Fifth Third Bank 2003 Annual Report Download - page 65

FIFTH THIRD BANCORP AND SUBSIDIARIES
63
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
required reserves is based on ongoing quarterly assessments of the
probable estimated losses inherent in the loan and lease portfolio. In
addition to the individual review of larger commercial loans that
exhibit probable or observed credit weaknesses, the commercial
credit review process includes the use of a risk grading system. The
risk grading system utilized in 2003 for commercial loans and leases
encompassed ten categories. This risk grading system was in the
process of being revised at the end of 2003 to provide for a dual risk
rating system that provides for 13 probability of default grade
categories and an additional 6 grade categories measuring loss
factors given an event of default. Previously, the probability of
default and loss given default analyses had not been separated. The
refined risk grading system is consistent with Basel II expectations,
and should allow for more precision in the analysis of commercial
credit risk. Scoring systems and delinquency monitoring are used to
assess the credit risk in the Bancorp's homogeneous consumer loan
portfolios.
Operational Risk Management
The Bancorp's approach for managing operational risk establishes
the framework to comprehensively and effectively identify, measure,
mitigate, monitor and report operational risks. The Bancorp
maintains a system of controls that provides timely and accurate
operational information. The Operational Risk Management
function within the Enterprise Risk Management division is
responsible for the analysis of all non-credit and non-market risks
faced by the Bancorp, and assisting line of business, affiliate and
support units in the enhancement of operational risk controls. The
Operational Risk Management function also coordinates with the
Internal Audit division on risk identification throughout the
Bancorp. The Operational Risk Management function oversees a
readiness assessment process that ensures that any significant change
introduced to the Bancorp's operating environment is properly
considered before implementation so that execution risk is
substantially reduced. Proper management of operational risks
through assessments, root cause analyses, controls and monitoring
can result in reduced expense and improved business practices.
Liquidity and Market Risk Management
The objective of the Bancorp’s asset/liability management function
is to maintain consistent growth in net interest income within the
Bancorp’s policy limits. This objective is accomplished through
management of the Bancorp’s balance sheet liquidity, composition
and interest rate risk exposures arising from changing economic
conditions, interest rates and customer preferences.
The goal of liquidity management is to provide adequate funds
to meet changes in loan and lease demand or unexpected deposit
withdrawals. This goal is accomplished by maintaining liquid assets
in the form of investment securities, maintaining sufficient unused
borrowing capacity in the national money markets and delivering
consistent growth in core deposits. The primary source of asset
driven liquidity is provided by debt securities in the available-for-
sale securities portfolio. The estimated average life of the available-
for-sale portfolio is 5.2 years at December 31, 2003 based on
current prepayment expectations. Of the $29 billion (fair value
basis) of securities in the portfolio at December 31, 2003, $5.7
billion, or 20%, is expected to mature or be prepaid in 2004 and an
additional $2.6 billion, or 9%, is expected to mature or be prepaid
in 2005. In addition to the sale of available-for-sale portfolio
securities, asset-driven liquidity is provided by the Bancorp’s ability
to sell or securitize loan and lease assets. In order to reduce the
exposure to interest rate fluctuations as well as to manage liquidity,
the Bancorp has developed securitization and sale procedures for
several types of interest-sensitive assets. A majority of the long-term,
fixed-rate single-family residential mortgage loans underwritten
according to Federal Home Loan Mortgage Corporation or Federal
National Mortgage Association guidelines are sold for cash upon
origination. Periodically, additional assets such as jumbo fixed-rate
residential mortgages, certain floating rate short-term commercial
loans and certain floating rate home equity loans are also securitized,
sold or transferred off-balance sheet. During 2003 and 2002, a total
of $15.9 billion and $9.7 billion, respectively, were sold, securitized,
or transferred off-balance sheet. The Bancorp also has in place a
shelf registration with the Securities and Exchange Commission
permitting ready access to the public debt markets. At December
31, 2003, $1.5 billion of debt or other securities were available for
issuance under this shelf registration. These sources, in addition to
the Bancorp’s 9.85% average equity capital base, provide a stable
funding base. During January 2004, in conjunction with the
continual management of the composition and mix of liabilities and
overall interest rate sensitivity of the balance sheet, a subsidiary of
the Bancorp issued a total of $1.1 billion of medium-term bank
notes with maturities ranging from 18 months to 3 years.
Since June 2002, Moody's senior debt rating for the Bancorp
has been Aa2, a rating equaled or surpassed by only three other U.S.
bank holding companies. This rating by Moody's reflects the
Bancorp's capital strength and financial stability.
Table 26–Agency Ratings
Standard
Moody’s & Poor’s Fitch
Fifth Third Bancorp:
Commercial Paper . . . . . . Prime-1 A-1+ F1+
Senior Debt . . . . . . . . . . . Aa2 AA- AA-
Fifth Third Bank and
Fifth Third Bank (Michigan):
Short-Term Deposit . . . . . Prime-1 A-1+ F1+
Long-Term Deposit . . . . . Aa1 AA- AA.
These debt ratings, along with capital ratios significantly above
regulatory guidelines, provide the Bancorp with additional access to
liquidity. Based on the continued strength of the balance sheet,
stable credit quality, risk management policies and revenue growth
trends, management does not currently expect any downgrade in
these credit ratings based on financial performance. Core customer
deposits have historically provided the Bancorp with a sizeable source
of relatively stable and low-cost funds. The Bancorp’s average core
deposits and stockholders’ equity funded 64% of its average total
assets during 2003. In addition to core deposit funding, the Bancorp
also accesses a variety of other short-term and long-term funding
sources, which includes the use of the Federal Home Loan Bank
(FHLB) as a funding source. Management does not rely on any one
source of liquidity and manages availability in response to changing
balance sheet needs.
Interest rate risk is the exposure to adverse changes in net interest
income due to changes in interest rates. Management considers interest
rate risk a prominent market risk in terms of its potential impact on
earnings. Interest rate risk can occur for any one or more of the
following reasons: (a) assets and liabilities may mature or re-price at
different times; (b) short-term and long-term market interest rates may
change by different amounts; or (c) the remaining maturity of various