Fifth Third Bank 2010 Annual Report Download - page 51

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Fifth Third Bancorp 49
commercial credit exposure, appropriate accounting for charge-
offs, and non-accrual status and specific reserves. Credit Risk
Review reports directly to the Risk and Compliance Committee of
the Board of Directors and administratively to the Director of
Internal Audit.
CREDIT RISK MANAGEMENT
The objective of the Bancorp's credit risk management strategy is
to quantify and manage credit risk on an aggregate portfolio basis,
as well as to limit the risk of loss resulting from an individual
customer default. The Bancorp's credit risk management strategy
is based on three core principles: conservatism, diversification and
monitoring. The Bancorp believes that effective credit risk
management begins with conservative lending practices. These
practices include conservative exposure and counterparty limits
and conservative underwriting, documentation and collection
standards. The Bancorp's credit risk management strategy also
emphasizes diversification on a geographic, industry and customer
level as well as regular credit examinations and monthly
management reviews of large credit exposures and credits
experiencing deterioration of credit quality. Lending officers with
the authority to extend credit are delegated specific authority
amounts, the utilization of which is closely monitored.
Underwriting activities are centrally managed, and ERM manages
the policy and the authority delegation process directly. The Credit
Risk Review function, which reports to the Risk and Compliance
Committee of the Board of Directors, provides objective
assessments of the quality of underwriting and documentation, the
accuracy of risk grades and the charge-off, nonaccrual and reserve
analysis process. The Bancorp's credit review process and overall
assessment of the adequacy of the allowance for credit losses is
based on quarterly assessments of the probable estimated losses
inherent in the loan and lease portfolio. The Bancorp uses these
assessments to promptly identify potential problem loans or leases
within the portfolio, maintain an adequate reserve and take any
necessary charge-offs. In addition to the individual review of
larger commercial loans that exhibit probable or observed credit
weaknesses, the commercial credit review process includes the use
of two risk grading systems. The risk grading system currently
utilized for reserve analysis purposes encompasses ten categories.
The Bancorp also maintains a dual risk rating system that provides
for thirteen probabilities of default grade categories and an
additional six grade categories for estimating losses given an event
of default. The probability of default and loss given default
evaluations are not separated in the ten-grade risk rating system.
The Bancorp has completed significant validation and testing of
the dual risk rating system. Scoring systems, various analytical
tools and delinquency monitoring are used to assess the credit risk
in the Bancorp's homogenous consumer and small business loan
portfolios.
Overview
General economic conditions remained weak throughout most of
2009, but showed some signs of moderation during 2010. These
conditions negatively impacted the 2009 performance of a
majority of the Bancorp's loan and lease products. Geographically,
the Bancorp continues to experience the most stress in Michigan
and Florida due to the decline in real estate values. Real estate
value deterioration, as measured by the Home Price Index, was
most prevalent in Florida due to past real estate price appreciation
and related over-development, and in Michigan due in part to
cutbacks in automobile manufacturing and the state's economic
downturn. Among commercial portfolios, the homebuilder and
developer and the remaining non-owner occupied commercial real
estate portfolios remained under stress throughout 2009 and 2010.
Among consumer portfolios, residential mortgage and brokered
home equity portfolios exhibited the most stress. Management
suspended homebuilder and developer lending in the fourth
quarter of 2007 and new commercial non-owner occupied real
estate lending in the second quarter of 2008, discontinued the
origination of brokered home equity products at the end of 2007
and tightened underwriting standards across both the commercial
and consumer loan product offerings. Since the fourth quarter of
2008, in an effort to reduce loan exposure to the real estate and
construction industries, the Bancorp has sold certain consumer
loans and sold or transferred to held for sale certain commercial
loans. Throughout 2009 and 2010, the Bancorp continued to
aggressively engage in other loss mitigation strategies such as
reducing credit commitments, restructuring certain commercial
and consumer loans, tightening underwriting standards on
commercial loans and across the consumer loan portfolio, as well
as utilizing expanded commercial and consumer loan workout
teams. In the financial services industry, there has been
heightened focus on foreclosure activity and processes in recent
months due to issues concerning documentation supporting
foreclosures. Fifth Third actively works with borrowers
experiencing difficulties and has modified or provided forbearance
to borrowers on approximately $1.8 billion of its own mortgages
during the past several years where a workable solution could be
found. Foreclosure is a last resort, and the Bancorp undertakes
foreclosures only when it believes they are necessary and
appropriate and are careful to ensure that customer and loan data
are accurate. The Bancorp conducted reviews of its foreclosure
processes and procedures in the third quarter of 2010, which did
not reveal any material deficiencies, and has continued to expand
and extend these reviews and improve its processes as additional
aspects of the industry’s foreclosure practices have come under
intensified scrutiny and criticism. These reviews are ongoing and
the Bancorp may determine to amend its processes and
procedures as a result of these reviews. While any impact to the
Bancorp that ultimately results from continued reviews cannot yet
be determined, management currently believes that such impact
will not materially adversely affect the Bancorp's results of
operations, liquidity or capital resources.
Commercial Portfolio
The Bancorp’s credit risk management strategy includes
minimizing concentrations of risk through diversification. The
Bancorp has commercial loan concentration limits based on
industry, lines of business within the commercial segment and
credit product type.
The risk within the commercial loan and lease portfolio is
managed and monitored through an underwriting process utilizing
detailed origination policies, continuous loan level reviews, the
monitoring of industry concentration and product type limits and
continuous portfolio risk management reporting. The origination
policies for commercial real estate outline the risks and
underwriting requirements for owner occupied, non-owner
occupied and construction lending. Included in the policies are
maturity and amortization terms, maximum LTV, minimum debt
service coverage ratios, construction loan monitoring procedures,
appraisal requirements, pre-leasing requirements (as applicable)
and sensitivity and pro-forma analysis requirements. The Bancorp
requires an appraisal of collateral be performed at origination and
on an as-needed basis, in conformity with market conditions and
regulatory requirements. It is the Bancorp’s policy to obtain an “as
is value” appraisal annually on all criticized assets. Independent
reviews are performed on appraisals to ensure the appraiser is
qualified and consistency in the evaluation process exists.