven by clients moving to lower fee, cash based products from equity products due to extreme market volatility and a decline in transaction based revenues. Additionally, institutional trust revenue
within investment advisory income decreased $7 million, or eight percent, due to overall lower asset values. Noninterest expense decreased $19 million, or five percent, compared to 2007 as the segment continued to focus on expense control by
reducing personnel and canceling certain projects.
Comparison of 2007 with 2006
Net income increased $9 million, or 10%, compared to 2006 on increases in investment advisory revenue of five percent. Net interest
income increased 11% to $153 million on a five percent increase in average loans and leases and a seven percent increase in core deposits. Overall, noninterest income increased six percent from 2006. Fifth Third Private Bank, the Bancorps
wealth management group, increased revenues by six percent on execution of cross-sell initiatives. Brokerage income also increased seven percent compared to 2006 as the overall equity markets performed well for much of 2007 and the segment increased
the number of registered representatives. The segment realized only modest gains in institutional services income. Noninterest expenses remained contained, increasing four percent compared to 2006.
General Corporate and Other
General Corporate and Other includes the unallocated portion of the investment securities portfolio, securities gains/losses, certain non-core deposit funding, unassigned equity, provision expense in excess of net charge-offs, the payment
of preferred stock dividends and certain support activities and other items not attributed to the business segments.
Comparison of
2008 with 2007
The results of General Corporate and Other were primarily impacted by the significant increase in the provision
expense in excess of net charge-offs, which increased from $167 million in 2007 to $1.9 billion in 2008. The results in 2008 also included $273 million in income related to the redemption of a portion of Fifth Thirds ownership interests in
Visa, $99 million in net reductions to noninterest expense to reflect the reversal of a portion of the litigation reserve related to the Bancorps indemnification of Visa, $229 million after-tax impact of charges relating to certain leveraged
leases, charges related to a reduction in the current cash surrender value of one of the Bancorps BOLI policies totaling $215 million, OTTI charges totaling $104 million from FNMA and FHLMC preferred stock and certain bank trust preferred
securities, and a net benefit of $40 million from the resolution of the CitFed litigation. The results in 2007 included a charge of $177 million related to a reduction in the current cash surrender value of one of the Bancorps BOLI policies
and charges totaling $172 million related to the Visa settlement with American Express.
Comparison of 2007 with 2006
Results were primarily impacted by a charge of $177 million to reduce the cash surrender value of one of the Bancorps BOLI
policies, charges totaling $172 million related to the Visa settlement with American Express, and the increase in provision expense in excess of net charge-offs compared to the prior year. Provision expense over charge-offs increased by
approximately $139 million compared to 2006 as the allowance for loan and lease losses as a percentage of loan and leases increased from 1.04% as of December 31, 2006 to 1.17% as of December 31, 2007. The increase is attributable to a
number of factors including an increase in delinquencies, the severity of loss due to real estate price deterioration and automobile loans and credit card balances.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOURTH QUARTER REVIEW
The Bancorps 2008 fourth quarter net loss was $2.2 billion, or $3.82 per diluted share, compared to a net loss of $81 million, or $0.14 per diluted
share, for the third quarter of 2008 and net income of $16 million, or $0.03 per diluted share, for the fourth quarter of 2007. Fourth quarter 2008 earnings were negatively impacted by a number of charges including: a $965 million charge to record
impairment on goodwill, $40 million in OTTI charges on securities, a $34 million charge to lower the current cash surrender value of one of the Bancorps BOLI policies and provision expense of $2.4 billion. Provision expense included the effect
of actions taken to address areas of the loan portfolio exhibiting the most significant credit deterioration as the Bancorp sold or transferred to held-for-sale loans with a carrying value of approximately $1.3 billion. Approximately 90% of these
loans were commercial real estate secured loans in Florida and Michigan. Overall, net charge-offs on loans sold or transferred to held-for-sale during the fourth quarter totaled $800 million. Additionally, provision expense was impacted by a
significant increase in the reserve for loan and lease losses to $2.8 billion, resulting in an allowance to loan and lease ratio of 3.31% as of December 31, 2008, compared to 2.41% as of September 30, 2008 and 1.17% as of December 31,
2007. Fourth quarter 2007 earnings were negatively impacted by a charge of $177 million to lower the current cash surrender value of one of the Bancorps BOLI policies and a charge of $94 million related to Visa members indemnification of
future litigation settlements.
Fourth quarter 2008 net interest income (FTE) of $897 million decreased $171 million from
the third quarter of 2008 and increased $112 million from the same period a year ago. Third and fourth quarter net interest income was affected by the loan discount accretion related to the second quarter of 2008 acquisition of First Charter.
Excluding the benefit of the loan discount accretion of $81 million in the fourth quarter and $215 million in the third quarter, net interest income declined $37 million, or four percent, from the third quarter of 2008 and increased $31 million, or
four percent, from the fourth quarter of 2007. The sequential decline was driven by a number of factors which included the effect of higher nonperforming loan balances, a change in the mix of deposits to higher priced savings and time deposits as a
result of the highly competitive pricing environment and the effect of a greater concentration in lower yielding commercial loans. The year-over-year increase in net interest income was due to the nine percent growth in interest-earning assets,
partially offset by margin compression due to the factors above.
Noninterest income of $642 million decreased by $75
million compared to the third quarter of 2008 and increased $133 million compared to the fourth quarter of 2007. Fourth quarter 2008 results included a $34 million charge to reduce the cash surrender value of one of the Bancorps BOLI policies,
compared to a charge of $27 million in the third quarter of 2008 and a $177 million charge in the fourth quarter of 2007. Third quarter results were also impacted by a $76 million gain related to a satisfactory resolution of the CitFed litigation.
Excluding the above items and non-mortgage related securities gains/losses, noninterest income decreased $15 million, or two percent, compared to the sequential quarter and increased $38 million, or six percent, compared to the same quarter a year
ago. The sequential decrease is a result of lower consumer activity levels, including average credit and debit card transaction and consumer deposit activity, while the year-over-year increase is a result of the growth in customers, particularly in
commercial and Fifth Third Processing Solutions.
Electronic payment processing (EPP) revenue of $230 million declined two
percent compared to the third quarter of 2008 and increased three percent from the fourth quarter of 2007. Merchant processing revenue was flat sequentially and compared to the same quarter last year, as the benefit of continued account acquisition
was offset by a decline in average dollar amount per credit card transaction due to lower consumer
spending. Financial institutions revenue decreased three percent compared with the previous quarter, relating to lower transaction volumes in a weaker
economic environment, and grew four percent from the fourth quarter of 2007 on higher transaction volumes. Card issuer interchange revenue declined two percent sequentially, driven primarily by a decline in the average dollar amount per debit and
credit card transaction. Card issuer interchange revenue increased seven percent from the previous year, driven by higher credit card transactions as a result of the Bancorps credit card growth initiative, partially offset by a lower dollar
amount per transaction.
Service charges on deposits of $162 million decreased six percent sequentially and increased two
percent compared with the same quarter last year. Retail service charges decreased 12% from the third quarter of 2008 and seven percent from the fourth quarter of 2007 due to lower checking account transaction volumes. Commercial service charges
increased three percent sequentially and 14% compared with last year. This growth primarily reflected an increase in customer accounts and lower market interest rates, as reduced earnings credit rates paid on customer balances have resulted in
higher realized net services fees to pay for treasury management services.
Corporate banking revenue of $121 million
increased by $17 million, or 16% from the previous quarter and $15 million, or 14% on a year-over-year basis and was driven by growth in most subcaptions as the Bancorp realized gains from the build out of its commercial product offerings in 2007.
Investment advisory revenue of $78 million was down 13% sequentially and 17% from the fourth quarter of 2007 reflecting
lower asset values on market declines and a shift in assets from equity products to lower yielding money market funds due to extreme market volatility.
Mortgage banking net revenue was a net loss of $29 million in the fourth quarter of 2008, a net gain of $45 million in the third quarter of 2008 and a net gain of $26 million in the fourth quarter of 2007. Including
securities gains on non-qualifying hedges on MSRs, income from mortgage banking activity was flat compared to the third quarter of 2008 and increased $35 million compared to the fourth quarter of 2007. Fourth quarter originations were $2.1 billion,
compared to $2.0 billion from the previous quarter and $2.7 billion from the same quarter last year. The adoption of SFAS No. 159 for mortgage banking in the first quarter of 2008 contributed $12 million of the year-over-year increase in
mortgage banking revenue, with corresponding origination costs recorded in noninterest expense.
Net losses on investment
securities were $40 million in the fourth quarter of 2008 compared with a net loss of $63 million last quarter. The fourth quarter losses were driven by an OTTI charge of $37 million on trust preferred securities. As of December 31, 2008, the
Bancorp held $154 million in trust preferred securities.
Noninterest expense of $2.0 billion increased $1.1 billion both
sequentially and from a year ago. The significant increase in expenses was primarily driven by the $965 million charge to record goodwill impairment in the fourth quarter of 2008. Excluding this charge, noninterest expense of $1.1 billion increased
$90 million sequentially and $117 million from a year ago. Fourth quarter results included higher expenses related to the difficult operating environment that included higher provision for unfunded commitments, higher reinsurance reserve accruals to
cover losses on proprietary private residential mortgage insurance and increased derivative counterparty marks. The combination of these expenses accounted for expense increases of $91 million sequentially and $96 million compared to the previous
year. Additionally, fourth quarter 2008 results included an estimated net $8 million charge due to changes in loss estimates related to our indemnification obligation with Visa, while third quarter results included a $45 million charge
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
related to Visa litigation, $36 million related to legal expenses associated with the satisfactory resolution of a the CitFed litigation, and $7 million in
seasonally higher pension expense. Fourth quarter 2007 results included a $94 million charge due to Visa litigation and $8 million in acquisition related expenses. On a year-over-year comparison basis, acquisitions added approximately $26 million of
additional operating expense, and the impact of the adoption of SFAS No. 159 on the classification of mortgage origination costs has added approximately $12 million. Remaining expense growth on both a sequential and year-over-year basis was
attributable to higher volume-related payment processing expense, increased equipment and occupancy expense, and higher loan and lease processing costs as a result of increased collection activities.
Net charge-offs totaled $1.6 billion in the fourth quarter. Results included net charge-offs of $800 million on commercial loans that
were either sold or transferred to held-for-sale during the quarter. Loss experience continued to be primarily associated with commercial residential builder and developer loans and consumer residential real estate loans, and to be
disproportionately concentrated in Michigan and Florida. In aggregate, Florida and Michigan represented approximately 66% of total losses during the quarter and less than 30% of total loans and leases. Losses on commercial and consumer real estate
loans in these states represented approximately 56% of total fourth quarter net charge-offs. Net charge-offs on loans to homebuilders and developers represented $568 million, or 35% of total net charge-offs. Provision for loan and lease losses
totaled $2.8 billion in the fourth quarter of 2008, exceeding net charge-offs by $729 million. The increase in the allowance for loan and lease losses was reflective of a number of factors including; increased estimated loss factors due to negative
trends in nonperforming assets and overall delinquencies; increased loss estimates due to the real estate price deterioration in some of the Bancorps key lending markets; and significant declines in general economic conditions.
COMPARISON OF THE YEAR ENDED 2007 WITH 2006
Net income for the year ended 2007 was $1.1 billion, or $1.99 per diluted share, a nine percent decrease compared to $1.2 billion, or $2.13 per diluted share, earned in 2006. Overall, increases in net interest margin
and fee revenue were offset by a $177 million charge to lower the current cash surrender value of one of the Bancorps BOLI policies and increased provision for loan and lease losses. The BOLI charge reflected a decrease in the cash surrender
value due to declines in the value of the policys underlying investments due to significant disruptions in the financial markets and widening credit spreads. Provision for loan and lease losses increased $285 million over 2006 to
$628 million, a result of the deteriorating credit environment.
Net interest income (FTE) increased five percent compared to 2006. Net interest margin increased to 3.36% in 2007 from 3.06% in 2006 largely due to the balance sheet actions taken in the fourth
quarter of 2006 to improve the asset/liability mix of the Bancorp and reduce the size of the Bancorps available-for-sale securities portfolio to a size that was more consistent with its liquidity, collateral and interest rate risk management
requirements.
Noninterest income increased 23% compared to 2006. Noninterest income in 2007 reflects the impact of the
previously mentioned $177 million BOLI charge, while the 2006 results included $415 million in losses related to the fourth quarter balance sheet actions. Excluding these items, noninterest income increased nine percent compared to 2006 with growth
in electronic payment processing, service charges on deposits and corporate banking revenue partially offset by lower mortgage banking net revenue.
Noninterest expense increased 14% compared to 2006. Noninterest expense in 2007 included $172 million in charges related to the Bancorps indemnification of estimated current and future Visa litigation
settlements and $8 million of acquisition-related costs, while 2006 results included $49 million in charges related to the termination of debt and other financing agreements. Excluding these items, noninterest expense increased nine percent
resulting from volume-based transaction growth in payment processing, higher technology related expenses reflecting infrastructure upgrades and higher occupancy expense from continued de novo banking center growth. During 2007, the Bancorp opened 77
additional banking centers through acquisitions and de novo expansion.
In 2007, net charge-offs as a percent of average
loans and leases were 61 bp compared to 44 bp in 2006. A majority of the increase in net charge-offs were due to the weakened real estate markets in the Upper Midwest and Florida, which suppressed collateral values. At December 31, 2007,
nonperforming assets as a percent of loans and leases increased to 1.32% from .61% at December 31, 2006. The Bancorp increased its allowance for loan and lease losses as percent of loans and leases from 1.04% as December 31, 2006 to 1.17%
as of December 31, 2007.
During 2007, the Bancorp completed its acquisition of Crown, a subsidiary of R&G
Financial Corporation, with $2.8 billion in assets and $1.7 billion in deposits located in Florida and Augusta, Georgia. Additionally, on August 16, 2007, the Bancorp announced its introduction into the North Carolina markets of Charlotte and
Raleigh with an agreement to acquire First Charter, which was completed in the second quarter of 2008.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BALANCE SHEET ANALYSIS
Loans and Leases
Total loans and leases increased $1.0 billion, or one percent, over 2007. The growth in total loans and leases was due to
acquisitions since 2007, the use of contingent liquidity facilities related to certain off-balance sheet programs and increased loan production across the Bancorps footprint, partially offset by loan securitizations.
Total commercial loans and leases increased $3.6 billion, or eight percent, compared to December 31, 2007. The increase was
primarily driven by growth in commercial loans of $3.1 billion, or 12%, compared to 2007 resulting from $1.8 billion from acquisitions since 2007 and $849 million from the use of contingent liquidity facilities related to certain off-balance sheet
programs that were drawn upon in 2008. Included within the contingent liquidity facilities were approximately $187 million of loans outstanding at December 31, 2008 that were repurchased from a QSPE under the Bancorps liquidity asset
purchase agreement. Also included in commercial loans at December 31, 2008 were $173 million in draws on outstanding letters of credit that were supporting certain securities issued as VRDNs. For further information on these arrangements, see
the Off-Balance Sheet Arrangements section and Note 10 of the Notes to Consolidated Financial Statements.
Commercial
mortgage loans increased eight percent compared to 2007, which primarily included the impact of acquisitions since 2007 of $971 million. The Bancorps largest gains in outstanding loans among industries included the financial services and
insurance, manufacturing, healthcare and business services. Reductions among originations to the real estate and construction industries were offset by the second quarter 2008 acquisition of First Charter. In aggregate, commercial loans in the
states of Michigan and Florida as a percentage of total commercial loans was 26% as of December 31, 2008 compared to 31% as of December 31, 2007.
Total consumer loans and
leases decreased $2.6 billion, or seven percent, compared to 2007, as a result of the decreases in automobile loans and residential mortgage loans partially offset by credit card and home equity loan growth. Automobile loans decreased by
approximately $2.6 billion, or 23%, due largely to automobile loan securitizations of $2.7 billion during the first quarter of 2008. Despite growth of $535 million of loans from acquisitions since 2007, residential mortgage loans were $10.3 billion
at December 31, 2008, down 10% from 2007, due to the sale of $1.7 billion of portfolio loans in 2008 compared to $572 million in 2007. Credit card loans increased to $1.8 billion, an increase of 14% over 2007, due to continued success in
cross-selling credit cards to its existing retail customer base. Home equity loans increased $878 million, primarily due to acquisitions since 2007.
Average total commercial loans and leases increased $8.0 billion, or 19%, compared to 2007. The increase in average total commercial loans and leases was primarily driven by growth in commercial loans and commercial
mortgage loans, which increased 27% and 15%, respectively, over 2007. The increase in average commercial loans was driven by the use of contingent liquidity facilities related to certain off-balance sheet programs. The growth in commercial mortgage
loans included the impact of acquisitions since 2007 of $693 million.
Average total consumer loans and leases decreased
$468 million, or one percent, compared to 2007 as a result of a decrease in automobile loans of 17% largely due to the aforementioned automobile securitizations that occurred in the first quarter of 2008. The decline was partially offset by growth
in credit card balances of $432 million, or 34%, and home equity loans of $504 million, or five percent. Acquisitions since 2007 impacted the change in residential mortgage loans and home equity loans by $1.5 billion and $409 million, respectively.
|
|
|
|
|
|
|
|
|
|
|
TABLE 19: COMPONENTS OF TOTAL LOANS AND LEASES (INCLUDES HELD FOR SALE) |
As of December 31 ($ in millions) |
|
2008 |
|
2007 |
|
2006 |
|
2005 |
|
2004 |
Commercial: |
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
$29,220 |
|
26,079 |
|
20,831 |
|
19,377 |
|
16,107 |
Commercial mortgage |
|
12,952 |
|
11,967 |
|
10,405 |
|
9,188 |
|
7,636 |
Commercial construction |
|
5,114 |
|
5,561 |
|
6,168 |
|
6,342 |
|
4,348 |
Commercial leases |
|
3,666 |
|
3,737 |
|
3,841 |
|
3,698 |
|
3,426 |
Subtotal - commercial |
|
50,952 |
|
47,344 |
|
41,245 |
|
38,605 |
|
31,517 |
Consumer: |
|
|
|
|
|
|
|
|
|
|
Residential mortgage loans |
|
10,292 |
|
11,433 |
|
9,905 |
|
8,991 |
|
7,912 |
Home equity |
|
12,752 |
|
11,874 |
|
12,154 |
|
11,805 |
|
10,318 |
Automobile loans |
|
8,594 |
|
11,183 |
|
10,028 |
|
9,396 |
|
7,734 |
Credit card |
|
1,811 |
|
1,591 |
|
1,004 |
|
788 |
|
794 |
Other consumer loans and leases |
|
1,194 |
|
1,157 |
|
1,167 |
|
1,644 |
|
2,092 |
Subtotal - consumer |
|
34,643 |
|
37,238 |
|
34,258 |
|
32,624 |
|
28,850 |
Total loans and leases |
|
$85,595 |
|
84,582 |
|
75,503 |
|
71,229 |
|
60,367 |
|
TABLE 20: COMPONENTS OF AVERAGE TOTAL LOANS AND LEASES (INCLUDES HELD FOR SALE) |
As of December 31 ($ in millions) |
|
2008 |
|
2007 |
|
2006 |
|
2005 |
|
2004 |
Commercial: |
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
$28,426 |
|
22,351 |
|
20,504 |
|
18,310 |
|
14,955 |
Commercial mortgage |
|
12,776 |
|
11,078 |
|
9,797 |
|
8,923 |
|
7,391 |
Commercial construction |
|
5,846 |
|
5,661 |
|
6,015 |
|
5,525 |
|
3,807 |
Commercial leases |
|
3,680 |
|
3,683 |
|
3,730 |
|
3,495 |
|
3,296 |
Subtotal - commercial |
|
50,728 |
|
42,773 |
|
40,046 |
|
36,253 |
|
29,449 |
Consumer: |
|
|
|
|
|
|
|
|
|
|
Residential mortgage loans |
|
10,993 |
|
10,489 |
|
9,574 |
|
8,982 |
|
6,801 |
Home equity |
|
12,269 |
|
11,887 |
|
12,070 |
|
11,228 |
|
9,584 |
Automobile loans |
|
8,925 |
|
10,704 |
|
9,570 |
|
8,649 |
|
8,128 |
Credit card |
|
1,708 |
|
1,276 |
|
838 |
|
728 |
|
740 |
Other consumer loans and leases |
|
1,212 |
|
1,219 |
|
1,395 |
|
1,897 |
|
2,340 |
Subtotal - consumer |
|
35,107 |
|
35,575 |
|
33,447 |
|
31,484 |
|
27,593 |
Total average loans and leases |
|
$85,835 |
|
78,348 |
|
73,493 |
|
67,737 |
|
57,042 |
Total average portfolio loans and leases (excludes held for sale) |
|
$83,895 |
|
76,033 |
|
72,447 |
|
66,685 |
|
55,951 |
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 21: COMPONENTS OF INVESTMENT SECURITIES
|
|
|
|
|
|
|
|
|
|
|
As of December 31 ($ in millions) |
|
2008 |
|
2007 |
|
2006 |
|
2005 |
|
2004 |
Trading: |
|
|
|
|
|
|
|
|
|
|
Variable rate demand notes |
|
$1,140 |
|
- |
|
- |
|
- |
|
- |
Other securities |
|
51 |
|
171 |
|
187 |
|
117 |
|
77 |
Total trading |
|
$1,191 |
|
171 |
|
187 |
|
117 |
|
77 |
Available-for-sale and other: (amortized cost basis) |
|
|
|
|
|
|
|
|
|
|
U.S. Treasury and Government agencies |
|
$186 |
|
3 |
|
1,396 |
|
506 |
|
503 |
U.S. Government sponsored agencies |
|
1,651 |
|
160 |
|
100 |
|
2,034 |
|
2,036 |
Obligations of states and political subdivisions |
|
323 |
|
490 |
|
603 |
|
657 |
|
823 |
Agency mortgage-backed securities |
|
8,529 |
|
8,738 |
|
7,999 |
|
16,127 |
|
17,571 |
Other bonds, notes and debentures |
|
613 |
|
385 |
|
172 |
|
2,119 |
|
2,862 |
Other securities |
|
1,248 |
|
1,045 |
|
966 |
|
1,090 |
|
1,006 |
Total available-for-sale and other |
|
$12,550 |
|
10,821 |
|
11,236 |
|
22,533 |
|
24,801 |
Held-to-maturity: |
|
|
|
|
|
|
|
|
|
|
Obligations of states and political subdivisions |
|
$355 |
|
351 |
|
345 |
|
378 |
|
245 |
Other bonds, notes and debentures |
|
5 |
|
4 |
|
11 |
|
11 |
|
10 |
Total held-to-maturity |
|
$360 |
|
355 |
|
356 |
|
389 |
|
255 |
Investment Securities
The Bancorp uses investment securities as a means of managing interest rate risk, providing liquidity support and providing collateral for pledging purposes. As of December 31, 2008, total investment securities were $14.3 billion
compared to $11.2 billion at December 31, 2007.
Securities are classified as trading when bought and held
principally for the purpose of selling them in the near term. Securities are classified as available-for-sale when, in managements judgment, they may be sold in response to, or in anticipation of, changes in market conditions. The
Bancorps
management has evaluated the securities in an unrealized loss position in the available-for-sale portfolio for OTTI on the basis of both the duration of the
decline in value of the security and the severity of that decline, and maintains the intent and ability to hold these securities to the earlier of the recovery of the loss or maturity. Securities, which management has the intent and ability to hold
to maturity and are classified as held-to-maturity are reported at amortized cost.
At December 31, 2008, the
Bancorps investment portfolio primarily consisted of AAA-rated agency mortgage-backed securities. The investment portfolio includes FHLMC preferred
TABLE 22: CHARACTERISTICS OF AVAILABLE-FOR-SALE AND OTHER SECURITIES
|
|
|
|
|
|
|
|
|
|
As of December 31, 2008 ($ 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 |
|
$41 |
|
$41 |
|
0.8 |
|
2.11 |
% |
Average life 1 5 years |
|
143 |
|
147 |
|
1.5 |
|
2.10 |
|
Average life 5 10 years |
|
- |
|
- |
|
- |
|
- |
|
Average life greater than 10 years |
|
2 |
|
2 |
|
11.2 |
|
2.46 |
|
Total |
|
186 |
|
190 |
|
1.5 |
|
2.11 |
|
U.S. Government sponsored agencies: |
|
|
|
|
|
|
|
|
|
Average life of one year or less |
|
164 |
|
165 |
|
0.1 |
|
4.47 |
|
Average life 1 5 years |
|
168 |
|
174 |
|
1.7 |
|
3.10 |
|
Average life 5 10 years |
|
1,319 |
|
1,391 |
|
7.7 |
|
3.79 |
|
Average life greater than 10 years |
|
- |
|
- |
|
- |
|
- |
|
Total |
|
1,651 |
|
1,730 |
|
6.4 |
|
3.78 |
|
Obligations of states and political subdivisions (a): |
|
|
|
|
|
|
|
|
|
Average life of one year or less |
|
202 |
|
203 |
|
0.3 |
|
7.31 |
|
Average life 1 5 years |
|
71 |
|
72 |
|
2.5 |
|
7.18 |
|
Average life 5 10 years |
|
49 |
|
50 |
|
7.5 |
|
6.87 |
|
Average life greater than 10 years |
|
1 |
|
1 |
|
12.1 |
|
3.93 |
|
Total |
|
323 |
|
326 |
|
1.9 |
|
7.21 |
|
Agency mortgage-backed securities: |
|
|
|
|
|
|
|
|
|
Average life of one year or less |
|
909 |
|
919 |
|
0.7 |
|
5.44 |
|
Average life 1 5 years |
|
7,337 |
|
7,470 |
|
2.7 |
|
5.24 |
|
Average life 5 10 years |
|
282 |
|
291 |
|
5.6 |
|
5.28 |
|
Average life greater than 10 years |
|
1 |
|
1 |
|
10.4 |
|
5.09 |
|
Total |
|
8,529 |
|
8,681 |
|
2.6 |
|
5.26 |
|
Other bonds, notes and debentures (b): |
|
|
|
|
|
|
|
|
|
Average life of one year or less |
|
186 |
|
178 |
|
0.1 |
|
2.51 |
|
Average life 1 5 years |
|
265 |
|
242 |
|
3.0 |
|
7.27 |
|
Average life 5 10 years |
|
112 |
|
102 |
|
6.6 |
|
7.55 |
|
Average life greater than 10 years |
|
50 |
|
48 |
|
25.4 |
|
7.20 |
|
Total |
|
613 |
|
570 |
|
4.6 |
|
5.87 |
|
Other securities (c) |
|
1,248 |
|
1,231 |
|
|
|
|
|
Total available-for-sale and other securities |
|
$12,550 |
|
$12,728 |
|
3.2 |
|
5.08 |
% |
(a) |
Taxable-equivalent yield adjustments included in the above table are 2.46%, 2.13%, 0.26%, 1.32% and 2.05% 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) |
Other bonds, notes, and debentures consist of commercial paper, non-agency mortgage backed securities, certain other asset backed securities (primarily automobile and commercial
loan backed securities) and corporate bond securities. |
(c) |
Other securities consist of Federal Home Loan Bank (FHLB) and Federal Reserve Bank restricted stock holdings that are carried at par, FHLMC and FNMA preferred stock, certain
mutual fund holdings and equity security holdings. |
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
stock and FNMA preferred securities with a remaining carrying value of $1 million after recognizing OTTI charges of $67 million during 2008. The Bancorp also
recognized OTTI charges of $37 million on certain trust preferred securities, which have a remaining carrying value of $79 million. Total trust preferred securities have a carrying value of $154 million at December 31, 2008. These charges were
recognized due to the severity of the decline in fair value of these securities throughout 2008. The Bancorp did not hold asset-backed securities backed by subprime mortgage loans in its investment portfolio at or for the year ended
December 31, 2008. Additionally, there were no material securities below investment grade as of December 31, 2008.
Trading securities increased from $171 million as of December 31, 2007 to $1.2 billion as of December 31, 2008. The increase was driven by $1.1 billion of VRDNs held by the Bancorp in its trading securities portfolio. These
securities were purchased from the market during 2008, through FTS, who was also the remarketing agent. For more information on the Bancorps obligations in remarketing VRDNs, see Note 15 of the Notes to Consolidated Financial Statements.
On an amortized cost basis, at the end of 2008, available-for-sale securities increased $1.7 billion since
December 31, 2007. At December 31, 2008 and 2007, available-for-sale securities were 12% and 11%, respectively, of interest-earning assets. Increases in the available-for-sale securities portfolio relate to the Bancorps overall
balance sheet growth coupled with the increased purchase of securities as a part of the Bancorps non-qualifying hedging strategy related to mortgage servicing rights. The estimated weighted-average life of the debt securities in the
available-for-sale portfolio was 3.2 years at December 31, 2008 compared to 6.8 years at December 31, 2007. The decrease in the weighted-average life of the debt securities portfolio was due to the decline in market rates during the fourth
quarter of 2008. The market rate decline increased the likelihood that borrowers would refinance, decreasing the weighted-average life of agency mortgage-backed securities, which are a majority of the Bancorps available-for-sale portfolio. At
December 31, 2008, the fixed-rate securities within the available-for-sale securities portfolio had a weighted-average yield of 5.08% compared to 5.31% at December 31, 2007.
During the second half of 2007 and continuing through 2008, as part of its liquidity support agreement, the Bancorp
began to purchase investment grade commercial paper from an unconsolidated QSPE that is wholly owned by an independent third-party. The commercial paper has
maturities ranging from as little as one day to 90 days. The purchase and maturity of the commercial paper is the primary contributor to the increase in the purchases and sales of available-for-sale securities during 2008 and 2007. The commercial
paper is backed by the assets held by the QSPE and, as of the December 31, 2008 and 2007, the Bancorp held $143 million and $83 million of this commercial paper in its available-for-sale portfolio. Refer to the Off-balance Sheet Arrangements
section for more information on the QSPE.
Information presented in Table 22 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. Market rates declined in 2008, particularly in the fourth quarter. This market rate decline led to unrealized gains of $152 million and $79 million, respectively, related to agency mortgage-backed securities and securities held
with U.S. Government sponsored agencies as of December 31, 2008. Total net unrealized gains on the available-for-sale securities portfolio was $178 million at December 31, 2008 compared to an unrealized loss of $144 million at
December 31, 2007 and a $183 million unrealized loss at December 31, 2006.
Deposits
Deposit balances represent an important source of funding and revenue growth opportunity. The Bancorp is continuing to focus on core deposit growth in its
retail and commercial franchises by expanding its retail franchise through acquisitions, offering competitive rates and enhancing its product offerings. At December 31, 2008, core deposits represented 55% of the Bancorps asset funding
base, compared to 59% at December 31, 2007.
Included in core deposits are foreign office deposits, which are
Eurodollar sweep accounts for the Bancorps commercial customers. These accounts bear interest at rates slightly higher than money market accounts, but the Bancorp does not have to pay FDIC insurance nor hold collateral. Other deposits consist
of brokered savings and money market deposits and the Bancorp uses these, as well as certificates of deposit $100,000 and over, as a
|
|
|
|
|
|
|
|
|
|
|
TABLE 23: DEPOSITS |
|
|
|
|
|
|
|
|
|
|
As of December 31 ($ in millions) |
|
2008 |
|
2007 |
|
2006 |
|
2005 |
|
2004 |
Demand |
|
$15,287 |
|
14,404 |
|
14,331 |
|
14,609 |
|
13,486 |
Interest checking |
|
13,826 |
|
15,254 |
|
15,993 |
|
18,282 |
|
19,481 |
Savings |
|
16,063 |
|
15,635 |
|
13,181 |
|
11,276 |
|
8,310 |
Money market |
|
4,689 |
|
6,521 |
|
6,584 |
|
6,129 |
|
4,321 |
Foreign office |
|
2,144 |
|
2,572 |
|
1,353 |
|
421 |
|
153 |
Transaction deposits |
|
52,009 |
|
54,386 |
|
51,442 |
|
50,717 |
|
45,751 |
Other time |
|
14,350 |
|
11,440 |
|
10,987 |
|
9,313 |
|
6,837 |
Core deposits |
|
66,359 |
|
65,826 |
|
62,429 |
|
60,030 |
|
52,588 |
Certificates - $100,000 and over |
|
11,851 |
|
6,738 |
|
6,628 |
|
4,343 |
|
2,121 |
Other |
|
403 |
|
2,881 |
|
323 |
|
3,061 |
|
3,517 |
Total deposits |
|
$78,613 |
|
75,445 |
|
69,380 |
|
67,434 |
|
58,226 |
|
|
|
|
|
|
TABLE 24: AVERAGE DEPOSITS |
|
|
|
|
|
|
|
|
|
|
As of December 31 ($ in millions) |
|
2008 |
|
2007 |
|
2006 |
|
2005 |
|
2004 |
Demand |
|
$14,017 |
|
13,261 |
|
13,741 |
|
13,868 |
|
12,327 |
Interest checking |
|
14,095 |
|
14,820 |
|
16,650 |
|
18,884 |
|
19,434 |
Savings |
|
16,192 |
|
14,836 |
|
12,189 |
|
10,007 |
|
7,941 |
Money market |
|
6,127 |
|
6,308 |
|
6,366 |
|
5,170 |
|
3,473 |
Foreign office |
|
2,153 |
|
1,762 |
|
732 |
|
248 |
|
85 |
Transaction deposits |
|
52,584 |
|
50,987 |
|
49,678 |
|
48,177 |
|
43,260 |
Other time |
|
11,135 |
|
10,778 |
|
10,500 |
|
8,491 |
|
6,208 |
Core deposits |
|
63,719 |
|
61,765 |
|
60,178 |
|
56,668 |
|
49,468 |
Certificates - $100,000 and over |
|
9,531 |
|
6,466 |
|
5,795 |
|
4,001 |
|
2,403 |
Other |
|
2,163 |
|
1,393 |
|
2,979 |
|
3,719 |
|
4,364 |
Total average deposits |
|
$75,413 |
|
69,624 |
|
68,952 |
|
64,388 |
|
56,235 |
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
method to fund earning asset growth.
Core deposits increased one percent compared to 2007 due to acquisitions during the past year. Exclusive of acquisitions, core deposits decreased three percent, as growth in demand, savings, and other time deposits was more than offset by a
three percent decrease in interest-bearing core deposits as a result of increased competitor pricing on time deposits. A majority of the increase in deposit pricing was the result of the impact of the illiquidity in the marketplace that provided
other financial institutions limited access to alternative funding sources. The Bancorp increased its rates during the third quarter of 2008 to approximate competitor rates and experienced increases in its interest-bearing core deposit products
following these actions.
Certificates $100,000 and over at December 31, 2008 increased by $5.1 billion and other
deposits decreased by $2.5 billion compared to December 31, 2007 primarily driven by growth in customer jumbo CDs and other time deposits in an overall effort by the Bancorp to reduce exposure to market related funding.
On an average basis, core deposits increased three percent primarily due to acquisitions that occurred since 2007. Exclusive of
acquisitions, average core deposits remained flat compared to 2007 as increases in demand deposits due to decreased earnings credit rates were partially offset by the decrease in interest-bearing core deposit products.
On an average basis, savings deposits increased nine percent primarily due to acquisitions that occurred since 2007. Exclusive of
acquisitions, average savings deposits increased seven percent. This growth is primarily due to a mix shift as customers migrated from lower yielding interest checking into higher yielding savings accounts.
Borrowings
Total borrowings
increased $1.8 billion, or eight percent, over 2007, to provide funding for the growth in the assets throughout 2008. As of December 31, 2008 and December 31, 2007, total
borrowings as a percentage of interest-bearing liabilities remained consistent at 27%.
Total short-term borrowings were $10.2 billion at December 31, 2008 compared to $9.2 billion at December 31, 2007. The
reduction in the overnight fed funds purchased balance was due to the receipt of $3.4 billion in equity funding from the U.S. Treasury under the CPP on December 31, 2008 and an increase in other short-term borrowings primarily through the
purchase of term funding through FHLB advances and Term Auction Facility funds.
Long-term debt at December 31, 2008
increased six percent compared with December 31, 2007 due to increased fair value marks on hedged debt. Among debt issuances, new issuances during the first and second quarters of 2008 were offset by $2.1 billion of long-term bank notes
maturing during 2008. In February 2008, the Bancorp issued $1.0 billion of 8.25% subordinated notes, a portion of which were subsequently hedged to floating, with a maturity date of March 1, 2038. In April 2008, the Bancorp issued $750 million
of 6.25% senior notes with a maturity date of May 1, 2013. The notes are not subject to redemption at the Bancorps option at any time prior to maturity. Additionally, in May 2008, an unconsolidated trust issued $400 million of Tier
1-qualifying trust preferred securities and invested these proceeds in junior subordinated notes issued by the Bancorp. The notes mature on May 15, 2068 and bear a fixed rate of 8.875% until May 15, 2058. After May 15, 2058, the notes
bear interest at a variable rate of three-month LIBOR plus 5.00%. The Bancorp has subsequently entered into hedges related to these notes.
Information on the average rates paid on borrowings is located in the Statements of Income Analysis. Further detail on the Bancorps long-term debt can be found in Note 14 of the Notes to Consolidated Financial
Statements. In addition, refer to the Liquidity Risk Management section for a discussion on the role of borrowings in the Bancorps liquidity management.
|
|
|
|
|
|
|
|
|
|
|
TABLE 25: BORROWINGS |
As of December 31 ($ in millions) |
|
2008 |
|
2007 |
|
2006 |
|
2005 |
|
2004 |
Federal funds purchased |
|
$287 |
|
4,427 |
|
1,421 |
|
5,323 |
|
4,714 |
Short-term bank notes |
|
- |
|
- |
|
- |
|
- |
|
775 |
Other short-term borrowings |
|
9,959 |
|
4,747 |
|
2,796 |
|
4,246 |
|
4,537 |
Long-term debt |
|
13,585 |
|
12,857 |
|
12,558 |
|
15,227 |
|
13,983 |
Total borrowings |
|
$23,831 |
|
22,031 |
|
16,775 |
|
24,796 |
|
24,009 |
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 (ERM), 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. In addition, the Internal Audit division provides an independent assessment of the
Bancorps internal control structure and related systems and processes. The risks faced by the Bancorp include, but are not limited to, credit, market, liquidity, operational and regulatory compliance. ERM includes the following key functions:
|
|
|
Commercial Credit Risk Management provides safety and soundness within an independent portfolio management framework that supports the Bancorps Commercial
loan growth strategies and underwriting practices, ensuring portfolio optimization and appropriate risk controls; |
|
|
|
Risk Strategies and Reporting is responsible for quantitative analysis needed to support the Commercial dual grading system, ALLL methodology and analytics
needed to assess credit risk and develop mitigation strategies related to that risk. The department also provides oversight, reporting and monitoring of commercial underwriting and credit administration processes. The Risk Strategies and Reporting
department is also responsible for the economic capital program; |
|
|
|
Consumer Credit Risk Management provides safety and soundless within an independent management framework that supports the Bancorps Consumer loan growth
strategies, ensuring portfolio optimization, appropriate risk controls and oversight, reporting, and monitoring of underwriting and credit administration processes; |
|
|
|
Operational Risk Management works with the line of business risk managers, affiliates and lines of business to maintain processes to monitor and manage all
aspects of operational risk including ensuring consistency in application of enterprise operational risk programs, Sarbanes-Oxley compliance, and serving as a policy clearinghouse for the Bancorp, including policies relating to credit, market and
operational risk. In addition, the Bank Protection function oversees and manages fraud prevention and detection and provide investigative and recovery services for the Bancorp; |
|
|
|
Capital Markets Risk Management is responsible for instituting, monitoring, and reporting appropriate trading limits, monitoring liquidity, interest rate risk,
and risk tolerances within the Treasury, Mortgage Company, and Capital Markets groups and utilizing a value at risk model for Bancorp market risk exposure; |
|
|
|
Regulatory Compliance Risk Management ensures that processes are in place to monitor and comply with federal and state banking regulations, including fiduciary
compliance processes. The function also has the responsibility for maintenance of an enterprise-wide compliance framework; and |
|
|
|
The ERM division creates and maintains other functions, committees or processes as are necessary to effectively manage credit, market and operational risk
throughout the Bancorp. |
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 five 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 Corporate Credit Committee, the Credit Policy Committee, the Operational Risk Committee, the Capital Committee, the Loan Loss Reserve
Committee, the Management Compliance Committee, the Retail Distribution Governance Committee, and the Executive Asset Liability 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.
Finally, Credit Risk Review is an independent function 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 exposure, appropriate accounting for charge-offs, and non-accrual status
and specific reserves. Credit Risk Review reports directly to the Risk and Compliance Committee of the Board of Directors and administratively to the Director of Internal Audit.
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 as well as 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. Underwriting activities are centralized, and ERM
manages the policy and the authority delegation process directly. The Credit Risk Review function, which reports to the Risk and Compliance Committee of the Board of Directors, provides objective assessments of the quality of underwriting and
documentation, the accuracy of risk grades and the charge-off, nonaccrual and reserve analysis process. The Bancorps credit review process and overall assessment of required allowances is based on 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
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 probabilities 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 has completed significant validation and testing of the dual risk rating system. Scoring systems, various analytical tools and delinquency monitoring are used to assess
the credit risk in the Bancorps homogenous consumer loan portfolios.
Overview
During 2008, general economic conditions continued to deteriorate which had an adverse impact across the majority of the Bancorps loan and lease
products. Geographically, the Bancorp experienced the most stress in the states of Michigan and Florida due to the decline in real estate prices. Real estate price deterioration, as measured by the Home Price Index, was most prevalent in Florida due
to past real estate price appreciation and related over-development, and in Michigan due in part to cutbacks by automobile manufacturers. The year-over-year deterioration in home prices has been as high as 20% in some of the Bancorps hardest
hit geographies. Among portfolios, the commercial homebuilder and developer, non-owner occupied residential mortgage and brokered home equity portfolios exhibited the most stress. Management suspended new lending to homebuilders and to commercial
non-owner occupied real estate, discontinued the origination of brokered home equity products and raised underwriting standards on non-owner occupied residential mortgages. During the fourth quarter, in an effort to reduce loan exposure to the real
estate and construction industries and obtain the highest realizable value, the Bancorp sold or moved to held-for-sale $1.3 billion in commercial loan balances. The Bancorp recognized $800 million in net charge-offs on these loans with approximately
49% of the losses representing real estate secured loans in Florida and 44% of the losses representing real estate secured loans in Michigan. Throughout 2008, the Bancorp aggressively engaged in other loss mitigation techniques such as reducing
lines of credit, restructuring certain consumer loans, tightening certain underwriting standards and expanding commercial and consumer loan workout teams. The following credit information presents the Bancorps loan portfolio diversification,
an analysis of nonperforming loans and loans charged-off and a discussion of the allowance for credit losses.
Commercial Portfolio
The Bancorps credit risk management strategy includes minimizing concentrations of risk through diversification. Table
27 provides breakouts of the total commercial loan and lease portfolio, including held for sale, by major industry classification (as defined by the North
American Industry Classification System), by loan size and by state, illustrating the diversity and granularity of the Bancorps commercial portfolio. The Bancorp has commercial loan concentration limits based on industry, lines of business
within the commercial segment and real estate project type.
As of December 31, 2008, the Bancorp had homebuilder
exposure of $4.0 billion and outstanding loans of $2.7 billion with $366 million of portfolio commercial loans and $215 million in held-for-sale commercial loans in nonaccrual loans. As of December 31, 2008, approximately 41% of the outstanding
loans to homebuilders are located in the states of Michigan and Florida and represent approximately 58% of the nonaccrual loans. As of December 31, 2007, the Bancorp had homebuilder exposure of $4.4 billion, outstanding loans of $2.9 billion
with $176 million in nonaccrual loans.
The risk within the commercial real estate portfolio is managed and monitored
through an underwriting process utilizing detailed origination policies, continuous loan level reviews, the monitoring of industry concentration and product type limits and continuous portfolio risk management reporting. The origination policies for
commercial real estate outline the risks and underwriting requirements for owner occupied, non-owner occupied and construction lending. Included in the policies are maturity and amortization terms, maximum loan-to-values (LTV), minimum debt service
coverage ratios, construction loan monitoring procedures, appraisal requirements, pre-leasing requirements (as applicable) and sensitivity and proforma analysis requirements.
The commercial real estate portfolio is diversified by product type, loan size and geographical location with concentration levels established to manage the exposure. Appraisals are obtained from
qualified appraisers and are reviewed by an independent appraisal review group to ensure independence and consistency in the valuation process. Appraisal values are updated on an as needed basis, in conformity with market conditions and regulatory
requirements. Table 26 provides further information on the location of commercial real estate and construction industry loans and leases.
The commercial portfolio has minimal direct exposure to auto manufactures and their suppliers, although any further deterioration of those industries would have negative impacts across the Bancorps lending
products. As of December 31, 2008, the Bancorp had automobile dealer exposure, included within the retail trade industry, of $3.1 billion and outstanding loans of $2.0 billion with $113 million in nonaccrual loans.
TABLE 26: COMMERCIAL REAL ESTATE AND CONSTRUCTION LOANS AND LEASES BY STATE
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding |
|
|
|
Nonaccrual |
As of December 31 ($ in millions) |
|
2008 |
|
2007 |
|
|
|
2008 |
|
2007 |
Ohio |
|
$4,247 |
|
4,167 |
|
|
|
$180 |
|
84 |
Michigan |
|
3,930 |
|
4,692 |
|
|
|
302 |
|
179 |
Florida |
|
2,374 |
|
2,790 |
|
|
|
399 |
|
79 |
Illinois |
|
1,384 |
|
1,425 |
|
|
|
95 |
|
21 |
Indiana |
|
1,108 |
|
1,298 |
|
|
|
86 |
|
26 |
North Carolina |
|
802 |
|
21 |
|
|
|
49 |
|
- |
Kentucky |
|
788 |
|
791 |
|
|
|
24 |
|
7 |
Tennessee |
|
455 |
|
496 |
|
|
|
51 |
|
4 |
All other states |
|
1,866 |
|
1,110 |
|
|
|
95 |
|
5 |
Total |
|
$16,954 |
|
16,790 |
|
|
|
$1,281 |
|
405 |
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 27: COMMERCIAL LOAN AND LEASE PORTFOLIO EXPOSURE (a)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008 |
|
2007 |
As of December 31 ($ in millions) |
|
Outstanding |
|
|
Exposure |
|
Nonaccrual |
|
Outstanding |
|
Exposure |
|
Nonaccrual |
By industry: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate |
|
$11,925 |
|
|
14,428 |
|
583 |
|
11,564 |
|
14,450 |
|
147 |
Manufacturing |
|
7,382 |
|
|
14,310 |
|
92 |
|
6,570 |
|
14,365 |
|
28 |
Construction |
|
5,030 |
|
|
7,788 |
|
698 |
|
5,226 |
|
8,534 |
|
258 |
Retail trade |
|
3,621 |
|
|
6,874 |
|
167 |
|
4,175 |
|
7,251 |
|
29 |
Financial services and insurance |
|
3,601 |
|
|
8,164 |
|
28 |
|
2,484 |
|
6,916 |
|
6 |
Healthcare |
|
3,081 |
|
|
5,057 |
|
20 |
|
2,347 |
|
4,007 |
|
15 |
Business services |
|
2,925 |
|
|
5,141 |
|
38 |
|
2,266 |
|
4,251 |
|
25 |
Transportation and warehousing |
|
2,726 |
|
|
3,224 |
|
26 |
|
2,565 |
|
3,076 |
|
21 |
Wholesale trade |
|
2,567 |
|
|
4,772 |
|
25 |
|
2,179 |
|
4,127 |
|
16 |
Other services |
|
1,203 |
|
|
1,712 |
|
22 |
|
1,049 |
|
1,455 |
|
17 |
Accommodation and food |
|
1,163 |
|
|
1,560 |
|
38 |
|
1,036 |
|
1,470 |
|
21 |
Individuals |
|
1,053 |
|
|
1,354 |
|
38 |
|
1,252 |
|
1,626 |
|
15 |
Communication and information |
|
951 |
|
|
1,547 |
|
19 |
|
741 |
|
1,439 |
|
1 |
Mining |
|
838 |
|
|
1,275 |
|
18 |
|
578 |
|
1,090 |
|
3 |
Entertainment and recreation |
|
765 |
|
|
1,009 |
|
35 |
|
617 |
|
873 |
|
6 |
Public administration |
|
725 |
|
|
938 |
|
- |
|
737 |
|
957 |
|
- |
Agribusiness |
|
635 |
|
|
815 |
|
21 |
|
606 |
|
788 |
|
3 |
Utilities |
|
584 |
|
|
1,231 |
|
- |
|
389 |
|
1,210 |
|
2 |
Other |
|
178 |
|
|
369 |
|
11 |
|
963 |
|
1,897 |
|
59 |
Total |
|
$50,953 |
|
|
81,568 |
|
1,879 |
|
47,334 |
|
79,782 |
|
672 |
By loan size: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than $200,000 |
|
3 |
% |
|
2 |
|
5 |
|
3 |
|
3 |
|
9 |
$200,000 to $1 million |
|
12 |
|
|
9 |
|
21 |
|
13 |
|
10 |
|
24 |
$1 million to $5 million |
|
25 |
|
|
21 |
|
45 |
|
28 |
|
23 |
|
43 |
$5 million to $10 million |
|
14 |
|
|
13 |
|
20 |
|
26 |
|
23 |
|
19 |
$10 million to $25 million |
|
23 |
|
|
24 |
|
9 |
|
13 |
|
14 |
|
5 |
Greater than $25 million |
|
23 |
|
|
31 |
|
- |
|
17 |
|
27 |
|
- |
Total |
|
100 |
% |
|
100 |
|
100 |
|
100 |
|
100 |
|
100 |
By state: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Ohio |
|
26 |
% |
|
30 |
|
14 |
|
26 |
|
30 |
|
20 |
Michigan |
|
17 |
|
|
16 |
|
22 |
|
20 |
|
18 |
|
36 |
Florida |
|
9 |
|
|
8 |
|
25 |
|
11 |
|
9 |
|
23 |
Illinois |
|
8 |
|
|
9 |
|
8 |
|
9 |
|
9 |
|
6 |
Indiana |
|
7 |
|
|
7 |
|
8 |
|
8 |
|
8 |
|
9 |
Kentucky |
|
5 |
|
|
5 |
|
5 |
|
5 |
|
5 |
|
2 |
North Carolina |
|
3 |
|
|
3 |
|
4 |
|
1 |
|
1 |
|
- |
Tennessee |
|
3 |
|
|
2 |
|
3 |
|
3 |
|
3 |
|
1 |
All other states |
|
22 |
|
|
20 |
|
11 |
|
17 |
|
17 |
|
3 |
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. |
Residential Mortgage Portfolio
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.
Certain mortgage
products have contractual features that may increase the risk of loss to the Bancorp in the event of a decline in housing prices. These types of mortgage products offered by the Bancorp include loans with high loan-to-value (LTV) ratios, multiple
loans on the same collateral that when combined result in an LTV greater than 80% (80/20 loans) and interest-only loans. Table 28 shows the Bancorps originations of these products for the year ended December 31, 2008 and 2007. The Bancorp
does not originate mortgage loans that permit customers to defer principal payments or make payments that are less than the accruing interest.
Table 29 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, 2008 and 2007. Reset
of rates on adjustable rate mortgages are not
expected to have a material impact on credit cost as two-thirds of adjustable rate mortgages have an LTV less than 80%. Geographically, the Bancorps
residential mortgage portfolio is dominated by three states with Florida, Michigan and Ohio representing 31%, 23% and 14% of the portfolio, respectively.
The Bancorp previously originated certain non-conforming residential mortgage loans known as Alt-A loans. Borrower qualifications were comparable to other conforming residential mortgage products. As of
December 31, 2008, the Bancorp held $115 million of Alt-A mortgage loans in its portfolio with approximately $17 million on nonaccrual.
The Bancorp previously sold certain mortgage products in the secondary market with recourse. At December 31, 2008 and 2007, the outstanding balances on these loans sold with recourse were approximately $1.3
billion and $1.5 billion, respectively, and the delinquency rates were approximately 6.40% and 3.03%, respectively. At December 31, 2008 and 2007, the Bancorp maintained an estimated credit loss reserve on these loans sold with recourse of
approximately $20 million and $17 million, respectively. See Note 10 of the Notes to Consolidated Financial Statements for further information.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 28: RESIDENTIAL MORTGAGE ORIGINATIONS
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2008 |
|
Percent of total |
|
|
2007 |
|
Percent of total |
|
Greater than 80% LTV with no mortgage insurance |
|
$15 |
|
- |
% |
|
$265 |
|
2 |
% |
Interest-only |
|
784 |
|
7 |
|
|
1,720 |
|
15 |
|
Greater than 80% LTV and interest-only |
|
2 |
|
- |
|
|
265 |
|
2 |
|
80/20 loans |
|
38 |
|
- |
|
|
212 |
|
2 |
|
80/20 loans and interest only |
|
- |
|
- |
|
|
62 |
|
1 |
|
TABLE 29: RESIDENTIAL MORTGAGE OUTSTANDINGS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008 |
|
|
2007 |
|
As of December 31 ($ in millions) |
|
Balance |
|
Percent of total |
|
|
Delinquency Ratio |
|
|
Balance |
|
Percent of total |
|
|
Delinquency Ratio |
|
Greater than 80% LTV with no mortgage insurance |
|
$2,024 |
|
22 |
% |
|
10.94 |
% |
|
$2,146 |
|
21 |
% |
|
8.93 |
% |
Interest-only |
|
1,702 |
|
18 |
|
|
4.11 |
|
|
1,620 |
|
16 |
|
|
1.83 |
|
Greater than 80% LTV and interest-only |
|
415 |
|
4 |
|
|
7.55 |
|
|
493 |
|
5 |
|
|
5.36 |
|
Home Equity Portfolio
The home
equity portfolio is characterized by 82% of outstanding balances within the Bancorps Midwest footprint of Ohio, Michigan, Kentucky, Indiana and Illinois. The portfolio has an average FICO score of 736 as of December 31, 2008, comparable
with 734 at December 31, 2007 and 735 at December 31, 2006. Further detail on channel origination and state location is included in Table 30. The Bancorp stopped origination of brokered home equity during the fourth quarter of 2007. In
addition, management actively manages lines of credit and makes reductions in lending limits when it believes it is necessary based on FICO score deterioration and property devaluation.
Analysis of Nonperforming Assets
A summary of nonperforming assets is
included in Table 31. 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) restructured consumer loans which have not yet met
the requirements to be classified as a performing asset; 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 is 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 $3.0 billion at December 31, 2008, compared to
$1.1 billion at December 31, 2007 and $455 million at December 31, 2006. At December 31, 2008, $473 million of nonaccrual commercial loans were held-for-sale, consisting primarily of real estate secured loans in Michigan and
Florida, and were carried at the lower of cost or market. Excluding the held-for-sale nonaccrual loans, nonperforming assets as a percentage of total loans,
leases and other assets, including other real estate owned, as of December 31, 2008 was 2.96% compared to 1.32% as of December 31, 2007 and .61% as of December 31, 2006. The composition of nonaccrual credits continues to be
concentrated in real estate as 82% of nonaccrual credits were secured by real estate as of December 31, 2008 compared to approximately 84% as of December 31, 2007 and approximately 45% as of December 31, 2006.
Including the $473 million of nonperforming loans held-for-sale, commercial nonperforming loans and leases increased from $672 million
at December 31, 2007 to $1.9 billion as of December 31, 2008. The majority of the increase was driven by the real estate and construction industries in the states of Florida and Michigan. These states combined to represent 47% of total
commercial nonaccrual credits as of December 31, 2008. As shown in Table 27, the real estate and construction industries contributed to approximately three-fourths of the year-over-year increase in nonaccrual credits. Of the $1.3 billion of
real estate and construction nonaccrual credits, $581 million is related to homebuilders or developers. As of December 31, 2008, $247 million of these homebuilder nonaccrual loans were specifically reviewed and the Bancorp provided $104 million
in reserves held against these loans. For additional information on credit reserves, see the discussion on allowance for credit losses later in this section.
Consumer nonperforming loans and leases increased from $221 million as of December 31, 2007 to $864 million as of December 31, 2008. The increase in consumer nonperforming loans is
primarily attributable to declines in the housing markets in the Michigan and Florida markets and the restructuring of certain loans. Michigan and Florida accounted for 58% of the increase in consumer nonperforming assets and, as of
December 31, 2008, represented 58% of total consumer nonperforming assets. The Bancorp has devoted significant attention to loss mitigation activities and has proactively restructured certain loans. Consumer restructured loans are recorded as
nonperforming loans until there is a sustained period of payment by the borrower, generally a minimum of six months of payments in accordance
TABLE 30: HOME EQUITY OUTSTANDINGS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retail |
|
|
|
|
Broker |
|
|
|
2008 |
|
|
2007 |
|
|
|
|
2008 |
|
|
2007 |
|
As of December 31 ($ in millions) |
|
Outstanding |
|
Delinquency Ratio |
|
|
Outstanding |
|
Delinquency Ratio |
|
|
|
|
Outstanding |
|
Delinquency Ratio |
|
|
Outstanding |
|
Delinquency Ratio |
|
Ohio |
|
$3,393 |
|
1.49 |
% |
|
$3,280 |
|
1.23 |
% |
|
|
|
$568 |
|
3.65 |
% |
|
$632 |
|
3.15 |
% |
Michigan |
|
2,245 |
|
2.24 |
|
|
2,158 |
|
1.63 |
|
|
|
|
484 |
|
5.51 |
|
|
530 |
|
3.56 |
|
Illinois |
|
1,147 |
|
2.10 |
|
|
908 |
|
1.18 |
|
|
|
|
261 |
|
4.93 |
|
|
274 |
|
2.66 |
|
Indiana |
|
968 |
|
2.07 |
|
|
991 |
|
1.67 |
|
|
|
|
244 |
|
4.59 |
|
|
278 |
|
3.16 |
|
Kentucky |
|
910 |
|
1.52 |
|
|
885 |
|
1.16 |
|
|
|
|
185 |
|
4.43 |
|
|
217 |
|
3.09 |
|
Florida |
|
909 |
|
4.13 |
|
|
738 |
|
2.37 |
|
|
|
|
77 |
|
12.16 |
|
|
89 |
|
7.97 |
|
All other states |
|
804 |
|
2.11 |
|
|
204 |
|
1.06 |
|
|
|
|
557 |
|
6.29 |
|
|
659 |
|
3.73 |
|
Total |
|
$10,376 |
|
2.06 |
% |
|
$9,164 |
|
1.45 |
% |
|
|
|
$2,376 |
|
5.22 |
% |
|
$2,679 |
|
3.48 |
% |
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
|
|
|
|
|
|
|
|
|
|
|
TABLE 31: SUMMARY OF NONPERFORMING ASSETS AND DELINQUENT LOANS |
As of December 31 ($ in millions) |
|
2008 |
|
|
2007 |
|
2006 |
|
2005 |
|
2004 |
Nonaccrual loans and leases: |
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
$541 |
|
|
175 |
|
127 |
|
140 |
|
105 |
Commercial mortgage loans |
|
482 |
|
|
243 |
|
84 |
|
51 |
|
51 |
Commercial construction loans |
|
362 |
|
|
249 |
|
54 |
|
31 |
|
13 |
Commercial leases |
|
21 |
|
|
5 |
|
6 |
|
5 |
|
5 |
Residential mortgage loans |
|
259 |
|
|
92 |
|
38 |
|
30 |
|
24 |
Home equity (a) |
|
26 |
|
|
45 |
|
40 |
|
|
|
|
Automobile loans (a) |
|
5 |
|
|
3 |
|
3 |
|
|
|
|
Other consumer loans and leases (a) |
|
- |
|
|
1 |
|
- |
|
37 |
|
30 |
Restructured loans and leases: |
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
- |
|
|
- |
|
- |
|
- |
|
1 |
Residential mortgage loans |
|
342 |
|
|
29 |
|
- |
|
- |
|
- |
Home equity |
|
196 |
|
|
46 |
|
- |
|
- |
|
- |
Automobile loans |
|
6 |
|
|
- |
|
- |
|
- |
|
- |
Credit card |
|
30 |
|
|
5 |
|
- |
|
- |
|
- |
Total nonperforming loans and leases |
|
2,270 |
|
|
893 |
|
352 |
|
294 |
|
229 |
Repossessed personal property and other real estate owned |
|
230 |
|
|
171 |
|
103 |
|
67 |
|
74 |
Total nonperforming assets (b) |
|
2,500 |
|
|
1,064 |
|
455 |
|
361 |
|
303 |
Nonaccrual loans held for sale |
|
473 |
|
|
- |
|
- |
|
- |
|
- |
Total nonperforming assets including loans held for sale |
|
$2,973 |
|
|
1,064 |
|
455 |
|
361 |
|
303 |
Commercial loans |
|
$76 |
|
|
44 |
|
38 |
|
20 |
|
21 |
Commercial mortgage loans |
|
136 |
|
|
73 |
|
17 |
|
7 |
|
8 |
Commercial construction loans |
|
74 |
|
|
67 |
|
6 |
|
7 |
|
5 |
Commercial leases |
|
4 |
|
|
4 |
|
2 |
|
1 |
|
1 |
Residential mortgage loans (c) |
|
198 |
|
|
186 |
|
68 |
|
53 |
|
43 |
Home equity |
|
96 |
|
|
72 |
|
51 |
|
|
|
|
Automobile loans |
|
21 |
|
|
13 |
|
11 |
|
|
|
|
Credit card |
|
56 |
|
|
31 |
|
16 |
|
10 |
|
13 |
Other consumer loans and leases |
|
1 |
|
|
1 |
|
1 |
|
57 |
|
51 |
Total 90 days past due loans and leases |
|
$662 |
|
|
491 |
|
210 |
|
155 |
|
142 |
Nonperforming assets as a percent of total loans, leases and other assets, including other real estate owned (b) |
|
2.96 |
% |
|
1.32 |
|
.61 |
|
.52 |
|
.51 |
Allowance for loan and lease losses as a percent of nonperforming assets (b) |
|
111 |
|
|
88 |
|
170 |
|
206 |
|
235 |
(a) |
Prior to 2006, other consumer loans and leases include home equity, automobile and other consumer loans and leases. |
(b) |
Does not include nonaccrual loans held for sale. |
(c) |
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, 2008, 2007, 2006 and 2005, these advances were $40 million, $25 million, $14 million and $13 million, respectively.
Information in 2004 was not available. |
with the loans modified terms. Consumer restructured loans contributed $574 million to nonperforming loans as of December 31, 2008 compared to $80 million in restructured loans as of
December 31, 2007.
Included in nonaccrual loans and leases as of December 31, 2008 were $342 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 2008 and 2007, interest income of $70 million and $22 million,
respectively, was recorded on nonaccrual and renegotiated loans and leases. For the years ended 2008 and 2007, additional interest income of $282 million and $144 million, respectively, would have been recorded if the nonaccrual and renegotiated
loans and leases had been current in accordance with the original terms. Although this value helps demonstrate the costs of carrying nonaccrual credits, the Bancorp does not expect to recover the full amount of interest as nonaccrual loans and
leases are generally carried below their principal balance.
Analysis of Net Loan Charge-offs
Net charge-offs as a percent of average loans and leases were 323 bp for 2008, compared to 61 bp for 2007. Table 32 provides a summary of credit loss
experience and net charge-offs as a percentage of average loans and leases outstanding by loan category.
The ratio of
commercial loan net charge-offs to average commercial loans outstanding increased to 399 bp in 2008 compared to 43 bp in 2007, as homebuilders, developers and related suppliers were affected by the downturn in the real estate markets. Commercial net
charge-offs include $800 million due to the sale or transfer to held-for-sale of $1.3 billion in commercial loan balances during the fourth quarter.
Homebuilders and developers net charge-offs for 2008 were $812 million, or 40% of total commercial charge-offs. Excluding the homebuilder and developer
portfolio, the commercial loan charge-offs to average commercial loans outstanding was 252 bp in 2008 with the most stress exhibited in the Eastern Michigan and South Florida regions and among auto dealers.
The ratio of consumer loan net charge-offs to average consumer loans outstanding increased to 208 bp in 2008 compared to 84 bp in 2007.
Residential mortgage charge-offs increased to $243 million in 2008 compared to $43 million in 2007, reflecting increased foreclosure rates in the Bancorps key lending markets coupled with an increase in severity of loss on mortgage loans.
Florida, Michigan and Ohio continue to rank among the top states in total mortgage foreclosures. These foreclosures not only added to the volume of charge-offs, but also hampered the Bancorps ability to recover the value of the homes
collateralizing the mortgages as they contributed to declining home prices. Florida affiliates continue to experience the most stress and accounted for over half of the residential mortgage charge-offs in 2008. Home equity charge-offs increased to
$205 million and 167 bp of average loans and continue to display distinct charge-off differences between lines and loans originated through the retail channel and those originated through brokered channels. Brokered home equity represented 50% of
home equity charge-offs during 2008 despite representing only 19% of home equity lines and loans as of December 31, 2008. Excluding home equity lines and loans originated through brokered channels, home equity charge-offs to average home equity
were 104 bp. Management responded to the performance of the brokered
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TABLE 32: SUMMARY OF CREDIT LOSS EXPERIENCE |
|
For the years ended December 31 ($ in millions) |
|
2008 |
|
|
2007 |
|
|
2006 |
|
|
2005 |
|
|
2004 |
|
Losses charged off: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
$(667 |
) |
|
(121 |
) |
|
(131 |
) |
|
(99 |
) |
|
(95 |
) |
Commercial mortgage loans |
|
(618 |
) |
|
(46 |
) |
|
(27 |
) |
|
(13 |
) |
|
(14 |
) |
Commercial construction loans |
|
(750 |
) |
|
(29 |
) |
|
(7 |
) |
|
(5 |
) |
|
(7 |
) |
Commercial leases |
|
- |
|
|
(1 |
) |
|
(4 |
) |
|
(38 |
) |
|
(8 |
) |
Residential mortgage loans |
|
(243 |
) |
|
(43 |
) |
|
(23 |
) |
|
(19 |
) |
|
(15 |
) |
Home equity |
|
(212 |
) |
|
(106 |
) |
|
(65 |
) |
|
(60 |
) |
|
(52 |
) |
Automobile loans |
|
(168 |
) |
|
(117 |
) |
|
(87 |
) |
|
(63 |
) |
|
(56 |
) |
Credit card |
|
(101 |
) |
|
(54 |
) |
|
(36 |
) |
|
(46 |
) |
|
(35 |
) |
Other consumer loans and leases |
|
(32 |
) |
|
(27 |
) |
|
(28 |
) |
|
(30 |
) |
|
(39 |
) |
Total losses |
|
(2,791 |
) |
|
(544 |
) |
|
(408 |
) |
|
(373 |
) |
|
(321 |
) |
Recoveries of losses previously charged off: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
18 |
|
|
12 |
|
|
24 |
|
|
24 |
|
|
14 |
|
Commercial mortgage loans |
|
5 |
|
|
2 |
|
|
3 |
|
|
3 |
|
|
5 |
|
Commercial construction loans |
|
2 |
|
|
- |
|
|
- |
|
|
1 |
|
|
- |
|
Commercial leases |
|
1 |
|
|
1 |
|
|
5 |
|
|
1 |
|
|
1 |
|
Residential mortgage loans |
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
Home equity |
|
7 |
|
|
9 |
|
|
9 |
|
|
10 |
|
|
10 |
|
Automobile loans |
|
34 |
|
|
32 |
|
|
30 |
|
|
18 |
|
|
18 |
|
Credit card |
|
7 |
|
|
8 |
|
|
5 |
|
|
5 |
|
|
6 |
|
Other consumer loans and leases |
|
7 |
|
|
18 |
|
|
16 |
|
|
12 |
|
|
15 |
|
Total recoveries |
|
81 |
|
|
82 |
|
|
92 |
|
|
74 |
|
|
69 |
|
Net losses charged off: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
(649 |
) |
|
(109 |
) |
|
(107 |
) |
|
(75 |
) |
|
(81 |
) |
Commercial mortgage loans |
|
(613 |
) |
|
(44 |
) |
|
(24 |
) |
|
(10 |
) |
|
(9 |
) |
Commercial construction loans |
|
(748 |
) |
|
(29 |
) |
|
(7 |
) |
|
(4 |
) |
|
(7 |
) |
Commercial leases |
|
1 |
|
|
- |
|
|
1 |
|
|
(37 |
) |
|
(7 |
) |
Residential mortgage loans |
|
(243 |
) |
|
(43 |
) |
|
(23 |
) |
|
(19 |
) |
|
(15 |
) |
Home equity |
|
(205 |
) |
|
(97 |
) |
|
(56 |
) |
|
(50 |
) |
|
(42 |
) |
Automobile loans |
|
(134 |
) |
|
(85 |
) |
|
(57 |
) |
|
(45 |
) |
|
(38 |
) |
Credit card |
|
(94 |
) |
|
(46 |
) |
|
(31 |
) |
|
(41 |
) |
|
(29 |
) |
Other consumer loans and leases |
|
(25 |
) |
|
(9 |
) |
|
(12 |
) |
|
(18 |
) |
|
(24 |
) |
Total net losses charged off |
|
$(2,710 |
) |
|
(462 |
) |
|
(316 |
) |
|
(299 |
) |
|
(252 |
) |
Net charge-offs as a percent of average loans and leases (excluding held for sale): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
2.31 |
% |
|
.49 |
|
|
.53 |
|
|
.41 |
|
|
.54 |
|
Commercial mortgage loans |
|
4.80 |
|
|
.40 |
|
|
.25 |
|
|
.10 |
|
|
.12 |
|
Commercial construction loans |
|
12.80 |
|
|
.51 |
|
|
.11 |
|
|
.08 |
|
|
.17 |
|
Commercial leases |
|
(.02 |
) |
|
.01 |
|
|
(.03 |
) |
|
1.06 |
|
|
.21 |
|
Total commercial loans and leases |
|
3.99 |
|
|
.43 |
|
|
.34 |
|
|
.35 |
|
|
.35 |
|
Residential mortgage loans |
|
2.47 |
|
|
.48 |
|
|
.27 |
|
|
.23 |
|
|
.25 |
|
Home equity |
|
1.67 |
|
|
.82 |
|
|
.46 |
|
|
.44 |
|
|
.44 |
|
Automobile loans |
|
1.56 |
|
|
.83 |
|
|
.60 |
|
|
.53 |
|
|
.48 |
|
Credit card |
|
5.51 |
|
|
3.55 |
|
|
3.65 |
|
|
5.65 |
|
|
3.92 |
|
Other consumer loans and leases |
|
2.10 |
|
|
.83 |
|
|
.91 |
|
|
1.06 |
|
|
.98 |
|
Total consumer loans and leases |
|
2.08 |
|
|
.84 |
|
|
.55 |
|
|
.57 |
|
|
.56 |
|
Total net losses charged off |
|
3.23 |
% |
|
.61 |
|
|
.44 |
|
|
.45 |
|
|
.45 |
|
home equity portfolio by reducing originations in 2007 of this product by 64% compared to 2006 and, at the end of 2007, eliminating this channel of origination. In addition, management actively manages lines of credit
and makes reductions in lending limits when it believes it is necessary based on FICO score deterioration and property devaluation. The ratio of automobile loan net charge-offs to average automobile loans was 156 bp for 2008, an increase of 73 bp
compared to 2007 displaying an expected increase due to a shift in the portfolio to a higher percentage of used automobiles and an increase in loss severity due to increased market depreciation of used automobiles. The net charge-off ratio on credit
card balances was 551 bp in 2008. Increases in the charge-off ratio over the previous two years reflects seasoning in the credit card portfolio and general economic conditions compared to 2007 and for 2006, due to increased personal bankruptcies in
2005 in anticipation of the changes in bankruptcy law. Management expects trends in the charge-off ratio on credit card balances to be consistent with general economic trends, such as unemployment and personal bankruptcy filings. The Bancorp employs
a risk-adjusted pricing methodology to help ensure adequate compensation is received for those products that have higher credit costs.
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 an 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. More information on the allowance for loan and lease losses can be found in the Critical Accounting Policies section of Managements Discussion and Analysis of Financial Condition and
Results of Operations.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
|
|
|
|
|
|
|
|
|
|
TABLE 33: CHANGES IN ALLOWANCE FOR CREDIT LOSSES |
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2008 |
|
2007 |
|
2006 |
|
2005 |
|
2004 |
Balance, beginning of year |
|
$1,032 |
|
847 |
|
814 |
|
785 |
|
770 |
Net losses charged off |
|
(2,710) |
|
(462) |
|
(316) |
|
(299) |
|
(252) |
Provision for loan and lease losses |
|
4,560 |
|
628 |
|
343 |
|
330 |
|
268 |
Net change in reserve for unfunded commitments |
|
100 |
|
19 |
|
6 |
|
(2) |
|
(1) |
Balance, end of year |
|
$2,982 |
|
1,032 |
|
847 |
|
814 |
|
785 |
Components of allowance for credit losses: |
|
|
|
|
|
|
|
|
|
|
Allowance for loan and lease losses |
|
$2,787 |
|
937 |
|
771 |
|
744 |
|
713 |
Reserve for unfunded commitments |
|
195 |
|
95 |
|
76 |
|
70 |
|
72 |
Total allowance for credit losses |
|
$2,982 |
|
1,032 |
|
847 |
|
814 |
|
785 |
In 2008, the Bancorp has not substantively changed any material aspect of 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 recorded in other liabilities in the Consolidated Balance Sheets. 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 in the Consolidated Statements of Income.
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 the 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 impaired commercial credits above specified thresholds and other qualitative
adjustments. Approximately 81% of the required reserves come from the baseline historical loss rates, specific reserve estimates and current credit grades; while 19% 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. The unallocated allowance as a percent of total portfolio loans and leases for the year ended
December 31, 2008 was .33%, or 10% of the total allowance, compared to .06%, or 5% of the total allowance, as of December 31, 2007. The increase in the unallocated allowance compared to the prior year was a
result of the steep decline in real estate prices, market volatility in the second half of 2008 and economic deterioration in some of the Bancorps
lending markets, for which the deterioration had not yet been captured in the historical loss rates and where the extent of deterioration cannot be determined.
As shown in Table 34, the allowance for loan and lease losses as a percent of the total loan and lease portfolio increased to 3.31% at December 31, 2008, compared to 1.17% at
December 31, 2007. Total allowance for loan and lease losses totaled $2.8 billion and $937 million as of December 31, 2008 and 2007, respectively. This increase is reflective of a number of factors including: the increase in commercial
impaired loans which are individually reviewed and allowed for, increased estimated loss factors due to negative trends in overall delinquencies, increased loss estimates once a loan becomes delinquent due to deterioration in the real estate
collateral values in some of the Bancorps key lending markets and declines in general economic conditions that are used to determine an economic factor adjustment. These factors were the primary drivers of the increased reserve amounts for
most of the Bancorps loan categories.
Impaired commercial loans increased to $1.5 billion as of December 31,
2008 compared to $494 million as of December 31, 2007. Impaired commercial loans above specified thresholds require individual review to determine loan and lease reserves. In addition to the increased volume of impaired commercial loans,
required loan and lease reserves on these loans were generally higher due to the deterioration in collateral values.
Delinquency trends have increased across most product lines and credit grades, leading to increases in expected loss rates and, therefore, increased reserve requirements for those products. In
|
|
|
|
|
|
|
|
|
|
|
|
TABLE 34: ATTRIBUTION OF ALLOWANCE FOR LOAN AND LEASE LOSSES TO PORTFOLIO LOANS AND LEASES |
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31 ($ in millions) |
|
2008 |
|
|
2007 |
|
2006 |
|
|