Fifth Third Bank 2012 Annual Report Download - page 43

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
41 Fifth Third Bancorp
interest income (FTE) and noninterest income) was 61.7% for 2012 compared to 62.3% in 2011.
Applicable Income Taxes
Applicable income tax expense for all periods includes the benefit
from tax-exempt income, tax-advantaged investments, certain gains
on sales of leveraged leases that are exempt from federal taxation
and tax credits, partially offset by the effect of certain nondeductible
expenses. The tax credits are associated with the Low-Income
Housing Tax Credit program established under Section 42 of the
IRC, the New Markets Tax Credit program established under
Section 45D of the IRC, the Rehabilitation Investment Tax Credit
program established under Section 47 of the IRC, and the Qualified
Zone Academy Bond program established under Section 1397E of
the IRC.
The effective tax rates for the years ended December 31, 2012
and 2011 were primarily impacted by $149 million and $135 million,
respectively, in tax credits and $19 million and $26 million,
respectively, of non-cash charges relating to previously recognized
tax benefits associated with stock-based compensation that will not
be realized.
As required under U.S. GAAP, the Bancorp established a
deferred tax asset for stock-based awards granted to its employees.
When the actual tax deduction for these stock-based awards is less
than the expense previously recognized for financial reporting or
when the awards expire unexercised, the Bancorp is required to
write-off the deferred tax asset previously established for these
stock-based awards. As a result of the expiration of certain stock
options and SARs and the lapse of restrictions on certain shares of
restricted stock during the year ended December 31, 2012, the
Bancorp recorded additional income tax expense of approximately
$19 million related to the write-off of a portion of the deferred tax
asset previously established. As a result of the Bancorp’s stock price
as of December 31, 2012, it is probable that the Bancorp will be
required to record an additional $13 million of income tax expense
during the next twelve months, primarily in the first quarter of 2013.
However, the Bancorp cannot predict its stock price or whether its
employees will exercise other stock-based awards with lower
exercise prices in the future; therefore, it is possible that the total
impact to income tax expense will be greater than or less than this
amount.
Deductibility of Executive Compensation
Certain sections of the IRC limit the deductibility of compensation
paid to or earned by certain executive officers of a public company.
This has historically limited the deductibility of certain executive
compensation to $1 million per executive officer, and the Bancorp’s
compensation philosophy has been to position pay to ensure
deductibility. However, both the amount of the executive
compensation that is deductible for certain executive officers and
the allowable compensation vehicles changed as a result of the
Bancorp’s participation in TARP. In particular, the Bancorp was not
permitted to deduct compensation earned by certain executive
officers in excess of $500,000 per executive officer as a result of the
Bancorp’s participation in TARP. Therefore, a portion of the
compensation earned by certain executive officers was not
deductible by the Bancorp for the period in which the Bancorp
participated in TARP. Subsequent to ending its participation in
TARP, certain limitations on the deductibility of executive
compensation will continue to apply to some forms of
compensation earned while under TARP. The Bancorp’s
Compensation Committee determined that the underlying executive
compensation programs are appropriate and necessary to attract,
retain and motivate senior executives, and that failing to meet these
objectives creates more risk for the Bancorp and its value than the
financial impact of losing the tax deduction. For the years ended
December 31, 2012 and 2011, the tax impact related to non-
deductible compensation expense, which is based on the grant date
fair values of the respective awards, was $1 million and $2 million,
respectively. In addition, the IRS limitation prevented the Bancorp
from recognizing a tax benefit of $3 million for the year ended
December 31, 2012 that otherwise would have resulted from the
vesting and/or exercise of certain stock based compensation awards
at fair values in excess of their respective grant date fair values.
The Bancorp’s income before income taxes, applicable income tax expense and effective tax rate are as follows:
TABLE 11: APPLICABLE INCOME TAXES
For the years ended December 31 ($ in millions) 2012 2011 2010 2009 2008
Income (loss) before income taxes $ 2,210 1,831 940 767 (2,664)
A
pplicable income tax expense (benefit) 636 533 187 30 (551)
Effective tax rate 28.8 % 29.1 19.8 3.9 20.7