Form 10-K
Table of Contents

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2009 ANNUAL REPORT

FINANCIAL CONTENTS

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  

Selected Financial Data

   14

Overview

   15

Non-GAAP Financial Measures

   17

Critical Accounting Policies

   18

Risk Factors

   21

Statements of Income Analysis

   26

Business Segment Review

   32

Fourth Quarter Review

   37

Balance Sheet Analysis

   39

Risk Management

   43

Off-Balance Sheet Arrangements

   60

Contractual Obligations and Other Commitments

   61

Management’s Assessment as to the Effectiveness of Internal Control over Financial Reporting

   62

Reports of Independent Registered Public Accounting Firm

   63

Financial Statements

  

Consolidated Balance Sheets

   64

Consolidated Statements of Income

   65

Consolidated Statements of Changes in Shareholders’ Equity

   66

Consolidated Statements of Cash Flows

   67

Notes to Consolidated Financial Statements

  

Summary of Significant Accounting and Reporting Policies

   68

Supplemental Cash Flow Information

   74

Business Combinations and Asset Acquisitions

   74

Restrictions on Cash and Dividends

   75

Securities

   75

Loans and Leases and Allowance for Loan and Lease Losses

   77

Loans with Deteriorated Credit Quality Acquired in a Transfer

   78

Bank Premises and Equipment

   79

Goodwill

   79

Intangible Assets

   80

Sales of Receivables and Servicing Rights

   80

Derivatives

   83

Other Assets

   87

Short-Term Borrowings

   88

Long-Term Debt

   89

 

  

Commitments, Contingent Liabilities and Guarantees

   90

Legal and Regulatory Proceedings

   93

Processing Business Sale

   93

Related Party Transactions

   93

Income Taxes

   94

Retirement and Benefit Plans

   96

Accumulated Other Comprehensive Income

   98

Common, Preferred and Treasury Stock

   99

Stock-Based Compensation

   100

Other Noninterest Income and Other Noninterest Expense

   102

Earnings Per Share

   103

Fair Value Measurements

   104

Certain Regulatory Requirements and Capital Ratios

   109

Parent Company Financial Statements

   110

Segments

   111

Annual Report on Form 10-K

   114

Consolidated Ten Year Comparison

   129

Directors and Officers

   130

Corporate Information

  

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 Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 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 “will likely result,” “may,” “are expected to,” “is anticipated,” “estimate,” “forecast,” “projected,” “intends to,” or may include other similar words or phrases such as “believes,” “plans,” “trend,” “objective,” “continue,” “remain,” or similar expressions, or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” or similar verbs. 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 nationally 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 Third’s ability to maintain required capital levels and adequate sources of funding and liquidity; (7) maintaining capital requirements may limit Fifth Third’s 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 Third’s 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 separating Fifth Third Processing Solutions from Fifth Third; (21) loss of income from any sale or potential sale of businesses that could have an adverse effect on Fifth Third’s earnings and future growth; (22) ability to secure confidential information through the use of computer systems and telecommunications networks; and (23) the impact of reputational risk created by these developments on such matters as business generation and retention, funding and liquidity.


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is management’s discussion and analysis (MD&A) of certain significant factors that have affected Fifth Third Bancorp’s (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 filing. Reference to the Bancorp incorporates the parent holding company and all consolidated subsidiaries.

 

TABLE 1: SELECTED FINANCIAL DATA              

For the years ended December 31 ($ in millions, except per share data)

   2009      2008    2007    2006    2005

Income Statement Data

             

Net interest income (a)

   $3,373      3,536    3,033    2,899    2,996

Noninterest income

   4,782      2,946    2,467    2,012    2,374

Total revenue (a)

   8,155      6,482    5,500    4,911    5,370

Provision for loan and lease losses

   3,543      4,560    628    343    330

Noninterest expense

   3,826      4,564    3,311    2,915    2,801

Net income (loss)

   737      (2,113)    1,076    1,188    1,549

Net income (loss) available to common shareholders

   511      (2,180)    1,075    1,188    1,548

Common Share Data

             

Earnings per share, basic (b)

   $.73      (3.91)    1.99    2.13    2.79

Earnings per share, diluted (b)

   .67      (3.91)    1.98    2.12    2.77

Cash dividends per common share

   .04      .75    1.70    1.58    1.46

Market value per share

   9.75      8.26    25.13    40.93    37.72

Book value per share

   12.44      13.57    17.18    18.00    16.98

Financial Ratios

             

Return on assets

   .64   (1.85)    1.05    1.13    1.50

Return on average common equity

   5.6      (23.0)    11.2    12.1    16.6

Average equity as a percent of average assets

   11.36      8.78    9.35    9.32    9.06

Tangible equity (c)

   9.71      7.86    6.05    7.79    6.87

Tangible common equity (d)

   6.45      4.23    6.14    7.95    7.22

Net interest margin (a)

   3.32      3.54    3.36    3.06    3.23

Efficiency (a)

   46.9      70.4    60.2    59.4    52.1

Credit Quality

             

Net losses charged off

   $2,581      2,710    462    316    299

Net losses charged off as a percent of average loans and leases

   3.20   3.23    .61    .44    .45

Allowance for loan and lease losses as a percent of loans and leases

   4.88      3.31    1.17    1.04    1.06

Allowance for credit losses as a percent of loans and leases (e)

   5.27      3.54    1.29    1.14    1.16

Nonperforming assets as a percent of loans, leases and other assets, including other real estate owned (f)(g)

   4.22      2.38    1.25    .61    .52

Average Balances

             

Loans and leases, including held for sale

   $83,391      85,835    78,348    73,493    67,737

Total securities and other short-term investments

   18,135      14,045    12,034    21,288    24,999

Total assets

   114,856      114,296    102,477    105,238    102,876

Transaction deposits (h)

   55,235      52,680    50,987    49,678    48,177

Core deposits (i)

   69,338      63,815    61,765    60,178    56,668

Wholesale funding (j)

   28,539      36,261    27,254    31,691    33,615

Shareholders’ equity

   13,053      10,038    9,583    9,811    9,317

Regulatory Capital Ratios

             

Tier I capital

   13.31   10.59    7.72    8.39    8.35

Total risk-based capital

   17.48      14.78    10.16    11.07    10.42

Tier I leverage

   12.43      10.27    8.50    8.44    8.08

Tier I common equity

   7.00      4.37    5.72    8.22    8.17
(a) Amounts presented on a fully taxable equivalent basis (FTE). The taxable equivalent adjustments for years ended December 31, 2009, 2008, 2007, 2006 and 2005 were $19 million, $22 million, $24 million, $26 million and $31 million, respectively.
(b) See Note 1 of the Notes to Consolidated Financial Statements for further information.
(c) The tangible equity ratio is calculated as tangible equity (shareholders’ equity less goodwill, intangible assets and accumulated other comprehensive income) divided by tangible assets (total assets less goodwill, intangible assets and tax effected accumulated other comprehensive income.). For further information, see the Non-GAAP Financial Measures section of the MD&A
(d) The tangible common equity ratio is calculated as tangible common equity (shareholders’ equity less preferred stock, goodwill, intangible assets and accumulated other comprehensive income) divided by tangible assets (defined above.) For further information, see the Non-GAAP Financial Measures section of the MD&A.
(e) The allowance for credit losses is the sum of the allowance for loan and lease losses and the reserve for unfunded commitments.
(f) Excludes nonaccrual loans held for sale.
(g) The Bancorp modified its nonaccrual policy in 2009 to exclude consumer troubled debt restructuring (TDR) loans less than 90 days past due as they were performing in accordance with restructuring terms. For comparability purposes, prior periods were adjusted to reflect this reclassification.
(h) Includes demand, interest checking, savings, money market and foreign office deposits.
(i) Includes transaction deposits plus other time deposits.
(j) Includes certificates $100,000 and over, other foreign office deposits, federal funds purchased, short-term borrowings and long-term debt.

 

TABLE 2: QUARTERLY INFORMATION (unaudited)
     2009         2008

For the three months ended ($ in millions, except per share data)

   12/31    9/30    6/30    3/31         12/31    9/30    6/30    3/31

Net interest income (FTE)

   $882    874    836    781       $897    1,068    744    826

Provision for loan and lease losses

   776    952    1,041    773       2,356    941    719    544

Noninterest income

   651    851    2,583    697       642    717    722    864

Noninterest expense

   967    876    1,021    962       2,022    967    858    715

Net income (loss)

   (98)    (97)    882    50       (2,142)    (56)    (202)    286

Net income (loss) available to common shareholders

   (160)    (159)    856    (26)       (2,184)    (81)    (202)    286

Earnings per share, basic (a)

   (.20)    (.20)    1.35    (.04)       (3.78)    (.14)    (.37)    .54

Earnings per share, diluted (a)

   (.20)    (.20)    1.15    (.04)         (3.78)    (.14)    (.37)    .54

 

(a) See Note 1 of the Notes to Consolidated Financial Statements for further information.

 

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Fifth Third Bancorp

 


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

OVERVIEW

 

This overview of management’s 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 Bancorp’s financial condition, results of operations and cash flows.

The Bancorp is a diversified financial services company headquartered in Cincinnati, Ohio. At December 31, 2009, the Bancorp had $113 billion in assets, operated 16 affiliates with 1,309 full-service Banking Centers including 103 Bank Mart® locations open seven days a week inside select grocery stores and 2,358 Jeanie® ATMs in the Midwestern and Southeastern regions of the United States. The Bancorp reports on four business segments: Commercial Banking, Branch Banking, Consumer Lending 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. The Bancorp believes 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 Bancorp’s revenues are dependent on both net interest income and noninterest income. For the year ended December 31, 2009, net interest income, on a fully taxable equivalent (FTE) basis, and noninterest income provided 41% and 59% 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 weakened economy within the Bancorp’s footprint.

Net interest income, net interest margin and the efficiency ratio are presented in Management’s 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 service charges on deposits, mortgage banking revenue, corporate banking revenue, fiduciary and investment management fees and card and processing revenue. Noninterest expense is primarily driven by personnel costs and occupancy expenses, costs incurred in the origination of loans and leases, and insurance expenses paid to the Federal Depository Insurance Corporation (FDIC).

On June 30, 2009, the Bancorp completed the sale (hereinafter the “Processing Business Sale”) of a majority interest in its merchant acquiring and financial institutions processing business. As a result of the sale, the Bancorp recognized a pre-tax gain of approximately $1.8 billion. Under the terms of the sale, Advent International acquired an approximate 51% interest in the business. The Bancorp accounts for the retained noncontrolling interest in the business under the equity method of accounting.

Earnings Summary

During 2009, the Bancorp continued to be affected by a challenging credit environment and the continued economic slowdown. The Bancorp’s net income available to common shareholders was $511 million, or $0.67 per diluted share, which included $226 million in preferred stock dividends. The Bancorp’s net loss available to common shareholders was $2.2 billion, or $3.91 per diluted share, for 2008, which included $67 million in preferred stock dividends. The Bancorp’s results for both years reflect a number of significant items.

Such items affecting 2009 include:

   

$1.8 billion of noninterest income from the Processing Business Sale to Advent International;

   

$244 million of noninterest income from the sale of the Bancorp’s Visa, Inc. Class B common shares and a $73 million reduction to noninterest expense from the release of Visa litigation reserves;

   

$136 million of net interest income due to the accretion of purchase accounting adjustments related to loans and deposits from acquisitions during 2008;

   

$106 million income tax benefit from the decision to surrender one of the Bancorp’s bank owned life insurance (BOLI) policies and the determination that previously recorded losses on the policy are now tax deductible;

   

$55 million of noninterest expense from a special assessment by the FDIC;

   

$55 million income tax benefit from an agreement with the Internal Revenue Service (IRS) to settle all of the Bancorp’s disputed leverage leases for all open years;

   

$53 million in charges to other noninterest income reflecting reserves recorded in connection with the intent to surrender one of the Bancorp’s BOLI policies as well as losses related to market value declines;

   

$35 million increase to net income available to common shareholders from the exchange of 63% of outstanding Series G preferred shares for approximately 60 million common shares and $230 million in cash; and

   

Preferred stock dividends of $226 million in 2009 compared to $67 million in 2008 due to the issuance of senior preferred stock and related warrants on December 31, 2008 to the U.S. Department of Treasury (U.S. Treasury) under the Capital Purchase Program (CPP) in exchange for $3.4 billion in cash.


 

 

Fifth Third Bancorp

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

For comparison purposes, such items affecting 2008 include:

   

$965 million of noninterest expense due to a goodwill impairment charge;

   

$358 million of net interest income due to the accretion of purchase accounting adjustments related to loans and deposits from acquisitions during 2008;

   

$273 million of other noninterest income related to the redemption of a portion of Fifth Third’s ownership interests in Visa, Inc. and $99 million in net reductions to noninterest expense to reflect the recognition of the Bancorp’s proportional share of the Visa escrow account;

   

$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;

   

$215 million reduction to other noninterest income to reflect a decline in the cash surrender value of one of the Bancorp’s BOLI policies;

   

$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; and

   

$76 million of other noninterest income, partially offset by $36 million in related litigation expense, due to the successful resolution of a prior court case.

Net interest income (FTE) decreased to $3.4 billion, from $3.5 billion in 2008. The primary reason for the five percent decrease in net interest income was a 21 basis point (bp) decline in the net interest rate spread. Additionally, the benefit from the accretion of purchase accounting adjustments related to the 2008 acquisition of First Charter was $136 million in 2009, compared to $358 million in 2008. Net interest margin was 3.32% in 2009, a decrease of 22 bp from 2008.

Noninterest income increased 62%, from $2.9 billion to $4.8 billion, in 2009, driven primarily by the Processing Business Sale in the second quarter of 2009, which resulted in a pre-tax gain of $1.8 billion, as well as a $244 million gain related to the sale of the Bancorp’s Visa, Inc. Class B shares and gains on mortgages sold. Mortgage banking net revenue increased $354 million resulting from strong growth in originations, which were up 89% to $21.7 billion in 2009 compared to $11.5 billion in 2008. Card and processing revenue decreased 33% due to the Processing Business Sale in the second quarter of 2009. Corporate banking revenue decreased 10% largely due to a lower volume of interest rate derivatives sales and foreign exchange revenue, partially offset by growth in institutional sales and business lending fees.

Noninterest expense decreased $738 million compared to 2008. Noninterest expense in 2008 included a $965 million charge due to goodwill impairment. Excluding this charge, noninterest expense increased $227 million due primarily to an increase of $196 million of FDIC insurance and other taxes as the result of an

increase in deposit insurance and participation in the Temporary Liquidity Guarantee Program (TLGP), as well as increased loan related expenses from higher mortgage origination volume and expenses incurred from the management of problem assets. These amounts were partially offset by lower card and processing expense due to the Processing Business Sale on June 30, 2009. In addition to the goodwill impairment charge, noninterest expense in 2008 included $36 million in litigation expenses due to the successful resolution of a prior court case, offset by a $99 million reduction to expenses related to the reversal of a portion of the Visa litigation reserve and Visa’s funding of an escrow account. For further information on the change in assessment rates during 2009, the FDIC special assessment in the second quarter of 2009 and the TLGP, see the noninterest expense section of Management’s Discussion and Analysis.

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. Throughout 2009, the Bancorp continued to be affected by rising unemployment rates, weakened housing markets, particularly in the upper Midwest and Florida, and a challenging credit environment. Credit trends began to show signs of stabilization in the fourth quarter of 2009 and, as a result, the provision for loan and lease losses decreased to $3.5 billion for the year ended December 31, 2009 compared to $4.6 billion during 2008. Net charge-offs as a percent of average loans and leases remained steady at 3.20% in 2009 compared to 3.23% in 2008. At December 31, 2009, nonperforming assets as a percent of loans, leases and other assets, including other real estate owned (excluding nonaccrual loans held for sale) increased to 4.22% from 2.38% at December 31, 2008. Refer to the Credit Risk Management section in Management’s Discussion and Analysis for more information on credit quality.

The Bancorp continued to take actions to strengthen its capital position in 2009. On June 4, 2009, the Bancorp completed an at-the-market offering resulting in the sale of $1 billion of its common shares at an average share price of $6.33. In addition, on June 17, 2009, the Bancorp completed its offer to exchange shares of its common stock and cash for shares of its Series G convertible preferred stock. As a result, the Bancorp recognized an increase in net income available to common shareholders of $35 million based upon the difference in carrying value of the Series G preferred shares and the fair value of the common shares and cash issued. See the Capital Management section of Management’s Discussion and Analysis for further information on the Bancorp’s capital transactions.

The Bancorp’s capital ratios exceed the “well-capitalized” guidelines as defined by the Board of Governors of the Federal Reserve System (FRB). As of December 31, 2009, the Tier 1 capital ratio was 13.31%, the Tier 1 leverage ratio was 12.43% and the total risk-based capital ratio was 17.48%.


 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

NON-GAAP FINANCIAL MEASURES

 

The Bancorp considers various measures when evaluating capital utilization and adequacy, including the tangible equity ratio and tangible common equity ratio, in addition to capital ratios defined by banking regulators. These calculations are intended to complement the capital ratios defined by banking regulators for both absolute and comparative purposes. Because accounting principles generally accepted in the United States of America (U.S. GAAP) do not include capital ratio measures, the Bancorp believes there are no comparable U.S. GAAP financial measures to these ratios.

The Bancorp believes these Non-GAAP measures are important because they reflect the level of capital available to withstand unexpected market conditions. Additionally,

presentation of these measures allows readers to compare certain aspects of the Bancorp’s capitalization to other organizations. However, because there are no standardized definitions for these ratios, the Bancorp’s calculations may not be comparable with other organizations, and the usefulness of these measures to investors may be limited. As a result, the Bancorp encourages readers to consider its Consolidated Financial Statements in their entirety and not to rely on any single financial measure.

The following table reconciles Non-GAAP financial measures to U.S. GAAP as of December 31:


TABLE 3: NON-GAAP FINANCIAL MEASURES             
($ in millions)    2009     2008  

Total shareholders’ equity

   $13,497      12,077   

Less:

    

Goodwill

   (2,417)      (2,624)   

Intangible assets

   (106)      (168)   

Accumulated other comprehensive income

   (241)      (98)   

Tangible equity (a)

   10,733      9,187   

Less: preferred stock

   (3,609)      (4,241)   

Tangible common equity (b)

   7,124      4,946   

Total assets

   113,380      119,764   

Less:

    

Goodwill

   (2,417)      (2,624)   

Intangible assets

   (106)      (168)   

Accumulated other comprehensive income, before tax

   (370)      (151)   

Tangible assets, excluding unrealized gains / losses (c)

   $110,487      116,821   

Ratios:

    

Tangible equity (a) / (c)

   9.71   7.86

Tangible common equity (b) / (c)

   6.45   4.23

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 2009 and 2008 and the expected impact of significant accounting standards issued, but not yet required to be adopted.

 

 

Fifth Third Bancorp

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

CRITICAL ACCOUNTING POLICIES

 

The Bancorp’s 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 Bancorp’s assets or liabilities and results of operations and cash flows. The Bancorp’s critical accounting policies 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 were made to the valuation techniques or models described below during the year ended December 31, 2009.

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 collectability 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 Bancorp’s review of the historical credit loss experience and such factors that, in management’s 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 Bancorp’s 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 management’s estimate of the borrower’s ability to repay the loan given the availability of collateral and other sources of cash flow, as well as evaluation of legal options available to the Bancorp. Any allowances for impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the fair value of the underlying collateral or readily observable secondary market values. The Bancorp evaluates the collectability of both principal and interest when assessing the need for a loss accrual. Historical 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 individual review. 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, revolving 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 management’s judgment, are necessary to reflect losses inherent in the portfolio. Factors that management considers in the analysis include the effects of the national and local economies; trends in the nature and volume of delinquencies, charge-offs and

nonaccrual loans; changes in loan mix; credit score migration comparisons; asset quality trends; risk management and loan administration; changes in the internal lending policies and credit standards; collection practices; and examination results from bank regulatory agencies and the Bancorp’s internal credit examiners.

The Bancorp’s 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 recorded at fair value as of the acquisition date. The Bancorp does not carry over the acquired company’s 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 Bancorp’s 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 Bancorp’s 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 historical loss rates based on credit grade migration. Net adjustments to the reserve for unfunded commitments are included in other noninterest expense in the Consolidated Statements of Income.

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 other assets and accrued taxes, interest and expenses, respectively 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 management’s judgment that realization is more-likely-than-not. This analysis is performed on a quarterly basis and includes an evaluation of all positive and negative evidence to determine whether 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


 

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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 period’s income tax expense and can be significant to the operating results of the Bancorp. For additional information on income taxes, see Note 20 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 mortgage 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. For additional information on servicing rights, see Note 11 of the Notes to Consolidated Financial Statements.

Fair Value Measurements

The Bancorp measures fair value in accordance with U.S. GAAP, which 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. Valuation techniques the Bancorp uses to measure fair value 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.

U.S. GAAP 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). An instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the instrument’s 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.

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 Bancorp’s 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 Bancorp’s own financial data such as internally developed pricing models and discounted cash flow methodologies, as well as instruments for which the fair value determination requires significant management judgment.

The Bancorp’s fair value measurements involve various valuation techniques and models, which involve inputs that are observable, when available, and include the following significant 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 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. Level 1 securities include government bonds and exchange traded equities. 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. Examples of such instruments, which would generally be classified within Level 2 of the valuation hierarchy, include corporate and municipal bonds, mortgage-backed securities, asset-backed securities and Variable Rate Demand Notes (VRDNs). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. Securities classified within Level 3 consist primarily of residual interests in securitizations of automobile loans. These residual interests are valued using discounted cash flow models that integrate significant unobservable inputs, including discount rates, prepayment speeds, and loss rates which are estimated based on actual performance of similar loans transferred in previous securitizations. Trading securities classified as Level 3 consist of auction rate securities. Due to the illiquidity in the market for these types of securities at December 31, 2009, the Bancorp measured fair value using a discount rate commensurate with the assumed holding period.


 

 

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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 or, for certain assets, discounted cash flow models that may incorporate the anticipated portfolio composition, credit spreads of asset-backed securities with similar collateral, and market conditions. Therefore, these loans are classified within Level 2 of the valuation 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 valued using discounted cash flow or other models that incorporate current market interest rates, credit spreads assigned to the derivative counterparties, and other market parameters. The majority of the Bancorp’s derivative positions are valued utilizing models that use as their basis readily observable market parameters and are classified within Level 2 of the valuation hierarchy. Such derivatives include basic and structured interest rate swaps and options. Derivatives that are valued based upon models with significant unobservable market parameters are classified within Level 3 of the valuation hierarchy. At December 31, 2009, derivatives classified as Level 3, which are valued using an option-pricing model containing unobservable inputs, consisted primarily of warrants and put rights associated with the Processing Business Sale and a total return swap associated with the Bancorp’s sale of its Visa, Inc. Class B shares. Level 3 derivatives also include interest rate lock commitments, which utilize internally generated loan closing rate assumptions as a significant unobservable input in the valuation process.

Valuation techniques and parameters used for measuring 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 assets and liabilities measured at fair value on a recurring basis, the Bancorp measures servicing rights, certain loans and long-lived assets at fair value on a nonrecurring basis. Refer to Note 27 of the Notes to Consolidated Financial Statements for further information on fair value measurements.

Goodwill

Business combinations entered into by the Bancorp typically include the acquisition of goodwill. U.S. GAAP requires goodwill to be tested for impairment at the Bancorp’s reporting unit level on an annual basis, which for the Bancorp is September 30, and more frequently if events or circumstances indicate that there may be impairment. The Bancorp has determined that its segments qualify as reporting units under U.S. GAAP. Impairment exists when a reporting unit’s 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. Since none of the Bancorp’s reporting units are publicly traded, individual reporting unit fair value determinations cannot be directly correlated to the Bancorp’s stock price. To determine the fair value of a reporting unit, the Bancorp employs an income-based approach, utilizing the reporting unit’s forecasted cash flows (including a terminal value approach to estimate cash flows beyond the final year of the forecast) and the reporting unit’s 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 Bancorp’s stock during the month including the measurement date, incorporating an additional control premium, and allocates this market-based fair value measurement to the Bancorp’s 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 unit’s 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. An impairment loss recognized cannot exceed the carrying amount of that goodwill and cannot be reversed even if the fair value of the reporting unit recovers.

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 9 of the Notes to Consolidated Financial Statements for further information regarding the Bancorp’s goodwill.


 

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RISK FACTORS

 

The risks listed here are not the only risks that Fifth Third faces. Additional risks that are not presently known or that Fifth Third presently deems to be immaterial could also have a material, adverse impact on our financial condition, the results of our operations, or our business.

RISKS RELATING TO ECONOMIC AND MARKET CONDITIONS

Weakness in the economy and in the real estate market, including specific weakness within Fifth Third’s 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 or does not improve in a reasonable time frame, this could result in, among other things, a deterioration in credit quality or a reduced demand for credit, including a resultant effect on Fifth Third’s loan portfolio and allowance for loan and lease losses and in the receipt of lower proceeds from the sale of loans and foreclosed properties. A significant portion of Fifth Third’s 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, greater charge-offs and increased losses on the sale of foreclosed real estate in future periods, which would materially adversely affect Fifth Third’s financial condition and results of operations.

Changes in interest rates could affect Fifth Third’s income and cash flows.

Fifth Third’s 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 Third’s 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.

Changes and trends in the capital markets may affect Fifth Third’s income and cash flows.

Fifth Third enters into and maintains trading and investment positions in the capital markets on its own behalf and manages investment positions on behalf of its customers. These investment positions include derivative financial instruments. The revenues and profits Fifth Third derives from managing proprietary and customer trading and investment positions are dependent on market prices. If Fifth Third does not correctly anticipate market changes and trends, Fifth Third may experience a decline in investment advisory revenue or investment or trading losses that may materially affect Fifth Third. 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 Third’s trading and investment positions could lead to a loss with respect to those investments and may adversely affect cash flows and funding costs.

The removal or reduction in stimulus activities sponsored by the Federal Government and its agents may have a negative impact on Fifth Third’s results and operations.

The Federal Government has intervened in an unprecedented manner to stimulate economic growth. Some of these activities have included the following:

   

Target fed funds rates which have remained close to zero percent;

   

Mortgage rates that have remained at historical lows in part due to the Federal Reserve Bank of New York’s $1.25 trillion mortgage-backed securities purchase program;

   

Bank funding that has remained stable through an increase in FDIC deposit insurance to a covered limit of $250,000 per account from the previous coverage limit of $100,000; and

   

Housing demand that has been stimulated by homebuyer tax credits.

The expiration or rescission of any of these programs may have an adverse impact on Fifth Third’s operating results by increasing interest rates, increasing the cost of funding, and reducing the demand for loan products, including mortgage loans.

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.

Fifth Third’s stock price is volatile.

Fifth Third’s stock price has been volatile in the past and several factors could cause the price to fluctuate substantially in the future. These factors include:

   

Actual or anticipated variations in earnings;

   

Changes in analysts’ recommendations or projections;

   

Fifth Third’s announcements of developments related to its businesses;

   

Operating and stock performance of other companies deemed to be peers;

   

Actions by government regulators;

   

New technology used or services offered by traditional and non-traditional competitors; and

   

News reports of trends, concerns and other issues related to the financial services industry.

Fifth Third’s stock price may fluctuate significantly in the future, and these fluctuations may be unrelated to Fifth Third’s 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.


 

 

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RISKS RELATING TO OUR GENERAL BUSINESS

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 credit conditions and the performance of its loan portfolio could deteriorate in the future. The downturn 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 dependent upon the real estate industry. If the performance of Fifth Third’s 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 Third’s credit portfolio could have a material adverse effect on earnings and results of operations.

Fifth Third must maintain adequate sources of funding and liquidity.

Fifth Third must maintain adequate funding sources in the normal course of business to support its operations and fund outstanding liabilities. Fifth Third’s ability to maintain 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.

If Fifth Third does not adjust to rapid changes in the financial services industry, its financial performance may suffer.

Fifth Third’s 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 Third’s 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.

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 Third’s 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 Third’s earnings and results of operations.

Fifth Third’s 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 Bancorp’s stock and interest and principal on its debt. Various federal and/or state laws and regulations limit the amount of dividends that Fifth Third’s bank and certain nonbank subsidiaries may pay. Also, Fifth Third Bancorp’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of that

subsidiary’s creditors. Limitations on Fifth Third Bancorp’s ability to receive dividends from its subsidiaries could have a material adverse effect on Fifth Third Bancorp’s liquidity and ability to pay dividends on stock or interest and principal on its debt.

The financial services industry is highly competitive and creates competitive pressures that could adversely affect Fifth Third’s 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, revenue generation, 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. Recently, 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 Third’s 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.

The Bancorp and/or the holders of its securities could be adversely affected by unfavorable ratings from rating agencies.

The Bancorp’s 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 the Bancorp, certain of its subsidiaries and particular classes of securities they issue. The interest rates that the Bancorp pays on its securities are also influenced by, among other things, the credit ratings that it, its subsidiaries and/or its securities receive from recognized rating agencies. A downgrade to the Bancorp’s, or its subsidiaries’, credit rating could affect its ability to access the capital markets, increase its borrowing costs and negatively impact its profitability. A ratings downgrade to the Bancorp, its subsidiaries or their securities could also create obligations or liabilities to the Bancorp under the terms of its outstanding securities that could increase the Bancorp’s costs or otherwise have a negative effect on the Bancorp’s results of operations or financial condition. Additionally, a downgrade of the credit rating of any particular security issued by the Bancorp or its subsidiaries 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. During 2009, Moody’s Investors Service downgraded the Bancorp’s issuer rating to “Baa1” from “A2” and downgraded the long term debt rating and deposit ratings for the Bancorp’s bank subsidiary to “A2” from “A1.” Standard & Poor’s Investors Service downgraded the Bancorp’s issuer rating to “BBB” from “A-” and downgraded the long term debt rating and deposit ratings for the Bancorp’s bank subsidiary to “BBB+” from “A.” DBRS Investors Service downgraded the Bancorp’s issuer rating to “A” from “AAL” and downgraded the long term debt rating and deposit ratings for the Bancorp’s bank subsidiary to “AH” from “AA.”

Fifth Third could suffer if it fails to attract and retain skilled personnel.

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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 Treasury Capital Purchase program (CPP), 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 Third’s 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. In 2009, the Federal Reserve issued a comprehensive proposal intended to ensure that a bank organization’s incentive compensation policies don’t encourage excessive risk taking. In addition, the FDIC recently issued a request for comments on whether banks with compensation plans that encourage excessive risk taking should be charged at higher deposit assessment rates than such banks would otherwise be charged. 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 Third’s performance, including its competitive position, could be materially adversely affected.

Fifth Third’s mortgage banking revenue can be volatile from quarter to quarter.

Fifth Third earns revenue from the fees Fifth Third receives for originating mortgage loans and for servicing mortgage loans. When rates rise, the demand for mortgage loans tends to fall, reducing the revenue Fifth Third receives from loan originations. At the same time, revenue from our mortgage servicing rights (MSRs) can increase through increases in fair value. When rates fall, mortgage originations tend to increase and the value of our MSRs tends to decline, also with some offsetting revenue effect. Even though they can act as a “natural hedge,” the hedge is not perfect, either in amount or timing. For example, the negative effect on revenue from a decrease in the fair value of residential MSRs is immediate, but any offsetting revenue benefit from more originations and the MSRs relating to the new loans would accrue over time. It is also possible that, because of the recession and deteriorating housing market, even if interest rates were to fall, mortgage originations may also fall or any increase in mortgage originations may not be enough to offset the decrease in the MSRs value caused by the lower rates.

    Fifth Third typically uses derivatives and other instruments to hedge our mortgage banking interest rate risk. Fifth Third generally does not hedge all of our risks, and the fact that Fifth Third attempts to hedge any of the risks does not mean Fifth Third will be successful. Hedging is a complex process, requiring sophisticated models and constant monitoring, and is not a perfect science. Fifth Third may use hedging instruments tied to U.S. Treasury rates, LIBOR or Eurodollars that may not perfectly correlate with the value or income being hedged. Fifth Third could incur significant losses from our hedging activities. There may be periods where Fifth Third elects not to use derivatives and other instruments to hedge mortgage banking interest rate risk.

The preparation of Fifth Third’s 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 Third’s 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 Third’s allowance for loan and lease losses is not adequate, Fifth Third’s 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 Third’s control. If Fifth Third’s litigation reserves are not adequate, Fifth Third’s 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 Third’s 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 Third’s 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 recasting of Fifth Third’s prior period financial statements.

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 Third’s 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.


 

 

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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. 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.

Material breaches in security of Fifth Third’s systems may have a significant effect on Fifth Third’s 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 as well as additional significant costs for privacy monitoring activities.

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, operating system disruptions or operational errors.

Negative public opinion can result from Fifth Third’s actual or alleged conduct in activities, such as lending practices, data security, corporate governance and acquisitions, and may damage Fifth Third’s reputation. Negative public opinion has been observed in relation to banks participating in the Treasury’s Troubled Asset Relief Program (TARP), in which Fifth Third was a participant. Should Fifth Third not be able to repay its TARP borrowing or make repayment subsequent to its regional peers, Fifth Third may be the focus of increased negative attention. Additionally, actions taken by government regulators and community organizations may also damage Fifth Third’s reputation. This negative public opinion can adversely affect Fifth Third’s ability to attract and keep customers and can expose it to litigation and regulatory action.

    Fifth Third’s 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 Third’s customers and result in a financial loss or liability.

The inability of FTPS to succeed as a stand-alone entity could have a negative impact on Fifth Third’s operating results and financial condition.

During the second quarter of 2009, Fifth Third sold an approximate 51% interest in Fifth Third Processing Solutions (FTPS) to Advent International. Prior to the sale, FTPS relied on Fifth Third to support its operating and administrative functions. Fifth Third has entered into agreements to provide FTPS certain services during the deconversion period. Fifth Third’s operating results may suffer if the cost of providing these services exceeds the amount received from FTPS. As part of the sale, FTPS also assumed loans owed Fifth Third. Repayment of these loans is contingent on future cash flows and profitability at FTPS.

In connection with the sale, Fifth Third provided Advent with certain put rights that are exercisable in the event of three unlikely circumstances. Based on Fifth Third’s current ownership share in FTPS of approximately 49%, FTPS is accounted for under the equity method and is not consolidated. The exercise of the put rights would result in FTPS becoming a wholly owned subsidiary of Fifth Third. As a result, FTPS would be consolidated and would subject Fifth Third to the risks inherent in integrating a business. Additionally, such a change in the accounting treatment for FTPS may adversely impact Fifth Third’s capital.

Weather related events or other natural disasters may have an effect on the performance of our loan portfolios, especially in our coastal markets, thereby adversely impacting our results of operations.

Fifth Third’s footprint stretches from the upper midwestern to lower southeastern regions of the United States. This area has experienced weather events including hurricanes and other natural disasters. The nature and level of these events and the impact of global climate change upon their frequency and severity cannot be predicted. If large scale events occur, they may significantly impact our loan portfolios by damaging properties pledged as collateral as well as impairing our borrower’s ability to repay their loans.

RISKS RELATED TO THE LEGAL AND REGULATORY ENVIRONMENT

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 Third’s 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 Third’s ability to expand or maintain present business levels.

Fifth Third’s subsidiary bank must remain well-capitalized for Fifth Third to retain its status as a financial holding company. In addition, failure by Fifth Third’s bank subsidiary 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.

The Bancorp’s business, financial condition and results of operations 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 the Bancorp’s participation in Treasury’s CPP and CAP, the U.S. Government has taken steps


 

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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 the Bancorp and other financial institutions who have participated in these programs to additional restrictions, oversight and/or costs that may have an impact on the Bancorp’s business, financial condition, results of operations or the price of its common stock.

Compliance with such regulation and scrutiny may significantly increase the Bancorp’s costs, impede the efficiency of its internal business processes, require it to increase its regulatory capital and limit its ability to pursue business opportunities in an efficient manner. The Bancorp also will be required to pay significantly higher FDIC premiums because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits. The increased costs associated with anticipated regulatory and political scrutiny could adversely impact the Bancorp’s results of operations.

New proposals for legislation continue to be introduced in the U.S. Congress that could further substantially increase regulation of the financial services industry. In January, the Obama administration proposed a tax on the fifty largest bank holding companies in the United States designed to recover losses incurred as a result of the Treasury’s TARP program. The proposal has not been finalized and the amount of the possible tax has not been determined. Federal and state regulatory agencies also frequently adopt changes to their regulations and/or change the manner in which existing regulations are applied. The Bancorp cannot predict whether any pending or future legislation will be adopted or the substance and impact of any such new legislation on the Bancorp. Additional regulation could affect the Bancorp in a substantial way and could have an adverse effect on its business, financial condition and results of operations.

Deposit insurance premiums levied against Fifth Third may increase if the number of bank failures do not subside or the cost of resolving failed banks increases.

The FDIC maintains a Deposit Insurance Fund (DIF) to resolve the cost of bank failures. The DIF is funded by fees assessed on insured depository institutions including Fifth Third. The magnitude and cost of resolving an increased number of bank failures have reduced the DIF. In 2009, the FDIC collected a special assessment to replenish the DIF. In addition, a prepayment of an estimated amount of future deposit insurance premiums was made on December 30, 2009. Future deposit premiums paid by Fifth Third depend on the level of the DIF and the magnitude and cost of future bank failures.

Legislative or regulatory compliance, changes or actions or significant litigation, could adversely impact the Bancorp or the businesses in which the Bancorp is engaged.

The Bancorp 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 the Bancorp 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 the Bancorp or its ability to increase the value of its business. Additionally, actions by regulatory agencies or significant litigation against the Bancorp could cause it to devote significant time and resources to defending itself and may lead to penalties that materially affect the Bancorp and its shareholders. Future changes in the laws, including tax laws, or, as a participant in the Capital Purchase Program under EESA, the rules and regulations promulgated

under EESA or ARRA, or regulations or their interpretations or enforcement may also be materially adverse to the Bancorp and its shareholders or may require the Bancorp to expend significant time and resources to comply with such requirements.

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 Third’s 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.

Fifth Third’s 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. Treasury’s 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. Treasury’s consent until the third anniversary of the U.S. Treasury’s 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 Third’s common stock, are prohibited until all accrued and unpaid dividends are paid on such preferred stock, subject to certain limited exceptions.


 

 

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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 rate 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, on free-funding, such as demand deposits or shareholders’ equity.

Table 5 presents the components of net interest income, net interest margin and net interest spread for 2009, 2008 and 2007. 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 6 provides the relative impact of changes in the balance sheet and changes in interest rates on net interest income.

Net interest income (FTE) was $3.4 billion for the year ended December 31, 2009, compared to $3.5 billion in 2008. Net interest income was affected by the amortization and accretion of premiums and discounts on acquired loans and deposits, primarily from the First Charter Acquisition, that increased net interest income by $136 million during 2009, compared to an increase of $358 million during 2008. Additionally, 2008 was impacted by the recalculation of cash flows on certain leveraged leases that reduced interest income on commercial leases by approximately $130 million. Excluding these impacts, net interest income decreased $71 million, or two percent, in 2009 compared to 2008. Net interest income was negatively impacted by the decline in market interest rates over the year as the Bancorp’s assets have repriced faster than its liabilities. The net interest rate spread was down 21 bp to 3.00% in 2009, which led to a decline in net interest income of $284 million compared to 2008. Partially offsetting the negative impact of declining market rates were improved pricing spreads on loan originations as well as a shift in funding composition to lower cost core deposits, as higher priced term deposits issued in the second half of 2008 continued to mature throughout 2009. For the year ended December 31, 2009, net interest income was further impacted by an increase of $1.6

billion in average interest-earning assets and a decline of $5.0 billion in average interest-bearing liabilities driven by growth in the Bancorp’s free-funding position. This led to an increase of $121 million in net interest income.

Net interest margin was 3.32% in 2009, compared to 3.54% in 2008. For 2009 and 2008, the accretion of the discounts on acquired loans and deposits increased the net interest margin by 14 bp and 36 bp, respectively. Additionally, 2008 included the negative impact of the leveraged lease charge that reduced the net interest margin by 13 bp. Exclusive of the accretion of discounts on acquired loans and deposits and the leveraged lease charge, net interest margin was down 13 bp on a year-over-year basis due to the previously mentioned decline in net interest rate spread and the growth in average interest earning assets.

Average interest-earning assets increased 2% from 2008 primarily due to an increase in the average investment portfolio, partially offset by decreases in average commercial loans. The increase in the average investment portfolio of $4.1 billion, or 29%, over 2008 was due to an increase in purchases of agency mortgage-backed securities and automobile asset-backed securities, the purchase of investment grade commercial paper from an unconsolidated qualifying special purpose entity (QSPE) and an increase in VRDNs held in the Bancorp’s trading portfolio. The decrease in average total commercial loans of five percent was due primarily to the decrease in commercial construction loans as a result of the suspension of new originations on non-owner occupied commercial real estate loans in the second quarter of 2008. Additionally, the decrease in commercial loans and commercial mortgage loans was due to decreases in line utilization, overall customer demand for commercial loan products, net charge-offs as well as implementation of tighter underwriting standards.

Interest income (FTE) from loans and leases decreased $1.0 billion compared to 2008. Exclusive of the accretion of discounts on acquired loans in 2009 and 2008 and the leveraged lease charge during 2008, interest income (FTE) from loans and leases decreased $925 million, or 20%, compared to the prior year. The year-over-year decrease in interest income from loans and leases is a result of a three percent decline in average loans as well as the repricing of variable rate loans in a declining rate environment, which led to a 104 bp decrease in average rates. Interest income (FTE) from investment securities and short-term investments increased nine percent compared to 2008. The increase in interest income from investment securities was a result of the 29% increase in the average investment portfolio partially offset by a 77 bp decrease in the weighted-average yield.


 

TABLE 4: CONDENSED CONSOLIDATED STATEMENTS OF INCOME

For the years ended December 31 ($ in millions, except per share data)

   2009    2008    2007    2006    2005

Interest income (FTE)

   $4,687    5,630    6,051    5,981    5,026

Interest expense

   1,314    2,094    3,018    3,082    2,030

Net interest income (FTE)

   3,373    3,536    3,033    2,899    2,996

Provision for loan and lease losses

   3,543    4,560    628    343    330

Net interest income (loss) after provision for loan and lease losses (FTE)

   (170)    (1,024)    2,405    2,556    2,666

Noninterest income

   4,782    2,946    2,467    2,012    2,374

Noninterest expense

   3,826    4,564    3,311    2,915    2,801

Income (loss) before income taxes and cumulative effect (FTE)

   786    (2,642)    1,561    1,653    2,239

Fully taxable equivalent adjustment

   19    22    24    26    31

Applicable income taxes

   30    (551)    461    443    659

Income (loss) before cumulative effect

   737    (2,113)    1,076    1,184    1,549

Cumulative effect of change in accounting principle, net of tax

   -    -    -    4    -

Net income (loss)

   737    (2,113)    1,076    1,188    1,549

Dividends on preferred stock

   226    67    1    -    1

Net income (loss) available to common shareholders

   $511    (2,180)    1,075    1,188    1,548

Earnings per share, basic

   $0.73    (3.91)    1.99    2.13    2.79

Earnings per share, diluted

   0.67    (3.91)    1.98    2.12    2.77

Cash dividends declared per common share

   0.04    0.75    1.70    1.58    1.46

 

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TABLE 5: CONSOLIDATED AVERAGE BALANCE SHEETS AND ANALYSIS OF NET INTEREST INCOME (FTE)

For the years ended December 31

  

2009

  

  2008      2007   

($ 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

   $27,556    $1,162    4.22   $28,426    $1,520    5.35   $22,351    $1,639    7.33

Commercial mortgage

   12,511    545    4.35      12,776    866    6.78      11,078    801    7.23   

Commercial construction

   4,638    134    2.90      5,846    342    5.85      5,661    421    7.44   

Commercial leases

   3,543    150    4.24      3,680    18    0.49      3,683    158    4.29   

Subtotal - commercial

   48,248    1,991    4.13      50,728    2,746    5.41      42,773    3,019    7.06   

Residential mortgage

   10,886    602    5.53      10,993    705    6.41      10,489    642    6.13   

Home equity

   12,534    520    4.15      12,269    701    5.71      11,887    897    7.54   

Automobile loans

   8,807    556    6.31      8,925    566    6.34      10,704    674    6.30   

Credit card

   1,907    193    10.10      1,708    167    9.77      1,276    133    10.39   

Other consumer loans and leases

   1,009    86    8.49      1,212    64    5.28      1,219    65    5.36   

Subtotal - consumer

   35,143    1,957    5.57      35,107    2,203    6.27      35,575    2,411    6.78   

Total loans and leases

   83,391    3,948    4.73      85,835    4,949    5.77      78,348    5,430    6.93   

Securities:

                        

Taxable

   16,861    721    4.28      13,082    643    4.91      11,131    566    5.08   

Exempt from income taxes (a)

   239    17    7.19      342    25    7.35      499    36    7.29   

Other short-term investments

   1,035    1    0.14      621    13    2.15      404    19    4.80   

Total interest-earning assets

   101,526    4,687    4.62      99,880    5,630    5.64      90,382    6,051    6.70   

Cash and due from banks

   2,329         2,490         2,275      

Other assets

   14,266         13,411         10,613      

Allowance for loan and lease losses

   (3,265)               (1,485)               (793)            

Total assets

   $114,856               $114,296               $102,477            

Liabilities and Shareholders’ Equity

                        

Interest-bearing liabilities:

                        

Interest-bearing core deposits:

                        

Interest checking

   $15,070    $40    0.26   $14,191    $128    0.91   $14,820    $318    2.14

Savings

   16,875    127    0.75      16,192    224    1.38      14,836    456    3.07   

Money market

   4,320    26    0.60      6,127    118    1.92      6,308    269    4.26   

Foreign office deposits

   2,108    10    0.45      2,153    34    1.60      1,762    73    4.15   

Other time deposits

   14,103    470    3.33      11,135    411    3.69      10,778    495    4.59   

Total interest-bearing core deposits

   52,476    673    1.28      49,798    915    1.84      48,504    1,611    3.32   

Certificates - $100,000 and over

   10,367    280    2.70      9,531    324    3.40      6,466    328    5.07   

Other foreign office deposits

   157    -    0.20      2,067    50    2.42      1,393    68    4.91   

Federal funds purchased

   517    1    0.20      2,975    70    2.34      3,646    184    5.04   

Other short-term borrowings

   6,463    42    0.64      7,785    178    2.29      3,244    140    4.32   

Long-term debt

   11,035    318    2.89      13,903    557    4.01      12,505    687    5.50   

Total interest-bearing liabilities

   81,015    1,314    1.62      86,059    2,094    2.43      75,758    3,018    3.98   

Demand deposits

   16,862         14,017         13,261      

Other liabilities

   3,926               4,182               3,875            

Total liabilities

   101,803         104,258         92,894      

Shareholders’ equity

   13,053               10,038               9,583            

Total liabilities and shareholders’ equity

   $114,856               $114,296               $102,477            

Net interest income

      $3,373         $3,536         $3,033   

Net interest margin

         3.32         3.54         3.36

Net interest rate spread

         3.00            3.21            2.72   

Interest-bearing liabilities to interest-earning assets

             79.80                86.16                83.82   
(a) The fully taxable-equivalent adjustments included in the above table are $19 million, $22 million and $24 million for the years ended December 31, 2009, 2008 and 2007, respectively.

 

    Average interest-bearing core deposits increased $2.7 billion, or five percent, compared to last year, primarily due to increased interest checking, savings other time deposits balances, partially offset by a decline in money market deposits. The cost of interest-bearing core deposits was 1.28% in 2009; a decrease of 56 bp from 1.84% in 2008. The year-over-year decrease is a result of the decrease in short-term market interest rates as the federal funds rate steadily declined over the course of 2008 and remained at a historically low rate throughout 2009.

    Interest expense on wholesale funding decreased 46% compared to the prior year due to a 21% decrease in average balances and a 100 bp decrease in the average rate. In 2009, wholesale funding represented 35% of interest-bearing liabilities, down from 42% in 2008. Impacting this change was a decrease in average long-term debt of $2.9 billion, or 21%, which included a yield decrease of 112 bp compared to 2008. This was driven by a $1.0 billion FHLB advance maturing in the first quarter of 2009 and $1.2 billion in bank notes maturing in the second quarter of

2009, which were the primary factors of the reduction in interest expense on long term debt of $239 million. Further impacting the wholesale funding balance was a $3.8 billion, or a 35%, decline in average short-term borrowings, including federal funds purchased, as well as a 169 bp decline in the average rate on short term borrowings, compared to 2008, which led to reductions in interest expense of $59 million and $146 million, respectively. The decreased reliance on wholesale funding in 2009 was a result of the increase in the Bancorp’s average equity position compared to 2008 due to the issuance of $1 billion of common stock in the second quarter of 2009 and from the sale of $3.4 billion of senior preferred shares and related warrants to the U.S. Treasury on December 31, 2008 under its Capital Purchase Program (CPP). For more information on the Bancorp’s interest rate risk management, including estimated earnings sensitivity to changes in market interest rates, see the Market Risk Management section of Management’s Discussion and Analysis.


 

 

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TABLE 6: CHANGES IN NET INTEREST INCOME (FTE) ATTRIBUTED TO VOLUME AND YIELD/RATE (a)

For the years ended December 31

   2009 Compared to 2008    2008 Compared to 2007

($ in millions)

   Volume    Yield/Rate    Total    Volume    Yield/Rate    Total

Assets

                 

Increase (decrease) in interest income:

                 

Loans and leases:

                 

Commercial loans

   $(45)    (313)    (358)    $385    (504)    (119)

Commercial mortgage

   (17)    (304)    (321)    117    (52)    65

Commercial construction

   (60)    (148)    (208)    13    (92)    (79)

Commercial leases

   (1)    133    132    -    (140)    (140)

Subtotal - commercial

   (123)    (632)    (755)    515    (788)    (273)

Residential mortgage

   (7)    (96)    (103)    32    31    63

Home equity

   15    (196)    (181)    28    (224)    (196)

Automobile loans

   (7)    (3)    (10)    (113)    5    (108)

Credit card

   20    6    26    42    (8)    34

Other consumer loans and leases

   (12)    34    22    -    (1)    (1)

Subtotal - consumer

   9    (255)    (246)    (11)    (197)    (208)

Total loans and leases

   (114)    (887)    (1,001)    504    (985)    (481)

Securities:

                 

Taxable

   169    (91)    78    96    (19)    77

Exempt from income taxes

   (7)    (1)    (8)    (11)    -    (11)

Other short-term investments

   5    (17)    (12)    8    (14)    (6)

Total interest-earning assets

   53    (996)    (943)    597    (1,018)    (421)

Cash and due from banks

                 

Other assets

                 

Allowance for loan and lease losses

                             

Total change in interest income

   $53    (996)    (943)    $597    (1,018)    (421)

Liabilities and Shareholders’ Equity

                 

Increase (decrease) in interest expense:

                 

Interest-bearing core deposits:

                 

Interest checking

   $8    (96)    (88)    $(13)    (177)    (190)

Savings

   9    (106)    (97)    39    (271)    (232)

Money market

   (28)    (64)    (92)    (7)    (144)    (151)

Foreign office deposits

   (1)    (23)    (24)    13    (52)    (39)

Other time deposits

   102    (43)    59    16    (100)    (84)

Total interest-bearing core deposits

   90    (332)    (242)    48    (744)    (696)

Certificates - $100,000 and over

   27    (71)    (44)    125    (129)    (4)

Other foreign office deposits

   (25)    (25)    (50)    26    (44)    (18)

Federal funds purchased

   (33)    (36)    (69)    (29)    (85)    (114)

Other short-term borrowings

   (26)    (110)    (136)    127    (89)    38

Long-term debt

   (101)    (138)    (239)    71    (201)    (130)

Total interest-bearing liabilities

   (68)    (712)    (780)    368    (1,292)    (924)

Demand deposits

                 

Other liabilities

                             

Total change in interest expense

   (68)    (712)    (780)    368    (1,292)    (924)

Shareholders’ equity

                             

Total liabilities and shareholders’ equity

                             

Total change in net interest income

   $121    (284)    (163)    $229    274    503
(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 decreased to $3.5 billion in 2009 compared to $4.6 billion in 2008. The decrease in the provision expense from the prior year was due to a decline in the growth rate of commercial and consumer delinquencies and a decline in the growth of loss estimates once the loans become delinquent. As of December 31, 2009, the allowance for loan and

lease losses as a percent of loans and leases increased to 4.88% from 3.31% at December 31, 2008.

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, 2009, noninterest income increased by $1.8 billion, or 62%, on a year-over-year basis, driven primarily by the Processing Business Sale in the second quarter of 2009 as well as strong growth in mortgage banking net revenue, partially offset by lower card and processing revenue in the second half of 2009. The components of noninterest income are shown in Table 7.


 

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TABLE 7: NONINTEREST INCOME

 

For the years ended December 31 ($ in millions)    2009    2008    2007    2006    2005

Service charges on deposits

   $632    641    579    517    522

Card and processing revenue

   615    912    826    717    622

Mortgage banking net revenue

   553    199    133    155    174

Corporate banking revenue

   399    444    367    318    299

Investment advisory revenue

   299    353    382    367    358

Gain on sale of processing business

   1,758    -    -    -    -

Other noninterest income

   479    363    153    299    360

Securities gains (losses), net

   (10)    (86)    21    (364)    39

Securities gains, net – non-qualifying hedges on mortgage servicing rights

   57    120    6    3    -

Total noninterest income

   $4,782    2,946    2,467    2,012    2,374

 

Service charges on deposits decreased $9 million, or one percent, to $632 million in 2009 compared to 2008. This was driven by a $15 million, or four percent, decrease in consumer service charges and an increase of $6 million, or two percent, in commercial service charges compared to 2008. Commercial deposit revenue increased to $299 million reflecting an increase in customer accounts and lower market interest rates, as reduced earnings credits paid on customer balances have resulted in higher realized net service fees to pay for treasury management services. 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 customer’s 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. Consumer deposit revenue decreased four percent, to $333 million in 2009 compared to 2008, which is attributable to lower Insufficient Funds (NSF) fees due to a change in the Bancorp’s overdraft policy. Deposit generation and growth in the number of customer deposit account relationships continue to be a primary focus of the Bancorp.

Mortgage banking net revenue increased to $553 million in 2009 from $199 million in 2008. The components of mortgage banking net revenue for the years ended December 31, 2009, 2008 and 2007 are shown in Table 8.

TABLE 8: COMPONENTS OF MORTGAGE BANKING NET REVENUE

 

For the years ended December 31

($ in millions)

   2009    2008    2007

Origination fees and gains on loan sales

   $485    260    79

Servicing revenue:

        

Servicing fees

   197    164    145

Servicing rights amortization

   (146)    (107)    (92)

Net valuation adjustments on servicing rights and free-standing derivatives entered into to economically hedge MSR

   17    (118)    1
Net servicing revenue (expense)    68    (61)    54
Mortgage banking net revenue    $553    199    133

    Mortgage banking net revenue increased by $354 million compared to 2008 due to strong growth in originations and higher margins on sold loans. Mortgage originations increased to $21.7 billion, up 89% from $11.5 billion in 2008 due to lower interest rates and government incentive programs, which have been designed to provide significant tax and other incentives to home buyers. Originations in 2009 resulted in gains on mortgage loan sales activity of $485 million compared to $260 million in 2008. It remains the intent of the Bancorp to sell a majority of the mortgage loans it originates.

Mortgage net servicing revenue increased $129 million compared to 2008. Net servicing revenue is comprised of gross servicing fees and related servicing rights amortization as well as

valuation adjustments on mortgage servicing rights and mark-to-market adjustments on both settled and outstanding free-standing derivative financial instruments. As discussed in more detail below, the increase in net servicing revenue was primarily due to a net gain of $17 million on the net valuation adjustments on mortgage servicing rights (MSRs) and MSR derivatives, compared to a net loss of $118 million in the prior year. The Bancorp’s total residential mortgage loans serviced at December 31, 2009 and 2008 was $58.5 billion and $50.7 billion, respectively, with $48.6 billion and $40.4 billion, respectively, of residential mortgage loans serviced for others.

Servicing rights are deemed temporarily impaired when a borrower’s 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 borrower’s loan rate. Further information on the valuation of mortgage servicing rights and free-standing derivatives used to hedge the MSR portfolio can be found in Note 11 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 $41 million, offset by a temporary impairment of $24 million, resulting in a net gain of $17 million for the year ended December 31, 2009 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, 2008, 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. 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 $57 million and $120 million in 2009 and 2008, respectively, was included in noninterest income within the Consolidated Statements of Income, but is shown separate from mortgage banking net revenue.

    Corporate banking revenue decreased $45 million, or 10%, in 2009, largely due to a lower volume of interest rate derivative sales and foreign exchange revenue, partially offset by growth in institutional sales and business lending fees. Foreign exchange derivative income of $76 million decreased $30 million compared to 2008 and income on interest rate derivatives was down $29 million to $21 million in 2009, both of which were driven by volume declines. Fees associated with business lending grew 22% to $103 million, compared to 2008. The Bancorp is committed to providing a comprehensive range of financial services to large and middle-market businesses.

Investment advisory revenue decreased $54 million, or 15%, from 2008 as the Bancorp experienced broad-based declines in all categories within investment advisory revenue. Brokerage fee income, which includes Fifth Third Securities income, decreased 18%, or $18 million, in 2009 as investors continued to migrate balances from stock and bond funds to money market funds resulting in reduced commission-based transactions. Mutual fund revenue decreased 28%, to $38 million, in 2009 reflecting lower


 

 

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valuations on assets under management and a continued shift to money market funds and lower fee products. As of December 31, 2009, the Bancorp had approximately $187 billion in assets under care and managed $25 billion in assets for individuals, corporations and not-for-profit organizations.

On June 30, 2009, the Bancorp completed the sale of a majority interest in its merchant acquiring and financial institutions processing businesses. The Processing Business Sale generated a pre-tax gain of $1.8 billion ($1.1 billion after-tax). As part of the transaction, the Bancorp retained certain debit and credit card interchange revenue and sold the financial institutions and merchant processing portions of the business, which historically comprised approximately 70% of total card and processing revenue. As a result of the sale, card and processing revenue decreased $297 million, or 33%, in 2009 compared to 2008. Card issuer interchange increased 6%, to $262 million, compared to 2008 due to strong growth in debit card transaction volumes, partially offset by lower credit card usage. Merchant processing and financial institutions revenue was $174 million and $179 million, respectively, in 2009, which represents activity prior to the Processing Business Sale.

Other noninterest income increased $116 million in 2009 compared to 2008. The components of other noninterest income are shown in Table 9. The increase was primarily due to net gains from the sale of loans of $38 million in 2009, net of charges of $54 million on certain held-for-sale commercial loans, compared to losses of $11 million on loan sales in 2008, and lower losses on bank owned life insurance. During 2009, the Bancorp recognized $53 million in charges to record a reserve in connection with the intent to surrender one of the Bancorp’s BOLI policies as well as losses related to market value declines, compared to charges of $215 million to lower the cash surrender value of one of the policies for the year ended December 31, 2008. Additionally, the year ended December 31, 2009 benefited from a $244 million gain relating to the sale of the Bancorp’s Visa, Inc. Class B shares, $76 million in revenue related to the Transition Service Agreement (TSA) entered into as part of the Processing Business Sale, and $18 million in mark-to-market adjustments on warrants and put options related to the Processing Business Sale. The year ended December 31, 2008 was impacted by a $273 million gain from the redemption of a portion of the Bancorp’s ownership interest in Visa, Inc. and a $76 million gain related to the satisfactory resolution of litigation associated with a prior acquisition.

Net securities losses totaled $10 million in 2009 compared to $86 million of net securities losses during 2008. 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.

Noninterest Expense

Total noninterest expense decreased $738 million, or 16%, in 2009 compared to 2008. The components of noninterest expense are shown in Table 10. Noninterest expense in 2009 included a $73 million reduction in the Visa litigation reserve as well as a $55 million FDIC special assessment charge. Noninterest expense in

 

TABLE 9: COMPONENTS OF OTHER NONINTEREST INCOME

 

For the years ended December 31

($ in millions)

   2009    2008    2007

Operating lease income

   $59    47    32

Cardholder fees

   48    58    56

Insurance income

   47    36    32

Consumer loan and lease fees

   43    51    46

Gain (loss) on loan sales

   38    (11)    25

Banking center income

   22    31    29

Gain on sale/redemption of Visa, Inc. ownership interests

   244    273    -

Loss on sale of other real estate owned

   (70)    (60)    (14)

Bank owned life insurance loss

   (2)    (156)    (106)

Litigation settlement

   -    76    -

Other

   50    18    53

Total other noninterest income

   $479    363    153

2008 included a $965 million charge to record goodwill impairment, $99 million in net reductions to noninterest expense to reflect the recognition of the Bancorp’s proportional share of the Visa escrow account, $36 million in legal expenses related to litigation associated with a prior acquisition and $20 million in acquisition-related expenses. Excluding these items, noninterest expense increased $202 million, or six percent, due to increased loan related expenses from higher mortgage origination volumes and expenses incurred from the management of problem assets and higher FDIC insurance costs from an increase in assessment rates during 2009, partially offset by lower card and processing expense due to the Processing Business Sale on June 30, 2009.

Total personnel costs (salaries, wages and incentives plus employee benefits) increased $35 million, or two percent in 2009 compared to 2008 due primarily to increased insurance costs, retirement plan contributions and deferred compensation expenses. As of December 31, 2009, the Bancorp employed 21,901 employees, of which 6,772 were officers and 2,370 were part-time employees. Full-time equivalent employees totaled 20,998 as of December 31, 2009 compared to 21,476 as of December 31, 2008.

Card and processing expense, which includes third-party processing expenses, card management fees and other bankcard processing, decreased $81 million, or 29%, in 2009 compared to 2008 due primarily to the Processing Business Sale in the second quarter of 2009. As part of the sale, the Bancorp entered into a transition service agreement (TSA) that resulted in the Bancorp incurring approximately $76 million in operating expenses that were offset with revenue from the TSA that was recorded in other noninterest income.

Total other noninterest expense increased $282 million, or 26%, in 2009 compared to 2008. The components of other noninterest expense are shown in Table 11. Loan and lease expense was higher compared to 2008 as a result of increased closing expenses resulting from growth in residential mortgage loan originations and higher expenses incurred in the management of problem assets. FDIC insurance and other taxes were higher due to a special assessment of $55 million in 2009 as well as increased assessment rates. These were partially offset by lower professional service fees and marketing expenses. The provision


TABLE 10: NONINTEREST EXPENSE

 

For the years ended December 31 ($ in millions)    2009     2008    2007    2006    2005

Salaries, wages and incentives

   $1,339      1,337    1,239    1,174    1,133

Employee benefits

   311      278    278    292    283

Net occupancy expense

   308      300    269    245    221

Card and processing expense

   193      274    244    184    145

Technology and communications

   181      191    169    141    142

Equipment expense

   123      130    123    116    105

Goodwill impairment

   -      965    -    -    -

Other noninterest expense

   1,371      1,089    989    763    772

Total noninterest expense

   $3,826      4,564    3,311    2,915    2,801

Efficiency ratio

   46.9   70.4    60.2    59.4    52.1

 

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for unfunded commitments was consistent with 2008 as estimates of inherent losses resulting from deterioration in the credit quality of the underlying borrowers remained high.

The Bancorp incurred $269 million of FDIC insurance and other taxes in 2009 compared to $73 million in 2008 as the result of an increase in deposit insurance and for participation in the TLGP. In December 2008, the FDIC implemented an interim rule under the FDIC restoration plan which increased the deposit insurance assessment rates 7 bp from the 2008 level for all banks for the first quarter of 2009. In February 2009, the FDIC adopted the final rule for the FDIC restoration plan that, effective April 1, 2009, made the assessment rates more risk sensitive and widened the range (7.0-77.5 bp) the FDIC may charge banks. Additionally, the FDIC imposed a special assessment, effective June 30, 2009, on each insured depository institution calculated as 5 bp of total assets less Tier 1 capital. As a result, the Bancorp recognized a $55 million special assessment charge in the second quarter of 2009.

The Bancorp participates in the FDIC’s TLGP which temporarily guarantees qualifying senior debt of participating FDIC-insured institutions and certain holding companies, as well as deposits in qualifying noninterest-bearing deposit transaction accounts. The Bancorp did not have qualifying senior debt insured under the TLGP in 2009, but did have qualifying deposit accounts.

The efficiency ratio (noninterest expense divided by the sum of net interest income (FTE) and noninterest income) was 46.9% and 70.4% for 2009 and 2008, 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 Bancorp’s income (loss) before income taxes, applicable income tax expense (benefit) 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

TABLE 11: COMPONENTS OF OTHER NONINTEREST EXPENSE

For the years ended December 31

($ in millions)

   2009    2008    2007

FDIC insurance and other taxes

   $269    73    31

Loan and lease

   234    188    119

Provision for unfunded commitments and letters of credit

   99    98    16

Affordable housing investments impairment

   83    67    57

Marketing

   79    102    84

Professional services fees

   63    102    54

Intangible asset amortization

   57    56    42

Postal and courier

   53    54    52

Insurance expense

   50    30    17

Travel

   41    54    54

Operating lease

   39    32    22

Recruitment and education

   30    33    41

Supplies

   25    31    31

Other real estate owned expense

   24    11    6

Data processing

   21    14    14

Visa litigation reserve

   (73)    (99)    172

Other

   277    243    177

Total other noninterest expense

   $1,371    1,089    989

income, tax-advantaged investments and general business tax credits, partially offset by the effect of nondeductible expenses. The effective tax rate for the tax year ended December 31, 2009 was primarily impacted by $112 million in tax credits, a $106 million tax benefit related to the decision to surrender one of the Bancorp’s BOLI policies and the determination that losses on the policy recorded in prior periods are now tax deductible, and a $55 million reduction in income tax expense related to the Bancorp’s leveraged lease litigation settlement with the IRS. The effective tax rate for the year ended December 31, 2008 was primarily impacted by the pre-tax loss for the year partially offset by tax expense of approximately $140 million required for interest related to the tax treatment of certain of the Bancorp’s leveraged leases for previous years and the nondeductible portion of the goodwill impairment charge. Additionally, see Note 20 of the Notes to Consolidated Financial Statements for further information on income taxes.


 

TABLE 12: APPLICABLE INCOME TAXES

For the years ended December 31 ($ in millions)

   2009      2008    2007    2006    2005

Income (loss) before income taxes and cumulative effect

   $767      (2,664)    1,537    1,627    2,208

Applicable income tax expense (benefit)

   30      (551)    461    443    659

Effective tax rate

   3.9   (20.7)    30.0    27.2    29.9

 

 

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BUSINESS SEGMENT REVIEW

 

At December 31, 2009, the Bancorp reports on four business segments: Commercial Banking, Branch Banking, Consumer Lending and Investment Advisors. Further detailed financial information on each business segment is included in Note 30 of the Notes to Consolidated Financial Statements.

Results of the Bancorp’s 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 Bancorp’s 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.

On June 30, 2009, the Bancorp completed the Processing Business Sale, which represented the sale of a majority interest in the Bancorp’s merchant acquiring and financial institutions processing businesses. Financial data for the merchant acquiring and financial institutions processing businesses was originally reported in the former Processing Solutions segment through June 30, 2009. As a result of the sale, the Bancorp no longer presents Processing Solutions as a segment and therefore, historical financial information for the merchant acquiring and financial institutions processing businesses has been reclassified under General Corporate and Other for all periods presented. Interchange revenue previously recorded in the Processing Solutions segment and associated with cards currently included in Branch Banking is now included in the Branch Banking segment for all periods presented. Additionally, the Bancorp retained its retail credit card and commercial multi-card service businesses, which were also originally reported in the former Processing Solutions segment through June 30, 2009, and are now included in the Consumer Lending and Commercial Banking segments, respectively, for all periods presented. Revenue from the remaining ownership interest in the Processing Business is recorded in General Corporate and Other as noninterest income.

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 Bancorp’s 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.

    Management made changes to the FTP methodology during 2009 to update the calculation of FTP charges and credits to each of the Bancorp’s business segments. Changes to the FTP methodology were applied retroactively to the year ended December 31, 2008 and included updating rates to reflect significant increases in the Bancorp’s liquidity premiums. The increased spreads reflect the Bancorp’s liability structure and are more weighted towards retail product pricing spreads. Management reviews FTP spreads periodically based on the extent of changes in market spreads.

The business segments are charged provision expense based on the actual net charge-offs experienced by the loans owned by each segment. Provision expense in excess of net charge-offs 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 existed 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)

   2009    2008    2007

Income Statement Data

        

Commercial Banking

   $(120)    (733)    714

Branch Banking

   324    632    642

Consumer Lending

   23    (148)    120

Investment Advisors

   53    98    99

General Corporate and Other

   457    (1,962)    (499)

Net income (loss)

   737    (2,113)    1,076

Dividends on preferred stock

   226    67    1

Net income (loss) available to common shareholders

   $511    (2,180)    1,075

 

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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)

   2009    2008    2007

Income Statement Data

        

Net interest income (FTE) (a)

   $1,383    1,567    1,312

Provision for loan and lease losses

   1,360    1,864    127

Noninterest income:

        

Corporate banking revenue

   357    414    344

Service charges on deposits

   196    186    152

Other noninterest income

   56    78    81

Noninterest expense:

        

Salaries, incentives and benefits

   221    243    255

Goodwill impairment

   -    750    -

Other noninterest expense

   768    675    540

Income (loss) before taxes

   (357)    (1,287)    967

Applicable income tax expense (benefit)

   (237)    (554)    253

Net income (loss)

   ($120)    (733)    714

Average Balance Sheet Data

        

Commercial loans

   $41,341    43,198    35,696

Demand deposits

   8,581    6,206    5,944

Interest checking

   6,018    4,632    4,107

Savings and money market

   2,457    4,046    4,462

Certificates $100,000 and over and other time

   4,376    2,293    1,855

Foreign office deposits

   1,275    1,835    1,486
(a) Includes taxable equivalent adjustments of $13 million for 2009, $15 million for 2008, and $14 million for 2007.

Comparison of 2009 with 2008

Commercial Banking incurred a net loss of $120 million compared to a net loss of $733 million in 2008. This improvement was primarily due to a $750 million goodwill impairment charge taken in 2008 and a decrease in provision for loan and lease losses of $504 million. The net loss in 2009 was driven by continued high levels of provision for loan and lease losses. Net interest income decreased $184 million or 12% driven by a $144 million decrease in the accretion of discounts on loans and deposits associated with the acquisition of First Charter in the second quarter of 2008. In addition, a decrease in average commercial loans combined with increases in average core deposits and higher priced certificates $100,000 and over and other time deposits from 2008 negatively impacted net interest income. Average commercial loans and leases decreased $1.9 billion, or four percent, compared to the prior year and included decreases of $1.2 billion and $267 million in commercial construction and commercial mortgages, respectively. The overall decrease in commercial loans and leases is due to lower utilization rates on corporate lines, net charge-offs and tighter lending standards that were implemented throughout the second half of 2008 and continued throughout 2009.

    Average core deposits increased 10% compared to 2008 as the Commercial Banking segment experienced growth in both demand deposits and interest checking accounts partially offset by a decline in savings accounts. Commercial customers opted to shift money out of savings and money market accounts into demand deposits and interest checking accounts due to increased attractiveness as a result of protection through FDIC insurance of demand deposit and interest checking accounts and a lower economic benefit from sweeping balances into interest-bearing vehicles. As a participant in the TLGP program the Bancorp

opted into the Transaction Account Guarantee (TAG) program which provides commercial customers unlimited FDIC insurance on demand deposit accounts in addition to other qualifying transactional accounts. Commercial customers also increased balances in certificates $100,000 and over and other time deposits as a result of certificates purchased in the second half of 2008 that matured at the end of 2009. Provision expense declined from $1.9 billion in 2008 to $1.4 billion in 2009 primarily due to a decrease in net charge-offs as net charge-offs as a percent of average loans and leases decreased to 329 bp in 2009. Net charge-offs decreased in comparison to prior year primarily due to $800 million of charge-offs incurred in the fourth quarter of 2008 when the Bancorp sold or transferred to held-for-sale $1.3 billion in commercial loans and commercial mortgage loans. Economic conditions continued to weaken throughout 2009 and the continuing deterioration of credit within the Bancorp’s footprint, particularly in Michigan and Florida, continued to cause high amounts of charge-offs throughout 2009.

Noninterest income declined $69 million or 10% from 2008 due to a $57 million decrease in corporate banking revenue and a $22 million decline of other noninterest income, partially offset by an increase in service charges on deposits of $10 million. Corporate banking revenue decreased from the prior year primarily due to a decline of $30 million in international income and a decline of $28 million on derivative fee income. Other noninterest income decreased from the prior year due to valuation write-downs on loans held for sale of $52 million partially offset by a net gain of $24 million on loan and OREO sales. Deposit fee income increased from the prior year due to a reduction of business service discounts provided to customers.

Noninterest expense decreased $679 million compared to 2008 primarily due to goodwill impairment of $750 million taken in 2008. Excluding the goodwill impairment charge, noninterest expense increased $71 million from 2008 due to increases in FDIC expenses of $52 million, loan and lease expenses of $26 million and $20 million in other losses and adjustments primarily due to realized credit losses on derivatives, partially offset by a decrease in salary and benefit expense of $22 million.

Comparison of 2008 with 2007

Commercial Banking incurred a net loss of $733 million in 2008 compared to net income of $714 million in 2007 as growth in net interest income and corporate banking revenue was more than offset by increased provision for loan and lease losses and a goodwill impairment charge. Net interest income increased $255 million compared to 2007, primarily due to accretion of loan discounts on acquired loans which contributed $204 million to net interest income in 2008. Average commercial loans and leases increased 21% to $43.2 billion due to acquisition activity and the purchase of assets from an unconsolidated QSPE under a liquidity asset purchase agreement with the Bancorp.

    Provision expense increased $1.7 billion in 2008 as a result of an increase in net charge-offs. Net charge-offs as a percent of average loans and leases increased to 435 bp from 36 bp in 2007 due to weakening economic conditions and the continuing deterioration of credit within the Bancorp’s footprint, particularly in Michigan and Florida. Additionally, net charge-offs were impacted by $800 million in net charge-offs resulting from the sale or transfer to held-for-sale of $1.3 billion in commercial loans and commercial mortgage loans in the fourth quarter of 2008.

Noninterest income increased $101 million compared to 2007 due to corporate banking revenue growth of $70 million and increased service charges on deposits of $34 million.

Noninterest expense increased $873 million compared to 2007 primarily due to goodwill impairment of $750 million in 2008 as well as sales incentives, which increased 21% to $105 million and growth in loan expenses of $33 million, to $64 million in 2008.


 

 

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Branch Banking

Branch Banking provides a full range of deposit and loan and lease products to individuals and small businesses through 1,309 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)

   2009    2008    2007

Net interest income

   $1,559    1,714    1,463

Provision for loan and lease losses

   585    352    162

Noninterest income:

        

Service charges on deposits

   428    447    421

Card and processing revenue

   264    246    220

Investment advisory revenue

   84    84    90

Other noninterest income

   122    130    121

Noninterest expense:

        

Salaries, incentives and benefits

   502    517    479

Net occupancy and equipment expense

   217    203    173

Other noninterest expense

   653    573    510

Income before taxes

   500    976    991

Applicable income tax expense

   176    344    349

Net income

   $324    632    642

Average Balance Sheet Data

        

Consumer loans

   $13,096    12,665    11,838

Commercial loans

   5,335    5,600    5,131

Demand deposits

   6,363    6,008    5,756

Interest checking

   7,395    7,845    8,692

Certificates $100,000 and over & other time

   16,995    13,749    13,419

Savings and money market

   17,010    16,184    14,621

Comparison of 2009 with 2008

Net income decreased $308 million, or 49%, compared to 2008 driven by a decrease in net interest income and service fees combined with a higher provision for loan and lease losses. Net interest income decreased $155 million, or nine percent, compared to 2008. This decrease was primarily due to a decline of $27 million on the accretion of discounts on loans and deposits associated with the acquisition of First Charter in 2008 combined with an increase in interest expense as a result of a higher average balance in certificates $100,000 and over and other time deposits. At the end of 2008, customers took advantage of competitive pricing on short term certificates $100,000 and over, which resulted in an increase to interest expense in 2009. Average loans and leases increased one percent compared to 2008 as a three percent growth in consumer loans was partially offset by a five percent decrease in commercial loans. Home equity loans grew four percent due to a low interest rate environment throughout 2009. The segment grew credit card balances by $211 million, or 14%, resulting from an increased focus on relationships with its current customers through the cross-selling of credit cards. The average commercial loan product balance, a subset of total commercial loans, decreased $229 million, or eight percent due to tighter lending standards implemented in 2008 that continued throughout 2009 and a decrease in customer line utilization rates. Average core deposits were up eight percent compared to 2008 primarily due to strong growth in short term consumer certificates, which were sold in late 2008 and a five percent

increase in average savings and money market account balances as customers continued to cut spending and increase savings.

Net charge-offs as a percent of average loan and leases increased in 2009 to 317 bp compared to 194 bp in 2008. Net charge-offs increased in comparison to 2008 as the segment experienced higher charge-offs involving home equity lines and loans, commercial loans and credit cards. The increase of $91 million in net charge-offs on home equity products reflected borrower stress and a decrease in home values primarily within the Bancorp’s footprint. Charge-offs involving credit cards increased $75 million compared to 2008 due to an increase in unemployment and bankruptcy filings in 2009. Commercial loan charge-offs increased $52 million compared to 2008 due to the weakening economy and the continuing deterioration of commercial credit, particularly in Michigan and Florida.

Noninterest income was relatively flat compared to 2008 as decreases in deposit fees and retail service fees, included in other noninterest income, were offset by an increase in card and processing revenue. Deposit fees, including consumer overdraft fees, declined $19 million, or four percent, from the prior year due to changes in the fee structure charged to consumers for overdrawn account balances. Retail service fees decreased $10 million or 11% from the prior year due to a decrease of $7 million, or 13%, in bankcard fees and a decrease of $3 million, or 13% in banking center fees. Card and processing revenue increased $18 million from 2008 due to a nine percent increase in interchange revenue associated with increased activity in debit card transactions.

Noninterest expense increased $80 million, or six percent, compared to 2008 primarily due to an increase in FDIC related expenses of $86 million as a result of a special assessment charged in 2009 coupled with an increase in assessment rates.

Comparison of 2008 with 2007

Net income decreased $9 million in 2008, or one percent, compared to 2007 as increases in net interest income and service fees were more than offset by higher provision for loan and lease losses and increased personnel and occupancy expense. Net interest income increased 17% compared to 2007 due to the increase in volume of higher yielding credit cards and the accretion of discounts on loans and deposits totaling $43 million, primarily related to the second quarter acquisition of First Charter. Average loans and leases increased eight percent compared to 2007 as home equity loans grew five percent primarily due to acquisitions. In addition, credit card balances grew by $396 million, or 36%. 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 due to the weakening economy and the continuing deterioration of credit quality particularly in Michigan and Florida.

    Noninterest income increased $54 million, or six percent, compared to 2007 primarily due to an increase in service charges on deposits of $26 million, or six percent, and an increase in card and processing revenue of $26 million, or 12%.

Noninterest expense increased $128 million, or 11%, compared to 2007 as salaries and incentives increased eight percent and net occupancy and equipment costs increased 17%. Other noninterest expense increased 12%, which can be attributed to higher loan costs associated with collections.


 

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Consumer Lending

Consumer Lending includes the Bancorp’s 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)

   2009    2008     2007

Income Statement Data

       

Net interest income

   $494    481      412

Provision for loan and lease losses

   574    441      159

Noninterest income:

       

Mortgage banking net revenue

   526    184      122

Other noninterest income

   101    167      92

Noninterest expense:

       

Salaries, incentives and benefits

   187    137      77

Goodwill impairment

   -    215      -

Other noninterest expense

   324    268      204

Income (loss) before taxes

   36    (229   186

Applicable income tax expense (benefit)

   13    (81   66

Net income (loss)

   $23    (148   120

Average Balance Sheet Data

       

Residential mortgage loans

   $10,650    10,698      10,156

Home equity

   995    1,142      1,328

Automobile loans

   8,024    7,984      9,712

Consumer leases

   629    797      917

Comparison of 2009 with 2008

Consumer Lending reported net income of $23 million compared to a net loss of $148 million in 2008 primarily due to a goodwill impairment charge of $215 million taken in 2008. In addition, in 2009 increases in net interest income and mortgage banking net revenue more than offset the growth in provision for loan and lease losses.

Net interest income increased $13 million from the prior year primarily due to a decrease in funding costs driven by low interest rates throughout 2009 partially offset by a decrease of $17 million on the accretion of discounts on loans and deposits associated with the acquisition of First Charter in 2008. Residential mortgage originations increased to $20.7 billion in 2009 from $11.2 billion in 2008 due to lower interest rates as well as government incentive programs, which have been designed to provide significant tax and other incentives to home buyers. The increase in volume as well as higher sales margins on loans held for sale were the primary reasons for the $342 million increase in mortgage banking net revenue compared to 2008. The decrease in other noninterest income to $101 million is attributable to decreases in securities gains related to mortgage servicing rights hedging activities.

    The increase in salaries, incentives and benefits compared to 2008 was driven by employee costs that were necessary to manage the increase in residential mortgage originations. The $56 million increase in other noninterest expense compared to 2008 is attributed to a $20 million increase in loan processing costs as a result of increased mortgage originations and $36 million in other credit related expenses and an increase in FDIC insurance expenses.

Net charge-offs as a percent of average loan and leases increased from 223 bp in 2008 to 313 bp in 2009. Net charge-offs in 2009 on residential mortgage loans increased $114 million compared to the prior year. Residential mortgage charge-offs increased due to a weakened economy and deteriorating real estate

values within the Bancorp’s footprint, particularly in Michigan and Florida. During 2009, Michigan and Florida accounted for approximately 75% of the residential mortgage charge-offs while only accounting for approximately 42% of all residential mortgage portfolio loans outstanding. The Consumer Lending segment continues to focus on managing credit risk through the restructuring of certain residential mortgage loans and careful consideration of underwriting and collection standards. As of December 31, 2009, the Bancorp had restructured approximately $1.1 billion of residential mortgage loans in an effort to mitigate losses.

Comparison of 2008 with 2007

Consumer Lending incurred a net loss of $148 million in 2008 compared to net income of $120 million in 2007 as the increases in net interest income, mortgage banking net revenue and securities gains were more than offset by growth in provision for loan and lease losses and a goodwill impairment charge of $215 million.

Net interest income was impacted by accretion of discounts on loans and deposits, totaling $60 million in 2008, primarily related to the second quarter acquisition of First Charter. Average residential mortgage loans increased five percent compared to 2007 due to acquisitions, including R-G Crown Bank 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 223 bp in 2008.

The increase in sales margins on loans held for sale and sales volume of portfolio loans were the primary reasons for the increase in mortgage banking net revenue compared to 2007. Residential 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. Also contributing to the increase in mortgage banking net revenue in 2008 was a $65 million benefit from the adoption of the fair value option under U.S. GAAP, on January 1, 2008, for 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.


 

 

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Investment Advisors

Investment Advisors provides a full range of investment alternatives for individuals, companies and not-for-profit organizations. Investment Advisors is made up of four main businesses: Fifth Third Securities, Inc., (FTS) an indirect wholly-owned subsidiary of the Bancorp; Fifth Third Asset Management, Inc., an indirect wholly-owned subsidiary of the Bancorp; Fifth Third Private Banking; and Fifth Third Institutional services. FTS offers full service retail brokerage services to individual clients and broker dealer services to the institutional marketplace. Fifth Third Asset Management, Inc., provides asset management services and also advises the Bancorp’s proprietary family of mutual funds. Fifth Third Private Banking offers holistic strategies to affluent clients in wealth planning, investing, insurance and wealth protection. Fifth Third Institutional services provide advisory services for institutional clients including states and municipalities. Table 17 contains selected financial data for the Investment Advisors segment.

 

TABLE 17: INVESTMENT ADVISORS

For the years ended December 31

($ in millions)

   2009    2008    2007

Income Statement Data

        

Net interest income

   $157    191    153

Provision for loan and lease losses

   57    49    12

Noninterest income:

        

Investment advisory revenue

   315    354    386

Other noninterest income

   21    32    22

Noninterest expense:

        

Salaries, incentives and benefits

   140    159    167

Other noninterest expense

   214    217    228

Income before taxes

   82    152    154

Applicable income tax expense

   29    54    55

Net income

   $53    98    99

Average Balance Sheet Data

        

Loans

   $3,112    3,527    3,206

Core deposits

   4,939    4,666    4,959

Comparison of 2009 with 2008

Net income decreased $45 million, or 46%, compared to 2008 as decreases in net interest income and investment advisory revenue were only partially offset by lower salaries and benefit expenses. Average loans decreased from $3.5 billion in 2008 to $3.1 billion in 2009 due to a decrease in commercial loans of $402 million while the balance in average consumer loans was flat compared to 2008. Average core deposits increased six percent compared to 2008 due to an increase in average foreign deposits of $642 million partially offset by a decrease in average savings balance of $359 million.

Noninterest income decreased $50 million, or 13%, compared to 2008, as investment advisory income decreased 11%, to $315 million, with private client services income declining $14 million or 10% and institutional income declining $13 million or 16%, driven by lower asset values on assets managed compared to 2008. Also included within investment advisory revenue is securities and brokerage income, which declined $10 million or nine percent compared to 2008, reflecting a decline in transaction-based revenue as well as the continued shift in assets from equity products to lower yielding money market funds due to market volatility through much of 2009.

Noninterest expense decreased $22 million, or six percent, compared to 2008 as the segment continued to focus on expense control by reducing personnel and reducing performance based compensation.

Comparison of 2008 with 2007

Net income decreased $1 million in 2008 compared to 2007 as higher net interest income and lower operating expenses were offset by higher provision for loan and lease losses and lower investment advisory revenue.

Noninterest income decreased $22 million in 2008 compared to 2007, as investment advisory revenue decreased to $354 million. Included in the decrease of investment advisory income was a decline in broker income of $11 million 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 revenue decreased $7 million due to overall lower asset values. Noninterest expense decreased $19 million compared to 2007 as the segment continued to focus on expense control.

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, historical financial information for the merchant acquiring and financial institutions processing businesses and certain support activities and other items not attributed to the business segments.

Comparison of 2009 with 2008

The results of General Corporate and Other were primarily impacted by a $1.8 billion pre-tax gain ($1.1 billion after tax) resulting from the Processing Business Sale in 2009 and provision expense in excess of net charge-offs of $1 billion in 2009. Current year results also include an $18 million benefit in noninterest income due to mark-to-market adjustments on warrants and put options related to the Processing Business Sale. A $106 million tax benefit was recognized in 2009 as a result of the Bancorp’s decision to surrender one of its BOLI policies partially offset by a $54 million BOLI charge reflecting reserves recorded in the connection with the intent to surrender the policy. Additionally, the Bancorp recorded a $244 million gain on the sale of its Visa Inc., Class B shares and a $73 million benefit from the reversal of Visa litigation reserve in non-interest expense. These benefits were partially offset by $226 million in preferred stock dividends and a $22 million pre-tax litigation reserve accrual recorded in other noninterest expense for litigation associated with bank card association membership. Provision expense in excess of net charge-offs decreased from $1.9 billion in 2008 to $1 billion in 2009.

Comparison of 2008 with 2007

Results 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 Third’s 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 Bancorp’s 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 Bancorp’s BOLI policies totaling $215 million, OTTI charges totaling $104 million from FNMA and FHLMC preferred stock and certain bank trust preferred securities, a net benefit of $40 million from the resolution of a prior litigation partially offset by $67 million in preferred stock dividends in 2008. The results in 2007 included a charge of $177 million related to a reduction in the current cash surrender value of one of the Bancorp’s BOLI policies and charges totaling $172 million in Visa related charges.


 

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FOURTH QUARTER REVIEW

 

The Bancorp’s 2009 fourth quarter net loss available to common shareholders was $160 million, or $0.20 per diluted share, compared to a net loss available to common shareholders of $159 million, or $0.20 per diluted share, for the third quarter of 2009 and a net loss available to common shareholders of $2.2 billion, or $3.78 per diluted share, for the fourth quarter of 2008. Fourth quarter 2009 earnings included the benefit of a $20 million pre-tax, mark-to-market adjustment on warrants related to the Processing Business Sale, recorded in other noninterest income, offset by a $22 million pre-tax litigation reserve recorded in other noninterest expense for litigation associated with a bank card association membership. Third quarter 2009 results included a pre-tax benefit of $317 million from the sale of the Bancorp’s Visa, Inc. Class B common shares and the release of related Visa litigation reserves. Fourth quarter 2008 earnings were impacted by a $965 million goodwill impairment charge, a $40 million OTTI charge on certain securities and a $34 million charge to lower the cash surrender value of a BOLI policy. Provision expense was $776 million in the fourth quarter of 2009, down from $952 million in the third quarter of 2009 and $2.4 billion in the fourth quarter of 2008. The decline from the third quarter of 2009 is reflective of a slight improvement in credit trends as evidenced by a decline in net charge-offs. Provision expense in the fourth quarter of 2008 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 and recognized net charge-offs of $800 million. The allowance to loan and lease ratio was 4.88% as of December 31, 2009, compared to 4.69% as of September 30, 2009 and 3.31% as of December 31, 2008.

Fourth quarter 2009 net interest income (FTE) of $882 million increased $8 million from the third quarter of 2009 and decreased $15 million from the same period a year ago. Net interest income was affected by the loan discount accretion related to the second quarter of 2008 acquisition of First Charter which resulted in increases to net interest income of $23 million in the fourth quarter 2009, $27 million in the third quarter, and $81 million in the fourth quarter of 2008. Excluding these benefits, net interest income increased $12 million from the third quarter of 2009 and increased $43 million from the fourth quarter of 2008. Both the sequential and year-over-year increases were largely driven by the runoff of higher cost term deposits throughout the year.

    Noninterest income, excluding securities gains and losses of $649 million, decreased $194 million compared to the third quarter of 2009 and decreased $33 million compared to the fourth quarter of 2008. Fourth quarter 2009 results included a benefit of $20 million in mark-to-market adjustments on warrants related to the Processing Business Sale while third quarter results included a $244 million gain from the sale of the Bancorp’s Visa, Inc. Class B shares. The decrease from the fourth quarter of 2008 was driven by a decrease in card and processing revenue due to the Processing Businesses Sale in the second quarter of 2009 and a decline in corporate banking revenue, partially offset by strong mortgage banking net revenue. The fourth quarter of 2008 also included a $34 million charge to reduce the cash surrender value of one of the Bancorp’s BOLI policies.

Service charges on deposits of $159 million decreased three percent sequentially and decreased two percent compared with the fourth quarter of 2008. Retail service charges declined six percent from the third quarter of 2009 and three percent from a year ago, largely driven by a reduction in NSF fees due to changes in overdraft policies. Commercial service charges increased one percent from the third quarter of 2009 and decreased one percent from the same quarter last year.

Mortgage banking net revenue was $132 million in the fourth quarter of 2009, compared to $140 million in the third quarter of

2009 and a net loss of $29 million in the fourth quarter of 2008. Fourth quarter originations were $4.8 billion, compared to $4.6 billion from the previous quarter and $2.1 billion from the same quarter last year. These originations resulted in gains on mortgage loan sales activity of $97 million in the fourth quarter of 2009, compared to $96 million in the third quarter of 2009 and $45 million in the fourth quarter of 2008. Including net securities gains on non-qualifying hedges on mortgage servicing rights, mortgage banking net revenue in the fourth quarter of 2009 decreased $8 million compared to the third quarter of 2009 and increased $65 million compared to the fourth quarter of 2008.

Corporate banking revenue of $98 million increased by $12 million, or 15%, from the previous quarter and decreased $23 million, or 19%, on a year-over-year basis. The sequential increase was driven primarily by growth in institutional sales, interest rate derivative sales revenue and business lending fees, partially offset by a decline in foreign exchange revenue. On a year-over-year basis, lower foreign exchange and interest rate derivative sales revenue more than offset growth in institutional sales and business lending fees.

Investment advisory revenue of $77 million increased four percent sequentially and decreased two percent from the fourth quarter of 2008. The sequential growth was driven by increases in institutional trust revenue, brokerage fees and private client revenue, partially offset by a 14% decline in mutual fund fees due to lower mutual fund balances. Compared to the fourth quarter of 2008, institutional trust revenue and private client service revenue increased 13% and five percent, respectively, but were more than offset by declines in mutual fund fees of 27% and brokerage fees of seven percent.

Card and processing revenue of $76 million increased three percent compared to the third quarter of 2009 and decreased 67% from the fourth quarter of 2008 as a result of the Processing Business Sale in the second quarter of 2009. As part of the transaction, the Bancorp retained certain debit and credit card interchange revenue and sold the financial institutions and merchant processing portions of the business, which historically comprised approximately 70% of total card and processing revenue. Card issuer interchange revenue increased five percent sequentially and 12% year-over-year, due to strong growth in debit card transaction volumes, partially offset by lower credit card usage.

The net gains on investment securities was $2 million in the fourth quarter of 2009 compared to a net gain of $8 million in the third quarter of 2009 and a net loss of $40 million in the fourth quarter of 2008. The fourth quarter of 2008 loss was driven by an OTTI charge of $40 million on certain securities.

    Noninterest expense of $967 million increased $91 million sequentially and decreased $1.1 billion from the fourth quarter of 2008. Fourth quarter 2009 results included a $22 million reserve established for litigation related to bank card association memberships. Third quarter 2009 results include the Visa litigation reserve reversal of $73 million and $10 million of seasonal pension settlement expense. Excluding these items, noninterest expense increased $6 million driven by higher FDIC insurance premiums, partially offset by a decrease in the provision for unfunded commitments. The decrease in noninterest expense from a year ago was driven by a $965 million charge to record goodwill impairment in the fourth quarter of 2008. Excluding these charges, noninterest expense decreased $112 million from a year ago, driven primarily by a decrease in processing expenses from the Processing Business Sale, as well as a decrease in the provision for unfunded commitments, partially offset by higher FDIC insurance premiums.

    Net charge-offs totaled $708 million in the fourth quarter of 2009, compared to $756 million in the third quarter of 2009 and $1.6 billion in the fourth quarter of 2008. Loss experience


 

 

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continued to be primarily associated with commercial home builder and developer loans and consumer residential real estate loans, and was disproportionately concentrated in Michigan and Florida. In aggregate, Florida and Michigan represented approximately 53% of total losses during the quarter but only 27% of total loans and leases. Commercial net charge-offs were $468 million in the fourth quarter of 2009, a decrease of $32 million from the third quarter of 2009 and a decrease of $159 million from the fourth quarter of 2008 excluding the loans that were sold or transferred to held-for-sale. Results from the fourth quarter of 2008 include net charge-offs of $800 million on commercial loans that were either sold or transferred to held-for-sale during that quarter. The provision for loan and lease losses totaled $776 million in the fourth quarter of 2009, exceeding net charge-offs by $68 million. In comparison, the provision for loan and lease losses totaled $952 million in the third quarter of 2009, exceeding net charge-offs by $196 million, and totaled $2.4 billion in the fourth quarter of 2008, which exceeded net charge-offs by $729 million.

COMPARISON OF THE YEAR ENDED 2008 WITH 2007

Net loss available to common shareholders for the year ended 2008 was $2.2 billion, or $3.91 per diluted share, compared to net income available to common shareholders of $1.1 billion, or $1.98 per diluted share, in 2007. Overall, increases in net interest income and fee revenue were offset by an increase in the provision for loan and lease losses of $3.9 billion over 2007 coupled with a goodwill impairment charge of $965 million. This increase in provision expense reflected the significant decline in general economic conditions in 2008, specifically in the Bancorp’s key lending markets, which led to an increase in impaired commercial loans, higher losses, increased estimated loss factors due to negative trends in overall delinquencies, and increased loss estimates once a loan becomes delinquent as a result of the deterioration in real estate collateral values. The goodwill impairment charge reflected a decline in estimated fair values of two of the Bancorp’s 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.

Net interest income (FTE) increased 17% compared to 2007. Net interest margin increased to 3.54% in 2008 from 3.36% in 2007. The increase in 2008 was driven by the positive impact from the accretion of the discounts on acquired loans, primarily from the acquisition of First Charter, which increased net interest margin approximately 34 bp, partially offset by a reduction to interest income on commercial leases as a result of the recalculation of cash flows on certain leveraged leases, as well as an increase in nonperforming loans.

Noninterest income increased 19% compared to 2007. This was driven in part by a $273 million gain from the redemption of a portion of the Bancorp’s ownership interest in Visa, Inc., partially offset by $104 million in OTTI charges on FNMA and FHLMC preferred stock and certain bank trust preferred securities. Growth occurred in several categories compared to 2007. Card and 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 a newly adopted U.S. GAAP accounting standard in 2008.

Noninterest expense increased $1.3 billion, or 38% compared to 2007. Noninterest expense in 2008 included the previously mentioned goodwill impairment charge of $965 million and an additional $65 million in mortgage origination costs from the adoption of newly issued U.S. GAAP accounting guidance, partially offset by $99 million in net reductions related to Visa litigation reserves and Visa’s funding of an escrow account. Noninterest expense in 2007 included charges of $172 million related to the indemnification of estimated current and future Visa litigation settlements. Excluding these items, noninterest expense increased 16% due to volume-related processing expenses, higher FDIC insurance, increased provision for unfunded commitments and higher loan and lease expense.

In 2008, net charge-offs as a percent of average loans and leases were 323 bp compared to 61 bp in 2007. This increase was impacted by commercial loan net charge-offs as homebuilders, developers and related suppliers were affected by the downturn in the real estate markets. In addition, residential mortgage charge-offs increased to $243 million in 2008, compared to $43 million in 2007, reflecting increased foreclosure rates in the Bancorp’s key lending markets. At December 31, 2008, nonperforming assets as a percent of loans and leases increased to 2.96% from 1.32% at December 31, 2007. The Bancorp increased its allowance for loan and lease losses as percent of loans and leases from 1.17% as of December 31, 2007 to 3.31% as of December 31, 2008.

During 2007, the Bancorp completed its acquisition of R-G Crown Bank (“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, in 2007 the Bancorp announced its introduction into the North Carolina markets of Charlotte and Raleigh with an agreement to acquire First Charter Corporation (“First Charter”) and completed the acquisition on June 6, 2008, adding approximately $4.8 billion in assets and $3.2 billion in deposits.


 

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BALANCE SHEET ANALYSIS

 

Loans and Leases

Total loans and leases, including loans held for sale, at December 31, 2009, decreased $6.7 billion, or eight percent, compared to December 31, 2008. The decrease in total loans and leases was primarily due to a $3.5 billion decrease in the commercial loans portfolio and a $1.5 billion decrease in the commercial construction portfolio.

Total commercial loans and leases decreased $5.9 billion, or 12%, compared to December 31, 2008. Lower customer demand, net charge-offs of $1.6 billion, a decrease in line utilization, and tighter underwriting standards implemented since the third quarter of 2008 and applied to new commercial originations and renewals contributed to the decrease in commercial loans and leases. The commercial loan product balance decreased $3.5 billion, or 12% from December 31, 2008 due to net charge-offs of $718 million and an overall decrease in customer line utilization to 33% at December 31, 2009 compared to 54% at December 31, 2008. Included within the commercial loan product balance at December 31, 2009 is $1.24 billion in loans issued in conjunction with the Processing Business Sale in the second quarter of 2009. Commercial mortgage loans decreased $795 million, or six percent from December 31, 2008 due to net charge-offs of $422 million, tighter lending requirements, and the Bancorp’s effort to limit overall exposure to commercial mortgages. Commercial construction loans decreased $1.5 billion, or 27%, primarily due to management’s strategy to suspend new lending on commercial non-owner occupied real estate in the second quarter of 2008. Other factors contributing to the decrease in commercial construction loans included net charge offs of $416 million along with continued pay downs on existing loans.

    Total consumer loans and leases decreased $826 million, or two percent, from December 31, 2008. Residential mortgage loans decreased $446 million, or four percent, from December 31, 2008 due to approximately $188 million of portfolio loans sales during 2009, net charge-offs of $356 million, as well as normal principal

pay downs. This decline in residential mortgage loans occurred despite the 81% increase in mortgage originations compared to 2008 as the Bancorp sells nearly all of its newly originated mortgage loans at or near loan closing. Home equity loans decreased $578 million, or five percent, from December 31, 2008 due to tighter underwriting standards on loan to value ratios and net charge-offs of $322 million. Other consumer loans and leases, primarily made up automobile leases and student loans designated as held-for-sale, decreased $382 million, or 32%, compared to the prior year end due to a decline in new originations as a result of tighter underwriting standards across the other consumer loan and lease portfolio. The growth in automobile loans of $401 million, or five percent, compared to December 31, 2008 was primarily the result of an increase in automobile loan originations due to the federal government offering cash rebates on new automobile purchases in the “Cash for Clunkers” program. Credit card loans increased $179 million, or 10%, from December 31, 2008 as a result of the Bancorp’s continued success in cross-selling credit cards to its existing retail customer base, but was partially offset by net charge-offs of $169 million.

Average total commercial loans and leases decreased $2.5 billion, or five percent, compared to December 31, 2008. The decrease in average total commercial loans and leases was driven by the aforementioned reasons as the Bancorp experienced declines in all commercial loan categories compared to December 31, 2008.

Average total consumer loans and leases were flat compared to 2008 as declines in other consumer loans and leases, driven by tighter underwriting standards, were offset by increases in credit card loans and home equity loans. Increases in average credit card loans of 12% are a result of cross-selling to the existing customer base and increases in average home equity loans of two percent was primarily due to the impact of acquisition activity in 2008.


 

TABLE 18: COMPONENTS OF TOTAL LOANS AND LEASES (INCLUDES HELD FOR SALE)

As of December 31 ($ in millions)

   2009    2008    2007    2006    2005

Commercial:

              

Commercial loans

   $25,687    29,220    26,079    20,831    19,377

Commercial mortgage

   11,936    12,731    11,967    10,405    9,188

Commercial construction

   3,871    5,335    5,561    6,168    6,342

Commercial leases

   3,535    3,666    3,737    3,841    3,698

Subtotal - commercial

   45,029    50,952    47,344    41,245    38,605

Consumer:

              

Residential mortgage loans

   9,846    10,292    11,433    9,905    8,991

Home equity

   12,174    12,752    11,874    12,154    11,805

Automobile loans

   8,995    8,594    11,183    10,028    9,396

Credit card

   1,990    1,811    1,591    1,004    788

Other consumer loans and leases

   812    1,194    1,157    1,167    1,644

Subtotal - consumer

   33,817    34,643    37,238    34,258    32,624

Total loans and leases

   $78,846    85,595    84,582    75,503    71,229

Total loans and leases (excludes held for sale)

   $76,779    84,143    80,253    74,353    69,925

TABLE 19: COMPONENTS OF AVERAGE TOTAL LOANS AND LEASES (INCLUDES HELD FOR SALE)

As of December 31 ($ in millions)    2009    2008    2007    2006    2005

Commercial:

              

Commercial loans

   $27,556    28,426    22,351    20,504    18,310

Commercial mortgage

   12,511    12,776    11,078    9,797    8,923

Commercial construction

   4,638    5,846    5,661    6,015    5,525

Commercial leases

   3,543    3,680    3,683    3,730    3,495

Subtotal - commercial

   48,248    50,728    42,773    40,046    36,253

Consumer:

              

Residential mortgage loans

   10,886    10,993    10,489    9,574    8,982

Home equity

   12,534    12,269    11,887    12,070    11,228

Automobile loans

   8,807    8,925    10,704    9,570    8,649

Credit card

   1,907    1,708    1,276    838    728

Other consumer loans and leases

   1,009    1,212    1,219    1,395    1,897

Subtotal - consumer

   35,143    35,107    35,575    33,447    31,484

Total average loans and leases

   $83,391    85,835    78,348    73,493    67,737

Total average portfolio loans and leases (excludes held for sale)

   $80,681    83,895    76,033    72,447    66,685

 

 

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TABLE 20: COMPONENTS OF INVESTMENT SECURITIES

As of December 31 ($ in millions)    2009    2008    2007    2006    2005

Available-for-sale and other: (amortized cost basis)

              

U.S. Treasury and Government agencies

   $464    186    3    1,396    506

U.S. Government sponsored agencies

   2,143    1,651    160    100    2,034

Obligations of states and political subdivisions

   240    323    490    603    657

Agency mortgage-backed securities

   11,074    8,529    8,738    7,999    16,127

Other bonds, notes and debentures

   2,541    613    385    172    2,119

Other securities

   1,417    1,248    1,045    966    1,090

Total available-for-sale and other

   $17,879    12,550    10,821    11,236    22,533

Held-to-maturity:

              

Obligations of states and political subdivisions

   $350    355    351    345    378

Other bonds, notes and debentures

   5    5    4    11    11

Total held-to-maturity

   $355    360    355    356    389

Trading:

              

Variable rate demand notes

   $235    1,140    -    -    -

Other securities

   120    51    171    187    117

Total trading

   $355    1,191    171    187    117

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, 2009, total investment securities were $18.9 billion compared to $14.3 billion at December 31, 2008. See Note 1 of the Notes to Consolidated Financial Statements for the Bancorp’s classification of investment securities and management’s evaluation of securities in an unrealized loss position for OTTI. During the year ended December 31, 2009, OTTI on available-for-sale and held-to-maturity securities was immaterial to the Bancorp’s consolidated financial statements.

At December 31, 2009, the Bancorp’s investment portfolio primarily consisted of AAA-rated agency mortgage-backed securities. The investment portfolio includes FHLMC preferred stock and FNMA preferred securities with carrying values as of December 31, 2009 and 2008 of $3 million and $1 million, respectively, after recognizing OTTI charges of $67 million during 2008. The Bancorp also recognized OTTI charges of $37 million on certain trust preferred securities in 2008, which have a carrying value of $102 million and $79 million, as of December 31, 2009 and 2008, respectively. Upon a change in U.S. GAAP in 2009, the Bancorp concluded that the OTTI charges on these trust preferred debt securities were due to non-credit related factors and therefore, recognized an increase of $37 million to the investment balance and related unrealized losses. See Note 1 to the Notes to Consolidated Financial Statements for further information on the Bancorp’s accounting for OTTI.

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, 2009. Additionally, there was approximately $178 million of securities classified as below investment grade as of December 31, 2009, the majority of which was made up of the above mentioned trust preferred securities.

    Trading securities decreased from $1.2 billion at December 31, 2008 to $355 million at December 31, 2009. The decrease was driven by the sale of VRDNs which were held by the Bancorp in its trading securities portfolio. These securities were purchased from the market during 2008 and 2009 through FTS who was also the remarketing agent. During the fourth quarter of 2009, the rates on these securities began to decline substantially, and as a result the Bancorp sold a majority of its VRDNs and replaced them with higher-yielding investments. For more information on the VRDNs, see Note 16 of the Notes to Consolidated Financial Statements. Included in trading securities as of December 31, 2009 were $13 million of auction rate securities, which had an unrealized loss of $4 million. The Bancorp did not hold auction rate securities in its trading portfolio during 2008.

    On an amortized cost basis, as of December 31, 2009, available-for-sale securities increased $5.3 billion from December

31, 2008. In the first quarter of 2009, financial market volatility created attractive investment opportunities. As a result, the Bancorp purchased $1.4 billion in AAA-rated automobile asset-backed securities and $1.5 billion of agency issued mortgage backed securities and debentures to manage the interest rate risk of the Bancorp. In addition, during the fourth quarter of 2009 the Bancorp continued to purchase similar agency and non-agency mortgage-backed securities to replace the VRDNs, as the rates on mortgage-backed and other available-for-sale securities presented better investment opportunities than the VRDNs, which were experiencing declining coupon rates. At December 31, 2009, available-for-sale securities increased to 18% of interest-earning assets, compared to 12% at December 31, 2008, primarily due to a 30% increase in agency mortgage-backed securities as discussed above, and a two percent decrease in total interest earning assets, driven by a $6.7 billion, or eight percent, decline in total loans and leases. The estimated weighted-average life of the debt securities in the available-for-sale portfolio was 4.4 years at December 31, 2009 compared to 3.2 years at December 31, 2008. The increase in the weighted-average life of the debt securities portfolio was primarily driven by the weighted-average lives of agency mortgage-backed securities. This can be attributed to a general decline in estimates of prepayment speeds as the combination of a portfolio with lower coupon rates compared to prior year and the stabilization of mortgage interest rates has led to a portfolio with a longer average life. At December 31, 2009, the fixed-rate securities within the available-for-sale securities portfolio had a weighted-average yield of 4.48% compared to 5.08% at December 31, 2008.

Since the second half of 2007, the Bancorp purchased investment grade commercial paper from an unconsolidated QSPE that is wholly owned by an independent third-party. The commercial paper has maturities ranging from one day to 90 days and is backed by the assets held by the QSPE. As of December 31, 2009 and 2008, the Bancorp held $805 million and $143 million, respectively, of this commercial paper in its available-for-sale portfolio. Refer to the Off-balance Sheet Arrangements section in Management’s Discussion and Analysis for more information on the QSPE.

    Information presented in Table 21 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 began to decline in the fourth quarter of 2008 and throughout 2009. This market rate decline led to unrealized gains on agency mortgage-backed securities of $323 million and $152 million as of December 31, 2009 and 2008, respectively. Total net unrealized gains on the available-for-sale securities portfolio was $334 million at December 31, 2009 compared to $178 million at December 31, 2008.


 

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TABLE 21: CHARACTERISTICS OF AVAILABLE-FOR-SALE AND OTHER SECURITIES

As of December 31, 2009 ($ 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

   $141    $142    0.5    2.09

Average life 1 – 5 years

   75    75    2.3    1.27   

Average life 5 – 10 years

   247    240    9.6    3.40   

Average life greater than 10 years

   1    1    11.8    1.46   

Total

   464    458    5.6    2.65   

U.S. Government sponsored agencies:

           

Average life of one year or less

   85    86    0.3    2.86   

Average life 1 – 5 years

   133    135    1.8    2.66   

Average life 5 – 10 years

   1,925    1,921    6.9    3.63   

Average life greater than 10 years

   -    -    -    -   

Total

   2,143    2,142    6.4    3.54   

Obligations of states and political subdivisions (a):

           

Average life of one year or less

   139    139    0.2    7.44   

Average life 1 – 5 years

   14    15    3.0    7.24   

Average life 5 – 10 years

   48    48    6.6    6.87   

Average life greater than 10 years

   39    41    11.6    3.91   

Total

   240    243    3.5    6.74   

Agency mortgage-backed securities:

           

Average life of one year or less

   233    238    0.6    4.92   

Average life 1 – 5 years

   3,725    3,839    3.1    4.69   

Average life 5 – 10 years

   7,115    7,304    6.1    4.95   

Average life greater than 10 years

   1    1    10.1    4.22   

Total

   11,074    11,382    5.0    4.88   

Other bonds, notes and debentures (b):

           

Average life of one year or less

   1,203    1,206    0.2    2.20   

Average life 1 – 5 years

   1,028    1,054    2.0    6.13   

Average life 5 – 10 years

   182    192    7.5    7.13   

Average life greater than 10 years

   128    117    17.1    7.45   

Total

   2,541    2,569    2.1    4.28   

Other securities (c)

   1,417    1,419      

Total available-for-sale and other securities

   $17,879    $18,213    4.4    4.48
(a) Taxable-equivalent yield adjustments included in the above table are 2.59%, 1.14%, 0.20%, 0.01% and 1.61% 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.

 

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 offering competitive rates and enhancing its product offerings. At December 31, 2009, core deposits represented 68% of the Bancorp’s asset funding base, compared to 56% at December 31, 2008.

Core deposits increased $9.8 billion or 15% compared to 2008 primarily due to a $5.7 billion increase in interest checking and $4.1 billion increase in demand deposits. A majority of the increase in interest checking was due to a $4.0 billion increase in the balance of public fund deposits, driven by strong growth in the fourth quarter of 2009 and a $1.6 billion increase in consumer accounts due to runoff of higher priced certificates originated in the second half of 2008. The growth in the demand deposit account balances can be attributed to a $3.4 billion increase in commercial demand deposit accounts as commercial customers took advantage of increased protection provided by FDIC insurance programs in 2009.

Included in core deposits are foreign office deposits, which are Eurodollar sweep accounts for the Bancorp’s 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. The Bancorp uses these deposits, as well as certificates of deposit $100,000 and over, as a method to fund earning asset growth. Certificates $100,000 and over at December 31, 2009 decreased by $4.2 billion compared to December 31, 2008 as customers opted to maintain their balances in liquid accounts due to lower pricing on certificates in 2009.

On an average basis, core deposits increased $5.5 billion or nine percent primarily due to increases in other time deposits of $3.0 billion, demand deposits of $2.8 billion, and savings deposits of $683 million, partially offset by a decrease in money market accounts of $1.8 billion. Average other time deposits balances increased compared to the prior year as customers took advantage of competitive rates in the fourth quarter of 2008 on short term certificates which matured in the second half of 2009. Average demand and savings accounts increased compared to the prior year as customers preferred to hold cash in the second half of 2009 due to lower pricing on certificates. Average money market accounts decreased from 2008 due to lower interest rates offered on accounts in 2009.


 

 

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TABLE 22: DEPOSITS

As of December 31 ($ in millions)    2009    2008    2007    2006    2005

Demand

   $19,411    15,287    14,404    14,331    14,609

Interest checking

   19,935    14,222    15,254    15,993    18,282

Savings

   17,898    16,063    15,635    13,181    11,276

Money market

   4,431    4,689    6,521    6,584    6,129

Foreign office

   2,454    2,144    2,572    1,353    421

Transaction deposits

   64,129    52,405    54,386    51,442    50,717

Other time

   12,466    14,350    11,440    10,987    9,313

Core deposits

   76,595    66,755    65,826    62,429    60,030

Certificates - $100,000 and over

   7,700    11,851    6,738    6,628    4,343

Other

   10    7    2,881    323    3,061

Total deposits

   $84,305    78,613    75,445    69,380    67,434
TABLE 23: AVERAGE DEPOSITS                  
As of December 31 ($ in millions)    2009    2008    2007    2006    2005

Demand

   $16,862    14,017    13,261    13,741    13,868

Interest checking

   15,070    14,191    14,820    16,650    18,884

Savings

   16,875    16,192    14,836    12,189    10,007

Money market

   4,320    6,127    6,308    6,366    5,170

Foreign office

   2,108    2,153    1,762    732    248

Transaction deposits

   55,235    52,680    50,987    49,678    48,177

Other time

   14,103    11,135    10,778    10,500    8,491

Core deposits

   69,338    63,815    61,765    60,178    56,668

Certificates - $100,000 and over

   10,367    9,531    6,466    5,795    4,001

Other

   157    2,067    1,393    2,979    3,719

Total average deposits

   $79,862    75,413    69,624    68,952    64,388

 

Borrowings

Total borrowings declined $11.7 billion from December 31, 2008, as the result of a combination of balance sheet activity and capital actions taken by the Bancorp throughout 2009. Portfolio loan balances declined $7.4 billion from December 31, 2008. This, coupled with increases in deposits of $5.7 billion from December 31, 2008, resulted in a decrease of the funding position of approximately $13.1 billion. Further, in the second quarter of 2009, the Processing Business Sale provided $562 million of cash, and the Bancorp raised an additional $1.0 billion through the issuance of common equity in the public market, further decreasing the Bancorp’s funding position needs. As of December 31, 2009 and December 31, 2008, total borrowings as a percentage of interest-bearing liabilities were 16% and 27%, respectively.

Total short-term borrowings were $1.6 billion at December 31, 2009, down from $10.2 billion at December 31, 2008. The Bancorp’s overall reduced reliance on short-term funding can be attributed to declining asset balances and strong deposit performance.

Long-term debt at December 31, 2009 decreased 23% compared to December 31, 2008. This was due in part to a $1.0 billion FHLB advance maturing in the first quarter of 2009 and $1.2 billion in bank notes maturing in the second quarter of 2009, neither of which were replaced due to the Bancorp’s strong liquidity position.

Information on the average rates paid on borrowings is included within the Statements of Income Analysis. Additionally, refer to the Liquidity Risk Management section for a discussion on the role of borrowings in the Bancorp’s liquidity management.


 

TABLE 24: BORROWINGS

As of December 31 ($ in millions)    2009    2008    2007    2006    2005

Federal funds purchased

   $182    287    4,427    1,421    5,323

Other short-term borrowings

   1,415    9,959    4,747    2,796    4,246

Long-term debt

   10,507    13,585    12,857    12,558    15,227

Total borrowings

   $12,104    23,831    22,031    16,775    24,796

 

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RISK MANAGEMENT

 

 

Managing risk is an essential component of successfully operating a financial services company. The Bancorp’s 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 Bancorp’s risk profile. The Enterprise Risk Management division (ERM), led by the Bancorp’s Chief Risk Officer, ensures consistency in the Bancorp’s approach to managing and monitoring risk within the structure of the Bancorp’s affiliate operating model. In addition, the Internal Audit division provides an independent assessment of the Bancorp’s internal control structure and related systems and processes.

The assumption of risk requires robust and active risk management practices that comprise an integrated and comprehensive set of activities, measures and strategies that apply to the entire organization. The Bancorp has established a Risk Appetite Framework that provides the foundations of corporate risk capacity, risk appetite and risk tolerances. The Bancorp’s risk capacity is represented by its available financial resources. Risk capacity sets an absolute limit on risk-assumption in the Bancorp’s annual and strategic plans. Our policy currently discounts our risk capacity by five percent to provide a buffer; as a result, the Bancorp’s risk appetite is limited by policy to 95% of our risk capacity.

Economic capital is the amount of unencumbered financial resources necessary to support the Bancorp’s risks. We measure economic capital under the assumption that we expect to maintain debt ratings at strong investment grade levels over time. Our capital policies require that the economic capital necessary in our business not exceed our risk capacity less the aforementioned buffer.

Risk appetite is the aggregate amount of risk the Bancorp is willing to accept in pursuit of its strategic and financial objectives. By establishing boundaries around risk taking and business decisions, and by incorporating the needs and goals of our shareholders, regulators, rating agencies and customers, the Bancorp’s risk appetite is aligned with its priorities and goals. The formulation of risk appetite considers the Bancorp’s risk capacity, its financial position, the resilience of its reputation and brand and its core competencies. Risk tolerance is the maximum amount of risk applicable to each of the eight specific risk categories included in its Enterprise Risk Management Framework. This is expressed both qualitatively, describing which risks may be taken, and quantitatively, describing the magnitude of tolerance. The Bancorp’s risk appetite and risk tolerances are supported by risk targets and risk limits. Those limits are used to monitor the amount of risk assumed at a granular level, which include key risk indicators, performance indicators and quantitative metrics for shocks and sensitivity measurements.

The risks faced by the Bancorp include, but are not limited to, credit, market, liquidity, operational, regulatory compliance, legal, reputational and strategic. Each of these risks are managed through the Bancorp’s risk program, including an Enterprise Risk Management Framework. ERM includes the following key functions:

   

Commercial Credit Risk Management provides safety and soundness within an independent portfolio management framework that supports the Bancorp’s 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, allowance for loan and lease losses (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 soundness within an independent management framework that supports the Bancorp’s 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. In addition, the Bank Protection function oversees and manages fraud prevention and detection and provides 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 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 six outside directors and has the responsibility for the oversight of risk management for the Bancorp, as well as for the Bancorp’s 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. The primary committee responsible for the oversight of risk management is the Enterprise Risk Management Committee (ERMC). Committees accountable to the ERMC, which support the core risk programs, are the Corporate Credit Committee, the Operational Risk Committee, the Management Compliance Committee, the Executive Asset Liability Management Committee and the Enterprise Marketing Committee. Other committees accountable to the ERMC include the Loan Loss Reserve Committee, Capital Committee and the Retail Distribution Governance 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


 

 

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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, 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 Bancorp’s 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 Bancorp’s 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 Bancorp’s 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. Corporate 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 Bancorp’s 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 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 nine 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 Bancorp’s homogenous consumer loan portfolios.

Overview

General economic conditions remained weak throughout 2009, which negatively impacted a majority of the Bancorp’s loan and lease products. Geographically, the Bancorp experienced the most stress in 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 in automobile manufacturing and the

state’s economic downturn. Among commercial portfolios, the homebuilder and developer and remaining non-owner occupied commercial real estate portfolios remained under stress throughout 2009. Among consumer portfolios, residential mortgage and brokered home equity portfolios exhibited the most stress. Management suspended homebuilder and developer lending in the fourth quarter of 2007 and new commercial non-owner occupied real estate lending in the second quarter of 2008, discontinued the origination of brokered home equity products at the end of 2007, and raised underwriting standards across both the commercial and consumer loan product offerings. During the fourth quarter of 2008, 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 loans. Throughout 2009, the Bancorp continued to aggressively engage in other loss mitigation techniques such as reducing lines of credit, restructuring certain commercial and consumer loans, tightening underwriting standards on commercial loans and across the consumer loan portfolio, as well as expanding commercial and consumer loan workout teams. The following credit information presents the Bancorp’s loan portfolio diversification, loan portfolios with elevated levels of risk, an analysis of nonperforming loans and loans charged-off, and a discussion of the allowance for credit losses.

Commercial Portfolio

The Bancorp’s credit risk management strategy includes minimizing concentrations of risk through diversification. The Bancorp has commercial loan concentration limits based on industry, lines of business within the commercial segment and credit product type.

The risk within the commercial loan and lease 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 pro-forma analysis requirements. The Bancorp requires an appraisal of collateral be performed at origination and on an as-needed basis, in conformity with market conditions and regulatory requirements. Independent reviews are performed on appraisals to ensure the appraiser is qualified and consistency in the evaluation process exists.

    As part of its commercial lending, the Bancorp participates in Shared National Credit (SNC) loans, which are facilities greater than $20 million shared by three or more federally supervised financial institutions that are reviewed by regulatory authorities at the agent bank level. At December 31, 2009, the Bancorp was a participant to SNC loans with an outstanding balance to the Bancorp of $6.4 billion with a total exposure of $20.0 billion. C&I loans make up a majority of SNC loans, totaling $5.5 billion at December 31, 2009. SNC loans adhere to the same credit underwriting standards as other commercial loans held by the Bancorp.

Table 25 provides detail on total commercial loan and leases, 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 Bancorp’s commercial loans and leases.


 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

TABLE 25: COMMERCIAL LOAN AND LEASE PORTFOLIO EXPOSURE (a)

 

     2009    2008
As of December 31 ($ in millions)    Outstanding     Exposure    Nonaccrual    Outstanding    Exposure    Nonaccrual

By industry:

                

Real estate

   $10,142      11,622    1,001    11,925    14,428    583

Manufacturing

   6,320      13,093    223    7,382    14,310    92

Financial services and insurance

   4,375      8,702    44    3,601    8,164    28

Construction

   3,778      5,281    765    5,030    7,788    698

Healthcare

   3,019      4,921    73    3,081    5,057    20

Retail trade

   2,692      5,552    114    3,621    6,874    167

Business services

   2,656      4,595    54    2,925    5,141    38

Transportation and warehousing

   2,516      3,003    55    2,726    3,224    26

Wholesale trade

   2,259      4,632    52    2,567    4,772    25

Other services

   1,133      1,558    37    1,203    1,712    22

Accommodation and food

   1,024      1,505    63    1,163    1,560    38

Communication and information

   796      1,346    8    951    1,547    19

Mining

   769      1,182    18    838    1,275    18

Entertainment and recreation

   744      949    17    765    1,009    35

Individuals

   741      905    21    1,053    1,354    38

Public administration

   684      877    -    725    938    -

Agribusiness

   588      742    65    635    815    21

Utilities

   475      1,310    -    584    1,231    -

Other

   318      679    6    178    369    11
Total    $45,029      72,454    2,616    50,953    81,568    1,879

By loan size:

                

Less than $200,000

   3   2    4    3    2    5

$200,000 to $1 million

   12      9    18    12    9    21

$1 million to $5 million

   26      20    39    25    21    45

$5 million to $10 million

   13      11    18    14    13    20

$10 million to $25 million

   24      26    17    23    24    9

Greater than $25 million

   22      32    4    23    31    -

Total

   100   100    100    100    100    100

By state:

                

Ohio

   28   31    15    26    30    14

Michigan

   16      14    18    17    16    22

Florida

   9      7    26    9    8    25

Illinois

   8      9    9    8    9    8

Indiana

   6      6    6    7    7    8

Kentucky

   5      5    4    5    5    5

North Carolina

   3      3    1    3    3    4

Tennessee

   2      2    4    3    2    3

Pennsylvania

   2      2    -    2    2    1

All other states

   21      21    17    20    18    10

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.

The Bancorp has identified certain categories of loans which it believes represent a higher level of risk, as compared to the rest of the Bancorp’s loan portfolio, due to economic or market conditions in the Bancorp’s key lending areas. Tables 26 – 33 provide analysis of each of the categories of loans as of and for the years ended December 31, 2009 and 2008.

TABLE 26: NON-OWNER OCCUPIED COMMERCIAL REAL ESTATE

 

As of December 31, 2009 ($ in millions)                            For the Year Ended
December 31, 2009
By State:    Outstanding    Exposure    90 Days
Past Due
   Nonaccrual    Net Charge-offs

Ohio

   $2,917    3,250    14    204    111

Michigan

   2,003    2,193    16    173    153

Florida

   1,517    1,611    7    384    229

Illinois

   820    935    4    109    48

North Carolina

   716    768    3    146    54

Indiana

   531    553    -    49    27

All other states

   1,037    1,345    3    154    99

Total

   $9,541    10,655    47    1,219    721

 

 

Fifth Third Bancorp

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

TABLE 27: NON-OWNER OCCUPIED COMMERCIAL REAL ESTATE

 

As of December 31, 2008 ($ in millions)                            For the Year Ended
December 31, 2008
By State:    Outstanding    Exposure    90 Days
Past Due
   Nonaccrual    Net Charge-offs

Ohio

   $3,068    3,738    9    144    56

Michigan

   2,379    2,827    61    124    215

Florida

   1,864    2,160    60    89    157

Illinois

   928    1,135    3    71    20

North Carolina

   925    1,242    6    25    6

Indiana

   628    760    10    66    37

All other states

   1,326    1,804    6    96    28

Total

   $11,118    13,666    155    615    519

TABLE 28: HOME BUILDER AND DEVELOPER (a)

 

As of December 31, 2009 ($ in millions)                            For the Year Ended
December 31, 2009
By State:    Outstanding    Exposure    90 Days
Past Due
   Nonaccrual    Net Charge-offs

Ohio

   $346    542    2    73    34

Florida

   318    336    4    136    98

Michigan

   278    351    7    63    77

North Carolina

   229    260    3    95    49

Indiana

   108    133    -    12    9

All other states

   284    383    3    94    91

Total

   $1,563    2,005    19    473    358
(a) Home Builder and Developer loans, exclusive of commercial and industrial loans with an outstanding balance of $200 million and a total exposure of $461 million are also included in Table 26: Non-Owner Occupied Commercial Real Estate

TABLE 29: HOME BUILDER AND DEVELOPER (a)

 

As of December 31, 2008 ($ in millions)                            For the Year Ended
December 31, 2008
By State:    Outstanding    Exposure    90 Days
Past Due
   Nonaccrual    Net Charge-offs

Ohio

   $491    856    2    67    42

Florida

   482    618    4    73    122

Michigan

   449    732    7    79    166

North Carolina

   415    661    3    35    5

Indiana

   121    196    -    19    10

All other states

   523    712    3    92    22

Total

   $2,481    3,775    19    365    367
(a) Home Builder and Developer loans, exclusive of commercial and industrial loans with an outstanding balance of $332 million and a total exposure of $798 million are also included in Table 27: Non-Owner Occupied Commercial Real Estate

TABLE 30: AUTOMOBILE DEALERS

 

As of December 31, 2009 ($ in millions)                            For the Year Ended
December 31, 2009
By State:    Outstanding    Exposure    90 Days
Past Due
   Nonaccrual    Net Charge-offs

Ohio

   $325    569    3    14    30

Illinois

   232    380    -    19    19

Michigan

   207    340    2    3    7

Florida

   114    190    1    9    14

Tennessee

   100    191    -    -    1

All other states

   215    319    -    9    6

Total

   $1,193    1,989    6    54    77

TABLE 31: AUTOMOBILE DEALERS

 

As of December 31, 2008 ($ in millions)                            For the Year Ended
December 31, 2008
By State:    Outstanding    Exposure    90 Days
Past Due
   Nonaccrual    Net Charge-offs

Ohio

   $630    1,050    1    42    41

Illinois

   401    610    -    26    53

Michigan

   324    518    -    5    3

Florida

   148    187    1    11    6

Tennessee

   146    231    -    -    -

All other states

   353    522    2    11    7

Total

   $2,002    3,118    4    95    110

 

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Fifth Third Bancorp

 


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

TABLE 32: AUTOMOBILE MANUFACTURING

 

As of December 31, 2009 ($ in millions)                            For the Year Ended
December 31, 2009
By State:    Outstanding    Exposure    90 Days
Past Due
   Nonaccrual    Net Charge-offs

Michigan

   $221    468    -    12    14

Ohio

   93    276    -    2    2

Illinois

   47    138    -    -    -

Kentucky

   32    48    -    -    -

All other states

   9    73    -    -    -

Total

   $402    1,003    -    14    16

TABLE 33: AUTOMOBILE MANUFACTURING

 

As of December 31, 2008 ($ in millions)                            For the Year Ended
December 31, 2008
By State:    Outstanding    Exposure    90 Days
Past Due
   Nonaccrual    Net Charge-offs

Michigan

   $288    793    -    1    1

Ohio

   184    401    -    2    -

Illinois

   69    148    -    -    -

Kentucky

   47    95    -    1    -

All other states

   29    144    -    -    3

Total

   $617    1,581    -    4    4

 

Consumer Portfolio

The Bancorp’s consumer portfolio is materially comprised of three categories of loans: residential mortgage loans, home equity loans, and automobile loans. While each of these loans has unique features, they have a common risk characteristic of loan amount to collateral value.

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 or may purchase mortgage insurance for the loans sold in order to mitigate credit risk.

The Bancorp does not originate mortgage loans that permit customers to defer principal payments or make payments that are less than the accruing interest. The Bancorp originates both fixed and adjustable rate residential mortgage loans. Resets of rates on adjustable rate mortgages are not expected to have a material

impact on credit costs in the current interest rate environment, as approximately $1.2 billion of adjustable rate residential mortgage loans will have rate resets in 2010 and a material amount of those loans are expected to have either no increase or a decrease in monthly payments, due to the decrease in index rates over the past year.

Certain residential mortgage products have contractual features that may increase credit exposure to the Bancorp in the event of a decline in housing prices. These types of mortgage products offered by the Bancorp include loans with high 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. The Bancorp monitors residential mortgages loans with greater than 80% LTV ratio and no mortgage insurance as it believes these loans represent a higher level of risk. Tables 34 and 35 provide analysis of the residential mortgage loans outstanding with a greater than 80% LTV ratio and no mortgage insurance as of December 31, 2009 and 2008, respectively.


 

TABLE 34: RESIDENTIAL MORTGAGE LOANS OUTSTANDING, LTV GREATER THAN 80%, NO MORTGAGE INSURANCE

 

As of December 31, 2009 ($ in millions)                      For the Year Ended
December 31, 2009
By State:    Outstanding    90 Days
Past Due
   Nonaccrual    Net Charge-offs

Ohio

   $673    4    25    18

Florida

   388    9    50    68

Michigan

   350    3    13    21

North Carolina

   169    5    9    8

Indiana

   145    1    7    4

Kentucky

   92    1    3    2

Illinois

   62    1    6    2

All other states

   141    2    8    5

Total

   $2,020    26    121    128

 

 

Fifth Third Bancorp

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

TABLE 35: RESIDENTIAL MORTGAGE LOANS OUTSTANDING, LTV GREATER THAN 80%, NO MORTGAGE INSURANCE

 

As of December 31, 2008 ($ in millions)                For the Year Ended
December 31, 2008
By State:    Outstanding    90 Days
Past Due
   Nonaccrual    Net Charge-offs

Ohio

   $760    7    24    14

Florida

   495    16    51    67

Michigan

   397    3    17    15

North Carolina

   202    2    4    2

Indiana

   168    1    6    3

Kentucky

   110    1    3    1

Illinois

   69    1    4    -

All other states

   173    5    2    2

Total

   $2,374    36    111    104

Home Equity Portfolio

The home equity portfolio is managed in two categories, loans outstanding with a LTV greater than 80% and those loans with a LTV of less than 80%. The carrying value of the greater than 80% LTV home equity loans and less than 80% LTV home equity loans are $5.0 billion and $7.2 billion, respectively, as of December 31, 2009. Of the total $12.2 billion of outstanding home equity loans, 82% reside within the Bancorp’s Midwest footprint of Ohio, Michigan, Kentucky, Indiana and Illinois. The portfolio has an average FICO score of 730 as of December 31, 2009 compared with 736 as of December 31, 2008.

The Bancorp stopped origination of brokered home equity loans during the fourth quarter of 2007. In addition, the Bancorp 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 Bancorp believes that home equity loans with a greater than 80% LTV ratio present a higher level of risk. The following tables provide analysis of these loans as of December 31, 2009 and 2008.


 

TABLE 36: HOME EQUITY LOANS OUTSTANDING WITH LTV GREATER THAN 80%

 

As of December 31, 2009 ($ in millions)                      For the Year Ended
December 31, 2009
By State:    Outstanding    Exposure    90 Days
Past Due
   Nonaccrual    Net Charge-offs

Ohio

   $1,727    2,465    13    6    43

Michigan

   1,091    1,417    14    6    61

Illinois

   505    689    5    3    32

Indiana

   499    691    5    2    13

Kentucky

   471    672    4    2    12

Florida

   198    248    8    3    35

All other states

   523    618    9    5    37

Total

   $5,014    6,800    58    27    233

 

 

TABLE 37: HOME EQUITY LOANS OUTSTANDING WITH LTV GREATER THAN 80%

 

As of December 31, 2008 ($ in millions)                     

For the Year Ended

December 31, 2008

By State:

   Outstanding    Exposure    90 Days
Past Due
   Nonaccrual    Net Charge-offs

Ohio

   $1,844    2,770    13    6    30

Michigan

   1,179    1,575    15    7    43

Illinois

   527    763    7    6    14

Indiana

   544    769    5    3    9

Kentucky

   524    764    3    2    8

Florida

   224    295    7    3    24

All other states

   591    707    10    5    28

Total

   $5,433    7,643    60    32    156

 

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Fifth Third Bancorp

 


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Automobile Portfolio

The automobile portfolio is characterized by direct and indirect lending products to consumers. As of December 31, 2009, the automobile loan portfolio was comprised of approximately 47% in new automobile loans. It is a common competitive practice to advance on automobile loans an amount in excess of the

automobile value due to the inclusion of taxes, title, and other fees paid at closing. The Bancorp monitors its exposure to these higher risk accounts. The following tables provide analysis of the Bancorp’s automobile loans with a LTV at origination greater than 100% as of December 31, 2009 and 2008.


 

TABLE 38: AUTOMOBILE LOANS OUTSTANDING WITH LTV GREATER THAN 100%

 

As of December 31, 2009 ($ in millions)                   For the Year Ended
December 31, 2009
By State:    Outstanding    90 Days
Past Due
   Nonaccrual    Net Charge-offs

Ohio

   $422    1    -    9

Illinois

   357    1    -    9

Michigan

   252    1    -    6

Indiana

   215    -    -    5

Florida

   193    1    -    11

Kentucky

   177    -    -    4

All other states

   2,067    6    1    46

Total

   $3,683    10<