Fifth Third Bank 2013 Annual Report Download - page 62

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
60 Fifth Third Bancorp
Overview
The economy grew slightly during 2013. Domestic economic risks
remain elevated as several weak economic factors persist (including
continued high unemployment, sluggish economic growth, weak job
creation), and could be further compounded by an extended
European recession. Other global issues include slower growth in
China and persistent fears regarding the Middle East. Housing
prices have largely stabilized and are increasing in many markets, but
overall current economic conditions are causing weaker than
desirable qualified loan demand and a relatively low interest rate
environment, which directly impacts the Bancorp’s growth and
profitability. Geographically, the Bancorp continues to experience
the most stress in Michigan and Florida due to previous declines 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 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.
As of December 31, 2013, consumer real estate loans originated
from 2005 through 2008 represent approximately 30% of the
consumer real estate portfolio and approximately 68% of total
losses in 2013. Loss rates continue to improve as newer vintages are
performing within expectations. With the stabilization of certain real
estate markets, the Bancorp 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 fundings are 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. The Bancorp
continues to aggressively engage in other loss mitigation strategies
such as reducing credit commitments, restructuring certain
commercial and consumer loans, as well as utilizing 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, 2013, repurchased loans restructured or
refinanced under these programs were immaterial to the Bancorp’s
Consolidated Financial Statements. Additionally, as of December
31, 2013 and 2012, $111 million and $475 million, respectively, of
loans refinanced under HARP 2.0 were included in loans held for
sale in the Bancorp’s Consolidated Balance Sheets. For the years
ended December 31, 2013 and 2012, the Bancorp recognized $97
million and $218 million, respectively, of noninterest 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.
During the fourth quarter of 2013, the Bancorp settled certain
repurchase claims related to mortgage loans originated and sold to
FHLMC prior to January 1, 2009 for $25 million, after paid claim
credits and other adjustments. The settlement removes the
Bancorp’s responsibility to repurchase or indemnify FHLMC for
representation and warranty violations on any loan sold prior to
January 1, 2009 except in limited circumstances.
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 adjustments to older
appraisals that relate to collateral dependent loans, which can
currently be up to 20-30% of the appraised value based on the type
of collateral. These incremental valuation adjustments 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
changes to the appraisal adjustments are warranted. Other factors