Fifth Third Bank 2003 Annual Report Download - page 55

FIFTH THIRD BANCORP AND SUBSIDIARIES
53
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
realized in the third quarter of 2002 related to treasury clearing and
other related settlement accounts. During the second quarter of
2003, the Bancorp concluded the review of the treasury clearing and
other related settlement accounts that gave rise to the $82 million
pre-tax charge-off, resulting in a $31 million pre-tax recovery,
realized as a credit to other operating expenses. Additionally, during
2003, the Bancorp realized a charge of approximately $20 million
related to the early retirement of approximately $200 million of
Federal Home Loan Bank advances, captured in other operating
expenses. Excluding the impact of the above discussed treasury
clearing and other related settlement items in both 2003 and 2002,
the early debt retirement charge of $20 million, third-party
consultant expenses of $24 million and the operating lease expense
of $94 million incurred as a result of the implementation of FIN 46
in the third quarter of 2003, total operating expenses for 2003
increased $207 million, or 10% over 2002; comparisons being
provided to supplement an understanding of the fundamental
trends in operating expenses. The Bancorp expects continued near-
term improvement from certain volume related expense items and
efficiency initiatives related to non-risk management expenses. For
instance, the Bancorp is aggressively reducing mortgage banking
volume-related processing expenses as originations have slowed in
recent periods. As part of a core emphasis on operating leverage,
these efficiency initiatives include increasing levels of automation of
processes, the rationalization and reduction of non-core businesses
as they relate to our retail and middle market commercial customer
base, returns on invested capital and related opportunities for
continued growth in 2004 and years to come.
As referred to above, during the third quarter of 2002, in
connection with overall data validation procedures completed in
preparation for a conversion and implementation of a new treasury
investment portfolio accounting system, and a review of related
account reconciliations, the Bancorp became aware of a misapplication
of proceeds from a mortgage loan securitization against unrelated
treasury items in a treasury clearing account. Upon this discovery and
after rectifying the mortgage loan securitization receivable, a treasury
clearing account used to process entries into and out of the Bancorp’s
securities portfolio went from a small credit balance to a debit balance
of approximately $82 million consisting of numerous posting and
settlement items, all relating to the Bancorp’s investment portfolio.
Upon concluding that the $82 million balance did not result from a
single item but rather numerous settlement and reconciliation items,
many of which had aged or for which no sufficient detail was readily
available for presentment for claim from counterparties, the Bancorp
recorded a charge-off for these items because it became apparent that
have reduced the Bancorp’s unfunded Plan status, net of benefit
obligations, from $66 million at December 31, 2002 to an unfunded
status of $41 million at December 31, 2003. During 2003, the
Bancorp made $62 million in cash contributions to the Plan and
believes that, based on the actuarial assumptions, no cash contribution
to the Plan will be required in 2004.
Additionally, the Bancorp anticipates adopting the fair value
method of expense recognition for employee stock-based
compensation on a retroactive basis during the first quarter of 2004.
See Note 1 to the Notes to Consolidated Financial Statements for
additional information, including historical compensation expense
impact as if the fair value method of expense recognition had been
applied during 2003, 2002 and 2001.
Full-time equivalent (FTE) employees were 18,899 at December
31, 2003 down from 19,119 at December 31, 2002 and up from
18,373 at December 31, 2001.
Equipment expense increased 3% in 2003 to $82 million and
decreased 13% to $79 million in 2002. The significant decrease in
equipment expense during 2002 was primarily due to dispositions
related to the 2001 Old Kent acquisition. Net occupancy expenses
increased 12% in 2003 to $159 million primarily due to the growth
in the number of banking centers and certain incremental leased
location costs. Banking centers at December 31, 2003 totaled 952
compared to 930 at December 31, 2002. Net occupancy expense
decreased 3% to $142 million in 2002 compared to 2001. The
decrease in 2002 was largely related to the elimination of duplicate
facilities in connection with the integration of Old Kent.
Other operating expenses increased to $945 million in 2003, up
$59 million or 7% over 2002 and increased $126 million or 17%
over 2001. Volume-related expenses and higher loan and lease
processing costs from strong origination volumes in the processing
and fee businesses contributed to the increases in 2003 and 2002
other operating expenses. Additionally, increases in other operating
expenses for 2003 relate to several categories, including increasing
insurance expenses, FDIC expenses, human resource expenses such
as recruiting and training and expenses related to certain third-party
consultant reviews. Third-party consultant reviews of reconciliation
activities and process evaluations associated with the March 26,
2003 Written Agreement entered into by the Bancorp, Fifth Third
Bank, the Federal Reserve Bank of Cleveland and the Ohio
Department of Commerce, Division of Financial Institutions
resulted in approximately $24 million in incremental expenses in
2003. Several other items, as described below, also impact
comparisons of other operating expense to prior periods. Other
operating expense for 2002 includes an $82 million pre-tax charge
Table 6–Distribution of Loan and Lease Portfolio
2003 2002 2001 2000 1999
($ in millions) Amount % Amount % Amount % Amount % Amount %
Commercial, financial
and agricultural loans. . . . . . $14,209 27% $12,743 28% $10,807 26% $10,669 25% $ 9,879 25%
Real estate –
construction loans . . . . . . . . 3,636 7 3,327 7 3,356 8 3,223 8 2,272 6
Real estate – mortgage loans . . . 11,319 22 9,380 20 10,590 26 11,862 28 12,336 32
Consumer loans . . . . . . . . . . . 17,432 33 15,116 33 12,565 30 11,551 27 9,054 23
Lease financing. . . . . . . . . . . . 5,712 11 5,362 12 4,230 10 5,225 12 5,296 14
Loans and leases, net of
unearned income. . . . . . . . . 52,308 100% 45,928 100% 41,548 100% 42,530 100% 38,837 100%
Reserve for credit losses. . . . . . (770) (683) (624) (609) (573)
Loans and leases, net of reserve . . $51,538 $45,245 $40,924 $41,921 $38,264
Loans held for sale . . . . . . . . . $ 1,881 $ 3,358 $ 2,180 $ 1,655 $ 1,198