Fifth Third Bank 2011 Annual Report Download - page 28

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
26 Fifth Third Bancorp
establishing reserves through a charge to earnings. The amount of
these reserves is based on Fifth Third’s assessment of credit losses
inherent in the loan portfolio (including unfunded credit
commitments). The process for determining the amount of the
allowance for loan and lease losses and the reserve for unfunded
commitments is critical to Fifth Third’s financial results and
condition. It requires difficult, subjective and complex judgments
about the environment, including analysis of economic or market
conditions that might impair the ability of borrowers to repay their
loans.
Fifth Third might underestimate the credit losses inherent in its
loan portfolio and have credit losses in excess of the amount
reserved. Fifth Third might increase the reserve because of changing
economic conditions, including falling home prices or higher
unemployment, or other factors such as changes in borrower’s
behavior. As an example, borrowers may "strategically default," or
discontinue making payments on their real estate-secured loans if
the value of the real estate is less than what they owe, even if they
are still financially able to make the payments.
Fifth Third believes that both the allowance for loan and lease
losses and reserve for unfunded commitments are adequate to cover
inherent losses at December 31, 2011; however, there is no
assurance that they will be sufficient to cover future credit losses,
especially if housing and employment conditions worsen. In the
event of significant deterioration in economic conditions, Fifth
Third may be required to build reserves in future periods, which
would reduce earnings.
For more information, refer to the "Risk Management - Credit
Risk Management," "Critical Accounting Policies - Allowance for
Loan and Leases," and “Reserve for Unfunded Commitments” of
the MD&A.
Fifth Third must maintain adequate sources of funding and
liquidity.
Fifth Third must maintain adequate funding sources in the normal
course of business to support its operations and fund outstanding
liabilities, as well as meet regulatory expectations. Fifth Third
primarily relies on bank deposits to be a low cost and stable source
of funding for the loans Fifth Third makes and the operations of
Fifth Third’s business. Core customer deposits, which include
transaction deposits and other time deposits, have historically
provided Fifth Third with a sizeable source of relatively stable and
low-cost funds (average core deposits funded 71% of average total
assets at December 31, 2011). In addition to customer deposits,
sources of liquidity include investments in the securities portfolio,
Fifth Third’s ability to sell or securitize loans in secondary markets
and to pledge loans to access secured borrowing facilities through
the FHLB and the FRB, and Fifth Third’s ability to raise funds in
domestic and international money and capital markets.
Fifth Third’s liquidity and ability to fund and run the business
could be materially adversely affected by a variety of conditions and
factors, including financial and credit market disruptions and
volatility or a lack of market or customer confidence in financial
markets in general similar to what occurred during the financial
crisis in 2008 and early 2009, which may result in a loss of customer
deposits or outflows of cash or collateral and/or ability to access
capital markets on favorable terms.
Other conditions and factors that could materially adversely
affect Fifth Third’s liquidity and funding include a lack of market or
customer confidence in Fifth Third or negative news about Fifth
Third or the financial services industry generally which also may
result in a loss of deposits and/or negatively affect the ability to
access the capital markets; the loss of customer deposits to
alternative investments; inability to sell or securitize loans or other
assets, and reductions in one or more of Fifth Third’s credit ratings.
A reduced credit rating could adversely affect Fifth Third’s ability to
borrow funds and raise the cost of borrowings substantially and
could cause creditors and business counterparties to raise collateral
requirements or take other actions that could adversely affect Fifth
Third’s ability to raise capital. Many of the above conditions and
factors may be caused by events over which Fifth Third has little or
no control such as what occurred during the financial crisis. While
market conditions have stabilized and, in many cases, improved,
there can be no assurance that significant disruption and volatility in
the financial markets will not occur in the future.
Other material adverse effects could include a reduction in
Fifth Third’s credit ratings resulting from a further decrease in the
probability of government support for large financial institutions
such as Fifth Third assumed by the ratings agencies in their current
credit ratings.
If Fifth Third is unable to continue to fund assets through
customer bank deposits or access capital markets on favorable terms
or if Fifth Third suffers an increase in borrowing costs or otherwise
fails to manage liquidity effectively, liquidity, operating margins,
financial results and condition may be materially adversely affected.
As Fifth Third did during the financial crisis, it may also need to
raise additional capital through the issuance of stock, which could
dilute the ownership of existing stockholders, or reduce or even
eliminate common stock dividends to preserve capital.
Fifth Third may have more credit risk and higher credit losses
to the extent loans are concentrated by location of the
borrower or collateral.
Fifth Third’s credit risk and credit losses can increase if its loans are
concentrated to borrowers engaged in the same or similar activities
or to borrowers who as a group may be uniquely or
disproportionately affected by economic or market conditions.
Deterioration in economic conditions, housing conditions and real
estate values in these states and generally across the country could
result in materially higher credit losses.
Bankruptcy laws may be changed to allow mortgage “cram-
downs,” or court-ordered modifications to mortgage loans
including the reduction of principal balances.
Under current bankruptcy laws, courts cannot force a modification
of mortgage and home equity loans secured by primary residences.
In response to the financial crises, legislation has been proposed to
allow mortgage loan “cram-downs,” which would empower courts
to modify the terms of mortgage and home equity loans including a
reduction in the principal amount to reflect lower underlying
property values. This could result in writing down the balance of
mortgage and home equity loans to reflect their lower loan values.
There is also risk that home equity loans in a second lien position
(i.e. behind a mortgage) could experience significantly higher losses
to the extent they became unsecured as a result of a cram-down.
The availability of principal reductions or other modifications to
mortgage loan terms could make bankruptcy a more attractive
option for troubled borrowers, leading to increased bankruptcy
filings and accelerated defaults.
Fifth Third may be required to repurchase mortgage loans or
reimburse investors and others as a result of breaches in
contractual representations and warranties.
Fifth Third sells residential mortgage loans to various parties,
including GSEs and other financial institutions that purchase
mortgage loans for investment or private label securitization. Fifth
Third may be required to repurchase mortgage loans, indemnify the
securitization trust, investor or insurer, or reimburse the
securitization trust, investor or insurer for credit losses incurred on
loans in the event of a breach of contractual representations or
warranties that is not remedied within a period (usually 90 days or
less) after Fifth Third receives notice of the breach. Contracts for
mortgage loan sales to the GSEs include various types of specific
remedies and penalties that could be applied to inadequate