Fifth Third Bank 2009 Annual Report Download - page 55

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Fifth Third Bancorp 53
In 2009, the Bancorp did not substantively change any
material aspect of its overall approach in the determination of the
allowance for loan and lease losses and there have been no
material changes in assumptions or estimation techniques as
compared to prior periods that impacted the determination of the
current period allowance. In addition to the allowance for loan
and lease losses, the Bancorp maintains a reserve for unfunded
commitments recorded in other liabilities in the Consolidated
Balance Sheets. The methodology used to determine the adequacy
of this reserve is similar to the Bancorp’s methodology for
determining the allowance for loan and lease losses. The provision
for unfunded commitments is included in other noninterest
expense in the Consolidated Statements of Income.
Certain inherent, but unconfirmed losses are probable within
the loan and lease portfolio. The Bancorp’s current methodology
for determining the level of losses is based on historical loss rates,
current credit grades, specific allocation on impaired commercial
credits above specified thresholds and other qualitative
adjustments. Due to the heavy reliance on realized historical losses
and the credit grade rating process, the model derived required
reserves tend to slightly lag the deterioration in the portfolio, in a
stable or deteriorating credit environment, and tend not to be as
responsive when improved conditions have presented themselves.
Given these model limitations, the qualitative adjustment factors
may be incremental or decremental to the quantitative model
results. An unallocated component to the allowance for loan and
lease losses is maintained to recognize the imprecision in
estimating and measuring loss. The unallocated allowance as a
percent of total portfolio loans and leases for the year ended
December 31, 2009 was .25%, or five percent of the total
allowance, compared to .33%, or 10% of the total allowance, as of
December 31, 2008. The decrease in the unallocated allowance
compared to the prior year was a result of many of the impacts of
recent economic events being more fully incorporated into the
historical loss rates within the portfolio specific models as well as
early signs of stabilization in real estate values in certain of the
Bancorp’s lending markets. These recent economic events include,
but are not limited to, falling home prices, rising unemployment,
bankruptcy filings and fluctuating commodity prices.
As shown in Table 44, the allowance for loan and lease losses
as a percent of the total loan and lease portfolio increased to
4.88% at December 31, 2009, compared to 3.31% at December
31, 2008. Total allowance for loan and lease losses totaled $3.7
billion and $2.8 billion as of December 31, 2009 and 2008,
respectively. This increase is reflective of a number of factors
including the increase in delinquencies, increased loss estimates
due to the real estate price deterioration in some of the Bancorp’s
key lending markets, increased stress in the commercial loan and
lease portfolio and the general decline in economic conditions.
These factors were the primary drivers of the increased reserve
amounts for most of the Bancorp’s loan categories.
The Bancorp’s determination of the allowance for
commercial loans is sensitive to the risk grades it assigns to these
loans. In the event that 10% of commercial loans in each risk
category would experience a downgrade of one risk category, the
allowance for commercial loans would increase by approximately
$210 million at December 31, 2009. In addition, the Bancorp’s
determination of the allowance for residential and consumer loans
is sensitive to changes in estimated loss rates. In the event that
estimated loss rates would increase by 10%, the allowance for
residential and consumer loans would increase by approximately
$104 million at December 31, 2009. As several qualitative and
quantitative factors are considered in determining the allowance
for loan and lease losses, these sensitivity analyses do not
necessarily reflect the nature and extent of future changes in the
allowance for loan and lease losses. They are intended to provide
insights into the impact of adverse changes to risk grades and
estimated loss rates and do not imply any expectation of future
deterioration in the risk ratings or loss rates. Given current
processes employed by the Bancorp, management believes the risk
grades and estimated loss rates currently assigned are appropriate.
Impaired commercial loans subject to specific evaluation
increased to $1.7 billion as of December 31, 2009 compared to
$1.5 billion as of December 31, 2008. Impaired commercial loans
above specified thresholds require individual review to determine
loan and lease reserves. In addition to the increased volume of
impaired commercial loans, required loan and lease reserves on
these loans were generally higher due to the deterioration in
collateral values.
Delinquency trends have increased across most product lines
and credit grades, leading to increases in loss rates and, therefore,
increased reserve requirements for those products. In general, the
increase in historical loss reserve factors was responsible for over
half of the year-over-year increase in the allowance for loan and
lease losses.
Real estate price deterioration, as measured by the Home
Price Index, was most prevalent in some of the key lending
markets of the Bancorp, with metropolitan areas in Florida,
Michigan and Ohio experiencing some of the most severe declines
nationally. The deterioration in real estate values increased the
inherent loss once a loan defaults, particularly for residential
mortgage and home equity loans with high loan-to-value ratios.
Economic trends such as gross domestic product,
unemployment rate, home sales and inventory and bankruptcy
filings have historically provided indicators of trends in loan and
lease loss rates. Compared to the prior year, negative trends in
general economic conditions in the national and local economies
caused increases in reserve factors used to determine the losses
inherent within the loan and lease portfolio.
The Bancorp continually reviews its credit administration and
loan and lease portfolio and makes changes based on the
performance of its products. Management discontinued the
origination of brokered home equity products at the end of 2007,
suspended homebuilder lending in the fourth quarter of 2007 and
new commercial non-owner occupied real estate lending in 2008,
and raised underwriting standards across both the commercial and
consumer loan product offerings.
TABLE 43: CHANGES IN ALLOWANCE FOR CREDIT LOSSES
For the years ended December 31 ($ in millions) 2009 2008 2007 2006 2005
Balance, beginning of year $2,982 1,032 847 814 785
Net losses charged off (2,581) (2,710) (462) (316) (299)
Provision for loan and lease losses 3,543 4,560 628 343 330
Net change in reserve for unfunded commitments 99 100 19 6 (2)
Balance, end of year $4,043 2,982 1,032 847 814
Components of allowance for credit losses:
Allowance for loan and lease losses $3,749 2,787 937 771 744
Reserve for unfunded commitments 294 195 95 76 70
Total allowance for credit losses $4,043 2,982 1,032 847 814