Fifth Third Bank 2012 Annual Report Download - page 60

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
58 Fifth Third Bancorp
Overview
General economic conditions showed only modest improvement in
2011 and 2012 as the economic recovery struggled to gain any
significant momentum. Uncertainty in terms of finding long term
solutions for federal government deficit spending continues to
weigh on the economy. 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, residential developer and
portions of the remaining non-owner occupied commercial real
estate portfolios continue to remain under stress.
Among consumer portfolios, residential mortgage and
brokered home equity portfolios exhibited the most stress.
Management suspended homebuilder and developer lending in 2007
and new commercial non-owner occupied real estate lending in
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.
With the stabilization of certain real estate markets, the Bank began
to selectively originate new homebuilder and developer lending and
non-owner occupied commercial lending real estate in the third
quarter of 2011. However, the level of new originations is below the
amortization and pay-off of the current portfolio. 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 2011 and 2012, 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. For commercial and consumer loans owned by the Bancorp,
loan modification strategies are developed that are workable for
both the borrower and the Bancorp when the borrower displays a
willingness to cooperate. These strategies typically involve either a
reduction of the stated interest rate of the loan, an extension of the
loan’s maturity date(s) with a stated rate lower than the current
market rate for a new loan with similar risk, or in limited
circumstances, a reduction of the principal balance of the loan or
the loan’s accrued interest. For residential mortgage loans serviced
for FHLMC and FNMA, the Bancorp participates in the HAMP
and HARP 2.0 programs. For loans refinanced under the HARP 2.0
program, the Bancorp strictly adheres to the underwriting
requirements of the program and promptly sells the refinanced loan
back to the agencies. Loan restructuring under the HAMP program
is performed on behalf of FHLMC or FNMA and the Bancorp does
not take possession of these loans during the modification process.
Therefore, participation in these programs does not significantly
impact the Bancorp’s credit quality statistics. The Bancorp
participates in trial modifications in conjunction with the HAMP
program for loans it services for FHLMC and FNMA. As these trial
modifications relate to loans serviced for others, they are not
included in the Bancorp’s troubled debt restructurings as they are
not assets of the Bancorp. In the event there is a representation and
warranty violation on loans sold through the programs, the Bancorp
may be required to repurchase the sold loan. As of December 31,
2012, repurchased loans restructured or refinanced under these
programs were immaterial to the Bancorp’s Consolidated Financial
Statements. Additionally, as of December 31, 2012, $475 million of
loans refinanced under HARP 2.0 were included in loans held for
sale in the Bancorp’s Consolidated Balance Sheets. For the year
ended December 31, 2012 the Bancorp recognized $218 million of
fee income in mortgage banking net revenue in the Bancorp’s
Consolidated Statements of Income related to the sale of loans
restructured or refinanced under the HAMP and HARP 2.0
programs.
In the financial services industry, there has been heightened
focus on foreclosure activity and processes. The Bancorp actively
works with borrowers experiencing difficulties and has regularly
modified or provided forbearance to borrowers 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 is careful to ensure that customer and
loan data are accurate. Reviews of the Bancorp’s foreclosure process
and procedures conducted in 2010 did not reveal any material
deficiencies. These reviews were expanded and extended in 2011 to
improve the Bancorp’s processes as additional aspects of the
industry's foreclosure practices have come under intensified scrutiny
and criticism. These reviews are complete and the Bancorp has
enhanced some of its processes and procedures to address some
concerns that were raised and to comply with changes in state laws.
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, geography 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,
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 and non-owner occupied and construction
lending. Included in the policies are maturity and amortization
terms, maximum LTVs, 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 a valuation of
real estate collateral, which may include third-party appraisals, be
performed at the time of origination and renewal in accordance with
regulatory requirements and on an as needed basis when market
conditions justify. Although the Bancorp does not back test these
collateral value assumptions, the Bancorp maintains an appraisal
review department to order and review third-party appraisals in
accordance with regulatory requirements. Collateral values on
criticized assets with relationships exceeding $1 million are reviewed
quarterly to assess the appropriateness of the value ascribed in the
assessment of charge-offs and specific reserves. In addition, the
Bancorp applies incremental valuation haircuts to older appraisals
that relate to collateral dependent loans, which can currently be up
to 25-40% of the appraised value based on the type of collateral.
These incremental valuation haircuts generally reflect the age of the
most recent appraisal as well as collateral type. Trends in collateral
values, such as home price indices and recent asset dispositions, are
monitored in order to determine whether adjustments to the
appraisal haircuts are warranted. Other factors such as local market
conditions or location may also be considered as necessary.
The Bancorp assesses all real estate and non-real estate
collateral securing a loan and considers all cross collateralized loans
in the calculation of the LTV ratio. The following table provides
detail on the most recent LTV ratios for commercial mortgage loans
greater than $1 million, excluding impaired commercial mortgage
loans individually evaluated. The Bancorp does not typically