Fifth Third Bank 2003 Annual Report Download - page 54

FIFTH THIRD BANCORP AND SUBSIDIARIES
52
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
fixed income trading and sales and a $16 million increase in
customer interest rate derivative product related fee revenue,
partially offset by a net $12 million decrease in various other
revenue categories.
Operating Expenses
The Bancorp’s proven expense discipline continues to drive its
efficiency ratio to levels well below its peer group within the banking
industry. The Bancorp’s success in controlling operating expenses
comes from efficient staffing, a focus on process improvement and
the centralization of various internal functions such as data
processing, loan servicing and other corporate overhead functions.
Operating expense levels are often measured using an efficiency
ratio (operating expenses divided by the sum of taxable equivalent net
interest income and other operating income). The efficiency ratio for
2003 was 45.0% compared to 44.9% in 2002.
Total operating expenses increased 10% in 2003 compared to
2002. Total operating expenses decreased 5% in 2002 compared to
2001 as the total operating expenses for 2001 included pretax
nonrecurring merger-related charges of $349 million associated with
the merger and integration of Old Kent. Excluding the effect of the
merger-related charges, total operating expenses increased 11% in
2002 compared to 2001.
Comparisons of 2003 total operating expenses to prior periods
are impacted by implications of growth in all of the Bancorp’s
markets and increases in spending related to the expansion and
improvement of the sales force, increases in employee benefit
expenses, third-party consulting expenses, continuing investment in
support personnel including the risk management and internal audit
functions among others, process improvement, technology and
infrastructure to support recent and future growth and volume
related increases in expenses such as bankcard and loan and lease
costs. The Bancorp has also invested significantly in the growth of
its retail banking platform with the opening of 58 new banking
centers since December of 2002. Although the Bancorp has seen
improvement, largely as a result of focused marketing initiatives, the
break-even contribution date for new banking center openings still
occurs on average approximately 11 months following the opening.
Operating expenses for 2003 also include $94 million of expense,
primarily depreciation expense, on operating lease assets consolidated
as a result of the early adoption of FIN 46. See Note 1 to the Con-
solidated Financial Statements for discussion of adoption of FIN 46.
Salaries, wages and incentives increased 2% in 2003 and 7% in
2002 and employee benefits expense increased 19% in 2003 and 36%
in 2002. The increase in 2003 employee benefits expense is
primarily related to an increase in pension and insurance expenses.
Net pension expense for 2003 was $31 million compared to $13
million in 2002. The increase in pension expense during 2003 was
due to a decrease in the expected return on assets in 2003 compared
to 2002 and an increased amortization of actuarial losses as the
unrecognized net actuarial losses exceeded the corridor limit in
2003. The increase in employee benefits expense in 2002 resulted
primarily from an increase in profit sharing expense due to the
inclusion of the former Old Kent employees in the Plan beginning
in January 2002.
The Bancorp’s net pension expense for 2003 is based upon
specific actuarial assumptions, including an expected long-term rate
of return of 9%. The expected long-term rate of return assumption
reflects the average return expected on the assets invested to provide
for the Plan’s liabilities. In determining the expected long-term rate
of return assumption, the Bancorp evaluated actuarial and economic
inputs, including long-term inflation rate assumptions and broad
equity and bond indices long-term return projections. The Bancorp
believes the 9% long-term rate of return assumption appropriately
reflects both projected broad equity and bond indices long-term
return projections as well as actual long-term historical Plan
performance. The discount rate assumption reflects the yield of a
portfolio of high quality fixed-income instruments that have a similar
duration to the Plan’s liabilities. The discount rate determined on this
basis has decreased from 6.75% at December 31, 2002 to 6% at
December 31, 2003. Lowering the expected long-term rate of return
on Plan assets by .25% (from 9% to 8.75%) would have increased
the pension expense for 2003 by approximately $1 million.
Lowering the discount rate by .25% (from 6.75% to 6.50%) would
have increased the pension expense for 2003 by approximately $2
million. The Plan assumptions are evaluated annually and are
updated as necessary.
The Bancorp based the determination of pension expense on a
market-related valuation of assets. This market-related valuation
recognizes investment gains or losses over a three-year period from
the year in which they occur. Investment gains or losses for this
purpose are the difference between the expected return calculated
using the market-related value of assets and the actual return based
on the market-related value of assets. Since the market-related value
of assets recognizes gains or losses over a three-year period, the future
value of assets will be impacted as previously deferred gains or losses
are recorded. As of December 31, 2003 the Bancorp had cumulative
losses of approximately $103 million which remain to be recognized in
the calculation of the market-related value of assets. These
unrecognized net actuarial losses result in an increase in the Bancorp’s
future pension expense depending on several factors, including
whether such losses at each measurement date exceed the corridor in
accordance with SFAS No. 87, “Employers’ Accounting for Pensions.”
The value of the Plan assets has increased from $177 million at
December 31, 2002 to $223 million at December 31, 2003. The
investment performance returns and contributions made during 2003
Table 5–Operating Expenses
($ in millions) 2003 2002 2001 2000 1999
Salaries, wages and incentives . . . . . . . . . . . . . . . . . . . . . . . . . $ 922 902 842 782 761
Employee benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240 201 148 144 142
Equipment expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82 79 91 100 98
Net occupancy expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159 142 146 138 131
Operating lease expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 ————
Other operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 945 886 760 665 649
Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,442 2,210 1,987 1,829 1,781
Merger-related charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — 349 87 108
Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,442 2,210 2,336 1,916 1,889