Fifth Third Bank 2004 Annual Report Download - page 22

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
20 Fifth Third Bancorp
The interest income (FTE) from investment securities and
short-term investments decreased by $16 million, or one percent, in
2004 compared to 2003. The decrease in interest income is due to
lower asset yields. As previously mentioned, the Bancorp sold approx-
imately $6.4 billion of securities in the fourth quarter of 2004 with a
weighted-average coupon of approximately 3.2% in order to improve
its long-term profi le and reduce the risks associated with increasing
interest rates.
The interest paid on interest-bearing deposits decreased $49
million, or eight percent, in 2004 compared to 2003. Average
interest-bearing deposits were lower by $100 million, or less than
one percent, compared to 2003. The four percent increase in aver-
age interest checking balances and nine percent increase in money
market balances were mitigated by the 37% decline in certifi cates
of deposit greater than $100,000. The movement in the certifi cates
of deposit category is largely a function of overall balance sheet
funding requirements. Average demand deposits in 2004 increased
$1.8 billion, or 18%, over 2003 refl ecting the Bancorp’s success in
generating new account growth in its commercial line of business.
The growth in noninterest-bearing funding is a critical component
in the growth in net interest income. A key focus of the Bancorp
in 2005 continues to be growing its transaction account products
such as checking, savings and money market accounts in order to
reduce its reliance on other sources to fund the expected growth in
the balance sheet.
The interest paid on long-term debt increased by $30 million,
or eight percent, in 2004 compared to 2003 due to the increase in
the average long-term debt outstanding. Average long-term debt
increased $4.6 billion, or 52%, in 2004 over 2003. The Bancorp has
increased long-term debt to fund the growth in the balance sheet
and to reduce its short-term wholesale funding position. Average
federal funds purchased declined $1.1 billion, or 16%, compared
to 2003. The interest expense associated with federal funds declined
by only $3 million, or four percent, due to the federal funds rate
increases that occurred throughout 2004.
Provision for Loan and Lease Losses
The Bancorp provides as an expense an amount for probable credit
losses within the loan portfolio that is based on factors discussed in
the Critical Accounting Policies. The provision is recorded to bring
the reserve for loan and lease losses to a level deemed appropriate
by the Bancorp. Actual credit losses on loans and leases are charged
against the reserve for loan and lease losses. The amount of loans
actually removed from the Consolidated Balance Sheets is referred
to as charge-offs and net charge-offs include current charge-offs less
recoveries in the current period on previously charged off assets.
The provision for loan and lease losses was $268 million
in 2004 compared to $399 million in 2003. The $131 million
decrease in the provision was due to the reduction in net charge-
offs as a percentage of average loans and leases and the continued
improvement and expected stability in credit quality trends. Net
charge-offs decreased to $252 million in 2004 as compared to $312
million in 2003. The reserve for loan and lease losses as a percent
of loans and leases declined to 1.19% at December 31, 2004 from
1.33% at December 31, 2003. In addition, nonperforming assets
as a percentage of loans, leases and other assets, including other real
estate owned, declined to .51% from .61% in 2003. Refer to the
Credit Risk Management section for further information on the
provision for loan and lease losses, net charge-offs, nonperforming
assets and other factors considered by the Bancorp in assessing the
credit quality of the loan portfolio and the reserve for loan and lease
losses.
Noninterest Income
Electronic payment processing revenue increased $47 million, or
eight percent, in 2004 despite the sales of certain small merchant
processing contracts. Excluding the lost revenue associated with
the sold contracts of approximately $70 million for all of 2004,
revenue increased 23%; comparisons being provided to supplement
an understanding of the fundamental revenue trends. The Bancorp
continues to realize strong sales momentum from the addition of
new customer relationships in both its merchant services and EFT
businesses. Merchant processing revenue was essentially fl at in 2004
compared to 2003 due to the above-mentioned sales of certain
small merchant processing contracts. Excluding the lost revenue
associated with the sold contracts, merchant processing revenue
increased 29% due to the addition of new customers and the result-
ing increases in merchant transaction volumes, as well as an increase
in transaction volume growth on the existing customer base refl ec-
tive of an improving retail sector of the economy. Compared to
2003, EFT revenues, including debit and credit card interchange,
increased by 18% in 2004. The Bancorp now handles electronic
processing for more than 127,000 merchant locations and 1,300
fi nancial institutions worldwide.
Service charges on deposits increased $30 million, or six
percent, over 2003 primarily due to continued sales success in
corporate treasury management products and commercial deposit
campaigns. Commercial deposit revenues increased 14% over 2003
on the strength of a continued focus on cross-sell initiatives, an
increased sales force and new customer relationships. Retail deposit
revenues were fl at compared to last year. Growth in the number of
retail checking account relationships and in deposits is a key focus
for the Bancorp for the upcoming year.
Mortgage banking net revenue declined to $178 million in
2004 from $302 million as a result of the record high level of
refi nancing activity seen in 2003 that has declined in 2004 due
to rising interest rates. The components of mortgage banking net
revenue are shown in Table 8. As a result of rising interest rates,
mortgage originations declined to $8.4 billion in 2004 compared to
$16.0 billion in 2003, directly contributing to the decrease in core
mortgage banking fees in 2004. The increase in interest rates during
2004 and the resulting impact of changing prepayment speeds led
to the recovery of $60 million in temporary impairment on the
MSR portfolio in 2004 as compared to the $3 million in tempo-
TABLE 6: COMPONENTS OF AVERAGE LOAN PORTFOLIO
For the Years Ended December 31 ($ in millions) 2004 2003 2002
Commercial loans:
Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $14,908 13,672 11,665
Mortgage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,391 6,299 5,834
Construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,807 3,097 3,023
Leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,296 3,037 2,640
Total commercial loans, including held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29,402 26,105 23,162
Consumer loans:
Installment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,755 16,343 13,461
Mortgage and construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,801 6,880 6,377
Credit card . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 787 591 478
Leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,297 2,495 2,061
Total consumer loans, including held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27,640 26,309 22,377
Total loan portfolio, including held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $57,042 52,414 45,539
Total loan portfolio, excluding held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $55,951 49,700 43,529