Fifth Third Bank 2008 Annual Report Download - page 26

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
24 Fifth Third Bancorp
STATEMENTS OF INCOME ANALYSIS
Net Interest Income
Net interest income is the interest earned on debt securities, loans
and leases (including yield-related fees) and other interest-earning
assets less the interest paid for core deposits (includes transaction
deposits and other time deposits) and wholesale funding (includes
certificates $100,000 and over, other deposits, federal funds
purchased, short-term borrowings and long-term debt). The net
interest margin is calculated by dividing net interest income by
average interest-earning assets. Net interest spread is the
difference between the average rate earned on interest-earning
assets and the average rate paid on interest-bearing liabilities. Net
interest margin is typically greater than net interest rate spread due
to the interest income earned on those assets that are funded by
non-interest-bearing liabilities, such as demand deposits, or
shareholders’ equity.
Table 4 presents the components of net interest income, net
interest margin and net interest spread for 2008, 2007 and 2006.
Nonaccrual loans and leases and loans held for sale have been
included in the average loan and lease balances. Average
outstanding securities balances are based on amortized cost with
any unrealized gains or losses on available-for-sale securities
included in other assets. Table 5 provides the relative impact of
changes in the balance sheet and changes in interest rates on net
interest income.
During 2008, a number of market forces impacted net
interest income. The decreasing rate environment, spurred by the
Federal Reserve monetary policies throughout the year, initially
allowed deposits to reprice further than loans due to increased
credit spreads on new originations. This effect was muted during
the second half of 2008 as disruptions in the credit markets
created a highly competitive deposit rate environment. Loan
yields came under further downward pressure due to the increased
levels of nonperforming loans and leases. Other adjustments
included the accretion of discounts on acquired loans, primarily as
a result of the second quarter 2008 acquisition of First Charter,
which increased net interest income by $339 million during 2008.
The purchase accounting accretion reflects the high discount rate
in the market at the time of the acquisition; the total loan
discounts are being accreted into net interest income over the
remaining period to maturity of the loans acquired. During the
second quarter of 2008, the Bancorp recognized a reduction of
approximately $130 million to interest income on commercial
leases as a result of the recalculation of cash flows on certain
leveraged leases. More information on the leveraged lease
adjustment can be found in Note 16 of the Notes to Consolidated
Financial Statements.
Overall, net interest income (FTE) was $3.5 billion for 2008,
compared to $3.0 billion earned in 2007. The increase in net
interest income compared to the prior year is the result of an 11%
increase in average interest-earning assets combined with a 49 bp
increase in net interest spread that was partially reduced by the
increase in nonperforming loans. In 2008, $282 million in
additional interest income would have been recorded if
nonaccrual loans had been current compared to $144 million in
2007. Exclusive of the purchase accounting and leveraged lease
adjustments, net interest income increased by $291 million, or
10%, over the prior year.
Reported net interest margin was 3.54% in 2008, compared
to 3.36% in 2007. For the year, the negative effects of the
leveraged lease adjustment, a reduction to net interest margin of
13 bp, and increase in nonperforming loans were offset by the
positive impact from the accretion of the discounts on acquired
loans, which increased net interest margin approximately 34 bp in
2008. Exclusive of the purchase accounting and leveraged lease
adjustments, net interest margin was flat on a year-over-year basis
as widening credit spreads were offset by higher nonaccrual loans
and leases and a greater concentration in lower yielding
commercial loans.
Total average interest-earning assets increased 11% from
2007. Average total commercial loans increased 19% and the
investment portfolio increased 17%, while consumer loans
decreased modestly. Commercial mortgage and commercial
construction loans increased primarily as a result of acquisitions
during the past year. Commercial and industrial loans increased
due to the origination for portfolio of loans that historically were
sold to the Bancorp’s off-balance sheet commercial paper conduit,
coupled with the use of contingent liquidity facilities related to
certain off-balance sheet programs that were drawn upon in 2008.
These commercial loans have the effect of lowering the overall
yield on commercial loans. Increases in the investment portfolio
relate to both the Bancorp’s desire to keep an appropriately sized
investment portfolio given the growth in loans and leases, which
occurred primarily from acquisitions, coupled with the purchase
of securities as part of the Bancorp’s non-qualifying hedging
strategy related to mortgage servicing rights.
Interest income (FTE) from loans and leases decreased $481
million compared to 2007. Exclusive of the accretion of
discounts on acquired loans and the leveraged lease adjustment
during the second quarter of 2008, interest income (FTE) from
loans and leases decreased $694 million, or 13%, compared to the
prior year. The year-over-year decrease in interest income is a
result of the repricing of variable rate loans in a declining rate
environment, partially offset by the increase in average loan and
lease balances. At the end of 2008, the Bancorp’s prime rate was
3.25% compared to 7.25% at the end of 2007. Interest income
(FTE) from investment securities and short-term investments
TABLE 3: CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the years ended December 31 ($ in millions, except per share data) 2008 2007 2006 2005 2004
Interest income (FTE) $5,630 6,051 5,981 5,026 4,150
Interest expense 2,094 3,018 3,082 2,030 1,102
Net interest income (FTE) 3,536 3,033 2,899 2,996 3,048
Provision for loan and lease losses 4,560 628 343 330 268
Net interest income (loss) after provision for loan and lease losses (FTE) (1,024) 2,405 2,556 2,666 2,780
Noninterest income 2,946 2,467 2,012 2,374 2,355
Noninterest expense 4,564 3,311 2,915 2,801 2,862
Income (loss) before income taxes and cumulative effect (FTE) (2,642) 1,561 1,653 2,239 2,273
Fully taxable equivalent adjustment 22 24 26 31 36
Applicable income taxes (551) 461 443 659 712
Income (loss) before cumulative effect (2,113) 1,076 1,184 1,549 1,525
Cumulative effect of change in accounting principle, net of tax -- 4 - -
Net income (loss) (2,113) 1,076 1,188 1,549 1,525
Dividends on preferred stock 67 1 - 1 1
Net income (loss) available to common shareholders ($2,180) 1,075 1,188 1,548 1,524
Earnings per share, basic ($3.94) 2.00 2.14 2.79 2.72
Earnings per share, diluted (3.94) 1.99 2.13 2.77 2.68
Cash dividends declared per common share 0.75 1.70 1.58 1.46 1.31