Fifth Third Bank 2005 Annual Report Download - page 35

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Fifth Third Bancorp 33
Comparison of 2004 with 2003
Net income in 2004 decreased to $1.5 billion compared to $1.7
billion in 2003. Diluted earnings per common share were $2.68
compared to $2.87. In 2004, return on average assets was 1.61%
and return on average shareholders’ equity was 17.2% versus
1.90% and 19.0%, respectively, in 2003. Earnings in 2004 were
negatively impacted by initiatives undertaken to better position the
balance sheet for market conditions, including debt termination
charges and securities losses totaling $404 million pre-tax ($259
million after-tax). Earnings in 2004 were positively impacted by a
$157 million pre-tax ($91 million after-tax) gain resulting from the
sale of certain third-party sourced merchant processing contracts.
Net interest income (FTE) was $3.0 billion in 2004 compared
to $2.9 billion in 2003. The net interest margin decline to 3.48% in
2004 from 3.62% in 2003 was primarily attributable to the
prolonged low interest rate environment in the first half of 2004
and interest-bearing liabilities repricing more quickly than interest-
earning assets in response to rising interest rates in the second half
of 2004. The decline in net interest margin occurred despite an
eight percent increase in average interest-earning assets from 2003
to 2004.
Noninterest income in 2004 was down slightly compared to
2003. Increases in service charges on deposits and electronic
payment processing and investment advisory revenues were
mitigated by a decrease in mortgage banking net revenue. The
decrease in mortgage banking net revenue was a result of the
record high level of refinancing activity seen in 2003.
Noninterest expense totaled $3.0 billion in 2004 compared to
$2.6 billion in 2003. The increase primarily resulted from the
previously discussed debt termination charges in 2004 totaling $325
million. Remaining increases primarily resulted from the expansion
of the sales force and investment in additional banking centers.
The provision for loan and lease losses was $268 million in
2004 compared to $399 million in 2003. The decrease in the
provision is due to the $60 million decrease in net charge-offs,
from $312 million, or .63% of average loans and leases
outstanding, in 2003 to $252 million, or .45% in 2004 as well as a
decrease in the overall assessed allowance for loan and lease losses
resulting from the consideration of historical and anticipated loss
rates in the portfolio. The total allowance for loan and lease losses
as a percent of total loans and leases was 1.19% at December 31,
2004 compared to 1.33% at December 31, 2003.
BUSINESS SEGMENT REVIEW
The Bancorp operates four main business segments: Commercial
Banking, Retail Banking, Investment Advisors and Processing
Solutions. Further detailed financial information on each business
segment is included in Note 29 of the Notes to the Consolidated
Financial Statements. For acquisitions accounted for under the
purchase method, management “pools” historical results to
improve comparability with the current period. For the prior
periods presented, the income and average assets of First National
have been included in the respective segments and are then
eliminated in the Acquisitions caption to agree to the prior period’s
reported results.
Results of the Bancorp’s business segments are presented
based on its management structure and management accounting
practices. The structure and practices are specific to the Bancorp;
therefore, the financial results of the Bancorp’s business segments
are not necessarily comparable with similar information for other
financial institutions. The Bancorp refines its methodologies from
time to time as management accounting practices are improved and
businesses change. Revisions to the Bancorp’s methodologies are
applied on a retroactive basis.
The Bancorp manages interest rate risk centrally at the
corporate level by employing a funds transfer pricing (“FTP”)
methodology. This methodology insulates the lines of business
from interest rate risk, enabling them to focus on servicing
customers through loan originations and deposit taking. The FTP
system assigns charge rates and credit rates to classes of assets and
liabilities, respectively, based on expected duration. The Bancorp
has not changed the conceptual application of FTP during 2005 or
2004. The net impact of the FTP methodology is included in
Other/Eliminations.
The financial results of the business segments include
allocations for shared services and headquarters expenses. Even
with these allocations, the financial results are not necessarily
indicative of the business segments’ financial condition and results
of operations as if they were to exist as independent entities.
Additionally, the business segments form synergies by taking
advantage of cross-sell opportunities and when funding operations
by accessing the capital markets as a collective unit. Net income by
business segment is summarized in Table 12.
Commercial Banking
Commercial Banking provides a comprehensive range of financial
services and products to large and middle-market businesses,
governments and professional customers. In addition to the
traditional lending and depository offerings, Commercial Banking
products and services include, among others, cash management,
foreign exchange and international trade finance, derivatives and
capital markets services, asset-based lending, real estate finance,
public finance, commercial leasing and syndicated finance.
Net income increased $79 million compared to 2004 largely as
a result of loan and deposit growth and success in customer
interest rate and foreign exchange derivative sales. Average loans
and leases included in the commercial banking segment increased
12% over 2004, to $30.0 billion, due to growth in commercial and
industrial loans, commercial mortgage loans and construction
loans. Average core deposits increased to $14.4 billion in 2005
from $12.3 billion in 2004. The increase in average core deposits
and loans and the related net FTP impact led to a $162 million
increase in net interest income compared to the same period last
year.
Noninterest income increased $85 million compared to 2004
largely due to an increase in customer interest rate derivative sales
and international service revenue. Revenue from customer interest
rate derivatives sales increased $24 million over 2004 and
international service revenue, which includes letters of credit and
foreign currency services, increased $16 million. Increases in these
categories were partially offset by the impact of increased earnings
credits, as a result of higher short-term interest rates, on service
charges on deposits.
Noninterest expense increased $107 million in 2005 compared
to 2004 as a result of sales force additions and higher information
technology expenses. Investment in the sales force throughout
2004 and 2005 resulted in an 18% increase in total full-time
TABLE 12: BUSINESS SEGMENT NET INCOME
For the years ended December 31 ($ in millions) 2005 2004
Commercial Banking $784 705
Retail Banking 1,091 1,063
Investment Advisors 127 118
Processing Solutions 120 207
Other/Eliminations (573) (556)
Acquisitions -(12)
Net income $1,549 1,525