10-K 1 d10k.htm FORM 10-K Form 10-K
Table of Contents

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2010 ANNUAL REPORT

FINANCIAL CONTENTS

 

Glossary of Terms

     14       

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

     

Selected Financial Data

     15       

Overview

     16       

Non-GAAP Financial Measures

     19       

Critical Accounting Policies

     20       

Risk Factors

     23       

Statements of Income Analysis

     29       

Business Segment Review

     35       

Fourth Quarter Review

     41       

Balance Sheet Analysis

     43       

Risk Management

     48       

Off-Balance Sheet Arrangements

     63       

Contractual Obligations and Other Commitments

     65       

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

     66       

Reports of Independent Registered Public Accounting Firm

     67       

Financial Statements

     

Consolidated Balance Sheets

     68       

Consolidated Statements of Income

     69       

Consolidated Statements of Changes in Equity

     70       

Consolidated Statements of Cash Flows

     71       

 

Notes to Consolidated Financial Statements

  

Summary of Significant Accounting and Reporting Policies

     72   

Supplemental Cash Flow Information

     78   

Business Combinations and Asset Acquisitions

     78   

Restrictions on Cash and Dividends

     79   

Securities

     79   

Loans and Leases

     81   

Credit Quality and the Allowance for Loan and Lease Losses

     82   

Loans with Deteriorated Credit Quality Acquired in a Transfer

     85   

Bank Premises and Equipment

     86   

Goodwill

     86   

Intangible Assets

     87   

Variable Interest Entities

     88   

Sales of Receivables and Servicing Rights

     90   

Derivatives

     93   

Other Assets

     97   

Short-Term Borrowings

     98   
 

 

Annual Report on Form 10-K

     129       

Consolidated Ten Year Comparison

     145       

Directors and Officers

     146       

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, including the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act); (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

GLOSSARY OF TERMS

Fifth Third Bancorp provides the following list of acronyms as a tool for the reader. The acronyms identified below are used in Management’s Discussion & Analysis of Financial Condition & Results of Operations, the Consolidated Financial Statements and in the Notes to Consolidated Financial Statements.

 

ALCO: Asset Liability Management Committee

ALLL: Allowance for Loan and Lease Losses

ARM: Adjustable Rate Mortgage

ASC: Accounting Standards Codification

BOLI: Bank Owned Life Insurance

bp: Basis Point(s)

C&I: Commercial and Industrial

CARD: Card Accountability, Responsibility and Disclosure

CDC: Fifth Third Community Development Corporation

CPP: Capital Purchase Program

DCF: Discounted Cash Flow

DIF: Deposit Insurance Fund

EESA: Emergency Economic Stabilization Act of 2008

ERISA: Employee Retirement Income Security Act

ERM: Enterprise Risk Management

ERMC: Enterprise Risk Management Committee

EVE: Economic Value of Equity

FASB: Financial Accounting Standards Board

FDIC: Federal Deposit Insurance Corporation

FHLB: Federal Home Loan Bank

FHLMC: Federal Home Loan Mortgage Corporation

FICO: Fair Isaac Corporation (credit rating)

FNMA: Federal National Mortgage Association

FRB: Federal Reserve Bank

FTAM: Fifth Third Asset Management, Inc.

FTE: Fully Taxable Equivalent

FTP: Funds Transfer Pricing

FTPS: Fifth Third Processing Solutions

FTS: Fifth Third Securities

GNMA: Government National Mortgage Association

IPO: Initial Public Offering

IRS: Internal Revenue Service

LAPA: Liquid Asset Purchase Agreement

LIBOR: London InterBank Offered Rate

LTV: Loan-to-Value

MD&A: Management’s Discussion & Analysis of Financial Condition and Results of Operations

MSR: Mortgage Servicing Right

NII: Net Interest Income

OCI: Other Comprehensive Income

OREO: Other Real Estate Owned

OTTI: Other-Than-Temporary Impairment

PMI: Private Mortgage Insurance

QSPE: Qualifying Special-Purpose Entity

RSA: Restricted Stock Award

SAR: Stock Appreciation Right

SEC: United States Securities and Exchange Commission

SCAP: Supervisory Capital Assessment Program

TAG: Transaction Account Guarantee

TARP: Troubled Asset Relief Program

TLGP: Temporary Liquidity Guarantee Program

TDR: Troubled Debt Restructuring

TSA: Transition Service Agreement

U.S.: United States of America

U.S. GAAP: Accounting principles generally accepted in the United States of America

VIE: Variable Interest Entity

VRDN: Variable Rate Demand Note

 

 

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Fifth Third Bancorp

 


Table of Contents

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

The following is 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)    2010     2009      2008     2007      2006  

Income Statement Data

            

Net interest income (a)

     $3,622        3,373         3,536        3,033         2,899   

Noninterest income

     2,729        4,782         2,946        2,467         2,012   

Total revenue (a)

     6,351        8,155         6,482        5,500         4,911   

Provision for loan and lease losses

     1,538        3,543         4,560        628         343   

Noninterest expense

     3,855        3,826         4,564        3,311         2,915   

Net income (loss) attributable to Bancorp

     753        737         (2,113     1,076         1,188   

Net income (loss) available to common shareholders

     503        511         (2,180     1,075         1,188   

Common Share Data

            

Earnings per share, basic

     $.63        .73         (3.91     1.99         2.13   

Earnings per share, diluted

     .63        .67         (3.91     1.98         2.12   

Cash dividends per common share

     .04        .04         .75        1.70         1.58   

Market value per share

     14.68        9.75         8.26        25.13         40.93   

Book value per share

     13.06        12.44         13.57        17.18         18.00   

Financial Ratios

            

Return on assets

     .67     .64         (1.85     1.05         1.13   

Return on average common equity

     5.0        5.6         (23.0     11.2         12.1   

Average equity as a percent of average assets

     12.22        11.36         8.78        9.35         9.32   

Tangible equity (b)

     10.42        9.71         7.86        6.05         7.79   

Tangible common equity (b)

     7.04        6.45         4.23        6.14         7.95   

Net interest margin (a)

     3.66        3.32         3.54        3.36         3.06   

Efficiency (a)

     60.7        46.9         70.4        60.2         59.4   

Credit Quality

            

Net losses charged off

     $2,328        2,581         2,710        462         316   

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

     3.02     3.20         3.23        .61         .44   

ALLL as a percent of loans and leases

     3.88        4.88         3.31        1.17         1.04   

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

     4.17        5.27         3.54        1.29         1.14   

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

     2.79        4.22         2.38        1.25         .61   

Average Balances

            

Loans and leases, including held for sale

     $79,232        83,391         85,835        78,348         73,493   

Total securities and other short-term investments

     19,699        18,135         14,045        12,034         21,288   

Total assets

     112,434        114,856         114,296        102,477         105,238   

Transaction deposits (f)

     65,662        55,235         52,680        50,987         49,678   

Core deposits (g)

     76,188        69,338         63,815        61,765         60,178   

Wholesale funding (h)

     18,917        28,539         36,261        27,254         31,691   

Bancorp shareholders’ equity

     13,737        13,053         10,038        9,583         9,811   

Regulatory Capital Ratios

            

Tier I capital

     13.94     13.30         10.59        7.72         8.39   

Total risk-based capital

     18.14        17.48         14.78        10.16         11.07   

Tier I leverage

     12.79        12.34         10.27        8.50         8.44   

Tier I common equity (b)

     7.50        6.99         4.37        5.72         8.22   
(a) Amounts presented on an FTE basis. The FTE adjustments for years ended December 31, 2010, 2009, 2008, 2007 and 2006 were $18, $19, $22, $24 and $26, respectively.
(b) The tangible equity, tangible common equity and Tier I common equity ratios are non-GAAP measures. For further information, see the Non-GAAP Financial Measures section of MD&A.
(c) The allowance for credit losses is the sum of the ALLL and the reserve for unfunded commitments.
(d) Excludes nonaccrual loans held for sale.
(e) The Bancorp modified its nonaccrual policy in 2009 to exclude consumer 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.
(f) Includes demand, interest checking, savings, money market and foreign office deposits.
(g) Includes transaction deposits plus other time deposits.
(h) 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)

       2010         2009   
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)

     $919         916         887         901         $882         874         836         781   

Provision for loan and lease losses

     166         457         325         590         776         952         1,041         773   

Noninterest income

     656         827         620         627         651         851         2,583         697   

Noninterest expense

     987         979         935         956         967         876         1,021         962   

Net income (loss) attributable to Bancorp

     333         238         192         (10)         (98)         (97)         882         50   

Net income (loss) available to common shareholders

     270         175         130         (72)         (160)         (159)         856         (26)   

Earnings per share, basic

     .34         .22         .16         (.09)         (.20)         (.20)         1.35         (.04)   

Earnings per share, diluted

     .33         .22         .16         (.09)         (.20)         (.20)         1.15         (.04)   

 

 

Fifth Third Bancorp

 

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Table of Contents

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

 

OVERVIEW

 

Fifth Third Bancorp is a diversified financial services company headquartered in Cincinnati, Ohio. At December 31, 2010, the Bancorp had $111 billion in assets and operated 15 affiliates with 1,312 full-service Banking Centers including 103 Bank Mart® locations open seven days a week inside select grocery stores and 2,445 Jeanie® ATMs in 12 states throughout 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 also has a 49% interest in Fifth Third Processing Solutions, LLC.

This overview of MD&A 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 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 emphasizing individual relationships. Through its affiliate operating model, individual managers at all levels within the affiliates 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, 2010, net interest income, on an FTE basis, and noninterest income provided 58% and 42% 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 MD&A 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 mortgage banking net revenue, service charges on deposits, 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 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.

Common Stock and Senior Notes Offerings

On January 25, 2011, the Bancorp raised $1.7 billion in new common equity through the issuance of 121,428,572 shares of common stock in an underwriting offering at an initial price of $14.00 per share. On January 24, 2011, the underwriters exercised their option to purchase an additional 12,142,857 shares at the offering price of $14.00 per share. In connection with this exercise, the Bancorp entered into a forward sale agreement which resulted in a final net payment of 959,821 shares on February 4, 2011.

On January 25, 2011, the Bancorp issued $1.0 billion of senior notes to third party investors, and entered into a Supplemental Indenture dated January 25, 2011 with Wilmington Trust Company, as Trustee, which modifies the existing Indenture for Senior Debt Securities dated April 30, 2008 between the Bancorp and the Trustee. The Supplemental Indenture and the Indenture define the rights of the Senior Notes, which Senior Notes are represented by Global Securities dated as of January 25, 2011. The senior notes bear a fixed rate of interest of 3.625% per annum. The notes are unsecured, senior obligations of the Bancorp. Payment of the full principal amount of the notes will be due upon maturity on January 25, 2016. The notes will not be subject to the redemption at the Bancorp’s option at any time prior to maturity.

Repurchase of Outstanding TARP Preferred Stock

As further discussed in Note 24 of the Notes to Consolidated Financial Statements, on December 31, 2008, the Bancorp issued $3.4 billion of Fixed Rate Cumulative Perpetual Preferred Stock, Series F, and related warrants to the U.S. Treasury under the U.S. Treasury’s CPP.

On February 2, 2011, the Bancorp redeemed all 136,320 shares of its Series F Preferred Stock held by the U.S. Treasury. As discussed above, the net proceeds from the Bancorp’s January 2011 common stock and senior notes offerings and other funds were used to redeem the $3.4 billion of Series F Preferred Stock.

    In connection with the redemption of the Series F preferred Stock, the Bancorp accelerated the accretion of the remaining issuance discount on the Series F Preferred Stock and recorded a corresponding reduction in retained earnings of $153 million. This resulted in a one-time, noncash reduction in net income available to common shareholders and related basic and diluted earnings per share. This transaction will be reflected in the Bancorp’s Consolidated Financial Statements for the quarter ended March 31, 2011.

 

 

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

 

Dividends of $15 million were paid on February 2, 2011 when the Series F Preferred Stock was redeemed. The Bancorp paid total dividends of $356 million to the U.S. Treasury while the Series F Preferred Stock was outstanding. The Bancorp notified the U.S. Treasury on February 17, 2011, of its intention to negotiate for the purchase of the warrants issued to the U.S. Treasury in connection with the CPP preferred stock investment.

Recent Legislative Developments

On July 21, 2010, the Dodd-Frank Act was signed into law. This act significantly changes the financial services industry and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The legislation establishes a Bureau of Consumer Financial Protection, changes the base for deposit insurance assessments, gives the Federal Reserve the ability to regulate and limit interchange rates charged to merchants for the use of debit cards, and excludes certain instruments currently included in determining Tier I regulatory capital. This act calls for federal regulatory agencies to adopt hundreds of new rules and conduct multiple studies over the next several years in order to implement its provisions. While the total impact of this legislation on Fifth Third is not currently known, the impact is expected to be substantial and may have an adverse impact on Fifth Third’s financial performance and growth opportunities.

Earnings Summary

The Bancorp’s net income available to common shareholders for 2010 was $503 million, or $0.63 per diluted share, which was net of $250 million in preferred stock dividends. The Bancorp’s net income available to common shareholders was $511 million, or $0.67 per diluted share, for 2009, which was net of $226 million in preferred stock dividends. The Bancorp’s results for both years reflect a number of significant items.

Such items affecting 2010 include:

   

$152 million of noninterest income from the settlement of litigation associated with one of the Bancorp’s BOLI policies and $25 million of noninterest expense from related legal fees;

   

$110 million of noninterest expense from charges to representation and warranty reserves related to residential mortgage loans sold to third-parties; and

   

$68 million of net interest income due to the accretion of purchase accounting adjustments related to loans and deposits from acquisitions during 2008.

For comparison purposes, 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 BOLI policies and the determination that previously recorded losses on the policy are tax deductible;

   

$31 million of noninterest expense from charges to representation and warranty reserves related to residential mortgage loans sold to third-parties;

   

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

   

$55 million income tax benefit from an agreement with the 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; and

   

$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.

Net interest income increased to $3.6 billion, from $3.4 billion in 2009. The primary reason for the seven percent increase in net interest income was a 39 bp increase in the net interest rate spread due to the runoff of higher priced term deposits in 2010 and the benefit of lower rates offered on new term deposits, as well as improved pricing on commercial loans. These benefits were partially offset by a decrease in the accretion of purchase accounting adjustments related to the 2008 acquisition of First Charter, which were $68 million in 2010, compared to $136 million in 2009. Net interest margin was 3.66% in 2010, an increase of 34 bp from 2009.

Noninterest income decreased 43% to $2.7 billion in 2010 compared 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 in 2009. Mortgage banking net revenue increased $94 million as a result of strong net servicing revenue and higher margins on sold loans, partially offset by a decline in mortgage originations. Card and processing revenue decreased 49% due to the Processing Business Sale in the second quarter of 2009. Service charges on deposits decreased $58 million primarily due to the impact of new overdraft regulation and policies which resulted in a decrease in overdraft occurrences. Investment advisory revenue increased $35 million as the result of improved market performance and sales production that drove an increase in brokerage activity and assets under care. Corporate banking revenue decreased two percent largely due to decreases in international income and lease remarketing fees, partially offset by growth in syndication and business lending fees.

    Noninterest expense increased $29 million, or one percent, compared to 2009. Noninterest expense in 2010 included $25 million in legal fees associated with the settlement of claims with the insurance carrier on one of the Bancorp’s BOLI policies while noninterest expense in 2009 included a $73 million reduction in the Visa litigation reserve as well as a $55 million FDIC special assessment charge. Total personnel costs increased $94 million, or six percent in 2010 compared to 2009, due primarily to investments in the sales force in 2010. In addition, charges to representation and warranty reserves related to residential mortgage loans sold to third-parties totaled $110 million in 2010, compared to $31 million in 2009 due to a higher volume of repurchase demands. Partially offsetting these negative impacts was a $123 million decrease in the provision for unfunded commitments and letters of credit due to lower estimates of inherent losses as the result of a decrease in delinquent loans driven by moderation in economic conditions during 2010. In addition, card and processing expense decreased $85 million compared to 2009 due to the Processing Business Sale in June of 2009. Noninterest expense in 2010 and 2009 included $242 million and $269 million, respectively, of FDIC insurance and other taxes.

 

 

 

Fifth Third Bancorp

 

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

 

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 weakened economic conditions. Throughout 2010, the Bancorp continued to be affected by high unemployment rates, weakened housing markets, particularly in the upper Midwest and Florida, and a challenging credit environment. Credit trends, however, continued to show signs of moderation in 2010 and, as a result, the provision for loan and lease losses decreased to $1.5 billion for the year ended December 31, 2010, compared to $3.5 billion during 2009.

Net charge-offs as a percent of average loans and leases decreased to 3.02% in 2010 compared to 3.20% in 2009. In the third quarter of 2010, the Bancorp took significant actions to reduce credit risk. Residential mortgage loans in the Bancorp’s portfolio with a carrying value of $228 million were sold for $105 million, generating $123 million in net charge-offs. Additionally, commercial loans with a carrying value prior to transfer of $961 million were transferred to held-for-sale, generating $387 million in net charge-offs. Including the impact of these actions, nonperforming assets as

a percent of loans, leases and other assets, including other real estate owned (excluding nonaccrual loans held for sale) decreased to 2.79% at December 31, 2010, from 4.22% at December 31, 2009. Refer to the Credit Risk Management section in MD&A for more information on credit quality.

The Bancorp took a number of 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 MD&A 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. As of December 31, 2010, the Tier 1 capital ratio was 13.94%, the Tier 1 leverage ratio was 12.79% and the total risk-based capital ratio was 18.14%.

 

 

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NON-GAAP FINANCIAL MEASURES

 

The Bancorp considers various measures when evaluating capital utilization and adequacy, including the tangible equity ratio, tangible common equity ratio and tier I 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 U.S. GAAP does not include capital ratio measures, the Bancorp believes there are no comparable U.S. GAAP financial measures to these ratios. Tier I common equity is not formally defined by U.S. GAAP or codified in the federal banking regulations and, therefore, is considered to be a non-GAAP financial measure. Since analysts and banking regulators may assess the Bancorp’s capital adequacy using these ratios, the Bancorp believes they are useful to provide investors the ability to assess its capital adequacy on the same basis.

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)    2010     2009  

Total Bancorp shareholders’ equity (U.S. GAAP)

     $14,051        $13,497   

Less:

    

Goodwill

     (2,417     (2,417

Intangible assets

     (62     (106

Accumulated other comprehensive income

     (314     (241

Tangible equity (1)

     11,258        10,733   

Less: preferred stock

     (3,654     (3,609

Tangible common equity (2)

     7,604        7,124   

Total assets (U.S. GAAP)

     111,007        113,380   

Less:

    

Goodwill

     (2,417     (2,417

Intangible assets

     (62     (106

Accumulated other comprehensive income, before tax

     (483     (370

Tangible assets, excluding unrealized gains / losses (3)

     $108,045        $110,487   

Total Bancorp shareholders’ equity (U.S. GAAP)

     14,051        $13,497   

Goodwill and certain other intangibles

     (2,546     (2,565

Unrealized gains

     (314     (241

Qualifying trust preferred securities

     2,763        2,763   

Other

     11        (26

Tier I capital

     13,965        13,428   

Less: Preferred stock

     (3,654     (3,609

Qualifying trust preferred securities

     (2,763     (2,763

Qualified noncontrolling interest in consolidated subsidiaries

     (30     —     

Tier I common equity (4)

     7,518        7,056   

Risk-weighted assets (5) (a)

     100,193        100,933   

Ratios:

    

Tangible equity (1) / (3)

     10.42     9.71

Tangible common equity (2) / (3)

     7.04     6.45

Tier I common equity (4) / (5)

     7.50     6.99
(a) Under the banking agencies’ risk-based capital guidelines, assets and credit equivalent amounts of derivatives and off-balance sheet exposures are assigned to broad risk categories. The aggregate dollar amount in each risk category is multiplied by the associated risk weight of the category. The resulting weighted values are added together, resulting in the Bancorp’s total risk-weighted assets.

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 2010 and 2009 and the expected impact of significant accounting standards issued, but not yet required to be adopted.

 

 

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CRITICAL ACCOUNTING POLICIES

 

The Bancorp’s Consolidated Financial Statements are prepared in accordance with U.S. GAAP. 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 the ALLL, 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, 2010.

ALLL

The Bancorp disaggregates its portfolio loans and leases into portfolio segments for purposes of determining the ALLL. The Bancorp’s portfolio segments include commercial, residential mortgage, and consumer. The Bancorp further disaggregates its portfolio segments into classes for purposes of monitoring and assessing credit quality based on certain risk characteristics. Classes within the commercial portfolio segment include commercial & industrial, commercial mortgage owner-occupied, commercial mortgage nonowner-occupied, commercial construction, and commercial leasing. The residential mortgage portfolio segment is also considered a class. Classes within the consumer segment include home equity, automobile, credit card, and other consumer loans and leases. For an analysis of the Bancorp’s ALLL by portfolio segment and credit quality information by class, see Note 7 of the Notes to Consolidated Financial Statements.

Larger commercial loans included within aggregate borrower relationship balances exceeding $1 million that exhibit probable or observed credit weaknesses, as well as loans that have been modified in a TDR, are subject to individual review for impairment. The Bancorp considers the current value of collateral, credit quality of any guarantees, the loan structure, and other factors when evaluating whether an individual loan is impaired. Other factors may include the industry of the borrower, size and financial condition of the borrower, cash flow, leverage of the borrower, and the Bancorp’s evaluation of the borrower’s management. When individual loans are impaired, allowances are determined based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow, as well as evaluation of legal options available to the Bancorp. Allowances for impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, fair value of the underlying collateral or readily observable secondary market values. The Bancorp evaluates the collectability of both principal and interest when assessing the need for a loss accrual.

Historical credit loss rates are applied to commercial loans that are not impaired or are impaired, but smaller than the established threshold of $1 million and thus not subject to specific allowance allocations. The loss rates are derived from a migration analysis, which tracks the historical net charge-off experience sustained on loans according to their internal risk grade. The risk grading system currently utilized for allowance analysis purposes encompasses ten categories.

    Homogenous loans and leases in the residential mortgage and consumer portfolio segments are not individually risk graded. Rather, standard credit scoring systems and delinquency monitoring are used to assess credit risks, and allowances are established based on the expected net charge-offs. Loss rates are based on the average net charge-off history by loan category. Historical loss rates 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 reviewers.

The Bancorp’s current methodology for determining the ALLL is based on historical loss rates, current credit grades, specific allocation on TDRs and impaired commercial credits above specified thresholds and other qualitative adjustments. Allowances on individual commercial 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 losses 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 ALLL, nor does the Bancorp add to its existing ALLL 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.

 

 

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Accrued taxes represent the net estimated amount due to taxing jurisdictions and are reported in accrued taxes, interest and expenses in the Consolidated Balance Sheets. The Bancorp evaluates and assesses the relative risks and appropriate tax treatment of transactions and filing positions after considering statutes, regulations, judicial precedent and other information and maintains tax accruals consistent with its evaluation of these relative risks and merits. Changes to the estimate of accrued taxes occur periodically due to changes in tax rates, interpretations of tax laws, the status of examinations being conducted by taxing authorities and changes to statutory, judicial and regulatory guidance that impact the relative risks of tax positions. These changes, when they occur, can affect deferred taxes and accrued taxes as well as the current period’s income tax expense and can be significant to the operating results of the Bancorp. For additional information on income taxes, see Note 21 of the Notes to Consolidated Financial Statements.

Valuation of Servicing Rights

When the Bancorp sells loans through either securitizations or individual loan sales in accordance with its investment policies, it often 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 13 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 investment and 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 are classified within Level 2 of the valuation hierarchy, include agency and non-agency mortgage-backed securities, other asset-backed securities, obligations of U.S. Government sponsored agencies, and corporate and municipal bonds. Agency mortgage-backed securities, obligations of U.S. Government sponsored agencies, and corporate and municipal bonds are generally valued using a market approach based on observable prices of securities with similar characteristics. Non-agency mortgage-backed securities and other asset-backed securities are generally valued using an income approach based on discounted cash flows, incorporating prepayment speeds, performance of underlying collateral and specific tranche-level attributes. 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. 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, 2010, the Bancorp measured fair value using a discount rate based on the assumed holding period.

 

 

 

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Residential mortgage loans held for sale and held for investment

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 ARM loans, discounted cash flow models that may incorporate the anticipated portfolio composition, credit spreads of asset-backed securities with similar collateral, and market conditions. The anticipated portfolio composition includes the effect of interest rate spreads and discount rates due to loan characteristics such as the state in which the loan was originated, the loan amount and the ARM margin. Residential mortgage loans held for sale that are valued based on mortgage-backed securities prices are classified within Level 2 of the valuation hierarchy as the valuation is based on external pricing for similar instruments. ARM loans classified as held for sale are also classified within Level 2 of the valuation hierarchy due to the use of observable inputs in the discounted cash flow model. These observable inputs include interest rate spreads from agency mortgage-backed securities market rates and observable discount rates. For residential mortgage loans reclassified from held for sale to held for investment, the fair value estimation is based primarily on the underlying collateral values. Therefore, these loans are classified within Level 3 of the valuation hierarchy.

Derivatives

Exchange-traded derivatives valued using quoted prices and certain over-the-counter derivatives valued using active bids are classified within Level 1 of the valuation hierarchy. Most of the Bancorp’s 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 and, therefore, 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, 2010, 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 28 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 10 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 its financial condition, the results of its operations, or its 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 declines 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 ALLL 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 could 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 than 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.

The price for shares of Fifth Third’s common stock 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 for shares of Fifth Third’s common stock, and the current market price of such shares may not be indicative of future market prices.

 

 

 

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RISKS RELATING TO FIFTH THIRD’S 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 ALLL, 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 continue to improve and/or stabilize, additional increases in the ALLL 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, as well as meet regulatory expectations. 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, as well as regulatory expectations, 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’s ability to receive dividends from its subsidiaries could have a material adverse effect on Fifth Third’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.

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

Fifth Third’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 Fifth Third, certain of its subsidiaries and particular classes of securities they issue. The interest rates that Fifth Third pays on its securities are also influenced by, among other things, the credit ratings that it, its subsidiaries and/or its securities receive from recognized rating agencies. A downgrade to Fifth Third 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 Fifth Third, its subsidiaries or their securities could also create obligations or liabilities to Fifth Third under the terms of its outstanding securities that could increase Fifth Third’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 Fifth Third 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. On November 1, 2010, citing their view that the likelihood of government support in the future for larger regional banks had declined, Moody’s downgraded ten large regional banks, including Fifth Third’s subsidiary bank, Fifth Third Bank. Fifth Third Bank’s credit ratings for short-term obligations, long-term deposit and senior debt were downgraded to P2, A3 and A3, respectively, from P1, A2 and A2, respectively. During 2010, DBRS Investors Service downgraded Fifth Third’s issuer rating to “AL” from “A” and downgraded the long term debt rating and deposit ratings for Fifth Third’s bank subsidiary to “A” from “AH.”

 

 

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

As Fifth Third continues to grow, its success depends, in large part, on its ability to attract and retain key individuals. Competition for qualified candidates in the activities and markets that Fifth Third serves is great and Fifth Third may not be able to hire these candidates and retain them. If Fifth Third is not able to hire or retain these key individuals, Fifth Third may be unable to execute its business strategies and may suffer adverse consequences to its business, operations and financial condition.

Pursuant to the standardized terms of the CPP, 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 June 2010, the federal banking agencies issued joint guidance on executive compensation intended to ensure that a bank organization’s incentive compensation policies don’t encourage excessive risk taking. In addition, the Dodd-Frank Act requires those agencies to adopt guidance or rules to enhance the reporting of incentive compensation and to prohibit certain compensation arrangements. Also in 2010, the FDIC 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 it 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 MSRs can increase through increases in fair value. When rates fall, mortgage originations tend to increase and the value of 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 its mortgage banking interest rate risk. Fifth Third generally does not hedge all of its 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 its 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 U.S. GAAP requires management to make significant estimates that affect the financial statements. Two of Fifth Third’s most critical estimates are the level of the ALLL and the valuation of mortgage servicing rights. Due to the uncertainty of estimates involved, Fifth Third may have to significantly increase the ALLL 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 ALLL is not adequate, Fifth Third’s business, financial condition, including its liquidity and capital, and results of operations could be materially adversely affected.

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 the FASB, the 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             

 

 

 

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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.

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, environmental risks from its properties, 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 U.S. Treasury’s TARP program, in which Fifth Third was a participant. 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 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 International 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 Fifth Third’s loan portfolios, especially in its coastal markets, thereby adversely impacting its 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 its loan portfolios by damaging properties pledged as collateral as well as impairing its 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 FRB, 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, well-managed and maintain at least a “Satisfactory” CRA rating for Fifth Third to retain its status as a financial holding company. Failure to meet these requirements could result in the FRB placing limitations or conditions on Fifth Third’s activities (and the commencement of new activities) and could

 

 

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ultimately result in the loss of financial holding company status. 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.

Fifth Third’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 U.S. Treasury’s CPP and Capital Assistance Program, the U.S. Government has taken steps that include enhancing the liquidity support available to financial institutions, establishing a commercial paper funding facility, temporarily guaranteeing money market funds and certain types of debt issuances, and increasing insured deposits. These programs subject 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 may 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. 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.

Fifth Third is subject to various regulatory requirements that limit its operations and potential growth.

Under federal and state laws and regulations pertaining to the safety and soundness of insured depository institutions and their holding companies, the FRB and the Ohio Division of Financial Institutions have the authority to compel or restrict certain actions by Fifth Third and its subsidiary bank. Fifth Third and its subsidiary bank are subject to such supervisory authority and, more generally, must, in certain instances, obtain prior regulatory approval before engaging in certain activities or corporate decisions. There can be no assurance that such approvals, if required, would be forthcoming or that such approvals would be granted in a timely manner. Failure to receive any such approval, if required, could limit or impair Fifth Third’s operations, restrict its growth and/or affect its dividend policy. Such actions and activities subject to prior approval include, but are not limited to, increasing dividends paid by Fifth Third or its subsidiary bank, purchasing or redeeming any shares of its stock, entering into a merger or                 

acquisition transaction, acquiring or establishing new branches, and entering into new businesses.

In addition, Fifth Third, as well as other financial institutions more generally, have recently been subjected to increased scrutiny from regulatory authorities stemming from broader systemic regulatory concerns, including with respect to stress testing, capital levels, asset quality, provisioning and other prudential matters, arising as a result of the recent financial crisis and efforts to ensure that financial institutions take steps to improve their risk management and prevent future crises.

In some cases, regulatory agencies may take supervisory actions that are considered to be confidential supervisory information which may not be publicly disclosed. Finally, as part of Fifth Third’s regular examination process, Fifth Third’s and its subsidiary bank’s respective regulators may advise it and its subsidiary bank to operate under various restrictions as a prudential matter. Such supervisory actions or restrictions, if and in whatever manner imposed, could have a material adverse effect on Fifth Third’s business and results of operations.

Fifth Third and/or its affiliates are or may become involved from time to time in information-gathering requests, investigations and proceedings by government and self-regulatory agencies which may lead to adverse consequences.

Fifth Third and/or its affiliates are or may become involved from time to time in information-gathering requests, reviews, investigations and proceedings (both formal and informal) by government and self-regulatory agencies, including the SEC, regarding their respective businesses. Such matters may result in material adverse consequences, including without limitation, adverse judgments, settlements, fines, penalties, injunctions or other actions, amendments and/or restatements of Fifth Third’s SEC filings and/or financial statements, as applicable, and/or determinations of material weaknesses in its disclosure controls and procedures. The SEC is investigating and has made several requests for information, including by subpoena, concerning issues which Fifth Third understands relate to accounting and reporting matters involving certain of its commercial loans. This could lead to an enforcement proceeding by the SEC which, in turn, may result in one or more such material adverse consequences.

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 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

 

 

 

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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 CPP under the EESA, the rules and regulations promulgated thereunder or the American Recovery and Reinvestment Act of 2009, 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.

On July 21, 2010 the President of the United States signed into law the Dodd-Frank Act. The Dodd-Frank Act will have material implications for Fifth Third and the entire financial services industry. Among other things it will or potentially could:

   

Result in Fifth Third being subject to enhanced oversight and scrutiny as a result of being a bank holding company with $50 billion or more in consolidated assets;

   

Result in the appointment of the FDIC as receiver of Fifth Third in an orderly liquidation proceeding, if the Secretary of the U.S. Treasury, upon recommendation of two-thirds of the FRB and the FDIC and in consultation with the President of the United States, finds Fifth Third to be in default or danger of default;

   

Affect the levels of capital and liquidity with which Fifth Third must operate and how it plans capital and liquidity levels (including a phased-in elimination of Fifth Third’s existing trust preferred securities as Tier 1 capital);

   

Subject Fifth Third to new and/or higher fees paid to various regulatory entities, including but not limited to deposit insurance fees to the FDIC;

   

Impact Fifth Third’s ability to invest in certain types of entities or engage in certain activities;

   

Impact a number of Fifth Third’s business and risk management strategies;

   

Restrict the revenue that Fifth Third generates from certain businesses, including interchange fee revenue generated by Fifth Third’s credit card business;

   

Subject Fifth Third to a new Consumer Financial Protection Bureau, which will have very broad rule-making and enforcement authorities; and

   

Subject Fifth Third to oversight and regulation by a new and different litigation and regulatory regime.

As the Dodd-Frank Act requires that many studies be conducted and that hundreds of regulations be written in order to fully implement it, the full impact of this legislation on Fifth Third, its business strategies and financial performance cannot be known at this time, and may not be known for a number of years. However, these impacts are expected to be substantial and some of them are likely to adversely affect Fifth Third and its financial performance. The extent to which Fifth Third can adjust its strategies to offset such adverse impacts also is not known at this time.

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.

Fifth Third’s ability to pay dividends or repurchase stock is subject to regulatory requirements and the need to meet regulatory expectations.

 

 

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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, or 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 2010, 2009 and 2008. 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 was $3.6 billion for the year ended December 31, 2010, compared to $3.4 billion in 2009. Net interest income was affected by the amortization and accretion of premiums and discounts on acquired loans and deposits, primarily from the acquisition of First Charter that increased net interest income by $68 million during 2010, compared to an increase of $136 million during 2009. Excluding this impact, net interest income increased $317 million, or 10%, in 2010 compared to 2009. The purchase accounting accretion reflects the high discount rate in the market at the time of the acquisition; the total loan discounts are being accreted into net interest income over the remaining period to maturity of the loans acquired. Based upon the remaining period to maturity, and excluding the impact of prepayments, the Bancorp anticipates recognizing approximately $41 million in additional net interest income during 2011 as a result of the amortization and accretion of premiums and discounts on acquired loans and deposits.

For the year ended December 31, 2010, net interest income was positively impacted by a decrease of $5.6 billion in average interest-bearing liabilities as well as a mix shift to lower cost core deposits from 2009. This was primarily a result of runoff of higher priced term deposits as well as the

benefit of lower rates offered on new term deposits. In addition, 2010 benefitted from a $3.2 billion increase in the free funding position. This benefit was partially offset by a $2.6 billion decrease in average interest earning assets from 2009. The shift in funding position, as well as improved pricing on commercial loans, led to a 39 bp increase in the net interest rate spread to 3.39% in 2010 compared to 2009.

Net interest margin was 3.66% in 2010, compared to 3.32% in 2009. For 2010 and 2009, the accretion of the discounts on acquired loans and deposits increased the net interest margin by 7 bp and 14 bp, respectively. Excluding the accretion of discounts on acquired loans and deposits, net interest margin was up 41 bp from 2009, driven by improved pricing on new commercial loan originations, the shift in funding composition to lower cost core deposits, an increase in free-funding balances and a decrease in the average rates paid on interest bearing liabilities.

Average interest-earning assets decreased three percent from 2009. Average commercial loans decreased $3.9 billion due to decreases across all commercial loan categories, and average consumer loans decreased $239 million due primarily to decreases in average residential mortgage, home equity and other consumer loans and leases, partially offset by an increase in average automobile loans. In addition, average investment securities decreased $729 million, or four percent, compared to 2009. The declines in average loans and investment securities were partially offset by a $2.3 billion increase in average other short-term investments, which includes interest bearing cash held at the Federal Reserve. For further discussion on the Bancorp’s loan and lease and investment securities portfolios, see the Loan and Lease and Investment Securities sections, respectively, of MD&A.

Interest income from loans and leases decreased $112 million compared to 2009. Excluding the accretion of discounts on acquired loans in 2010 and 2009, interest income from loans and leases decreased $46 million, or one percent, compared to the prior year. The year-over-year decrease in interest income from loans and leases is a result of a five percent decline in average balances, partially offset by an 11 bp increase in the average yield. Interest income from investment securities decreased nine percent compared to 2009 due to a 68 bp decrease in the weighted-average yield and a four percent decline in average balances.

Average interest-bearing core deposits increased $4.0 billion, or eight percent, compared to 2009, primarily due to increased interest checking, savings, money market and foreign office deposits, partially offset by a decline in other time deposits. The cost of interest-bearing core deposits was 0.83% in 2010; a decrease of 45 bp from 2009. The decrease is a result of a mix shift to lower cost core deposits and a decrease in rates on average time deposits of 71 bp compared to 2009.

 
TABLE 4: CONDENSED CONSOLIDATED STATEMENTS OF INCOME                                      
For the years ended December 31 ($ in millions, except per share data)    2010      2009     2008     2007      2006  

Interest income (FTE)

   $ 4,507         4,687        5,630        6,051         5,981   

Interest expense

     885         1,314        2,094        3,018         3,082   

Net interest income (FTE)

     3,622         3,373        3,536        3,033         2,899   

Provision for loan and lease losses

     1,538         3,543        4,560        628         343   

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

     2,084         (170     (1,024     2,405         2,556   

Noninterest income

     2,729         4,782        2,946        2,467         2,012   

Noninterest expense

     3,855         3,826        4,564        3,311         2,915   

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

     958         786        (2,642     1,561         1,653   

Fully taxable equivalent adjustment

     18         19        22        24         26   

Applicable income tax expense (benefit)

     187         30        (551     461         443   

Income (loss) before cumulative effect

     753         737        (2,113     1,076         1,184   

Cumulative effect of change in accounting principle, net of tax

     —           —          —          —           4   

Net income (loss)

     753         737        (2,113     1,076         1,188   

Less: Net income attributable to noncontrolling interest

     —           —          —          —           —     

Net income (loss) attributable to Bancorp

     753         737        (2,113     1,076         1,188   

Dividends on preferred stock

     250         226        67        1         —     

Net income (loss) available to common shareholders

   $ 503         511        (2,180     1,075         1,188   

Earnings per share

   $ 0.63         0.73        (3.91     1.99         2.13   

Earnings per diluted share

     0.63         0.67        (3.91     1.98         2.12   

Cash dividends declared per common share

     0.04         0.04        0.75        1.70         1.58   

 

 

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

 

Interest expense on wholesale funding decreased 35% compared to the prior year due to a 34% decrease in average balances and a 45 bp decrease in average rates. In 2010, wholesale funding represented 25% of interest-bearing liabilities, down from 35% in 2009. Impacting this change was a decrease of $4.8 billion in average other short term borrowings due to the repayment of Term Auction Facility funds and FHLB advances which had an average balance of                 

$3.7 billion and $1.2 billion, respectively, in 2009. In addition, average certificates of deposit over $100,000 decreased $4.3 billion from 2009 due to maturities throughout 2010. The decreased reliance on wholesale funding in 2010 was a result of the growth of core deposits and a decline in average interest earning assets. 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 MD&A.

.

 

 

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

For the years ended December 31

     2010        2009        2008   

($ 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 and industrial loans

     $26,334        $1,238         4.70     $27,556        $1,162         4.22     $28,426        $1,520         5.35

Commercial mortgage

     11,585        476         4.11        12,511        545         4.35        12,776        866         6.78   

Commercial construction

     3,066        93         3.01        4,638        134         2.90        5,846        342         5.85   

Commercial leases

     3,343        147         4.40        3,543        150         4.24        3,680        18         0.49   

Subtotal - commercial

     44,328        1,954         4.41        48,248        1,991         4.13        50,728        2,746         5.41   

Residential mortgage

     9,868        478         4.84        10,886        602         5.53        10,993        705         6.41   

Home equity

     11,996        479         4.00        12,534        520         4.15        12,269        701         5.71   

Automobile loans

     10,427        608         5.83        8,807        556         6.31        8,925        566         6.34   

Credit card

     1,870        201         10.73        1,907        193         10.10        1,708        167         9.77   

Other consumer loans and leases

     743        116         15.58        1,009        86         8.49        1,212        64         5.28   

Subtotal - consumer

     34,904        1,882         5.39        35,143        1,957         5.57        35,107        2,203         6.27   

Total loans and leases

     79,232        3,836         4.84        83,391        3,948         4.73        85,835        4,949         5.77   

Securities:

                     

Taxable

     16,054        650         4.05        16,861        721         4.28        13,082        643         4.91   

Exempt from income taxes (a)

     317        13         3.92        239        17         7.19        342        25         7.35   

Other short-term investments

     3,328        8         0.25        1,035        1         0.14        621        13         2.15   

Total interest-earning assets

     98,931        4,507         4.56        101,526        4,687         4.62        99,880        5,630         5.64   

Cash and due from banks

     2,245             2,329             2,490        

Other assets

     14,841             14,266             13,411        

Allowance for loan and lease losses

     (3,583                      (3,265                      (1,485                 

Total assets

     $112,434                         $114,856                         $114,296                    

Liabilities and Equity

                     

Interest-bearing liabilities:

                     

Interest-bearing core deposits:

                     

Interest checking

     $18,218        $52         0.29     $15,070        $40         0.26     $14,191        $128         0.91

Savings

     19,612        107         0.55        16,875        127         0.75        16,192        224         1.38   

Money market

     4,808        19         0.40        4,320        26         0.60        6,127        118         1.92   

Foreign office deposits

     3,355        12         0.35        2,108        10         0.45        2,153        34         1.60   

Other time deposits

     10,526        276         2.62        14,103        470         3.33        11,135        411         3.69   

Total interest-bearing core deposits

     56,519        466         0.83        52,476        673         1.28        49,798        915         1.84   

Certificates - $100,000 and over

     6,083        125         2.06        10,367        280         2.70        9,531        324         3.40   

Other foreign office deposits

     6        —           0.13        157        —           0.20        2,067        50         2.42   

Federal funds purchased

     291        1         0.17        517        1         0.20        2,975        70         2.34   

Other short-term borrowings

     1,635        3         0.21        6,463        42         0.64        7,785        178         2.29   

Long-term debt

     10,902        290         2.65        11,035        318         2.89        13,903        557         4.01   

Total interest-bearing liabilities

     75,436        885         1.17        81,015        1,314         1.62        86,059        2,094         2.43   

Demand deposits

     19,669             16,862             14,017        

Other liabilities

     3,580                         3,926                         4,182                    

Total liabilities

     98,685             101,803             104,258        

Equity

     13,749                         13,053                         10,038                    

Total liabilities and equity

     $112,434                         $114,856                         $114,296                    

Net interest income

       $3,622             $3,373             $3,536      

Net interest margin

          3.66          3.32          3.54

Net interest rate spread

          3.39             3.00             3.21   

Interest-bearing liabilities to interest-earning assets

                      76.25                         79.80                         86.16   
(a) The FTE adjustments included in the above table are $18, $19 and $22 for the years ended December 31, 2010, 2009 and 2008, respectively.

 

 

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

 

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

For the years ended December 31

     2010 Compared to 2009        2009 Compared to 2008   

($ in millions)

     Volume        Yield/Rate        Total        Volume        Yield/Rate        Total   

Assets

            

Increase (decrease) in interest income:

            

Loans and leases:

            

Commercial and industrial loans

   ($ 53     129        76      ($ 45     (313     (358

Commercial mortgage

     (39     (30     (69     (17     (304     (321

Commercial construction

     (46     5        (41     (60     (148     (208

Commercial leases

     (8     5        (3     (1     133        132   

Subtotal - commercial

     (146     109        (37     (123     (632     (755

Residential mortgage

     (53     (71     (124     (7     (96     (103

Home equity

     (22     (19     (41     15        (196     (181

Automobile loans

     97        (45     52        (7     (3     (10

Credit card

     (4     12        8        20        6        26   

Other consumer loans and leases

     (27     57        30        (12     34        22   

Subtotal - consumer

     (9     (66     (75     9        (255     (246

Total loans and leases

     (155     43        (112     (114     (887     (1,001

Securities:

            

Taxable

     (34     (37     (71     169        (91     78   

Exempt from income taxes

     6        (10     (4     (7     (1     (8

Other short-term investments

     5        2        7        5        (17     (12

Total interest-earning assets

     (178     (2     (180     53        (996     (943

Cash and due from banks

            

Other assets

            

Allowance for loan and lease losses

                                                

Total change in interest income

   ($ 178     (2     (180   $ 53        (996     (943

Liabilities and Equity

            

Increase (decrease) in interest expense:

            

Interest-bearing core deposits:

            

Interest checking

   $ 8        4        12      $ 8        (96     (88

Savings

     18        (38     (20     9        (106     (97

Money market

     2        (9     (7     (28     (64     (92

Foreign office deposits

     4        (2     2        (1     (23     (24

Other time deposits

     (105     (89     (194     102        (43     59   

Total interest-bearing core deposits

     (73     (134     (207     90        (332     (242

Certificates - $100,000 and over

     (98     (57     (155     27        (71     (44

Other foreign office deposits

     —          —          —          (25     (25     (50

Federal funds purchased

     —          —          —          (33     (36     (69

Other short-term borrowings

     (21     (18     (39     (26     (110     (136

Long-term debt

     (3     (25     (28     (101     (138     (239

Total interest-bearing liabilities

     (195     (234     (429     (68     (712     (780

Demand deposits

            

Other liabilities

                                                

Total change in interest expense

     (195     (234     (429     (68     (712     (780

Equity

                                                

Total liabilities and equity

                                                

Total change in net interest income

   $ 17        232        249      $ 121        (284     (163

(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 ALLL 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 ALLL. 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 $1.5 billion in 2010 compared to $3.5 billion in 2009. The decrease

in provision expense from the prior year was due to decreases in nonperforming assets and delinquencies in commercial and consumer loans. In addition to these trends, signs of moderation in general economic conditions during 2010 further contributed to a decrease in expected loss rates. As of December 31, 2010, the ALLL as a percent of loans and leases decreased to 3.88%, from 4.88% at December 31, 2009.

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 ALLL.

 

 

 

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TABLE 7: NONINTEREST INCOME                                      

For the years ended December 31 ($ in millions)

     2010         2009        2008        2007         2006   

Mortgage banking net revenue

     $647         553        199        133         155   

Service charges on deposits

     574         632        641        579         517   

Corporate banking revenue

     364         372        431        367         318   

Investment advisory revenue

     361         326        366        382         367   

Card and processing revenue

     316         615        912        826         717   

Gain on sale of processing business

     -         1,758        -        -         -   

Other noninterest income

     406         479        363        153         299   

Securities gains (losses), net

     47         (10     (86     21         (364

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

     14         57        120        6         3   

Total noninterest income

     $2,729         4,782        2,946        2,467         2,012   

 

Noninterest Income

Total noninterest income decreased $2.1 billion, or 43%, in 2010 compared to 2009, due primarily to the Processing Business Sale in the second quarter of 2009 as well as decreases in service charges on deposits, corporate banking revenue and card and processing revenue, partially offset by strong growth in mortgage banking net revenue and investment advisory revenue. The components of noninterest income are shown in Table 7.

Mortgage banking net revenue increased to $647 million in 2010 from $553 million in 2009. The components of mortgage banking net revenue for the years ended December 31, 2010, 2009 and 2008 are shown in Table 8.

TABLE 8: COMPONENTS OF MORTGAGE BANKING NET REVENUE

For the years ended December 31

($ in millions)

   2010     2009     2008  

Origination fees and gains on loan sales

   $ 490        485        260   

Servicing revenue:

      

Servicing fees

     221        197        164   

Servicing rights amortization

     (137     (146     (107

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

     73        17        (118

Net servicing revenue (expense)

     157        68        (61

Mortgage banking net revenue

   $ 647        553        199   

Origination fees and gains on loan sales increased $5 million compared to 2009 as higher margins on loans sold were largely offset by a decline in mortgage originations due to the homebuyer tax credit expiring in the second quarter of 2010, as well as tighter underwriting standards and declining home values. Mortgage originations were $20.3 billion in 2010 compared to $21.7 billion in 2009.

    Mortgage net servicing revenue increased $89 million compared to 2009. 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. The increase in net servicing revenue was driven by an increase of $24 million in servicing fees due to an increase in residential mortgage loans serviced and a $9 million decrease in servicing rights amortization due to a decline in prepayments. The Bancorp’s total residential mortgage loans serviced at December 31, 2010 and 2009 was $63.2 billion and $58.5 billion, respectively, with $54.2 billion and $48.6 billion, respectively, of residential mortgage loans serviced for others. Also impacting the increase in net servicing revenue were improvements in net valuation adjustments on MSRs and MSR derivatives as gains on the Bancorp’s free-standing MSR derivatives exceeded impairment losses recorded against the hedged MSRs. This was a result of a widening spread between swap rates and primary and secondary market mortgage rates as swap rates declined more than primary and secondary market mortgage rates over the year, as well as a positive carry in the net MSR hedge position. These factors led to a net gain of $73 million on the net valuation adjustments on MSRs, compared to a net gain of $17 million in 2009.

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 MSRs can be found in Note 13 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 the valuation on the MSR portfolio. See Note 14 of the Notes to Consolidated Financial Statements for more information on the free-standing derivatives used to hedge the MSR portfolio.

The Bancorp recognized a gain from MSR derivatives of $109 million, offset by a temporary impairment of $36 million, resulting in a net gain of $73 million for the year ended December 31, 2010. For the year ended December 31, 2009, 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. 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 these non-qualifying hedges on mortgage servicing rights of $14 million and $57 million in 2010 and 2009, respectively, was included in noninterest income within the Consolidated Statements of Income, but is shown separate from mortgage banking net revenue.

Service charges on deposits decreased $58 million, or nine percent, to $574 million in 2010 compared to 2009. Consumer deposit revenue decreased $56 million from 2009 as the impact of Regulation E and new overdraft policies resulted in a decrease in overdraft occurrences. Regulation E is a Federal Reserve Board rule that prohibits financial institutions from charging customers fees for paying overdrafts on ATMs and one-time debit card transactions unless a customer consents to the overdraft service for those types of transactions. Regulation E became effective on July 1, 2010 for new accounts and August 15, 2010 for existing accounts.

    Commercial deposit revenue was flat compared to 2009 as a two percent increase in service fees for treasury management services was largely offset by an increase in earnings credits paid on customer balances. 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. Earning 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.

 

 

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

 

Corporate banking revenue decreased $8 million, or two percent, in 2010, largely due to decreases in international income and lease remarketing fees, partially offset by growth in syndication and business lending fees. Foreign exchange derivative income of $63 million decreased 17% driven by volume declines. Loan syndication fees were $28 million in 2010, compared to $8 million in 2009.

Investment advisory revenue increased $35 million, or 11%, from 2009 as the result of improved market performance and sales production that drove an increase in brokerage activity and assets under care. Brokerage fee income, which includes Fifth Third Securities income, increased $23 million in 2010 as investors migrated balances to stock and bond funds due to improved market performance, which increased commission-based transactions. As of December 31, 2010, the Bancorp had $266 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 $299 million, or 49%, compared to 2009. Card issuer interchange, which was retained by the Bancorp, increased eight percent, to $284 million, compared to 2009 due to strong growth in debit and credit card transaction volumes.

Other noninterest income decreased $73 million in 2010 compared to 2009. The components of other noninterest income are shown in Table 9. The decrease was primarily due a $244 million gain relating to the sale of the Bancorp’s Visa, Inc. Class B shares in 2009 and a $27 million decrease in revenue in 2010 related to the TSA entered into as part of the Processing Business Sale, partially offset by an increase of $196 million in BOLI income. The year ended December 31, 2010 includes a $152 million litigation settlement related to one of the Bancorp’s BOLI policies while 2009 includes $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.

Net securities gains totaled $47 million in 2010 compared to $10 million of net securities losses during 2009.

Noninterest Expense

Total noninterest expense remained relatively flat in 2010 compared to 2009 as increases in salaries, wages and incentives and the expense for representation and warranties were largely offset by a decrease in the provision for unfunded commitments and letters of credit, lower FDIC insurance and other taxes and a decrease in card and processing expense. The components of noninterest expense are shown in Table 10. Noninterest expense in 2010 included $49 million of expenses related to the TSA and $25 million in legal fees associated with the settlement of claims with the insurance carrier on one of the Bancorp’s BOLI policies Noninterest expense in 2009 included $76 million of expense related to the TSA and a $55 million FDIC special assessment charge, partially offset by a $73 million reduction in the Visa litigation reserve.

 

TABLE 9: COMPONENTS OF OTHER NONINTEREST INCOME

For the years ended December 31

($ in millions)

     2010        2009        2008   

BOLI income (loss)

     194        (2     (156

Operating lease income

     62        59        47   

Gain (loss) on loan sales

     51        38        (11

TSA revenue

     49        76        -   

Insurance income

     38        47        36   

Cardholder fees

     36        48        58   

Consumer loan and lease fees

     32        43        51   

Banking center income

     22        22        31   

Loss on sale of OREO

     (78     (70     (60

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

     -        244        273   

Litigation settlement

     -        -        76   

Other, net

     -        (26     18   

Total other noninterest income

   $ 406      $ 479        363   

Total personnel costs (salaries, wages and incentives plus employee benefits) increased $94 million, or six percent in 2010 compared to 2009 due primarily to increased base, variable and incentive compensation, partially offset by lower deferred compensation. Base and incentive compensation increased due primarily to investments in the sales force and expanded banking center hours during 2010. As of December 31, 2010, the Bancorp employed 21,613 employees, of which 6,742 were officers and 2,519 were part-time employees. Full-time equivalent employees totaled 20,838 as of December 31, 2010 compared to 20,998 as of December 31, 2009. The decrease in full-time equivalent employees is primarily due to the transfer of employees on January 1, 2010 from the Processing Business Sale, partially offset by an increase in the sales force in 2010.

Card and processing expense includes third-party processing expenses, card management fees and other bankcard processing expenses. Card and processing expense decreased $85 million, or 44%, in 2010 compared to 2009 due to the Processing Business Sale in June of 2009.

Total other noninterest expense increased $23 million in 2010 compared to 2009. The components of other noninterest expense are shown in Table 11. The increase from 2009 was primarily due to increased charges to representation and warranty reserves related to residential mortgage loans sold to third-parties, as well as higher impairment on affordable housing investments, higher marketing expense due to increased consumer marketing campaigns and an increase in professional services fees primarily due to legal expenses related to the settlement of one of the Bancorp’s BOLI policies. The increase in affordable housing investment impairment was due to an increase in the volume of investments. These impacts were partially offset by a decrease in the provision for unfunded commitments and letters of credit, lower FDIC insurance and other taxes and a decrease in

 

 

TABLE 10: NONINTEREST EXPENSE                                       

For the years ended December 31 ($ in millions)

     2010        2009         2008         2007         2006   

Salaries, wages and incentives

   $ 1,430        1,339         1,337         1,239         1,174   

Employee benefits

     314        311         278         278         292   

Net occupancy expense

     298        308         300         269         245   

Technology and communications

     189        181         191         169         141   

Equipment expense

     122        123         130         123         116   

Card and processing expense

     108        193         274         244         184   

Goodwill impairment

     -        -         965         -         -   

Other noninterest expense

     1,394        1,371         1,089         989         763   

Total noninterest expense

   $ 3,855        3,826         4,564         3,311         2,915   

Efficiency ratio

     60.7     46.9         70.4         60.2         59.4   

 

 

Fifth Third Bancorp

 

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

 

intangible asset amortization due to certain customer deposit intangibles from previous acquisitions being fully amortized. Additionally, the Bancorp recorded a $73 million reversal of the Visa litigation reserve in 2009. The expense for representation and warranties, which is included in losses and adjustments, totaled $110 million and $31 million in 2010 and 2009, respectively, with the increase resulting primarily from a higher volume of repurchase demands. The decrease in the provision for unfunded commitments was due to lower estimates of inherent losses resulting from a decrease in delinquent loans as general economic conditions began to show signs of moderation in 2010.

The Bancorp incurred $242 million of expense for FDIC insurance and other taxes in 2010 compared to $269 million in 2009. Effective June 30, 2009, the FDIC imposed a special assessment on each insured depository institution calculated as 5 bp of total assets less Tier 1 capital which resulted in the Bancorp incurring a $55 million special assessment charge in the second quarter of 2009. Due to the passage of the Dodd-Frank Act, the FDIC was required to redefine the deposit insurance assessment base, make changes to assessment rate methodology and implement new DIF dividend provisions. The FDIC adopted the final rule on February 7, 2011, that revises the risk-based assessment system for all large insured depository institutions. The Bancorp anticipates a decline in FDIC insurance for the year ended December 31, 2011, compared to levels incurred for the year ended December 31, 2010.

The efficiency ratio (noninterest expense divided by the sum of net interest income and noninterest income) was 60.7% and 46.9% for 2010 and 2009, respectively. The increase from 2009 was driven by the Processing Business Sale which resulted in a pre-tax gain of $1.8 billion in 2009. Excluding the gain from the Processing Business Sale, the efficiency ratio was 60.0% for 2009. 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         

TABLE 11: COMPONENTS OF OTHER
NONINTEREST EXPENSE
 

For the years ended December 31

($ in millions)

     2010        2009        2008   

FDIC insurance and other taxes

   $ 242        269        73   

Loan and lease

     211        234        188   

Losses and adjustments

     187        110        95   

Affordable housing investments impairment

     100        83        67   

Marketing

     98        79        102   

Professional services fees

     77        63        102   

Travel

     51        41        54   

Postal and courier

     48        53        54   

Intangible asset amortization

     43        57        56   

Insurance expense

     42        50        30   

Operating lease

     41        39        32   

OREO

     33        24        11   

Recruitment and education

     31        30        33   

Supplies

     24        25        31   

Data processing

     24        21        14   

Visa litigation reserve

     -        (73     (99

Provision for unfunded commitments and letters of credit

     (24     99        98   

Other

     166        167        148   

Total other noninterest expense

   $ 1,394        1,371        1,089   

tax-exempt income, tax-advantaged investments and general business tax credits, partially offset by the effect of nondeductible expenses. The effective tax rate for the tax year ended December 31, 2010 was primarily impacted by $133 million in tax credits, a $26 million tax benefit resulting from the settlement of certain uncertain tax positions with the IRS and $25 million of non-cash charges relating to previously recognized tax benefits associated with stock-based compensation that will not be realized. 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. See Note 21 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)    2010     2009      2008     2007      2006  

Income (loss) before income taxes and cumulative effect

   $ 940        767         (2,664     1,537         1,627   

Applicable income tax expense (benefit)

     187        30         (551     461         443   

Effective tax rate

     19.8     3.9         20.7        30.0         27.2   

 

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

 

BUSINESS SEGMENT REVIEW

 

At December 31, 2010, the Bancorp reports on four business segments: Commercial Banking, Branch Banking, Consumer Lending and Investment Advisors. Additional detailed financial information on each business segment is included in Note 31 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 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 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.

The business segments are charged provision expense based on the actual net charge-offs experienced by the loans owned by each segment. Provision expense attributable to loan growth and changes in factors in the ALLL 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) by business segment is summarized in the following table.

TABLE 13: BUSINESS SEGMENT NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS

For the years ended December 31

($ in millions)

     2010        2009        2008   

Income Statement Data

      

Commercial Banking

     $165        (120     (733

Branch Banking

     201        324        632   

Consumer Lending

     (40     23        (148

Investment Advisors

     29        53        98   

General Corporate and Other

     398        457        (1,962

Net income (loss)

     753        737        (2,113

Less: Net income attributable to noncontrolling interest

     -        -        -   

Net income (loss) attributable to Bancorp

     753        737        (2,113

Dividends on preferred stock

     250        226        67   

Net income (loss) available to common shareholders

     $503        511        (2,180
 

 

 

Fifth Third Bancorp

 

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

 

Commercial Banking

Commercial Banking offers banking, cash management and financial services to large and middle-market businesses and government and professional customers. In addition to the traditional lending and depository offerings, Commercial Banking products and services include global cash management, foreign exchange and international trade finance, derivatives and capital markets services, asset-based lending, real estate finance, public finance, commercial leasing and syndicated finance. The following table contains selected financial data for the Commercial Banking segment.

 

TABLE 14: COMMERCIAL BANKING

 

For the years ended December 31

($ in millions)

     2010        2009        2008   

Income Statement Data

      

Net interest income (FTE) (a)

   $ 1,545        1,383        1,567   

Provision for loan and lease losses

     1,159        1,360        1,864   

Noninterest income:

      

Corporate banking revenue

     346        353        401   

Service charges on deposits

     199        196        186   

Other noninterest income

     90        60        91   

Noninterest expense:

      

Salaries, incentives and benefits

     254        221        243   

Goodwill impairment

     —          —          750   

Other noninterest expense

     736        768        675   

Income (loss) before taxes

     31        (357     (1,287

Applicable income tax benefit

     (134     (237     (554

Net income (loss)

   $ 165        (120     (733

Average Balance Sheet Data

      

Commercial loans

   $ 38,304        41,341        43,198   

Demand deposits

     10,872        8,581        6,206   

Interest checking

     8,432        6,018        4,632   

Savings and money market

     2,823        2,457        4,046   

Certificates $100,000 and over and other time

     3,014        4,376        2,293   

Foreign office deposits

     2,017        1,275        1,835   
(a) Includes FTE adjustments of $14 for 2010, $13 for 2009 and $15 for 2008

Comparison of 2010 with 2009

Commercial Banking realized net income of $165 million in 2010 compared to a net loss of $120 million in 2009. This improvement was primarily due to an increase in net interest income and a decrease in provision for loan and lease losses partially offset by growth in salaries, incentives and benefits. Net interest income increased $162 million, or 12%, primarily due to a mix shift from higher cost term deposits to lower cost deposit products which resulted in a decrease to interest expense of 34% during 2010. This improvement was partially offset by the negative impact to net interest income of a decrease in average commercial loans during 2010 and a decrease of $35 million in the accretion of discounts on loans associated with the acquisition of First Charter in 2008.

Provision for loan and lease losses decreased $201 million, or 15%, from 2009. Net charge-offs as a percent of average loans and leases decreased from 329 bp in 2009 to 302 bp in 2010. These decreases are primarily due to actions taken by the Bancorp to address problem loans which resulted in significant net charge-offs recorded in 2008 and 2009, as well as the impact of loss mitigation activities such as suspending home builder and developer lending and non-owner occupied commercial real estate lending in 2007 and 2008, respectively, and tighter underwriting standards across commercial loan product offerings.

    Noninterest income increased $26 million, or four percent, from 2009 primarily as a result of $24 million increase in gains on private equity investments, included in other noninterest income, and a $5 million increase in card and                                 

processing revenue due to an increase in commercial credit card activity, partially offset by a $7 million decrease in corporate banking revenue. Corporate banking revenue decreased from the prior year primarily as a result of a $6 million decrease in fees on letters of credit.

Noninterest expense was flat compared to 2009 due to an increase in salaries, incentives and benefits offset by a decrease in other noninterest expense. Salaries, incentives and benefits increased $33 million, or 15%, due to compensation related to improved performance in the segment and an increase in headcount during 2010. Loan and lease expense decreased $32 million, or four percent, as a result of lower loan demand during 2010, a decrease in collection related expenses and a decrease in FDIC expenses due to a special assessment in the second quarter of 2009.

Average commercial loans and leases decreased $3.0 billion, or seven percent, compared to the prior year due to decreases across all commercial loan categories. Commercial construction loans decreased $1.5 billion, commercial and industrial loans decreased $655 million, commercial mortgage loans decreased $631 million and commercial leases decreased $209 million. These decreases were the result of lower customer demand for new originations, lower utilization rates on corporate lines and tighter underwriting standards applied to both new commercial loan originations and renewals. These impacts were partially offset by the consolidation of $724 million of commercial and industrial loans on January 1, 2010, which had a remaining balance of $372 million at December 31, 2010.

Average core deposits increased $5.8 billion, or 32%, compared to 2009 due to the migration of higher priced certificates of deposit into transaction accounts, as well as the impact of historically low interest rates and excess customer liquidity.

Comparison of 2009 with 2008

Commercial Banking reported a net loss of $120 million in 2009 compared to a net loss of $733 million in 2008. This improvement was due to a $750 million goodwill impairment charge taken in 2008 and a $504 million decrease in the provision for loan and lease losses in 2009, partially offset by a decrease in net interest income of $184 million. The decrease in net interest income compared to 2008 was primarily due to a decrease in the accretion of loan discounts on acquired loans and deposits which contributed $204 million to net interest income in 2008 compared to $60 million in 2009. Average commercial loans and leases decreased $1.9 billion, or four percent, due to lower utilization rates on corporate lines, net charge-offs and tighter lending standards implemented in the second half of 2008 and continued throughout 2009.

Provision expense decreased from $1.9 billion in 2008 to $1.4 billion in 2009. Net charge-offs as a percent of average loans and leases decreased to 329 bp from 432 bp in 2008 due primarily to $800 million in net charge-offs in 2008 resulting from the sale or transfer to held-for-sale of $1.3 billion in commercial and industrial loans and commercial mortgage loans in the fourth quarter of 2008.

Noninterest income decreased $69 million compared to 2008 due to a decrease in corporate banking revenue of $48 million and a $31 million decline in other noninterest income, partially offset by a $10 million increase in service charges on deposits.

    Noninterest expense decreased $679 million compared to 2008 primarily due to goodwill impairment of $750 million in 2008. Excluding the goodwill impairment charge, noninterest expense increased $71 million due to increases in FDIC and loan and leases expenses.

 

 

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

 

Branch Banking

Branch Banking provides a full range of deposit and loan and lease products to individuals and small businesses through 1,312 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 automobiles and other personal financing needs, as well as products designed to meet the specific needs of small businesses, including cash management services. The following table contains selected financial data for the Branch Banking segment.

 

TABLE 15: BRANCH BANKING                        

For the years ended December 31

($ in millions)

     2010         2009         2008   

Net interest income

     $1,501         1,559         1,714   

Provision for loan and lease losses

     542         585         352   

Noninterest income:

        

Service charges on deposits

     369         428         447   

Card and processing revenue

     303         264         246   

Investment advisory revenue

     106         84         84   

Other noninterest income

     115         122         130   

Noninterest expense:

        

Salaries, incentives and benefits

     552         502         517   

Net occupancy and equipment expense

     223         217         203   

Card and processing expense

     102         68         45   

Other noninterest expense

     664         585         528   

Income before taxes

     311         500         976   

Applicable income tax expense

     110         176         344   

Net income

     $201         324         632   

Average Balance Sheet Data

        

Consumer loans

     $12,944         13,096         12,665   

Commercial loans

     4,815         5,335         5,600   

Demand deposits

     6,936         6,363         6,008   

Interest checking

     7,332         7,395         7,845   

Savings and money market

     19,963         17,010         16,184   

Other time

     12,712         16,995         13,749   

Comparison of 2010 with 2009

Net income decreased $123 million, or 38%, compared to 2009 driven by an increase in noninterest expense and a decrease in net interest income partially offset by a decrease in provision for loan and lease losses. Net interest income decreased $58 million, or four percent, compared to 2009 as the impact of lower loan balances more than offset a favorable shift in the segment’s deposit mix towards lower cost transaction deposits.

Provision for loan and lease losses decreased $43 million, or seven percent, from 2009. Net charge-offs as a percent of average loans and leases decreased from 317 bp in 2009 to 305 bp in 2010 as a result of a 36 bp decrease in consumer net charge-offs as a percent of average consumer loans partially offset by a 52 bp increase in commercial net charge-offs as a percent of average commercial loans. The decrease in consumer net charge-offs was primarily the result of a decrease in delinquencies, tighter underwriting standards and signs of improvement in economic conditions during 2010. The increase in commercial net charge-offs was primarily due to $24 million of charge-offs taken on $60 million of commercial loans which were sold or moved to held for sale during the third quarter of 2010.

    Noninterest income decreased $5 million, or one percent, from 2009 as decreases in service charges on deposits and other noninterest income were partially offset by increases in card and processing revenue and investment advisory revenue. Service charges on deposits decreased $59 million, or 14%, compared to 2009 as a result of new regulations in 2010 that decreased income on overdrafts. Card and processing revenue increased $39 million, or 15%, from 2009 primarily due to an increase in debit and credit card transactions that resulted in a

13% increase in both credit and debit card interchange revenue. Investment advisory revenue increased $22 million, or 26%, compared to 2009 primarily due to an increase in retail brokerage transactions. Other noninterest income decreased $7 million, or six percent, primarily due to the CARD Act of 2009, which resulted in the reduction of certain credit card fees.

Noninterest expense increased $169 million, or 12%, from 2009 due to increases in each category. Salaries, incentives and benefits increased $50 million, or 10%, from the prior year due primarily to additional branch personnel related to expanded branch hours of operation and greater incentive accruals attributable to success in opening new deposit and brokerage accounts. Net occupancy and equipment expense increased $6 million, or three percent, as a result of increases to rent expenses during 2010. Card and processing expense increased $34 million, or 50%, from 2009 due to increased costs associated with an increase in credit and debit card transaction volumes during 2010. Other noninterest expense increased $79 million, or 14%, due to increases in loan and lease expense, marketing expense and other allocated shared service expenses.

Average consumer loans decreased $152 million, or one percent, and average commercial loans decreased $520 million, or 10%. The decrease in average consumer loans was the result of a $311 million decrease in home equity loans due to a decrease in demand and tighter underwriting standards that limited allowable loan to value ratios, partially offset by a $254 million increase in residential mortgage loans due to management’s decision to retain certain residential mortgage loans in portfolio upon origination. The decrease in average commercial loans was due to lower customer demand for new originations, lower utilization rates on corporate lines and tighter underwriting standards applied to both new commercial loan originations and renewals.

Average core deposits were flat compared to 2009 as runoff of higher priced consumer certificates of deposit, included in other time deposits, was replaced with growth in transaction accounts due to excess customer liquidity and low interest rates.

Comparison of 2009 with 2008

Net income decreased $308 million, or 49%, in 2009 compared to 2008 driven by decreases in net interest income and service fees combined with a higher provision for loan and lease losses. Net interest income decreased nine percent compared to 2008 due to a $27 million decline in the accretion of discounts on acquired loans and deposits combined with an increase in interest expense due to higher average balances in other time deposits.

Net charge-offs as a percent of average loan and leases increased to 317 bp in 2009, from 194 bp in 2008. Net charge-offs increased compared to 2008 as the segment experienced higher charge-offs on home equity lines and loans, commercial loans and credit cards reflecting borrower stress and a decrease in home values primarily within the Bancorp’s footprint.

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.

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.

    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. In addition, credit card balances grew $211 million, or 14%. Average core deposits were up eight percent compared to 2008 primarily due to growth in short term consumer certificates.

 

 

 

Fifth Third Bancorp

 

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

 

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 and automobile dealers. The following table contains selected financial data for the Consumer Lending segment.

 

TABLE 16: CONSUMER LENDING                 

For the years ended December 31

($ in millions)

     2010        2009         2008   

Income Statement Data

       

Net interest income

     $418        494         481   

Provision for loan and lease losses

     582        574         441   

Noninterest income:

       

Mortgage banking net revenue

     619        526         184   

Other noninterest income

     43        101         167   

Noninterest expense:

       

Salaries, incentives and benefits

     200        187         137   

Goodwill impairment

     —          —           215   

Other noninterest expense

     359        324         268   

Income (loss) before taxes

     (61     36         (229

Applicable income tax expense (benefit)

     (21     13         (81

Net income (loss)

     ($40     $23         (148

Average Balance Sheet Data

       

Residential mortgage loans

     $9,384        10,650         10,698   

Home equity

     851        995         1,142   

Automobile loans

     9,713        8,024         7,984   

Consumer leases

     384        629         797   

Comparison of 2010 with 2009

Consumer Lending reported a net loss of $40 million in 2010 compared to net income of $23 million in 2009 due to a decrease in net interest income and an increase in noninterest expense partially offset by an increase in noninterest income. Net interest income decreased $76 million, or 15%, from 2009 primarily due to a decrease in yields on average interest earning assets, which includes the impact of a $21 million decrease in the accretion of discounts on loans associated with the acquisition of First Charter in 2008, partially offset by a decrease in funding costs during 2010.

Provision for loan and lease losses increased $8 million, or one percent, from 2009. Net charge-offs as a percent of average loans and leases decreased from 313 bp in 2009 to 309 bp in 2010. The increase in provision for loan and lease losses from the prior year was the result of a 23% increase in net charge-offs on residential mortgage loans primarily due to $123 million in charge-offs taken on $228 million of portfolio loans which were sold during the third quarter of 2010. Automobile loan net charge-offs decreased $44 million compared to 2009 as a result of tighter underwriting standards implemented in 2008, maturation of the automobile portfolio and higher resale values on automobiles sold at auction. Home equity net charge-offs decreased $24 million from 2009 due to run off of brokered home equity loans, the origination of which were discontinued in 2007.

Noninterest income increased $35 million, or six percent, as the result of an increase in mortgage banking net revenue partially offset by a decrease in other noninterest income. Mortgage banking net revenue increased $93 million, or 18%, from 2009 primarily due to an $89 million increase in net servicing revenue. The increase in net servicing revenue was driven by a $56 million increase in net valuation adjustments on MSRs and MSR derivatives and a $24 million increase in servicing fees. Residential mortgage loans serviced for others at December 31, 2010 and 2009 were $54.2 billion and $48.6 billion, respectively. Other noninterest income decreased $58 million, or 57%, primarily due to decreases in securities gains related to mortgage servicing rights hedging activities and an increase in bankcard rewards program costs recognized within fee income.

Noninterest expense increased $48 million, or nine percent, due to increases in salaries, incentives and benefits and other noninterest expense. Salaries, incentives and benefits increased $13 million, or seven percent, from 2009 due to the continued high levels of mortgage loan originations in 2010. Other noninterest expense increased $35 million, or 11%, from 2009 primarily as a result of a $48 million increase in the representation and warranty reserve partially offset by a $13 million decrease in loan and lease expense.

Average consumer loans were flat compared to 2009 as a $1.7 billion increase in automobile loans was offset by decreases in all other consumer loan and lease products. Average residential mortgage loans decreased $1.3 billion from 2009 due to a decrease in origination activity during the first half of 2010. Average home equity loans decreased $144 million from 2009 due to the previously mentioned run off of brokered home equity loans. The increase in automobile loans was due to a change in U.S. GAAP that required the Bancorp to consolidate certain automobile loans on January 1, 2010 and a strategic focus to increase automobile lending during 2010 through consistent and competitive pricing, enhanced customer service with our dealership network and disciplined sales execution. The automobile loans consolidated due to the change in U.S. GAAP had an average balance of $920 million during 2010. Average consumer leases decreased $245 million due to run off of consumer leases which were discontinued in the fourth quarter of 2008.

Comparison of 2009 with 2008

Consumer Lending reported net income of $23 million in 2009 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, increases in net interest income and mortgage banking net revenue in 2009 more than offset the growth in provision for loan and lease losses.

Net interest income increased $13 million in 2009 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.

Mortgage banking net revenue increased $342 million due to an increase in residential mortgage originations from $11.2 billion in 2008 to $20.7 billion in 2009 due to lower interest rates and government incentive programs offered to home buyers as well as higher sales margins on sold loans. The decrease in other noninterest income to $101 million in 2009 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.

Average residential mortgage loans and average automobile loans remained relatively flat compared to 2008. Net charge-offs as a percent of average loan and leases increased from 223 bp in 2008 to 313 bp in 2009.

 

 

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

 

Investment Advisors

Investment Advisors provides a full range of investment alternatives for individuals, companies and not-for-profit organizations. Investment Advisors is made up of four main businesses: FTS, an indirect wholly-owned subsidiary of the Bancorp; FTAM, an indirect wholly-owned subsidiary of the Bancorp; Fifth Third Private Bank; 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. The following table contains selected financial data for the Investment Advisors segment.

 

TABLE 17: INVESTMENT ADVISORS                  

For the years ended December 31

($ in millions)

     2010         2009         2008   

Income Statement Data

        

Net interest income

     $138         157         191   

Provision for loan and lease losses

     44         57         49   

Noninterest income:

        

Investment advisory revenue

     346         315         354   

Other noninterest income

     10         21         32   

Noninterest expense:

        

Salaries, incentives and benefits

     156         140         159   

Other noninterest expense

     249         214         217   

Income before taxes

     45         82         152   

Applicable income tax expense

     16         29         54   

Net income

     $29         $53         98   

Average Balance Sheet Data

        

Loans and leases

     $2,574         3,112         3,527   

Core deposits

     5,897         4,939         4,666   

Comparison of 2010 with 2009

Net income decreased $24 million, or 45%, compared to 2009 as a decrease in net interest income and an increase in noninterest expense were partially offset by a decrease in provision for loan and lease losses and an increase in investment advisory revenue. Net interest income decreased $19 million, or 12%, from 2009 due to a decrease in average loans and leases partially offset by an increase in the yield on interest earning assets.

Provision for loan and lease losses decreased $13 million, or 23%, from 2009. Net charge-offs as a percent of average loans and leases decreased from 183 bp in 2009 to 171 bp in 2010 reflecting moderation of general economic conditions during 2010.

Noninterest income increased $20 million, or six percent, compared to 2009 due to an increase in investment advisory revenue partially offset by a decrease in other noninterest income. Investment advisory revenue increased $31 million,     

or 10%, compared to 2009 due to increases in securities and broker income, private client service income and institutional income. Securities and broker income increased $18 million, or 17%, from 2009 due to continued expansion of the sales force and effective sales management, resulting in strong net asset and account growth. Private client service income increased $11 million, or eight percent, and institutional income increased $5 million, or seven percent, from 2009 due to increases in the market value of managed assets and an increase in transaction activity. Assets under care increased from $182 billion at December 31, 2009 to $266 billion at December 31, 2010 and managed assets increased from $24 billion at December 31, 2009 to $25 billion at December 31, 2010.

Noninterest expense increased $51 million, or 14%, compared to 2009 due to an increase in salaries, incentives and benefits and other noninterest expense. Salaries, incentives and benefits increased $16 million, or 11%, primarily due to the expansion of the sales force and compensation related to improved performance in investment advisory revenue related fees. Other noninterest expense increased $35 million, or 16%, primarily due to an increase in expenses associated with the revenue sharing agreement between Investment Advisors and Branch Banking.

Average loans and leases decreased $538 million, or 17%, from 2009 primarily due to a $418 million decrease in commercial loans as a result of a decrease in demand and decrease in line utilization rates among the Bancorp’s high net worth customers due to excess liquidity. Average core deposits increased $958 million, or 19%, compared to 2009 primarily due to growth in interest checking and foreign deposits as customers have opted to maintain excess funds in liquid transaction accounts as rates remained near historic lows.

Comparison of 2009 with 2008

Net income decreased $45 million in 2009, 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.

Noninterest income decreased $50 million in 2009 compared to 2008, as investment advisory revenue decreased $39 million, with private client services income declining $14 million and institutional income declining $13 million, 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.

 

 

 

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General Corporate and Other

General Corporate and Other includes the unallocated portion of the investment securities portfolio, securities gains and losses, certain non-core deposit funding, unassigned equity, provision expense in excess of net charge-offs or income from the reduction of ALLL, 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 2010 with 2009

The results for 2010 were impacted by $789 million in income due to a reduction in the ALLL during 2010 compared to $967 million of provision expense recorded in excess of net charge-offs during 2009. The decrease in provision expense was due to a decrease in nonperforming assets and improvement in credit trends as general economic conditions began to show signs of moderation. The 2010 results were also impacted by $152 million of noninterest income recognized from the settlement of litigation associated with one of the Bancorp’s BOLI policies and $25 million of noninterest expense from related legal fees associated with the settlement. The results for 2009 were primarily impacted by a $1.8 billion pre-tax gain ($1.1 billion after tax) resulting from the Processing Business Sale in the second quarter of 2009. Results for 2009 also included a $244 million gain on the sale of the Bancorp’s Visa Inc., Class B shares and a $73 million benefit from the reversal of the Visa litigation reserve, an $18 million benefit in noninterest income due to mark-to-market adjustments on         

warrants and put options related to the Processing Business Sale and a $106 million tax benefit as a result of the Bancorp’s decision to surrender one of its BOLI policies. These benefits were 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 dividends on preferred stock of $226 million during 2009 compared to $250 million during 2010.

Comparison of 2009 with 2008

The results for 2009 were primarily impacted by the previously mentioned Processing Business Sale, gain on the sale of the Bancorp’s Visa Inc., Class B shares and benefit from the reversal of the Visa litigation reserve, mark-to-market adjustments on warrants and put options related to the Processing Business Sale, and the tax benefit as a result of the Bancorp’s decision to surrender one of its BOLI policies, partially offset by charges reflecting reserves recorded in the connection with the intent to surrender the policy. The results for 2008 were impacted by $273 million in income related to the redemption of a portion of Fifth Third’s ownership interest 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, and $215 million in charges related to reduction in the cash surrender value of one of the Bancorp’s BOLI policies. Provision expense in excess of net charge-offs decreased from $1.9 billion in 2008 to $967 million in 2009. Dividends on preferred stock increased from $67 million in 2008 to $226 million in 2009.

 

 

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FOURTH QUARTER REVIEW

 

The Bancorp’s 2010 fourth quarter net income available to common shareholders was $270 million, or $0.33 per diluted share, compared to net income available to common shareholders of $175 million, or $0.22 per diluted share, for the third quarter of 2010 and a net loss available to common shareholders of $160 million, or $0.20 per diluted share, for the fourth quarter of 2009. Fourth quarter 2010 earnings included the impact of a $17 million charge related to the early extinguishment of $1.0 billion in FHLB borrowings as well as $21 million in net investment securities gains. Third quarter 2010 results included a $127 million benefit, net of expenses, from the settlement of litigation associated with one of the Bancorp’s BOLI policies. Fourth quarter 2009 earnings were impacted by the benefit of a $20 million pre-tax, mark-to-market adjustment on warrants related to the Processing Business Sale, offset by a $22 million pre-tax litigation reserve for litigation associated with a bank card association membership. Provision expense was $166 million in the fourth quarter of 2010, down from $457 million in the third quarter of 2010 and $776 million in the fourth quarter of 2009. Both the sequential decrease and the decline from the fourth quarter of 2009 reflect improved credit trends, as evidenced by a decrease in net charge-offs and improvements in nonperforming assets and delinquent loans. The allowance to loan and lease ratio was 3.88% as of December 31, 2010, compared to 4.20% as of September 30, 2010 and 4.88% as of December 31, 2009.

Fourth quarter 2010 net interest income of $919 million increased $3 million from the third quarter of 2010 and increased $37 million from the same period a year ago. Net interest income was affected by the loan and deposit discount accretion related to the acquisition of First Charter in the second quarter of 2008, which resulted in increases to net interest income of $15 million in the fourth quarter 2010, $14 million in the third quarter 2010 and $23 million in the fourth quarter of 2009. Excluding these benefits, net interest income increased $2 million from the third quarter of 2010 and increased $45 million from the fourth quarter of 2009. The increase from the fourth quarter of 2009 was driven by a 20 bp increase in the net interest margin, largely the result of a mix shift from higher cost term deposits to lower cost deposit products throughout 2010.

Noninterest income decreased $171 million compared to the third quarter of 2010 and increased $5 million compared to the fourth quarter of 2009. The sequential decline was driven by a $152 million benefit from the settlement of litigation related to one of the Bancorp’s BOLI policies in the third quarter of 2010, as well as a 36% decrease in mortgage banking net revenue, partially offset by an increase in corporate banking revenue. Compared to the fourth quarter of 2009, increases in corporate banking revenue, mortgage banking net revenue, investment advisory revenue and card and processing revenue were largely offset by a decrease in service charges on deposits and a $28 million decline in TSA revenue related to the Processing Business Sale. The fourth quarter of 2010 included a benefit of $3 million in mark-to-market adjustments on warrants and put options related to the Processing Business Sale, compared to a negative $5 million adjustment in the third quarter of 2010 and a $20 million benefit in the fourth quarter of 2009.

Mortgage banking net revenue was $149 million in the fourth quarter of 2010, compared to $232 million in the third quarter of 2010 and $132 million in the fourth quarter of 2009. Fourth quarter originations were $7.4 billion, compared to $5.6 billion in the previous quarter and $4.8 billion in the same quarter last year. These originations resulted in gains on mortgage loan sales activity of $158 million in the fourth quarter of 2010, compared to $173 million in the third quarter of 2010 and $97 million in the fourth quarter of 2009. Gain on sale margins declined compared to record levels in the third quarter of 2010 due to rising mortgage interest rates in the                                              

fourth quarter of 2010 but increased compared to the fourth quarter of 2009 due to declining mortgage interest rates in the fourth quarter of 2010 compared with the fourth quarter of 2009. Also impacting mortgage banking net revenue was net valuation adjustments on MSRs and MSR derivatives. In the fourth quarter of 2010, losses on the Bancorp’s free-standing MSR derivatives exceeded impairment reversal recorded against the hedged MSRs. By comparison, in both the third quarter of 2010 and the fourth quarter of 2009, gains on the MSR derivatives exceeded impairment losses recognized against the hedged MSRs. These factors led to a net loss of $20 million on the net valuation adjustments on MSRs in the fourth quarter of 2010, compared to net gains of $46 million and $9 million in the third quarter of 2010 and the fourth quarter of 2009, respectively. A net gain on non-qualifying hedges on mortgage servicing rights of $14 million in the fourth quarter of 2010 was included in noninterest income within the Consolidated Statements of Income, but shown separate from mortgage banking net revenue. Net gains on non-qualifying hedges on mortgage servicing rights were immaterial in both the third quarter of 2010 and the fourth quarter of 2009.

Service charges on deposits of $140 million decreased three percent sequentially and decreased 12% compared to the fourth quarter of 2009. Retail service charges declined nine percent from the third quarter of 2010 and 26% from a year ago, largely driven by the impact of Regulation E. Commercial service charges increased three percent sequentially and two percent from the same quarter last year due to an increase in fees for treasury management services.

Corporate banking revenue of $103 million increased $17 million, or 21%, from the previous quarter and increased $14 million, or 16%, from the fourth quarter of 2009. The sequential increase was driven primarily by higher loan syndication fee revenue and lease remarketing fees, as well as growth in business lending fees and foreign exchange revenue due primarily to higher loan volumes. Compared to the fourth quarter of 2009, increased loan syndication and lease remarketing fees, as well as revenue from interest rate derivative sales and business lending fees, more than offset a decline in institutional sales.

Investment advisory revenue of $93 million increased four percent sequentially and eight percent from the fourth quarter of 2009. The sequential growth was driven by higher private client service revenue, institutional trust revenue and brokerage fees due to market value increases and improved sales production resulting in improved net asset and account growth. Including the previously mentioned impacts, the increase from the fourth quarter of 2009 also reflected an overall increase in equity and bond market values.

Card and processing revenue of $81 million increased five percent compared to the third quarter of 2010 and increased seven percent from the fourth quarter of 2009. Both increases were driven by higher transaction volumes.

The net gain on investment securities was $21 million in the fourth quarter of 2010 compared to a net gain of $4 million in the third quarter of 2010 and a net gain of $2 million in the fourth quarter of 2009.

    Noninterest expense of $987 million increased $8 million sequentially and increased $20 million from the fourth quarter of 2009. Fourth quarter 2010 results included $17 million of expenses related to the early termination of $1.0 billion in FHLB borrowings as well as $11 million of expenses related to the TSA. Third quarter 2010 results included $25 million in legal expenses associated with the settlement of litigation associated with one of the Bancorp’s BOLI policies and $13 million of expenses related to the TSA, while fourth quarter 2009 included a $22 million reserve established for litigation

 

 

 

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associated with bank card memberships and $39 million of expenses related to the TSA. Excluding these items, noninterest expense increased $16 million sequentially and $25 million from the fourth quarter of 2009 driven by higher compensation expense due to sales force expansion, partially offset by lower credit-related expenses. Expenses incurred related to problem assets totaled $53 million in the fourth quarter of 2010, compared to $67 million in the third quarter of 2010 and $73 million in the fourth quarter of 2009.

Net charge-offs totaled $356 million in the fourth quarter of 2010, compared to $956 million in the third quarter of 2010 and $708 million in the fourth quarter of 2009. Third quarter 2010 net charge-offs included $510 million related to the sale or transfer of loans to held-for-sale. Excluding these losses, net charge-offs declined $90 million from the third quarter of 2010. The decreases in net charge-offs from both periods reflects continued improvement in the credit quality of portfolio loans. Commercial net charge-offs were $173 million in the fourth quarter of 2010, compared to $627 million in the third quarter of 2010 and $468 million in the fourth quarter of 2009. Third quarter 2010 net charge-offs include $387 million from the transfer of commercial loans to held-for-sale. Excluding these losses, commercial net charge-offs declined $67 million from the third quarter of 2010. Consumer net charge-offs were $183 million in the fourth quarter of 2010, compared to $329 million in the third quarter of 2010 and $240 million in the fourth quarter of 2009. Third quarter 2010 net charge-offs include $123 million in net charge-offs on the sale of portfolio residential mortgage loans during the quarter. Excluding these losses, consumer net charge-offs decreased $23 million from the third quarter of 2010. The provision for loan and lease losses totaled $166 million in the fourth quarter of 2010 compared to $457 million in the third quarter of 2010 and $776 million in the fourth quarter of 2009. The decrease from each quarter was primarily due to a decline in delinquent loans and net charge-offs.

COMPARISON OF THE YEAR ENDED 2009 WITH 2008

Net income available to common shareholders for the year ended 2009 was $511 million, or $0.67 per diluted share, compared to a net loss available to common shareholders of $2.2 billion, or $3.91 per diluted share, in 2008. Overall, a $1.8 billion pre-tax gain on the Processing Business Sale and $244 million of noninterest income on the sale of the Bancorp’s Visa, Inc. Class B shares as well as an increase in mortgage banking net revenue and a decrease in the provision for loan and lease losses of $1.0 billion compared to 2008, were partially offset by decreases in net interest income and card and processing revenue. In addition, the Bancorp recorded a $965 million goodwill impairment charge in 2008. While 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 late 2009, which led to the decrease in provision expense. The 2008 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 decreased five percent compared to 2008. This was primarily due to a 21 bp decline in the net interest rate spread, as well as a decrease in the benefit from the accretion of purchase accounting adjustments related to the 2008 acquisition of First Charter, which added $136 million to net interest income in 2009 compared to $358 million in 2008. Net interest margin decreased to 3.32% in 2009 from 3.54% in 2008.

Noninterest income increased 62% compared to 2008. This was 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. Mortgage banking net revenue increased $354 million as a result of strong growth in originations, which were up 89% to $21.7 billion in 2009. Card and processing revenue decreased 33% compared to 2008 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, or 16% compared to 2008. Noninterest expense in 2008 included the previously mentioned goodwill impairment charge of $965 million. 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 TLGP, as well as increased loan related expenses from higher mortgage origination volume and expenses incurred from the management of problem assets.

In 2009, net charge-offs as a percent of average loans and leases remained relatively steady at 320 bp, compared to 323 bp in 2008. This was impacted by a decrease of $446 million in commercial loan net charge-offs due primarily to net charge-offs of $800 million on $1.3 billion on loans moved to held-for-sale or sold in the fourth quarter of 2008. These actions were taken to address areas of the loan portfolio exhibiting the most significant credit deterioration. In addition, residential mortgage net charge-offs increased to $357 million in 2009, compared to $243 million in 2008, reflecting increased foreclosure rates in the Bancorp’s key lending markets. At December 31, 2009, nonperforming assets as a percent of loans and leases increased to 4.22% from 2.38% at December 31, 2008. The Bancorp increased its allowance for loan and lease losses as percent of loans and leases from 3.31% as of December 31, 2008 to 4.88% as of December 31, 2009.

The Bancorp took a number of 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 MD&A for further information on the Bancorp’s capital transactions.

 

 

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BALANCE SHEET ANALYSIS

 

Loans and Leases

The Bancorp classifies its loans and leases based upon the primary purpose of the loan. Table 18 summarizes end of period loans and leases, including loans held for sale, and Table 19 summarizes average total loans and leases, including loans held for sale.

At December 31, 2010, total loans and leases, including loans held for sale, increased $861 million, or one percent, compared to December 31, 2009. The increase consisted of a $2.1 billion increase in consumer loans partially offset by a $1.3 billion decrease in commercial loans. In accordance with a change in U.S. GAAP, on January 1, 2010 the Bancorp consolidated certain commercial and industrial, automobile and home equity loans with remaining outstanding balances of $372 million, $648 million and $241 million, respectively, at December 31, 2010. Excluding the impact of this change in U.S. GAAP, total loans and leases were relatively flat compared to December 31, 2009. For further discussion on this change in U.S. GAAP, refer to Note 1 of the Notes to Consolidated Financial Statements.

Total commercial loans and leases decreased $1.3 billion, or three percent, compared to December 31, 2009 primarily as the result of decreases in commercial construction loans and commercial mortgage loans, partially offset by an increase in commercial and industrial loans. Commercial construction loans decreased $1.8 billion, or 45%, from December 31, 2009 primarily due to management’s strategy to suspend new lending on commercial non-owner occupied real estate beginning in 2008 and the outflow of completed construction projects that were transitioned to commercial mortgage loans. Despite the transition of commercial construction loans, commercial mortgage loans decreased $944 million, or eight percent, from December 31, 2009 due to tighter underwriting standards on commercial real estate loans in an overall effort to limit exposure to commercial real estate. Commercial and industrial loans increased $1.6 billion, or six percent, compared to December 31, 2009 as a result of the previously mentioned change in U.S. GAAP and an increase in new loan originations activity, primarily due to an increase in customer demand with continued growth in the manufacturing and healthcare industries. This increase was partially offset by an $856 million decrease in loans originally issued to FTPS in conjunction with the Processing Business Sale; FTPS refinanced the original $1.25 billion in loans into a larger syndicated loan structure in connection with an acquisition.

Total consumer loans and leases increased $2.1 billion, or six percent, from December 31, 2009. This increase was primarily the result of increases in automobile loans and residential mortgage loans, partially offset by a decrease in home equity loans. Automobile loans increased $2.0 billion, or 22%, compared to December 31, 2009 primarily as a result of the previously mentioned impact on automobile loans due                     

to the change in U.S. GAAP and a strategic focus to increase automobile lending during 2010 through consistent and competitive pricing, enhanced customer service with our dealership network and disciplined sales execution. Residential mortgage loans increased $1.0 billion, or 10%, from December 31, 2009 as a result of a 51% increase in origination activity for the fourth quarter of 2010 compared to the fourth quarter of 2009 and management’s decision in the third quarter of 2010 to retain certain mortgage loans primarily originated through the Bancorp’s retail branches. Home equity loans decreased $660 million, or five percent, from December 31, 2009 as tighter underwriting standards and a decrease in customer demand were partially offset by the previously mentioned impact on home equity loans due to the change in U.S. GAAP. Credit card loans decreased $94 million, or five percent, as a result of a decrease in new account origination activity throughout 2010. Other consumer loans and leases, primarily made up of student loans designated as held for sale and automobile leases, decreased $110 million, or 14%, due to a decline in new originations driven by tighter underwriting standards.

Average commercial loans and leases decreased $3.9 billion, or eight percent, compared to 2009. The decrease in average commercial loans consisted of a decrease of $1.6 billion, or 34%, in average commercial construction loans, $1.2 billion, or four percent, in average commercial and industrial loans and $926 million, or seven percent, in average commercial mortgage loans. These decreases were driven by lower customer line utilization rates, lower demand for new loans and tighter underwriting standards on commercial real estate loans to manage risk, partially offset by the impact of the previously discussed change in U.S. GAAP. Commercial and industrial loans experienced an increase in origination activity primarily during the fourth quarter of 2010 which led to a higher period end balance at December 31, 2010 compared to December 31, 2009

Average consumer loans and leases were relatively flat compared to 2009. An increase in average automobile loans of $1.6 billion, or 18%, was offset by decreases in average residential mortgage loans of $1.0 billion, or nine percent, and average home equity loans of $538 million, or four percent. The impact of the previously mentioned consolidation of automobile and home equity loans was largely offset by a decrease in customer demand and tighter underwriting standards. Residential mortgage originations in 2009 were higher than in 2010 resulting in a lower annual average; however volume of new originations during the fourth quarter of 2010 were greater than the fourth quarter of 2009 resulting in a higher period end balance at December 31, 2010 compared to December 31, 2009.

 

 

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

 

As of December 31 ($ in millions)

     2010         2009         2008         2007         2006   

Commercial:

              

Commercial and industrial loans

   $ 27,275         25,687         29,220         26,079         20,831   

Commercial mortgage

     10,992         11,936         12,731         11,967         10,405   

Commercial construction

     2,111         3,871         5,335         5,561         6,168   

Commercial leases

     3,378         3,535         3,666         3,737         3,841   

Subtotal – commercial

     43,756         45,029         50,952         47,344         41,245   

Consumer:

              

Residential mortgage loans

     10,857         9,846         10,292         11,433         9,905   

Home equity

     11,513         12,174         12,752         11,874         12,154   

Automobile loans

     10,983         8,995         8,594         11,183         10,028   

Credit card