Fifth Third Bank 2004 Annual Report Download - page 20

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
18 Fifth Third Bancorp
Net Interest Income
The relative performance of lending and deposit-raising functions
is frequently measured by two statistics – net interest margin and
net interest rate spread. Net interest margin is determined by divid-
ing net interest income (FTE) by average interest-earning assets.
Net interest rate spread is the difference between the average FTE
yield on interest-earning assets and the average rate paid on inter-
est-bearing liabilities. Net interest margin is generally greater than
the net interest rate spread due to the additional income earned on
those assets funded by noninterest-bearing liabilities, or free fund-
ing, such as demand deposits and shareholders’ equity.
Table 4 presents net interest income, net interest margin and
net interest spread for the three years ended December 31, 2004,
2003 and 2002, comparing interest income, average interest-bear-
ing liabilities and average free funding outstanding. Nonaccrual
loans and leases and loans held for sale have been included in the
average loans and leases balances. Average outstanding securities
balances are based upon amortized cost with any unrealized gains or
losses on available-for-sale securities included in other assets. Table
5 also provides the relative impact of growth in the balance sheet
and changes in interest rates on net interest income.
Net interest income (FTE) in 2004 was $3.0 billion, a four
percent increase over $2.9 billion in 2003. The increase in net inter-
est income was due to the $6.3 billion, or eight percent, increase
in average interest-earning assets, mitigated by the 14 basis point
(“bp”) decrease in net interest margin. The net interest margin
contracted in 2004 as compared to 2003 due to the low absolute
level of interest rates in the fi rst half of 2004 and interest-bear-
ing liabilities repricing more quickly than interest-earning assets in
response to rising interest rates in the second half of 2004. Addi-
tionally, the contribution of noninterest-bearing funding to the net
interest margin decreased to 31 bp in 2004 from 34 bp in 2003.
The Bancorp implemented several actions, largely in the fourth
quarter, to improve its long-term profi le and reduce the risks associ-
ated with increasing interest rates. These actions included: (i) the
sale of approximately $6.4 billion of available-for-sale securities
with a weighted-average coupon of 3.2%; (ii) the early retirement
of approximately $3.8 billion of long-term debt, $2.8 billion in the
fourth quarter, with a weighted-average rate of 5.4% and a weight-
ed-average remaining maturity of approximately fi ve years and; (iii)
the termination of approximately $4.9 billion in notional of receive-
fi xed/pay-variable interest rate swaps. In total, these actions resulted
in pre-tax securities losses of $79 million recorded in noninterest
income and pre-tax debt termination charges of $325 million, $247
million in the fourth quarter, recorded in other noninterest expense.
The Bancorp also decreased certain wholesale borrowings in order
to further decrease the speed at which liabilities reprice relative to
earning assets in response to anticipated increases in interest rates.
These actions stabilized and improved the net interest margin as
the 2004 year ended and have resulted in improved balance sheet
positioning. Margin trends in 2005 will depend upon the timing,
frequency, magnitude and direction of further interest rate changes,
the level and mix of earning asset and deposit growth and the impact
of capital management activities. The Bancorp currently expects net
interest income and earning asset growth on an annualized sequen-
tial basis during 2005 in the low double digit range.
Interest income (FTE) on loans and leases increased $136
million, or fi ve percent, compared to 2003. The increase in aver-
age loans and leases included growth in commercial loans of $3.3
billion, or 13% in 2004. Excluding the impact of the Franklin
Financial acquisition, average commercial loans increased by 12%;
comparisons being provided to supplement an understanding of
the fundamental trends. The increase in average commercial loans
was primarily due to strong growth in the Chicago, Indianapolis
and Cincinnati markets. The Bancorp’s continued investment in
additional commercial sales people has largely contributed to its
commercial loan portfolio growth in a period of fl at to declining
commercial loan demand. The Bancorp continues to benefi t from
increased credit line usage from existing commercial customers
as well as success in gaining new customers within its footprint.
Average consumer loans increased by $1.3 billion, or fi ve percent,
compared to 2003. Comparisons in consumer loans are impacted
by the sales and securitizations of $903 million of home equity lines
in the third quarter of 2003 and $750 million of automotive loans
in the second quarter of 2004. Excluding these transactions, average
consumer loans increased nine percent in 2004 from 2003; compar-
isons being provided to supplement an understanding of the funda-
mental trends. Average consumer loans increased in nearly all of
the Bancorp’s markets with strong growth in Cleveland, Columbus
and Detroit.
TABLE 3: CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31 ($ in millions, except per share data) 2004 2003 2002 2001 2000
Interest income (FTE) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $4,150 4,030 4,168 4,754 4,994
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,102 1,086 1,430 2,278 2,697
Net interest income (FTE) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,048 2,944 2,738 2,476 2,297
Provision for loan and lease losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 268 399 246 236 138
Net interest income after provision for loan and lease losses (FTE) . . . . 2,780 2,545 2,492 2,240 2,159
Noninterest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,465 2,483 2,183 1,788 1,476
Noninterest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,972 2,551 2,337 2,453 2,027
Income from continuing operations before income taxes, minority
interest and cumulative effect (FTE) . . . . . . . . . . . . . . . . . . . . . . . . 2,273 2,477 2,338 1,575 1,608
Taxable equivalent adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 39 39 45 47
Applicable income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 712 786 734 523 511
Income from continuing operations before minority interest and
cumulative effect . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,525 1,652 1,565 1,007 1,050
Minority interest, net of tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — (20) (38) (2) —
Income from continuing operations before cumulative effect . . . . . . . . 1,525 1,632 1,527 1,005 1,050
Income from discontinued operations, net of tax . . . . . . . . . . . . . . . . . — 44445
Income before cumulative effect . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,525 1,676 1,531 1,009 1,055
Cumulative effect of change in accounting principle, net of tax . . . . . . — (11) — (7) —
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,525 1,665 1,531 1,002 1,055
Earnings per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2.72 2.91 2.64 1.74 1.86
Earnings per diluted share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.68 2.87 2.59 1.70 1.83
Cash dividends declared per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.31 1.13 .98 .83 .70
STATEMENTS OF INCOME ANALYSIS