Fifth Third Bank 2007 Annual Report Download - page 33

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Fifth Third Bancorp 31
Net interest income (FTE) decreased three percent compared
to 2005. Net interest margin decreased to 3.06% in 2006 from
3.23% in 2005 largely due to rising short-term interest rates, the
impact of the primarily fixed-rate securities portfolio and mix
shifts within the core deposit base from demand deposit and
interest checking categories to savings, money market and other
time deposit categories paying higher rates of interest.
Noninterest income decreased 15% in 2006 compared to
2005 primarily due to the losses on the sale of securities and
related derivative losses from the balance sheet actions taken in
the fourth quarter of 2006 totaling $415 million. Excluding these
losses, noninterest income increased $54 million, or two percent,
in 2006 compared to 2005 due to continued strong growth in
electronic payment processing and corporate banking revenue
offset by a $19 million decline in mortgage banking revenue.
Noninterest expense increased four percent in 2006
compared to 2005 primarily due to increases in employee
incentives, volume-related payment processing expenditures,
equipment expenditures and occupancy expense related to the
addition of de novo banking centers, and $39 million in charges
related to the termination of certain repurchase and reverse
repurchase agreements. Excluding the $39 million in charges,
noninterest expense increased by three percent.
In 2006, net charge-offs as a percent of average loans and
leases were 44 bp compared to 45 bp in 2005. At December 31,
2006, nonperforming assets as a percent of loans and leases
increased to .61% from .52% at December 31, 2005.
BUSINESS SEGMENT REVIEW
The Bancorp reports on five business segments: Commercial
Banking, Branch Banking, Consumer Lending, Investment
Advisors and Processing Solutions. Further detailed financial
information on each business segment is included in Note 27 of
the Notes to Consolidated Financial Statements.
Results of the Bancorp’s business segments are presented
based on its management structure and management accounting
practices. The structure and accounting 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. During 2007, the
Bancorp changed the reporting of Processing Solutions to include
certain revenues and expenses related to credit card processing
that were previously listed under the Commercial and Branch
Banking segments. 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 business segments
from interest rate volatility, enabling them to focus on serving
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 and the
Treasury swap curve. Matching duration, or the expected average
term until an instrument can be repriced, allocates interest income
and interest expense to each segment so its resulting net interest
income is insulated from interest rate risk. In a rising rate
environment, the Bancorp benefits from the widening spread
between deposit costs and wholesale funding costs. However, the
Bancorp’s FTP system credits this benefit to deposit-providing
businesses, such as Branch Banking and Investment Advisors, on
a duration-adjusted basis. The net impact of the FTP
methodology is captured in General Corporate and Other.
Management made several changes to the FTP methodology
in 2007 to more appropriately calculate FTP charges and credits to
each of the Bancorp’s business segments. Changes to the FTP
methodology were applied retroactively and included adding a
liquidity premium to loans, deposits and certificates of deposit to
properly reflect the Bancorp’s marginal cost of longer term
funding. In addition, an FTP charge on fixed assets based on the
average 5 year Treasury curve was added to the new FTP
methodology.
The business segments are charged provision expense based
on the actual net charge-offs experienced by the loans owned by
each segment. Provision expense attributable to loan growth and
change in factors in the allowance for loan and lease losses are
captured in General Corporate and Other. 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 13.
Commercial Banking
Commercial Banking offers banking, cash management and
financial services to large and middle-market businesses,
government and professional customers. In addition to the
traditional lending and depository offerings, Commercial Banking
products and services include, among others, foreign exchange
and international trade finance, derivatives and capital markets
services, asset-based lending, real estate finance, public finance,
commercial leasing and syndicated finance. Table 14 contains
selected financial data for the Commercial Banking segment.
Comparison of 2007 with 2006
Net income increased $9 million, or one percent, compared to
2006 as a result of continued success in the sale of corporate
banking services, offset by a higher provision for loan and lease
losses and growth in noninterest expense.
Net interest income was modestly lower in comparison to
2006 due to a 32 bp decline in the spread between loan yields and
the related FTP charge. Average loans and leases increased nine
percent over 2006, to $35.7 billion, with growth concentrated in
C&I loans and commercial mortgage loans. The increase in
commercial mortgage loans can be attributed to loans acquired
from Crown in November 2007 and to the conversion of
construction loans to permanent financing throughout 2007.
Average core deposits increased modestly to $15.9 billion in 2007
compared to 2006 as the decrease in savings and money market
balances were more than offset by the growth in foreign office
deposits. Foreign office deposits represent commercial customers
Eurodollar sweeps that pay rates comparable to money market
deposits. Net charge-offs as a percent of average loans increased
from 31 bp in 2006 to 36 bp in 2007 as the segment experienced a
$15 million fraud related charge-off in its Chicago affiliate and an
increase in charge-offs of commercial mortgage loans in parts of
its footprint, specifically eastern Michigan and northeastern Ohio.
TABLE 13: BUSINESS SEGMENT NET INCOME
For the years ended December 31
($ in millions) 2007 2006 2005
Income Statement Data
Commercial Banking $702 693 600
Branch Banking 621 562 515
Consumer Lending 130 179 203
Investment Advisors 100 91 72
Processing Solutions 153 138 123
General Corporate and Other (630) (475) 36
Net income $1,076 1,188 1,549