Fifth Third Bank 2007 Annual Report Download - page 21

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Fifth Third Bancorp 19
OVERVIEW
This overview of management’s discussion and analysis highlights
selected information in the financial results of the Bancorp and
may not contain all of the information that is important to you.
For a more complete understanding of trends, events,
commitments, uncertainties, liquidity, capital resources and critical
accounting policies and estimates, you should carefully read this
entire document. Each of these items could have an impact on
the Bancorp’s financial condition, results of operations and cash
flows.
The Bancorp is a diversified financial services company
headquartered in Cincinnati, Ohio. At December 31, 2007, the
Bancorp had $111.0 billion in assets, operated 18 affiliates with
1,227 full-service Banking Centers including 102 Bank Mart®
locations open seven days a week inside select grocery stores and
2,211 Jeanie® ATMs in Ohio, Kentucky, Indiana, Michigan,
Illinois, Florida, Tennessee, West Virginia, Pennsylvania, Missouri
and Georgia. The Bancorp reports on five business segments:
Commercial Banking, Branch Banking, Consumer Lending,
Investment Advisors and Fifth Third Processing Solutions
(“FTPS”).
The Bancorp believes that banking is first and foremost a
relationship business where the strength of the competition and
challenges to growth can vary in every market. Its affiliate
operating model provides a competitive advantage by keeping the
decisions close to the customer and by emphasizing individual
relationships. Through its affiliate operating model, individual
managers from the banking center to the executive level are given
the opportunity to tailor financial solutions for their customers.
The Bancorp’s revenues are fairly evenly dependent on net
interest income and noninterest income. For the year ended
December 31, 2007, net interest income, on a fully taxable
equivalent (“FTE”) basis, and noninterest income provided 55%
and 45% of total revenue, respectively. Therefore, changes in
interest rates, credit quality, economic trends and the capital
markets are primary factors that drive the performance of the
Bancorp. As discussed in the Risk Management section, risk
identification, measurement, monitoring, control and reporting are
important to the management of risk and to the financial
performance and capital strength of the Bancorp.
Net interest income is the difference between interest income
earned on assets such as loans, leases and securities, and interest
expense paid on liabilities such as deposits, short-term borrowings
and long-term debt. Net interest income is affected by the general
level of interest rates, the relative level of short-term and long-
term interest rates, changes in interest rates and changes in the
amount and composition of interest-earning assets and interest-
bearing liabilities. Generally, the rates of interest the Bancorp
earns on its assets and pays on its liabilities are established for a
period of time. The change in market interest rates over time
exposes the Bancorp to interest rate risk through potential adverse
changes to net interest income and financial position. The
Bancorp manages this risk by continually analyzing and adjusting
the composition of its assets and liabilities based on their payment
streams and interest rates, the timing of their maturities and their
sensitivity to changes in market interest rates. Additionally, in the
ordinary course of business, the Bancorp enters into certain
derivative transactions as part of its overall strategy to manage its
interest rate and prepayment risks. The Bancorp is also exposed
to the risk of losses on its loan and lease portfolio as a result of
changing expected cash flows caused by loan defaults and
inadequate collateral due to a weakening economy within the
Bancorp’s footprint.
Net interest income, net interest margin, net interest rate
spread and the efficiency ratio are presented in Management’s
Discussion and Analysis of Financial Condition and Results of
Operations on an FTE basis. The FTE basis adjusts for the tax-
favored status of income from certain loans and securities held by
the Bancorp that are not taxable for federal income tax purposes.
The Bancorp believes this presentation to be the preferred
industry measurement of net interest income as it provides a
relevant comparison between taxable and non-taxable amounts.
Noninterest income is derived primarily from electronic
funds transfer (“EFT”) and merchant transaction processing fees,
card interchange, fiduciary and investment management fees,
corporate banking revenue, service charges on deposits and
mortgage banking revenue. Noninterest expense is primarily
driven by personnel costs and occupancy expenses in addition to
expenses incurred in the processing of credit and debit card
transactions for its customers and merchant and financial
institution clients.
On November 2, 2007, the Bancorp completed its
acquisition of R-G Crown Bank (“Crown”), a subsidiary of R&G
Financial Corporation, with $2.8 billion in assets and $1.7 billion
in deposits located in Florida and Augusta, Georgia. As of
December 31, 2007, the Bancorp’s Florida affiliates have 141 full-
service locations, of which 28 were acquired as part of the Crown
acquisition. Additionally, the 3 Crown banking centers in Augusta
allowed the Bancorp to enter the state of Georgia.
On August 16, 2007, the Bancorp announced an agreement
to acquire First Charter Corporation ("First Charter"), which
operates 57 banking centers in North Carolina and 2 in suburban
Atlanta. The acquisition is awaiting regulatory approval with a
planned close in the second quarter of 2008.
Earnings Summary
The Bancorp’s net income was $1.1 billion or $1.99 per diluted
share in 2007, a nine percent decrease compared to $1.2 billion
and $2.13 per diluted share in 2006. Current year results were
impacted by a $177 million charge to lower the current cash
surrender value of one of the Bancorp’s bank-owned life
insurance (“BOLI”) policies. The BOLI charge reflected a
decrease in cash surrender value due to declines in value of the
policies underlying investments due to significant disruptions in
the financial markets and widening credit spreads. This charge
reflected an additional $22 million recorded subsequent to the
Bancorp’s issuance of fourth quarter of 2007 earnings. Current
year results were also impacted by provision for loan and lease
losses of $628 million, an increase of $285 million over 2006. The
increased provision for loan and lease losses was a result of the
deteriorating credit environment discussed further in the Risk
Management section.
Net interest income (FTE) increased five percent compared
to 2006. Net interest margin increased to 3.36% in 2007 from
3.06% in 2006 largely due to the balance sheet actions taken in the
fourth quarter of 2006. See Comparison of 2006 with 2005
section for specific balance sheet actions taken.
Noninterest income increased 23% compared to 2006.
Noninterest income in 2007 reflects the impact of the previously
mentioned $177 million BOLI charge, while the 2006 results
included $415 million in losses related to fourth quarter balance
sheet actions. Excluding these items, noninterest income
increased nine percent compared to 2006 with growth in
electronic payment processing, service charges on deposits and
corporate banking revenue offset by lower mortgage banking net
revenue.
Noninterest expense increased 14% compared to 2006.
Noninterest expense in 2007 included $172 million in charges
related to the Bancorp’s indemnification of estimated current and
future Visa Inc. (“Visa”) litigation settlements and $8 million of
acquisition-related costs, while 2006 results included $49 million
in charges related to the termination of debt and other financing
agreements. Excluding these items, noninterest expense increased
nine percent resulting from volume-based transaction growth in