Fifth Third Bancorp
annual report 2005
focused.
company profile
focused
on stability.
Fifth Third Bancorp is a diversified financial services company headquartered
in Cincinnati, Ohio. The Company has $105.2 billion in assets and operates 19
affiliates with 1,119 full-service banking centers, including 119 Bank Mart®
locations open seven days a week inside select grocery stores, and 2,024
Jeanie® ATMs in Ohio, Kentucky, Indiana, Michigan, Illinois, Florida,
Tennessee, West Virginia, Pennsylvania and Missouri. The financial
strength of Fifth Third’s Ohio and
Michigan banks continues to be
recognized by rating agencies with
deposit ratings of AA- and Aa1
from Standard & Poor’s and
Cleveland
Pittsburgh
Traverse
City
Grand Rapids
Detroit
Toledo
Chicago
Indianapolis
Dayton
Columbus
Huntington
Moody’s, respectively. Additionally,
Fifth Third Bancorp continues to maintain
among the highest short-term ratings available
at A-1+ and Prime-1 and is recognized by Moody’s
St. Louis
Evansville
Cincinnati
Florence
Louisville
Lexington
Nashville
with a senior debt rating of Aa2. Fifth Third operates
four main businesses: Retail, Commercial, Investment
Advisors and Fifth Third Processing Solutions. Fifth Third
is among the largest money managers in the Midwest and,
as of December 31, 2005, has $196 billion in assets under
care – of which it manages $33 billion for individuals, corporations
and not-for-profit organizations. Investor information
and press releases can be viewed at www.53.com.
Fifth Third’s common stock is traded through the
NASDAQ® National Market System under the
Orlando
symbol “FITB.”
Tampa
Sarasota
Naples
For the years ended December 31
$ in millions, except per share data
Earnings and Dividends
Net Income
Common Dividends Declared
Per Share
Earnings
Diluted Earnings
Cash Dividends
Book Value
At Year-End
Assets
Total Loans and Leases
Deposits
Shareholders’ Equity
Year-End Market Price
Market Capitalization
Key Ratios (percent)
Return on Average Assets (ROA)
Return on Average Equity (ROE)
Net Interest Margin
Efficiency Ratio
Average Shareholders’ Equity to Average Assets
Actuals
Common Shares Outstanding (in thousands)
Banking Centers
Full-Time Equivalent Employees
financial highlights
2005
2004
Percent
Change
$ 1,549
810
$ 2.79
2.77
1.46
17.00
$ 105,225
71,229
67,434
9,446
37.72
20,958
1.50
16.6
3.23
53.2
9.06
$ 1,525
735
$ 2.72
2.68
1.31
16.00
$ 94,456
60,367
58,226
8,924
47.30
26,377
1.61
17.2
3.48
53.9
9.34
555,623
1,119
21,681
557,649
1,011
19,659
2
10
3
3
11
6
11
18
16
6
(20)
(21)
(7)
(3)
(7)
(1)
(3)
-
11
10
Deposit and Debt Ratings
Moody’s Standard & Poor’s Fitch
Fifth Third Bancorp
Commercial Paper
Senior Debt
Fifth Third Bank and Fifth Third Bank (Michigan)
Short-Term Deposit
Long-Term Deposit
Prime -1
Aa2
Prime -1
Aa1
A-1
A+
A-1+
AA-
F1+
AA-
F1+
AA
1
letter from the President & Chief Executive Officer
focused on
value creation.
Dear Shareholders and Friends,
2005 proved to be a challenging year
for Fifth Third, with both revenue and
net income significantly below our
initial expectations. Earnings per diluted
share for the full-year were $2.77, an
increase of three percent over last year’s
earnings of $2.68. Total revenues were
flat compared to the prior year and
totaled $5.5 billion.
Return on average assets for the full-year 2005 was
1.50 percent and return on average equity was 16.6
percent, compared to 1.61 percent and 17.2 percent,
respectively, in 2004. Despite these relatively modest
results, your company still earned more than $1.5 billion
in net income and added significantly to our customer
base.
Throughout its history, the story of Fifth Third has been
one of growth and value creation that was perhaps
unrivaled in the banking industry. In fact, Fifth Third is
more than five times larger than it was when I sat down
to compose this letter just 10 years ago. During that
time, deposits, loans, assets and, most importantly,
net income have all increased more than five-fold.
Unfortunately, we have learned that challenges can also
increase with size and even the most highly regarded
George A. Schaefer, Jr.
President & Chief Executive Officer
2
“We have learned that challenges can also
increase with size and even the most
highly regarded of companies and strongest
of cultures are not immune to difficulties.”
companies and strongest cultures are not immune
to difficulties. Our performance over the last two years
has not matched our historical success. And while
disappointing and below our potential, I believe these
results are best understood within the context of the
many things we accomplished this year to improve our
competitive position and drive revenue and earnings
growth in the years to come – progress that will
ultimately be reflected in our performance. After
reviewing both our business performance and key
priorities as detailed in this letter and the pages that
follow, I hope you will agree that Fifth Third is making
significant progress and taking the right steps to regain
traction and enhance shareholder value over the long
run.
2005 Business Performance
Loan growth remained strong in 2005, with period end
total loans and leases increasing by $10.9 billion, or 18
percent, over 2004. Commercial customer additions and
steadily improving loan demand throughout the year
resulted in a 22 percent increase in commercial loan
outstandings. Similar success was achieved through the
hard work of our retail employees, with consumer loans
increasing by 13 percent over the prior year.
Retail transaction account growth and commercial
customer additions resulted in good deposit growth
trends in 2005, despite a sluggish start to the year. On a
full-year average basis, total transaction deposits increased
by $4.8 billion, or 11 percent, and total core deposits
increased by $7.0 billion, or 14 percent, over 2004.
Noninterest revenues experienced mixed results in
2005, with strong performance from Fifth Third
Processing Solutions and our commercial line of
business mitigated by more modest results in other areas.
In total, noninterest revenues increased by a healthy
10 percent over the prior year, excluding operating lease
revenue, gains and losses on the sales of securities and
a gain realized on the sales of certain third-party sourced
merchant processing contracts in 2004.
Despite good loan and deposit trends, spread-based
revenues proved to be our greatest challenge in 2005
and remained essentially unchanged from prior year
levels. Increased funding costs resulting from the
convergence of short- and long-term interest rates and
sharp declines in returns realized from our securities
portfolio resulted in 25 basis points of contraction in our
net interest margin. This compression offset growth
generated from core banking activities and resulted in
flat overall revenue performance for the year.
Operating expenses decreased by two percent compared
to 2004 but increased by 11 percent when debt
termination charges in the prior year are excluded. This
increase was largely due to sales force and banking
center additions and investments in information
technology. While the investments associated with this
increase in spending resulted in negative operating
leverage in 2005, we believe that these improvements in
distribution and infrastructure are essential to the future
success of Fifth Third.
3
Our Priorities
Investing For Growth
With the profit margins available in our business,
success has always been a function of the ability to
generate revenue growth. However, the temptation to
curtail investments and slash costs is extremely high
during difficult times. The benefits of these strategies
are generally short term in nature and the impact can
extend well into the future. Success in any business is
defined as consistently delivering above average returns
that compound over time. History has shown that a
company cannot shrink its way to meeting that standard.
During 2005, Fifth Third:
• Invested in distribution. We added 63 de-novo
banking centers and relocated other existing
facilities across the footprint to drive deposit and
loan growth in the years to come. These additions
complement the 76 new banking centers added in
2004 and together will be an integral growth driver
as we continue to attract customers and increase
productivity. We acquired and integrated First
National Bankshares of Florida, creating three
affiliates in some of the fastest growing deposit
markets in the country. Continuing de-novo
investments will result in powerful distribution
networks in the Orlando, Tampa and Southwest
Florida metropolitan markets.
• Invested in people. We increased our sales force by
nearly 1,400 positions in 2005. We still have work
to do in reaching productivity goals for many of
these additions, but I remain confident that a
strong culture of sales measurement, accountability
and performance-based rewards will drive future
revenue growth.
4
• Invested in customer service. The manner and
efficiency in which we support and interact with
our customers is critical to Fifth Third's success.
In order to improve our service, we began
extensive customer polling efforts to identify
successes as well as opportunities for
improvement. Based on feedback from our
customers, we realigned employee incentives,
adjusted fee policies and expanded our product
set. More opportunities exist to enhance customer
service levels and improve retention, and
we are committed to delivering best-in-class
customer service.
• Invested in technology. With the expertise that
comes from the successful handling of more than
16.4 billion electronic transactions in 2005,
we are dedicated to providing a proven sales
culture with the absolute best tools available to
serve and grow our customer base. Initiatives
included new relationship management systems,
fully automated and integrated teller platforms,
new call center management systems and
improved processing capabilities with enhanced
capacity, reliability and scale.
“Success in any business
is defined as consistently
delivering above average returns
that compound over time.
History has shown that a
company cannot shrink its way
to meeting that standard.”
“Our primary responsibility
is to invest shareholders’ capital
in a manner that enhances value while ensuring
that our businesses are being properly
compensated for the level of risk being assumed.”
Maintaining Financial Discipline
Financial discipline is the foundation of great companies,
and great companies consistently deliver superior
risk-adjusted returns relative to the competition.
Fifth Third is determined to once again be one of those
companies. Our primary responsibility is to invest
shareholders’ capital in a manner that enhances value
while ensuring that our businesses are being properly
compensated for the level of risk being assumed.
We will continue to improve our ability to measure and
manage risk in all its various forms – credit, interest rate,
operational, liquidity and general business – in order to
reduce volatility and react more quickly to changing
business and economic climates.
In business, just as in personal finance, investment
climates are not all created equal. Fifth Third will take a
long-term view and will forego short-term profits if they
are accompanied by the potential for excess risk and
volatility. During 2005, Fifth Third:
• Responded to relatively low long-term interest rates
and a poor climate for acquisitions by returning
excess capital to shareholders. We increased the
dividend by 11 percent to $1.46 per common
share and repurchased 38 million shares, six
percent of total outstanding, for $1.6 billion.
• Responded to the relatively inferior return inherent
in continuing to invest in bond securities by
foregoing current period earnings through a
$5.6 billion, or 18 percent, reduction in average
securities held on the balance sheet.
5
Fostering a Team-Driven Culture
I have always believed, regardless of starting position, the
bank with the best people will gain leading market share
over time. Everything we do at Fifth Third is focused on
identifying and rewarding top performers with the
opportunity to drive results through our unique affiliate
operating model. In recent years, as we have many times
in the past, we experienced some change at both the
affiliate and senior management levels. We thank these
leaders for their efforts and honor their contributions by
recommitting to the challenge of revenue growth and
matching the work ethic for which this company has
long been known. In each of our affiliates, we have
experienced leaders working as a team to serve all of the
customers in their market. Whether, like me, these
leaders have been with Fifth Third for a very long time
or have brought to our company many years of banking
experience gained elsewhere, we all share a team
orientation, a sales focus and a desire to serve our
customers and shareholders. We remain committed to
the challenge of driving revenue growth and capitalizing
on the opportunities that lie ahead.
Supporting Our Communities
Fifth Third has always operated under the premise that
helping to build stronger communities will result in a
stronger and more dynamic bank. Lending to build and
revitalize neighborhoods, philanthropic giving and active
community involvement are long-standing traditions at
Fifth Third. I invite you to read about our most recent
efforts on page 20 of this report.
6
“We remain committed to the
challenge of driving revenue
growth and capitalizing on the
opportunities that lie ahead.”
“We have asked a great deal of our employees
in 2005, and they have delivered.
However, many challenges remain,
and we still have a lot of work remaining
to complete our shared vision of what
Fifth Third can become.”
In Closing
Fifth Third has truly been transformed in the last couple
of years, but perhaps not in the manner you would
expect. The growth trajectories of the key drivers in our
business – deposits, fees and loans – remain intact, with
annualized growth rates consistent with Fifth Third’s
standards and historical performance. Change can be
seen, however, in improvements in our commitment to
customer service, use of technology, corporate
governance and capital and risk management. Perhaps
more so than at any time in our history, Fifth Third
today has the infrastructure necessary to aggressively
compete in a consolidating financial services landscape
while maintaining the local market differentiation
provided by our affiliate bank model. In the years to
come, you can expect to see Fifth Third continuing to
increase our presence in high opportunity markets while
remaining mindful of opportunities to establish affiliates
in new metropolitan markets.
I would like to thank our customers, employees, board
members and the communities in our 19 affiliates for
their contributions and continued support. We have
asked a great deal of our employees in 2005, and they
have delivered. However, many challenges remain, and
we still have a lot of work remaining to complete our
shared vision of what Fifth Third can become.
The focus for 2006 will be on continuing to generate
quality deposit and loan growth, enhancing all of our
businesses and gaining market share by meeting more of
the financial services needs of our customers. Our
existing competitive and financial strengths, combined
with superior talent and an enhanced infrastructure and
focus, make me extremely optimistic about the years
to come.
Sincerely,
George A. Schaefer, Jr.
President & Chief Executive Officer
January 2006
7
sticking to a successful business model
focused
on commitment.
Our affiliate operating structure differentiates
us from the competition and ensures that our
customers receive individualized service and
comprehensive financial solutions. All aspects of
customer relationships are managed locally by
affiliate presidents responsible for each affiliate’s
operation and community development.
Competitive pressures are different in every market,
so we rely on experienced local officers empowered
with the authority and infrastructure to employ
the best practices of our company to deliver a
personalized level of service to our customers.
FITB
Affiliate
Deposits
(billions)
Percent
of FITB
Assets
(billions)
Banking
Centers
Affiliate
President
State
Years in
Banking
Cincinnati
Chicago
Western Michigan
Detroit
Columbus
Cleveland
South Florida
Dayton
Indianapolis
Toledo
Southern Indiana
Louisville
Northern Michigan
Northern Kentucky
Nashville
Lexington
Ohio Valley
Tampa Bay
Orlando
OH
IL
MI
MI
OH
OH
FL
OH
IN
OH
IN
KY
MI
KY
TN
KY
WV
FL
FL
$12.3
8.9
7.3
4.4
3.7
3.7
3.6
3.3
3.3
3.2
2.4
1.8
1.4
1.3
1.1
1.1
0.9
0.9
0.7
%
18
13
11
7
5
5
5
5
5
5
4
3
2
2
2
2
1
1
1
$17.4
10.1
9.6
7.1
5.1
5.7
6.8
3.8
5.4
4.6
3.4
2.2
2.1
1.7
2.1
1.8
1.6
1.4
1.3
106
140
135
83
65
86
45
62
81
50
52
46
25
34
20
21
27
26
15
R. Sullivan
T. Zink
M. Van Dyke
G. Kosch
R. Eversole
T. Clossin
T. Quinn
R. Webb
M. Spagnoletti
R. LaClair
J. Daniel
P. McHugh
J. Pelizzari
T. Rawe
D. Hogan
S. Barnes
D. Call
B. Keenan
G. Howlett
30
17
20
22
21
22
13
19
31
23
36
19
27
31
21
34
18
19
30
8
our existing South Florida affiliate with the January
acquisition of First National Bankshares of Florida.
Fifth Third now has three affiliates, $5.2 billion in
deposits and $9.5 billion in assets in the state of
Florida. Efforts are underway to continue to expand
our presence in these markets with the planned
addition of 22 new banking centers in 2006. In
addition, the seeds for two new affiliates were planted
in 2005, with the opening of two banking centers in
St. Louis and three banking centers in Pittsburgh.
Fifth Third now operates 19 affiliates with 1,119
banking centers and 2,024 Jeanie® ATMs in 10 states.
Fifth Third believes in the affiliate model. In a
relationship business, this model keeps motivated
decision makers close to the customer. It creates the
ability to respond with market-specific strategies and
flexible pricing to go after entrenched large
market share competitors and the less efficient smaller
institutions. It is based on the individual talent and
entrepreneurship of our employees. It inspires new
ideas from the bottom up because all of our affiliates,
business lines and banking centers are managed to
detailed financial statements. It fosters a culture of
business ownership. It rewards talented individuals for
making the right decisions for customers, communities
and shareholders. It encourages our employees to
work together across business lines to develop
complete financial solutions for our customers.
Our affiliate model is characterized by a local presence
with market knowledge, management accountability
and a team approach. We believe it is the key to our
past and future success, and we are committed to it.
Establishing a presence in new metropolitan markets
is an important part of our continuing growth.
In 2005, new affiliates were established in Tampa and
Orlando, and our presence was greatly enhanced in
Fifth Third operates 19
affiliates with 1,119 banking
centers and 2,024 Jeanie®
ATMs in 10 states and
now has three affiliates with
$5.2 billion in deposits
and $9.5 billion in assets
in the state of Florida.
9
long-term vision of people and technology
focused
on expertise.
Fifth Third has been highly successful over the
years in gaining new customers. High-performing
employees, a performance-based sales culture,
a strong balance sheet and nimble operating model
have afforded Fifth Third numerous advantages
in a highly competitive industry. Beginning in
2004 and continuing in earnest through 2005,
Fifth Third endeavored to add another advantage
over peers – a superior “Service First” mentality
enabled by increasingly streamlined processes
and technological innovation.
10
We are committed
to improving the experience
our customers have when
they enter a banking center.
implementing a new system to track the effective
resolution of customer service issues, allowing for
faster identification and improvement of processes.
Fifth Third is implementing an improved customer
service model through a long-term investment in
technology and efficiency that will provide a
competitive advantage for years to come. These
efforts represent a tremendous challenge, but one
in which Fifth Third has laser-like focus. Recent
increases in equipment and depreciation expenses
illustrate these investments are not without cost.
However, Fifth Third expects information technology
expenses to begin to show trend improvement in 2006,
and benefits will be realized through improvement in
customer service and ongoing growth in both our
customer base and in products delivered.
Improving the way we support and grow our customer
base is critical to continuing Fifth Third’s growth.
In order to succeed, we must improve information
flow to create a better understanding of our customers,
the products they have, the products they should have
and the opportunities to serve them better. In 2005,
we made an investment in an improved customer
relationship management solution that creates a single
customer view across our key operating platforms.
This solution crosses business lines and affiliates with
a seamless integration of a common set of sales and
management information. The simplified and faster
information flow will increase reaction time for sales
opportunities and allow for management decisions that
consider all aspects of a customer relationship.
We are committed to improving the experience our
customers have when they enter a banking center.
Recent improvements in the automation and
standardization of account opening procedures,
with predetermined touch and follow-up points, will
greatly reduce new account attrition. Our new teller
automation platform is a significant step toward
improving customer service and supplying employees
with the tools they need to deliver a great customer
experience. By eliminating the manual processes and
paper forms that create inefficiency, we are reducing
the workload to execute a single transaction and
allowing our front line employees to focus more time
where it belongs – with the customer.
Our operations group is taking major steps to ensure a
“Service First” mentality within our central call center.
Customer service personnel currently handle
approximately 50 million calls annually. Fifth Third
strives to show our customers that we value every
single one of those experiences. Strategic changes are
being implemented in how we manage, recognize and
reward representatives, with emphasis migrating from
volume to resolution. We also are in the midst of
11
retail banking
focused
on service.
Fifth Third’s 1,119 banking centers, including
119 Bank Mart® locations open seven days a
week inside select grocery stores, and 2,024
Jeanie® ATM’s serve as the primary point of
contact for our six million customers. Fifth
Third’s internet banking and bill payment
system provides an additional point of access
for customers to manage their money quickly
and conveniently – 24 hours a day, seven days
a week. Through these channels, Fifth Third
strives to provide industry leading products,
convenience and customer service to the
individual and small business customers within
our geographic footprint.
Bancorp Average
Transaction Deposits
$47.9
$ billions
40
Average Consumer
Loans & Leases
$43.2
$40.4
$35.8
$26.4
$22.5
$31.6
$27.6
$26.3
$22.1
$22.4
$21.4
35
30
25
20
15
10
2000
2001
2002
2003
2004
2005
2000
2001
2002
2003
2004
2005
$ billions
50
45
40
35
30
25
20
15
10
12
basis in 2005. Despite this success, we are continuing
to develop a number of additional initiatives to
improve the overall customer experience.
Small business banking received special focus in 2005.
Fifth Third believes that competition in the small
business segment is primarily service related.
We deploy individual relationship managers to work
with small business customers and learn about their
businesses. That knowledge allows us to deliver
customized solutions through integrated web-based
platforms that offer big company functionality at
small business prices. With increased database
marketing and new bundled deposit and cash
management products, small business deposits
increased by 19 percent in 2005 and now total
$5.1 billion. Investments in streamlined underwriting
capabilities drove similar performance in small
business lending with 19 percent growth over the
prior year.
We will continue recent de-novo banking center
expansion activities with the planned addition of
approximately 50 net new offices in 2006.
Investments in this area continue to be primarily
concentrated in the Chicago, Florida, Detroit and
Nashville markets, but expansion efforts also will
continue in Pittsburgh and St. Louis.
With increased database
marketing and new deposit
and cash management
products, small business
deposits increased
by 19 percent in 2005.
Fifth Third is focused on continuing to drive core
deposit growth within the retail franchise, with the
goal of core funding total earning asset growth. To
accomplish this goal, we introduced an “everyday great
rate” approach on transaction accounts and time
deposits, improved customer and account
segmentation and put new tools in the hands of our
retail sales force. Our banking center employees
responded in 2005. Average transaction account
balances increased by 11 percent in 2005, highlighted
by 33 percent growth in average savings and money
market balances and eight percent growth in average
consumer demand deposits. Average core deposits
overall increased by 14 percent over the prior year.
Consumer loan generation also remained strong in
2005 with period end balances increasing by
$3.8 billion, or 13 percent, over 2004.
In 2005, our long-standing dedication to sales
performance and tracking individual results was
complemented by increased emphasis on customer
service and retention. Today, we interview customers
about their experiences in our banking centers so we
can evaluate the service we deliver in every affiliate,
region and banking center. For the first time, incentive
compensation programs across the Bancorp
incorporate customer satisfaction results to ensure that
we are providing best-in-class customer service. Our
initial efforts are meeting with success, with total retail
account openings increasing by 13 percent and
attrition rates improving by 20 percent on a full-year
13
commercial banking
focused
on relationships.
Fifth Third’s commercial relationship officers are
respected for their commitment to understanding
the challenges and opportunities facing each of our
commercial customers. Our relationship officers
provide creative and insightful perspectives that
come from our almost 150 years of commercial
banking experience. Decisions are made locally by
people familiar with our business partners and the
communities in which they operate. Fifth Third’s
commercial team has the experience to advise our
customers, the financial resources to support their
growth and the willingness, infrastructure and
ability to provide customized financial solutions.
Period End
Commercial Loans & Leases
Average Commercial
Demand Deposits
$ billions
40
$38.5
$ billions
11
$31.5
$27.7
$24.7
$22.4
$22.6
35
30
25
20
15
$7.0
$5.3
$4.0
$4.4
9
7
5
3
1
$10.2
$8.9
2000
2001
2002
2003
2004
2005
2000
2001
2002
2003
2004
2005
14
Fifth Third has always recognized the importance of
maintaining conservative underwriting and a strong
credit culture. Profitable growth is achieved by
attracting new customers, not simply by increasing
exposure to existing customers. The result is a diverse
and granular commercial loan portfolio with industry
concentrations and exposure limits closely monitored.
At year end 2005, over 89 percent of commercial loan
and lease obligations were less than $5 million and
88 percent of exposures were originated in footprint.
As we begin a new year, we see tremendous potential
for further growth in a number of our markets. In
2005, Fifth Third opened its first commercial banking
office in Toronto, Canada, which offers seamless,
cross-border banking to Canadian- and U.S.-based
companies. With a proven strategy, a dedication to
forging strong local partnerships, an expanded sales
force and conservative credit culture, Fifth Third will
continue to provide our customers with solutions that
create lasting business relationships.
New customer additions
and increasing loan demand
throughout the year contributed
to 49 percent growth in
commercial loan- and
lease-related fees.
Fifth Third’s team of commercial bankers is committed
to a single goal – building solid relationships with our
business partners by quickly and efficiently matching
products and services to their needs. Fifth Third
offers a comprehensive product set from traditional
commercial and industrial lending, to real estate and
leasing, to corporate and international finance, trade
facilitation and payment solutions. Our extensive
cash management expertise spans across industries
and international borders. Fifth Third offers
dedicated teams and strategic partnerships ready to
assist companies in improving cash flow and growing
their business.
Sales force additions and increasing productivity
drove significant market share gains across our
footprint in 2005. The resulting customer growth and
sales of corporate treasury management products
resulted in 14 percent growth in average commercial
demand deposits and 23 percent average commercial
loan and lease growth. Related deposit service
revenues were essentially unchanged from 2004 levels,
fully overcoming the negative impact on deposit
revenues from increasing earnings credit rates on
compensating balances.
The depth and breadth of Fifth Third’s commercial
relationships can be seen in commercial noninterest
income performance in 2005. Commercial banking
revenue increased 22 percent over 2004 with
widespread strength across numerous subcategories.
Foreign exchange revenues increased by 16 percent,
and international letter of credit revenues increased
by 15 percent, driving 15 percent growth in
international related revenues overall. New customer
additions and increasing loan demand throughout
the year contributed to 49 percent growth in
commercial loan- and lease-related fees. Separately,
corporate finance also delivered very strong growth
with a 142 percent increase in customer interest rate
derivative sales revenue.
15
processing solutions
focused
on growth.
Fifth Third Processing Solutions (FTPS),
our electronic payment processing division,
initiates, captures, authorizes and settles electronic
payment transactions as part of integrated cash
management solutions for financial institutions,
merchants and consumers all over the world.
As a leading electronic payment processor, we
help our customers eliminate paper and reduce
cycle time and expense while providing instant
online access to information through a platform
integrated with traditional banking services.
With robust systems architecture, including three
world-class data centers, we provide a highly
reliable processing environment for even the
most demanding processing applications.
FTPS Revenue
$735
$622
$575
$512
$ millions
800
700
600
500
400
300
200
100
$347
$252
16
2000
2001
2002
2003
2004
2005
FTPS currently drives approximately 12,500
automated teller machines and supports more
than 33 million debit cards for approximately 1,500
financial institutions around the world. In 2005,
financial institution and card revenues increased
by 21 percent over the prior year.
As one of the few processors that can offer customers
a complete array of financial services solutions,
the outlook for FTPS remains as bright as ever.
In Merchant Services, FTPS is building upon its core
competencies in large merchant processing and
increasing profit margins by continuing recent
momentum in the penetration of the middle market
channel. The Financial Institutions group continues to
see significant growth potential through the expansion
of relationships with existing customers and by
increasing the card issuer base through upstream
participation of large financial institutions. FTPS is
also experiencing significant success in partnering with
retail teammates in the expansion of Fifth Third’s
credit card portfolio through increased focus and
enhanced point-of-sale approval strategies.
FTPS had another outstanding year and delivered
an 18 percent increase in annual revenues. Exclusive
of the impact of the 2004 sales of certain third-party
sourced merchant processing contracts, electronic
payment processing revenue increased 23 percent. In
2005, FTPS processed more than 16.4 billion
electronic transactions, an increase of 33 percent over
2004 and double the number processed just three
years ago. FTPS operates three primary businesses –
Merchant Services, Financial Institution and Card
Services.
Our Merchant Services group provides over 127,000
merchant locations with debit, credit and stored-value
payment processing. For more than three decades,
Fifth Third has been trusted by the nation’s top
retailers and businesses to provide superior card
acceptance solutions. At Fifth Third, we understand
that all merchants are not the same. We have
developed flexible system architecture with a wealth of
technology options and processing features capable of
meeting the individual requirements of any business.
Among the largest bankcard acquirers in the nation,
FTPS currently processes annual credit and debit card
volume of nearly $200 billion. In 2005, merchant
revenues increased by 15 percent, or 27 percent on a
core basis.
Our Financial Institution and Card Services groups
together provide a complete global payments solution
delivered with a consultative approach from one of the
nation’s leading financial institutions. We act as a
business advisor to our clients, forging strategic
partnerships and creating solutions that enable revenue
enhancements while simultaneously reducing costs.
Customers are provided with a full array of capabilities
including correspondent banking services, Check 21
processing and support, automated teller machine
processing, credit and debit card management,
network gateway access, fraud monitoring services
and international banking.
17
investment advisors
focused on
wealth creation.
Fifth Third Investment Advisors is a full-service
money management business with $33 billion in
assets under management and $196 billion in
assets under care. Fifth Third takes a careful,
disciplined approach to investing client assets
and delivers a full spectrum of investment
strategies of varying scope and complexity for
both long- and short-term investment horizons.
Our broad array of equity and fixed income
products are offered through separately
managed portfolios, daily-valued collective
funds, lifestyle funds and our nationally
recognized mutual funds*.
2005 Revenue Mix
Private Client
66%
Asset Management
5%
Retail Brokerage
15%
Institutional
14%
18
*For important disclosures, see the bottom of page 31.
• Trust Services
Dedicated to servicing wealth across generations
with trust strategies that help preserve wealth
and provide for efficient transfer to heirs
or charitable institutions.
• Private Banking
Comprehensive services designed to meet
traditional and specialized banking needs,
including personal checking and cash
management, mortgage loans, lines of credit
and other customized solutions.
• Wealth Protection
Specialized tools and techniques to safeguard
wealth, including customized hedging and
diversification strategies, as well as tailored
insurance strategies for wealth creation,
preservation and business planning.
Investment advisory revenues were essentially
unchanged in 2005, but ended the year on a positive
note with fourth quarter revenues increasing five
percent over the prior year. Modest revenue
performance in 2005 resulted primarily from declines
in brokerage-related revenues.
Fifth Third continues to focus its efforts on improving
execution in retail brokerage and growing the
institutional money management business by improving
penetration and cross-sell of money management
products and 401(k) plans into our large middle
market commercial customer base. Success in these
efforts will help drive growth and diversification of
revenues in 2006.
Fifth Third’s institutional investment professionals help
commercial clients manage their assets more efficiently
and profitably, provide retirement planning for their
employees and achieve their financial goals through a
range of innovative services.
Fifth Third Asset Management (FTAM) professionals
are committed to helping clients successfully manage
investment funds by taking the time to learn their needs
and carefully creating individualized plans tailored to
their risk, reward and liquidity objectives. FTAM
provides advisory services for a long list of institutional
clients including states and municipalities, Taft-Hartley
plans, pension and profit sharing plans and foundations
and endowments.
Fifth Third’s retail brokerage business encompasses
over 2,400 full-time licensed securities representatives
deployed throughout the affiliate network. Our
brokerage sales force is focused on working closely with
banking center personnel to deepen customer
relationships and meet all of the financial services needs
of our retail customers. Fifth Third’s experienced team
of financial advisors offers customers sound advice to
achieve well-diversified portfolios that remain aligned
with long-term financial goals.
Fifth Third’s private client group creates individualized,
comprehensive solutions to assist our customers in
achieving financial success including:
• Wealth Planning
Expert advice concerning life event planning, cash
flow and tax efficiency analysis, benefit and stock
option optimization, wealth transfer, business
succession and tax and estate planning strategies.
• Investment Services
Investment strategies constructed around specific
objectives offering choices between managed
portfolios and self-directed brokerage services
available through Fifth Third Securities.
19
committed to our neighbors & community
focused
on community.
The Foundation Office administers grants on behalf of the
Fifth Third Foundation and the eight charitable trusts
for which the bank serves as trustee. The primary areas of giving
for the Fifth Third Foundation are arts & culture, community
development, education and health & human services.
In 2005, the Fifth Third Foundation announced a
matching gift of $500,000 to the American Veterans
Disabled for Life Memorial, which is to be built near
the National Mall in Washington, D.C. in 2010. The
gift was the first corporate foundation gift for the
Memorial, which will be the first to honor all of
America’s disabled veterans.
Fifth Third Community Development Corporation
invests in low-income housing, historic tax credit and
economic development projects to support community
revitalization in neighborhoods throughout the Fifth
Third footprint.
Our Community Affairs department identifies lending
and real estate opportunities in traditionally
underserved markets, such as ethnically diverse, urban
and low- to moderate-income census tracts. This
group also champions financial literacy by providing
homebuyer training, credit counseling and college
savings match programs.
United Way Giving
Over the past five years, Fifth Third’s corporate
and employee contributions to the United Way
have reached $44.2 million.
2005 was a year marked by natural disasters –
hurricanes Katrina and Rita changed the landscape of
our country and caused an outpouring of generosity
from individuals from all walks of life. Fifth Third
employees were no different. Many volunteered at
disaster collection stations, some held fundraisers, while
still others made contributions to organizations such as
the United Way and the American Red Cross. In honor
of its nearly 22,000 employees, Fifth Third donated
$500,000 to the 2005 disaster relief effort.
$ millions
12
11
10
9
8
7
6
5
4
3
2
1
United Way Giving
$10.9
$10.4
$9.0
$7.4
$6.5
2001
2002
2003
2004
2005
20
FIFTH THIRD BANCORP
2005 ANNUAL REPORT
FINANCIAL CONTENTS
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Selected Financial Data
Overview
Recent Accounting Standards
Critical Accounting Policies
Risk Factors
Statements of Income Analysis
Business Segment Review
Fourth Quarter Review
Balance Sheet Analysis
Risk Management
Controls and Procedures
Management’s Assessment as to the Effectiveness of Internal Control over Financial Reporting
Reports of Independent Registered Public Accounting Firm
Financial Statements
Consolidated Statements of Income
Consolidated Balance Sheets
Consolidated Statements of Changes in Shareholders’ Equity
Consolidated Statements of Cash Flows
Notes to the Consolidated Financial Statements
Summary of Significant Accounting and Reporting Policies
Securities
Loans and Leases and Allowance for Loan and Lease Losses
Bank Premises and Equipment
Goodwill
Intangible Assets
Servicing Rights
Derivatives
Other Assets
Short-Term Borrowings
Long-Term Debt
Commitments and Contingent Liabilities
Legal and Regulatory Proceedings
Guarantees
Related Party Transactions
Annual Report on Form 10-K
Consolidated Ten Year Comparison
Directors and Officers
Corporate Information
54
59
60
61
61
62
62
63
65
65
66
67
67
68
69
Other Comprehensive Income
Common Stock and Treasury Stock
Stock-Based Compensation
Other Noninterest Income and Other Noninterest Expense
Sales and Transfers of Loans
Discontinued Operations
Income Taxes
Retirement and Benefit Plans
Earnings Per Share
Fair Value of Financial Instruments
Business Combinations
Certain Regulatory Requirements and Capital Ratios
Parent Company Financial Statements
Segments
22
23
24
24
26
28
33
35
36
38
47
48
49
50
51
52
53
69
69
70
71
72
73
74
75
76
76
77
78
79
79
81
89
90
91
FORWARD-LOOKING STATEMENTS
This report may contain forward-looking statements about Fifth Third Bancorp and/or the company as combined acquired entities within the meaning of Sections 27A
of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and 21E of the Securities Exchange Act of 1934, as amended, and Rule 3b-6
promulgated thereunder, that involve inherent risks and uncertainties. This report may contain certain forward-looking statements with respect to the financial condition,
results of operations, plans, objectives, future performance and business of Fifth Third Bancorp and/or the combined company including statements preceded by,
followed by or that include the words or phrases such as “believes,” “expects,” “anticipates,” “plans,” “trend,” “objective,” “continue,” “remain” or similar expressions
or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may” or similar expressions. There are a number of important factors that
could cause future results to differ materially from historical performance and these forward-looking statements. Factors that might cause such a difference include, but
are not limited to: (1) competitive pressures among depository institutions increase significantly; (2) changes in the interest rate environment reduce interest margins; (3)
prepayment speeds, loan origination and sale volumes, charge-offs and loan loss provisions; (4) general economic conditions, either national or in the states in which
Fifth Third, one or more acquired entities and/or the combined company do business, are less favorable than expected; (5) political developments, wars or other
hostilities may disrupt or increase volatility in securities markets or other economic conditions; (6) changes and trends in the securities markets; (7) legislative or
regulatory changes or actions, or significant litigation, adversely affect Fifth Third, one or more acquired entities and/or the combined company or the businesses in
which Fifth Third, one or more acquired entities and/or the combined company are engaged; (8) difficulties in combining the operations of acquired entities and (9) the
impact of reputational risk created by the developments discussed above on such matters as business generation and retention, funding and liquidity. Fifth Third
undertakes no obligation to release revisions to these forward-looking statements or reflect events or circumstances after the date of this report.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is management’s discussion and analysis of certain significant factors that have affected Fifth Third Bancorp’s (the
“Bancorp” or “Fifth Third”) financial condition and results of operations during the periods included in the Consolidated Financial
Statements, which are a part of this report. Reference to the Bancorp incorporates the parent holding company and all consolidated
subsidiaries.
TABLE 1: SELECTED FINANCIAL DATA
For the years ended December 31 ($ in millions, except per share data)
Income Statement Data
Net interest income (a)
Noninterest income
Total revenue (a)
Provision for loan and lease losses
Noninterest expense
Net income
Common Share Data
Earnings per share, basic
Earnings per share, diluted
Cash dividends per common share
Book value per share
Dividend payout ratio, as originally reported
Financial Ratios
Return on average assets
Return on average equity
Average equity as a percent of average assets
Net interest margin (a)
Efficiency (a)
Credit Quality
Net losses charged off
Net losses charged off as a percent of average loans and leases
Allowance for loan and lease losses as a percent of loans and leases (b)
Allowance for credit losses as a percent of loans and leases (b)
Nonperforming assets as a percent of loans, leases and other assets,
including other real estate owned
Underperforming assets as a percent of loans, leases and other assets,
including other real estate owned
2005
$2,996
2,500
5,496
330
2,927
1,549
$2.79
2.77
1.46
17.00
52.7 %
1.50 %
16.6
9.06
3.23
53.2
$299
.45 %
1.06
1.16
.52
.74
2004
3,048
2,465
5,513
268
2,972
1,525
2.72
2.68
1.31
16.00
48.9
1.61
17.2
9.34
3.48
53.9
252
.45
1.19
1.31
.51
.74
2003
2,944
2,483
5,427
399
2,551
1,665
2.91
2.87
1.13
15.29
39.4
1.90
19.0
10.01
3.62
47.0
312
.63
1.33
1.47
.61
.89
2002
2,738
2,183
4,921
246
2,337
1,531
2.64
2.59
.98
14.98
37.8
2.04
18.4
11.08
3.96
47.5
187
.43
1.49
1.49
.59
.95
2001
2,476
1,788
4,264
236
2,453
1,002
1.74
1.70
.83
13.31
48.8
1.42
13.6
10.40
3.82
57.5
227
.54
1.50
1.50
.57
.96
Average Balances
Loans and leases, including held for sale
Total securities and other short-term investments
Total assets
Transaction deposits
Core deposits
Interest-bearing deposits
Short-term borrowings
Long-term debt
Shareholders’ equity
Regulatory Capital Ratios
Tier I capital
Total risk-based capital
Tier I leverage
(a) Amounts presented on a fully taxable equivalent basis (“FTE”).
(b) At December 31, 2004, the reserve for unfunded commitments was reclassified from the allowance for loan and lease losses to other liabilities. The 2003 year-end reserve for unfunded commitments
$67,737
24,999
102,876
47,929
56,420
50,520
9,511
16,384
9,317
52,414
28,947
87,481
40,370
46,796
44,008
12,373
8,747
8,754
57,042
30,597
94,896
43,175
49,383
43,908
13,539
13,323
8,860
44,888
19,938
70,683
26,363
39,836
38,255
8,799
6,301
7,348
45,539
23,585
75,037
35,819
44,674
39,976
7,191
7,640
8,317
8.38 %
10.45
8.08
11.11
13.56
9.23
11.84
13.65
9.84
10.31
12.31
8.89
12.49
14.55
10.64
has been reclassified to conform to the current year presentation. The allowance for credit losses is the sum of the allowance for loan and lease losses and the reserve for unfunded commitments.
TABLE 2: QUARTERLY INFORMATION (unaudited)
For the three months ended ($ in millions, except per share data)
Net interest income (FTE)
Provision for loan and lease losses
Noninterest income
Noninterest expense
Net income
Earnings per share, basic
Earnings per share, diluted
12/31
$735
134
636
763
332
.60
.60
2005
9/30
745
69
622
732
395
.71
.71
6/30
758
60
635
728
417
.75
.75
3/31
759
67
607
705
405
.73
.72
12/31
752
65
479
935
176
.31
.31
2004
9/30
766
26
611
648
471
.84
.83
6/30
771
90
749
742
448
.80
.79
3/31
759
87
626
648
430
.76
.75
22
Fifth Third Bancorp
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
This overview of management’s discussion and analysis highlights
selected information in the financial results of the Bancorp and
may not contain all of the information that is important to you. For
a more complete understanding of trends, events, commitments,
uncertainties, liquidity, capital resources, risk factors and critical
accounting policies and estimates, you should carefully read this
entire document. Each of these items could have an impact on the
Bancorp’s financial condition and results of operations.
The Bancorp is a diversified financial services company
headquartered in Cincinnati, Ohio. The Bancorp has $105.2 billion
in assets and operates 19 affiliates with 1,119 full-service Banking
Centers and 2,024 Jeanie® ATMs in Ohio, Kentucky, Indiana,
Michigan, Illinois, Florida, Tennessee, West Virginia, Pennsylvania
and Missouri. The financial strength of the Bancorp’s largest banks,
Fifth Third Bank and Fifth Third Bank (Michigan), continues to be
recognized by rating agencies with deposit ratings of AA- and Aa1
from Standard & Poor’s and Moody’s, respectively. Additionally,
the Bancorp is recognized by Moody’s with a senior debt rating of
Aa2. The Bancorp operates four main businesses: Commercial
Banking, Retail Banking, Investment Advisors and Fifth Third
Processing Solutions (“FTPS”).
Fifth Third believes that banking is first and foremost a
relationship business where the strength of the competition and
challenges for growth can vary in every market. Our affiliate
operating model provides a competitive advantage by keeping the
decisions close to the customer and by emphasizing individual
relationships. Through our affiliate operating model, individual
managers, from the banking center to the executive level, are given
the opportunity to tailor financial solutions for their customers.
The Bancorp’s revenues are fairly evenly dependent on net
interest income and noninterest income. During 2005, net interest
income, on a fully taxable equivalent (“FTE”) basis, and
noninterest income provided 54% and 46% of total revenue,
respectively. Therefore, changes in interest rates, credit quality,
economic trends and the capital markets are primary factors that
drive the performance of the Bancorp. As discussed later in the
identification, measurement,
Risk Management section, risk
monitoring, control and
the
important
management of risk and to the continuation of the strong financial
performance and capital strength of the Bancorp.
reporting are
to
Net interest income, which continues to be the Bancorp’s
largest revenue source, is the difference between interest income
earned on assets such as loans, leases and securities, and interest
expense paid on liabilities such as deposits and borrowings. Net
interest income is affected by the general level of interest rates, the
relative level of short-term and long-term interest rates, changes in
interest rates and changes in the amount and composition of
interest-earning assets and interest-bearing liabilities. Generally,
the rates of interest the Bancorp earns on its assets and owes on its
liabilities are established for a period of time. The change in market
interest rates over time exposes the Bancorp to interest rate risk
through potential adverse changes in net interest income and
financial position. The Bancorp manages this risk by continually
analyzing and adjusting the composition of its assets and liabilities
based on their payment streams and interest rates, the timing of
their maturities and their sensitivity to changes in market interest
rates. Additionally, in the ordinary course of business, the Bancorp
enters into certain derivative transactions as part of its overall
strategy to manage its interest rate and prepayment risks.
The Bancorp is also exposed to the risk of losses on its loan
and lease portfolio as a result of changing expected cash flows
caused by loan defaults and inadequate collateral, among other
factors.
Noninterest income is derived primarily from electronic funds
transfer (“EFT”) and merchant transaction processing fees,
fiduciary and investment management fees, banking fees and
service charges and mortgage banking revenue.
Net interest income, net interest margin, net interest rate
spread and the efficiency ratio are presented in Management’s
Discussion and Analysis of Financial Condition and Results of
Operations on an FTE basis. The FTE basis adjusts for the tax-
favored status of income from certain loans and securities held by
the Bancorp that are not taxable for federal income tax purposes.
The Bancorp believes this measure to be the preferred industry
measurement of net interest income as it provides a relevant
comparison between taxable and non-taxable amounts.
Fiscal 2005 was a challenging year. The continued flattening
of the yield curve, reduction in contribution from the largely fixed-
rate securities portfolio, increased operating costs largely related to
sales force additions, technology and de-novo investments and
elevated charge-off experience in the fourth quarter contributed to
nominal earnings per share growth and flat revenue performance
for the year. The Bancorp did, however, continue to experience
strong loan growth as well as a rebound in deposit growth trends
following the implementation of the new deposit pricing strategy in
the second half of 2005. Although net interest income will
continue to be negatively impacted in 2006 by the overall
contribution from and continued reductions in the securities
portfolio, the benefits from the recent investments in the banking
center distribution network, sales force expansion and technology
infrastructure should drive improved financial trends in 2006.
The Bancorp completed its acquisition of First National
Bankshares of Florida, Inc. (“First National”), a bank holding
company with $5.6 billion in assets located primarily in Orlando,
Tampa, Sarasota, Naples and Fort Myers, on January 1, 2005. The
Bancorp completed its conversion activity associated with the First
National acquisition in the first quarter of 2005. As of December
31, 2005, the Bancorp’s Florida affiliates have 86 full-service
locations, of which 74 were acquired as part of the First National
acquisition.
The Bancorp’s net income was $1.55 billion in 2005, a two
percent increase compared to $1.53 billion in 2004. Earnings per
diluted share were $2.77 in 2005, a three percent increase from
$2.68 in 2004. The Bancorp’s dividend in 2005 increased to $1.46
per common share from $1.31, an increase of 11%.
Net interest income (FTE) decreased two percent compared
to 2004. The net interest margin decreased from 3.48% in 2004 to
3.23% in 2005 largely due to the rise in short-term interest rates,
the impact of the primarily fixed-rate securities portfolio and mix
shifts within the core deposit base. Noninterest income was flat,
predominantly due to the $157 million pre-tax gain recognized in
2004 on the sales of certain third-party sourced merchant
processing contracts. Excluding the impact of the pre-tax gain,
noninterest income increased eight percent largely due to an 18%
increase in electronic payment processing revenue. Excluding the
impact of 2004 debt retirement charges, noninterest expense
increased 11% compared to last year, primarily due to increases in
marketing, information technology, volume-related bankcard costs
and the significant investments in the sales force and retail
distribution network. Compared to 2004, average sales personnel
increased by approximately 1,400 and 63 new banking centers have
opened, excluding relocations, as well as the 70 net new Florida
banking centers as a result of the acquisition of First National.
Credit quality metrics deteriorated during the fourth quarter of
2005 with full-year net charge-offs increasing 19% over 2004 as a
result of certain commercial airline bankruptcies and an increase in
consumer bankruptcies declared prior to the recently enacted
reform legislation. Despite a ratio of .67% in the fourth quarter of
2005, net charge-offs as a percent of average loans and leases
remained at .45% in 2005. Nonperforming assets as a percent of
loans and leases were .52% at December 31, 2005 compared to
.51% at December 31, 2004.
Fifth Third Bancorp 23
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Bancorp’s capital ratios exceed the “well-capitalized”
guidelines as defined by the Board of Governors of the Federal
Reserve System (“FRB”). As of December 31, 2005, the Tier I
capital ratio was 8.38% and the Total risk-based capital ratio was
10.45%. The Bancorp’s capital strength and financial stability have
enabled the Bancorp to maintain a Moody’s credit rating that is
equaled or surpassed by only four other U.S. bank holding
companies.
RECENT ACCOUNTING STANDARDS
In December 2002, the Financial Accounting Standards Board
(“FASB”) issued Statement of Financial Accounting Standard
(“SFAS”) No. 148, “Accounting for Stock-Based Compensation-
Transition and Disclosure—an Amendment of FASB Statement
No. 123.” This Statement provides alternative methods of
transition for a voluntary change to the fair value method of
accounting for stock-based employee compensation. Effective
January 1, 2004, the Bancorp adopted the fair value recognition
provisions of SFAS No. 123 using the retroactive restatement
method described in SFAS No. 148. As a result, financial
information for all periods prior to 2004 has been restated to
reflect the compensation expense that would have been recognized
had the fair value method of accounting been applied to all awards
Stock-based
granted to employees after January 1, 1995.
loss experience and such factors that,
CRITICAL ACCOUNTING POLICIES
Allowance for Loan and Lease Losses
The Bancorp maintains an allowance to absorb probable loan and
lease losses inherent in the portfolio. The allowance is maintained
at a level the Bancorp considers to be adequate and is based on
ongoing quarterly assessments and evaluations of the collectibility
and historical loss experience of loans and leases. Credit losses are
charged and recoveries are credited to the allowance. Provisions
for loan and lease losses are based on the Bancorp’s review of the
historical credit
in
management’s judgment, deserve consideration under existing
economic conditions in estimating probable credit losses. In
determining the appropriate level of the allowance, the Bancorp
estimates
losses using a range derived from “base” and
“conservative” estimates. The Bancorp’s strategy for credit risk
management includes a combination of conservative exposure
limits significantly below legal lending limits and conservative
underwriting, documentation and collections standards. The
strategy also emphasizes diversification on a geographic, industry
and customer level, regular credit examinations and quarterly
management reviews of
loans
experiencing deterioration of credit quality.
large credit exposures and
Larger commercial loans that exhibit probable or observed
credit weaknesses are subject to individual review. Where
appropriate, allowances are allocated to individual loans based on
management’s estimate of the borrower’s ability to repay the loan
given the availability of collateral, other sources of cash flow and
legal options available to the Bancorp. The review of individual
loans includes those loans that are impaired as provided in SFAS
No. 114, “Accounting by Creditors for Impairment of a Loan.”
Any allowances for impaired loans are measured based on the
present value of expected future cash flows discounted at the loan’s
effective interest rate or fair value of the underlying collateral. The
Bancorp evaluates the collectibility of both principal and interest
when assessing the need for loss accrual. Historical loss rates are
applied to other commercial loans not subject to specific allowance
allocations. The loss rates are derived from a migration analysis,
which computes the net charge-off experience sustained on loans
according to their internal risk grade. The risk grading system
utilized
ten
categories. The Bancorp also maintains a dual risk rating system
that provides for 13 probability of default grade categories and an
for allowance analysis purposes encompasses
24
Fifth Third Bancorp
The Bancorp continues to invest in the geographic areas that
offer the best growth prospects, as it believes this is the most cost
efficient method of expansion within its largest affiliate markets.
The Bancorp opened 63 new banking centers during 2005,
excluding relocations, with a net increase of 34, excluding
acquisitions. The Bancorp plans to continue adding banking
centers in key markets during 2006 with a planned addition of
approximately 50 net new locations during the year.
compensation expense is included in salaries, wages and incentives
expense in the Consolidated Statements of Income.
This Statement
In December 2004, the FASB issued SFAS No. 123 (Revised
2004), “Share-Based Payment.”
requires
measurement of the cost of employee services received in exchange
for an award of equity instruments based on the grant-date fair
value of the award with the cost to be recognized over the service
period. As the Bancorp has previously adopted the fair value
recognition provisions of SFAS No. 123 and the retroactive
restatement method described in SFAS No. 148, the adoption of
this Statement will not have a material impact on the Bancorp’s
Consolidated Financial Statements.
See Note 1 of the Notes to the Consolidated Financial
Statements for discussion of certain proposal stage accounting
literature developments.
additional six grade categories measuring loss factors given an
event of default. The probability of default and loss given default
analyses are not separated in the ten grade risk rating system. The
Bancorp is in the process of completing significant validation and
testing of the dual risk rating system prior to implementation for
allowance analysis purposes. The dual risk rating system is
consistent with Basel II expectations and allows for more precision
in the analysis of commercial credit risk.
Homogenous loans and leases, such as consumer installment,
residential mortgage and automobile leases are not individually risk
graded. Rather, standard credit scoring systems and delinquency
monitoring are used to assess credit risks. Allowances are
established for each pool of loans based on the expected net
charge-offs for one year. Loss rates are based on the average net
charge-off history by loan category.
Historical loss rates for commercial and consumer loans may
be adjusted for significant factors that, in management’s judgment,
reflect the impact of any current conditions on loss recognition.
Factors that management considers in the analysis include the
effects of the national and local economies, trends in the nature
and volume of loans (delinquencies, charge-offs and nonaccrual
loans), changes in mix, credit score migration comparisons, asset
quality trends, risk management and loan administration, changes
in the internal lending policies and credit standards, collection
practices and examination results from bank regulatory agencies
and the Bancorp’s internal credit examiners.
An unallocated allowance is maintained to recognize the
imprecision in estimating and measuring loss when evaluating
allowances for individual loans or pools of loans. Allowances on
individual loans and historical loss rates are reviewed quarterly and
adjusted as necessary based on changing borrower and/or
collateral conditions and actual collection and charge-off
experience.
Loans acquired by the Bancorp through a purchase business
impairment.
combination are evaluated for possible credit
Reduction to the carrying value of the acquired loans as a result of
credit impairment is recorded as an adjustment to goodwill. The
Bancorp does not carry over the acquired company’s allowance for
loan and lease losses nor does the Bancorp add to its existing
allowance for the acquired loans as part of purchase accounting.
The Bancorp’s determination of the allowance for commercial
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
loans is sensitive to the credit risk ratings it assigns to these loans.
In the event that 10% of commercial loans in each risk category
experienced downgrades of one risk category, the allowance for
commercial loans would have increased by approximately $69
million at December 31, 2005. The Bancorp’s determination of the
allowance for residential and retail loans is sensitive to changes in
estimated loss rates. In the event that estimated loss rates increased
by 10%, the allowance for residential and retail loans would have
increased by approximately $23 million at December 31, 2005.
Because several quantitative and qualitative factors are considered
in determining the allowance for loan and lease losses, these
sensitivity analyses do not necessarily reflect the nature and extent
of future changes in the allowance for loan and lease losses. They
are intended to provide insights into the impact of adverse changes
in risk rating and inherent losses and do not imply any expectation
of future deterioration in the risk rating or loss rates. Given current
processes employed by the Bancorp, management believes the risk
ratings and inherent loss rates currently assigned are appropriate.
The Bancorp’s primary market areas for lending are Ohio,
Kentucky, Indiana, Michigan, Illinois, Florida, Tennessee, West
Virginia and Pennsylvania. When evaluating the adequacy of
allowances, consideration is given to this regional geographic
concentration and the closely associated effect changing economic
conditions have on the Bancorp’s customers.
In the current year, the Bancorp has not substantively changed
any aspect to its overall approach in the determination of allowance
for loan and lease losses. There have been no material changes in
assumptions or estimation techniques as compared to prior periods
that impacted the determination of the current period allowance
for loan and lease losses. Based on the procedures discussed
above, the Bancorp is of the opinion that the allowance of $744
million was adequate, but not excessive, to absorb estimated credit
losses associated with the loan and lease portfolio at December 31,
2005.
losses related
Reserve for Unfunded Commitments
The reserve for unfunded commitments is maintained at a level
believed by management to be sufficient to absorb estimated
to unfunded credit facilities. The
probable
determination of the adequacy of the reserve is based upon an
evaluation of the unfunded credit facilities, including an assessment
of historical commitment utilization experience, credit risk grading
and credit grade migration. Net adjustments to the reserve for
unfunded commitments are included in other noninterest expense.
Taxes
The Bancorp estimates income tax expense based on amounts
expected to be owed to the various tax jurisdictions in which the
Bancorp conducts business. On a quarterly basis, management
assesses the reasonableness of its effective tax rate based upon its
current estimate of the amount and components of net income, tax
credits and the applicable statutory tax rates expected for the full
year. The estimated income tax expense is recorded in the
Consolidated Statements of Income.
Deferred income tax assets and liabilities are determined using
the balance sheet method and are reported in accrued taxes,
interest and expenses in the Consolidated Balance Sheet. Under
this method, the net deferred tax asset or liability is based on the
tax effects of the differences between the book and tax basis of
assets and liabilities, and recognizes enacted changes in tax rates
and
Deferred tax assets are recognized subject to
management judgment that realization is more likely than not.
laws.
Accrued taxes represent the net estimated amount due or to
be received from taxing jurisdictions and are reported in accrued
taxes, interest and expenses in the Consolidated Balance Sheets.
The Bancorp evaluates and assesses the relative risks and
appropriate tax treatment of transactions and filing positions after
considering statutes, regulations, judicial precedent and other
its
information and maintains tax accruals consistent with
evaluation of these relative risks and merits. Changes to the
estimate of accrued taxes occur periodically due to changes in tax
rates, interpretations of tax laws, the status of examinations being
conducted by taxing authorities and changes to statutory, judicial
and regulatory guidance that impact the relative risks of tax
positions. These changes, when they occur, can affect deferred
taxes and accrued taxes as well as the current period’s income tax
expense and can be significant to the operating results of the
Bancorp. As described in greater detail in Note 13 of the Notes to
the Consolidated Financial Statements, the Internal Revenue
Service is currently challenging the Bancorp’s tax treatment of
certain leasing transactions. For additional information, see Note
22 of the Notes to the Consolidated Financial Statements.
Valuation of Servicing Rights
When the Bancorp sells loans through either securitizations or
individual loan sales in accordance with its investment policies, it
often retains servicing rights. Servicing rights resulting from loan
sales are amortized in proportion to and over the period of
estimated net servicing revenues. Servicing rights are assessed for
impairment monthly, based on fair value, with temporary
impairment recognized
through a valuation allowance and
permanent impairment recognized through a write-off of the
servicing asset and related valuation allowance. Key economic
assumptions used in measuring any potential impairment of the
servicing rights include the prepayment speeds of the underlying
loans, the weighted-average life of the loan, the discount rate, the
weighted-average coupon and the weighted-average default rate, as
applicable. The primary risk of material changes to the value of the
servicing rights resides in the potential volatility in the economic
assumptions used, particularly the prepayment speeds.
The Bancorp monitors risk and adjusts its valuation allowance
as necessary to adequately reserve for any probable impairment in
the portfolio. For purposes of measuring impairment, the
servicing rights are stratified based on the financial asset type and
interest rates. In addition, the Bancorp obtains an independent
third-party valuation of mortgage servicing rights (“MSR”) on a
quarterly basis. Fees received for servicing loans owned by
investors are based on a percentage of the outstanding monthly
principal balance of such loans and are included in noninterest
income as loan payments are received. Costs of servicing loans are
charged to expense as incurred.
The change in the fair value of MSRs at December 31, 2005,
due to immediate 10% and 20% adverse changes in the current
prepayment assumption would be approximately $19 million and
$38 million, respectively, and due to immediate 10% and 20%
favorable changes in the current prepayment assumption would be
approximately $21 million and $43 million, respectively. The
change in the fair value of the MSR portfolio at December 31,
2005, due to immediate 10% and 20% adverse changes in the
discount rate assumption would be approximately $16 million and
$31 million, respectively, and due to immediate 10% and 20%
favorable changes in the discount rate assumption would be
approximately $17 million and $36 million, respectively. Sensitivity
analysis related to other consumer and commercial servicing rights
is not material to the Bancorp’s Consolidated Financial Statements.
These sensitivities are hypothetical and should be used with
caution. As the figures indicate, change in fair value based on a
10% and 20% variation in assumptions typically cannot be
extrapolated because the relationship of the change in assumptions
to change in fair value may not be linear. Also, the effect of
variation in a particular assumption on the fair value of the retained
interests is calculated without changing any other assumption; in
reality, changes in one factor may result in changes in another,
which might magnify or counteract the sensitivities. Additionally,
the effect of the Bancorp’s non-qualifying hedging strategy, which
is maintained to lessen the impact of changes in value of the MSR
portfolio, is excluded from the above analysis.
Fifth Third Bancorp 25
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RISK FACTORS
General economic conditions, either national or in the states
within Fifth Third’s footprint, are less favorable than
expected.
The Bancorp is affected by general economic conditions in the
United States and, in particular, the states within its footprint,
which covers much of the Midwest and Florida. An economic
downturn within the Bancorp’s footprint or the nation as a whole
could negatively impact household and corporate incomes. This
impact may lead to decreased demand for both loan and deposit
products and increase the number of customers who fail to pay
interest or principal on their loans.
its merchant and financial
The revenues of FTPS are dependent on the transaction
institution
volume generated by
customers, which is largely dependent on consumer and corporate
spending. If consumer confidence suffers and retail sales decline,
FTPS will be negatively impacted. Similarly, if an economic
downturn results in a decrease in the overall volume of corporate
transactions, FTPS will be negatively impacted. FTPS is also
impacted by the financial stability of its merchant customers.
FTPS assumes certain contingent
the
processing of Visa® and MasterCard® merchant card transactions.
These liabilities typically arise from billing disputes between the
merchant and the cardholder that are ultimately resolved in favor
of the cardholder. These transactions are charged back to the
merchant and disputed amounts are returned to the cardholder. If
FTPS is unable to collect these amounts from the merchant, it will
bear the loss.
liabilities related
to
The fee revenue of Investment Advisors is largely dependent
on the fair market value of assets under care and trading volumes
in the brokerage business. General economic conditions and their
subsequent effect on the securities markets tend to act in a
correlation. When general economic conditions deteriorate,
consumer and corporate confidence in securities markets erodes,
and Investment Advisors’ revenues are negatively impacted as asset
values and trading volumes decrease. Neutral economic conditions
can also negatively impact revenue when stagnant securities
markets fail to attract investors.
If Fifth Third does not adjust to rapid changes in the
financial services industry, its financial performance may
suffer.
The Bancorp’s ability to deliver strong financial performance and
returns on investment to shareholders will depend in part on its
ability to expand the scope of available financial services offerings
to meet the needs and demands of its customers. In addition to the
challenge of competing against other banks in attracting and
retaining customers for traditional banking services, the Bancorp’s
competitors also include securities dealers, brokers, mortgage
bankers, investment advisors, specialty finance and insurance
companies who seek to offer one-stop financial services that may
include services that banks have not been able or allowed to offer
to their customers in the past. The increasingly competitive
environment is primarily a result of changes in regulation, changes
in technology and product delivery systems and the accelerating
pace of consolidation among financial service providers.
Legislative or regulatory changes or actions, or significant
litigation, could adversely impact Fifth Third or the
businesses in which Fifth Third is engaged.
The Bancorp is subject to extensive state and federal regulation,
supervision and legislation that govern almost all aspects of its
operations. Laws and regulations may change from time to time
and are primarily intended for the protection of consumers,
depositors and the deposit insurance funds. The impact of any
changes to laws and regulations or other actions by regulatory
agencies may negatively impact the Bancorp or its ability to
its business. Additionally, actions by
increase the value of
26
Fifth Third Bancorp
regulatory agencies or significant litigation against the Bancorp
could cause it to devote significant time and resources to defending
itself and may lead to penalties that materially affect the Bancorp
and its shareholders. Future changes in the laws or regulations or
their interpretations or enforcement could be materially adverse to
the Bancorp and its shareholders.
Fifth Third is exposed to operational risk.
Similar to any large corporation, the Bancorp is exposed to many
types of operational risk, including reputational risk, legal and
compliance risk, the risk of fraud or theft by employees or
outsiders, unauthorized transactions by employees or operational
errors, including clerical or record-keeping errors or those resulting
from faulty or disabled computer or telecommunications systems.
Negative public opinion can result from the Bancorp’s actual
or alleged conduct in any number of activities, including lending
practices, corporate governance and acquisitions and from actions
taken by government regulators and community organizations in
response to those activities. Negative public opinion can adversely
affect the Bancorp’s ability to attract and keep customers and can
expose it to litigation and regulatory action.
Given the volume of transactions at the Bancorp, certain
errors may be repeated or compounded before they are discovered
and successfully rectified. The Bancorp’s necessary dependence
upon automated systems to record and process its transaction
volume may further increase the risk that technical system flaws or
employee tampering or manipulation of those systems will result in
losses that are difficult to detect. The Bancorp may also be subject
to disruptions of its operating systems arising from events that are
wholly or partially beyond its control (for example, computer
viruses or electrical or telecommunications outages), which may
give rise to disruption of service to customers and to financial loss
or liability. The Bancorp is further exposed to the risk that its
external vendors may be unable to fulfill their contractual
obligations (or will be subject to the same risk of fraud or
operational errors by their respective employees as is the Bancorp)
and to the risk that the Bancorp’s (or its vendors’) business
continuity and data security systems prove to be inadequate.
Changes in interest rates could affect Fifth Third’s income
and cash flows.
The Bancorp’s income and cash flows depend to a great extent on
the difference between the interest rates earned on interest-earning
assets such as loans and investment securities, and the interest rates
paid on interest-bearing liabilities such as deposits and borrowings.
These rates are highly sensitive to many factors that are beyond the
Bancorp’s control, including general economic conditions and the
policies of various governmental and regulatory agencies (in
particular, the FRB). Changes in monetary policy, including
changes in interest rates, will influence the origination of loans, the
prepayment speed of loans, the purchase of investments, the
generation of deposits and the rates received on loans and
investment securities and paid on deposits or other sources of
funding. The impact of these changes may be magnified if the
Bancorp does not effectively manage the relative sensitivity of its
assets and
interest rates.
Fluctuations in these areas may adversely affect the Bancorp and its
shareholders.
to changes
in market
liabilities
Changes and trends in the capital markets may affect Fifth
Third’s income and cash flows.
The Bancorp enters into and maintains trading and investment
positions in capital markets on its own behalf and on behalf of its
customers. These positions also
include derivative financial
instruments. The revenues and profits the Bancorp derives from
its trading and investment positions are dependent on market
prices. If it does not correctly anticipate market changes and
trends, the Bancorp may experience investment or trading losses
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
that may materially affect the Bancorp and its shareholders. Losses
on behalf of its customers could expose the Bancorp to credit risks
or could lead to the loss of revenue from those customers.
Additionally, substantial losses in the Bancorp’s trading and
investment positions could lead to a loss of relative liquidity with
respect to those positions and may adversely affect cash flows and
funding costs.
regulatory bodies, periodically change
Changes in accounting standards could impact reported
earnings.
The accounting standard setters, including the FASB, SEC and
other
financial
accounting and reporting standards that govern the preparation of
the Bancorp’s consolidated financial statements. These changes
can be hard to predict and can materially impact how it records and
reports its financial condition and results of operations. In some
cases, the Bancorp could be required to apply a new or revised
standard retroactively, resulting in the restatement of prior period
financial statements.
the
The preparation of Fifth Third’s financial statements requires
the use of estimates that may vary from actual results.
The preparation of consolidated financial statements in conformity
with accounting principles generally accepted in the United States
of America requires management to make significant estimates that
affect the financial statements. Two of the Bancorp’s most critical
estimates are the level of the allowance for credit losses and the
valuation of mortgage servicing rights. Due to the inherent nature
of these estimates, the Bancorp cannot provide absolute assurance
that it will not significantly increase the allowance for credit losses
and/or sustain credit losses that are significantly higher than the
provided allowance, nor that it will not recognize a significant
provision for impairment of its mortgage servicing rights. For
more information on the sensitivity of these estimates, refer to the
Critical Accounting Policies section.
Fifth Third’s stock price is volatile.
The Bancorp’s stock price has been volatile in the past, and several
factors could cause the price to fluctuate substantially in the future.
These factors include:
• Actual or anticipated variations in earnings
• Changes in analysts’ recommendations or projections
• The Bancorp’s announcements of developments related to its
businesses
• Operating and stock performance of other companies deemed to
be peers
• New technology used or services offered by traditional and non-
traditional competitors
• News reports of trends, concerns and other issues related to the
financial services industry
The Bancorp’s stock price may fluctuate significantly in the future,
and these fluctuations may be unrelated to the Bancorp’s
performance. General market price declines or market volatility in
the future could adversely affect the price of its common stock,
and the current market price may not be indicative of future
market prices.
Any future acquisitions will dilute current shareholders’
ownership of Fifth Third and may cause Fifth Third to
become more susceptible to adverse economic events.
Future business acquisitions could be material to the Bancorp and
it may issue additional shares of common stock to pay for those
acquisitions, which would dilute current shareholders’ ownership
interest. Acquisitions also could require the Bancorp to use
substantial cash or other liquid assets or to incur debt. In those
events, it could become more susceptible to economic downturns
and competitive pressures.
Difficulties in combining the operations of acquired entities
with Fifth Third’s own operations may prevent Fifth Third
from achieving the expected benefits from its acquisitions.
The Bancorp may not be able to achieve fully the strategic
objectives and operating efficiencies in an acquisition. Inherent
uncertainties exist in integrating the operations of an acquired
entity. In addition, the markets and industries in which the Bancorp
and its potential acquisition targets operate are highly competitive.
The Bancorp may lose customers or the customers of acquired
entities as a result of an acquisition. Fifth Third also may lose key
personnel, either from the acquired entity or from itself, as a result
of an acquisition. These factors could contribute to Fifth Third not
achieving the expected benefits from its acquisitions within desired
time frames, if at all.
Fifth Third Bancorp 27
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
STATEMENTS OF INCOME ANALYSIS
Net Interest Income
The relative performance of lending and deposit-raising functions
is frequently measured by two statistics – net interest margin and
net interest rate spread. Net interest margin is determined by
dividing net interest income (FTE) by average interest-earning
assets. Net interest rate spread is the difference between the
average rate (FTE) earned on interest-earning assets and the
average rate paid on interest-bearing liabilities. Net interest margin
is greater than the net interest rate spread due to the interest
income earned on those assets funded by noninterest-bearing
liabilities, or free funding, such as demand deposits and
shareholders’ equity.
Table 4 presents the components of net interest income in
addition to net interest margin and net interest spread for the three
years ended December 31, 2005, 2004 and 2003. Nonaccrual loans
and leases and loans held for sale have been included in the average
loans and leases balances. Average outstanding securities balances
are based on amortized cost with any unrealized gains or losses on
available-for-sale securities included in other assets. Table 5
provides the relative impact of changes in the balance sheet and
changes in interest rates on net interest income.
The continued flattening of the yield curve resulted in a
challenging environment for financial institutions in 2005. The
average interest rate spread between the 3-month Treasury bill and
the 10-year Treasury note compressed from 287 basis points (“bp”)
in 2004 to 107 bp in 2005. At December 31, 2005, this interest rate
spread declined to 31 bp. This significant decline illustrates the
relative pressure between shorter-term and longer-term funding
costs and general security portfolio reinvestment opportunities.
Net interest income (FTE) decreased two percent compared
to 2004 as a result of net interest margin contracting 25 bp. The
decline in net interest margin occurred despite a six percent
increase in average interest-earning assets and a 13% increase in
average demand deposits. In terms of mix between volume and
yield, net interest income (FTE) decreased seven percent due to the
impact of changes in interest rates. The decline in net interest
margin largely resulted from the decrease in net interest rate spread
attributable to the increased cost of deposits and wholesale
funding, the impact of the primarily fixed-rate securities portfolio,
the change in mix within the core deposit base and the additional
non-core deposit funding resulting from common stock repurchase
activity. Net interest rate spread declined 41 bp from 3.17% in
2004 to 2.76% in 2005.
The growth in average loans and leases of $10.7 billion over
2004 outpaced the $7.0 billion growth in core deposits in 2005.
The $3.7 billion funding shortfall was more than offset through the
$5.6 billion reduction in the average available-for-sale securities
portfolio, as the Bancorp continues to reduce its reliance on
wholesale funding. For the year, wholesale funding and long-term
debt represented 44% of interest-bearing liabilities, down from
48% in 2004. The average securities portfolio represented 27% of
interest-earning assets in 2005, down from 35% in the prior year.
On an amortized cost basis, the average balance of the available-
for-sale securities portfolio decreased 19% from 2004 to $24.4
billion as a result of the balance sheet initiative undertaken in the
fourth quarter of 2004 and the 2005 run-off of the securities
portfolio in order to fund loan growth in excess of core deposit
growth. In 2006, the Bancorp will continue to use cash flows from
its available-for-sale securities portfolio to fund its loan and lease
growth, as it believes the loan portfolio provides the best
reinvestment opportunity.
During 2005, the Bancorp began a strategic shift in its deposit
pricing as it moved away from promotional rates towards highly
competitive daily rates. As part of this strategy, the Bancorp
aggressively increased deposit rates, including focusing on the
relative pricing between the more and less liquid deposit products,
and directed customers into the right products given their liquidity
needs. In 2005, the average rate paid on interest-bearing core
deposits increased 93 bp compared to a 186 bp increase in the
average federal funds rate, whereas in 2004, the average rate paid
on interest-bearing deposits decreased 15 bp compared to a 22 bp
increase in the average federal funds rate. The combined results of
these actions have been a 45% increase in net new account
additions compared to 2004 and a migration of interest checking
balances into money market and savings accounts.
In 2005, the cost of interest-bearing core deposits was 2.10%,
up from 1.17% in 2004. Despite more aggressive increases in
deposit rates during 2005 compared to 2004, the relative cost
advantage of interest-bearing core deposits compared to non-core
deposit funding increased by 45 bp to 126 bp in 2005. Within
interest-bearing core deposits, the money market and other time
deposit balances combined to represent 32% of the total in 2005
compared to 26% in 2004. Money market and other time deposit
balances generally receive a higher rate of interest than interest
checking and savings balances. In 2005, the combined rate paid on
money market and other time deposit balances was 2.95%
compared to the combined rate of 1.70% on interest checking and
savings balances.
TABLE 3: CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the years ended December 31 ($ in millions, except per share data)
Interest income (FTE)
Interest expense
Net interest income (FTE)
Provision for loan and lease losses
Net interest income after provision for loan and lease losses (FTE)
Noninterest income
Noninterest expense
Income from continuing operations before income taxes, minority interest and
cumulative effect (FTE)
Fully taxable equivalent adjustment
Applicable income taxes
Income from continuing operations before minority interest and cumulative effect
Minority interest, net of tax
Income from continuing operations before cumulative effect
Income from discontinued operations, net of tax
Income before cumulative effect
Cumulative effect of change in accounting principle, net of tax
Net income
Earnings per share, basic
Earnings per share, diluted
Cash dividends declared per common share
2005
$5,026
2,030
2,996
330
2,666
2,500
2,927
2,239
31
659
1,549
-
1,549
-
1,549
-
$1,549
$2.79
2.77
1.46
2004
4,150
1,102
3,048
268
2,780
2,465
2,972
2,273
36
712
1,525
-
1,525
-
1,525
-
1,525
2.72
2.68
1.31
2003
4,030
1,086
2,944
399
2,545
2,483
2,551
2,477
39
786
1,652
(20)
1,632
44
1,676
(11)
1,665
2.91
2.87
1.13
2002
4,168
1,430
2,738
246
2,492
2,183
2,337
2,338
39
734
1,565
(38)
1,527
4
1,531
-
1,531
2.64
2.59
.98
2001
4,754
2,278
2,476
236
2,240
1,788
2,453
1,575
45
523
1,007
(2)
1,005
4
1,009
(7)
1,002
1.74
1.70
.83
28
Fifth Third Bancorp
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 4: CONSOLIDATED AVERAGE BALANCE SHEETS AND ANALYSIS OF NET INTEREST INCOME (FTE)
For the years ended December 31
Average
Balance
2005
Revenue/
Cost
Average
Yield/Rate
Average
Balance
Average
Yield/Rate
Average
Balance
2004
Revenue/
Cost
2003
Revenue/
Cost
Average
Yield/Rate
($ in millions)
Assets
Interest-earning assets:
Loans and leases
Securities:
Taxable
Exempt from income taxes
Other short-term investments
Total interest-earning assets
Cash and due from banks
Other assets
Allowance for loan and lease losses
Total assets
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Interest checking
Savings
Money market
Other time deposits
Certificates - $100,000 and over
Foreign office deposits
Federal funds purchased
Short-term bank notes
Other short-term borrowings
Long-term debt
Total interest-bearing liabilities
Demand deposits
Other liabilities
Total liabilities
Minority interest
Shareholders’ equity
Total liabilities and shareholders’ equity
Net interest income margin
Net interest rate spread
Interest-bearing liabilities to interest-earning assets
$67,737
$3,930
5.80 %
$57,042
$2,860
5.01 %
$52,414
$2,724
5.20 %
1,032
58
6
5,026
4.30
7.39
2.89
5.42
24,017
789
193
92,736
2,758
8,102
(720)
$102,876
$314
176
140
263
129
126
138
6
138
600
2,030
1.66 %
1.76
2.71
3.09
3.22
3.17
3.26
2.60
2.74
3.66
2.66
$18,884
10,007
5,170
8,491
4,001
3,967
4,225
248
5,038
16,384
76,415
13,868
3,276
93,559
-
9,317
$102,876
1,226
77
3
4,030
4.45
7.26
.97
4.95
$189
64
32
196
63
44
80
-
55
363
1,086
1.01 %
.79
1.01
3.04
1.65
1.13
1.14
1.06
1.03
4.15
1.67
29,365
917
315
87,639
2,216
5,763
(722)
$94,896
$19,434
7,941
3,473
6,208
2,403
4,449
5,896
1,003
6,640
13,323
70,770
12,327
2,939
86,036
-
8,860
$94,896
1,217
68
5
4,150
4.15
7.44
1.48
4.73
$174
58
39
162
48
58
77
15
78
393
1,102
.89 %
.72
1.12
2.62
1.99
1.31
1.30
1.46
1.14
2.95
1.56
27,584
1,056
307
81,361
1,600
5,250
(730)
$87,481
$18,679
8,020
3,189
6,426
3,832
3,862
7,001
22
5,350
8,747
65,128
10,482
2,883
78,493
234
8,754
$87,481
$2,996
3.23%
2.76
82.40
$3,048
3.48%
3.17
80.75
$2,944
3.62%
3.28
80.05
The benefit of noninterest-bearing funding increased to 47 bp
in 2005 from 31 bp in the prior year due to a $1.5 billion increase
in average demand deposits and higher short-term interest rates.
The growth in noninterest-bearing funding is a critical component
to the future growth in net interest income.
Interest income (FTE) from loans and leases increased $1.1
billion, or 37%, compared to 2004. The increase in average loans
and leases in 2005 included growth in commercial loans of $6.8
billion, or 23%. The yield on commercial loans was 5.90% in 2005,
an increase of 103 bp from 2004. Average consumer loans
increased by $3.9 billion, or 14%, compared to 2004. The yield on
consumer loans was 5.69% in 2005, an increase of 52 bp from
2004.
The interest income (FTE) from investment securities and
other short-term investments decreased $194 million, or 15%, in
2005 compared to 2004 due to the previously discussed reduction
of the investment securities portfolio. The average yield on taxable
securities increased by only 15 bp compared to 2004 largely due to
the impact of the fixed-rate securities within the portfolio and the
relative stability of longer-term interest rates throughout 2005 and
TABLE 5: CHANGES IN NET INTEREST INCOME (FTE) ATTRIBUTED TO VOLUME AND YIELD/RATE (a)
For the years ended December 31
($ in millions)
Increase (decrease) in interest income:
2005 Compared to 2004
Yield/Rate
Volume
Volume
Total
2004 Compared to 2003
Yield/Rate
Loans and leases
Securities:
Taxable
Exempt from income taxes
Other short-term investments
Total change in interest income
Increase (decrease) in interest expense:
$582
(228)
(10)
(2)
342
488
43
-
3
534
1,070
(185)
(10)
1
876
235
76
(10)
-
301
Interest checking
Savings
Money market
Other time deposits
Certificates - $100,000 and over
Foreign office deposits
Federal funds purchased
Short-term bank notes
Other short-term borrowings
Long-term debt
8
(1)
3
(7)
(26)
7
(13)
15
15
154
Total change in interest expense
155
146
Total change in net interest income
(a) Changes in interest not solely due to volume or yield/rate are allocated in proportion to the absolute amount of change in volume or yield/rate.
145
100
75
33
39
75
88
-
83
104
742
(208)
(5)
18
26
68
42
(7)
(27)
(9)
(23)
103
186
$156
140
118
101
101
81
68
61
(9)
60
207
928
(52)
(99)
(85)
1
2
(181)
(23)
(5)
4
(27)
11
7
10
-
8
(124)
(139)
(42)
Total
136
(9)
(9)
2
120
(15)
(6)
7
(34)
(15)
14
(3)
15
23
30
16
104
Fifth Third Bancorp 29
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
as compared to 2004.
lease losses.
The interest paid on interest-bearing core deposits increased
$460 million, or 106%, in 2005 compared to 2004 as a result of a
93 bp increase in cost and a $5.5 billion increase in average balance.
The interest paid on long-term debt increased $204 million, or
52%, in 2005 due to a 69 bp increase in the cost of long-term debt
and an increase in the average long-term debt outstanding.
Average long-term debt increased $3.1 billion in 2005 to reduce the
short-term wholesale funding position of the Bancorp. Average
short-term wholesale funding declined $2.9 billion, or 14%,
compared to 2004. The interest expense associated with wholesale
funding increased $264 million, or 96%, due to rising short-term
interest rates throughout 2005.
Provision for Loan and Lease Losses
The Bancorp provides as an expense an amount for probable loan
and lease losses within the loan portfolio that is based on factors
discussed in the Critical Accounting Policies section. The
provision is recorded to bring the allowance for loan and lease
losses to a level deemed appropriate by the Bancorp. Actual credit
losses on loans and leases are charged against the allowance for
loan and lease losses. The amount of loans actually removed from
the Consolidated Balance Sheets is referred to as charge-offs. Net
charge-offs include current charge-offs less recoveries in the
current period on previously charged off assets.
The provision for loan and lease losses was $330 million in
2005 compared to $268 million in 2004. The $62 million increase
from the prior year is due to the increase in net-charge-offs, which
increased from $252 million in 2004 to $299 million in 2005, as
well as 17% portfolio loan growth. The increase in net charge-offs
was primarily due to $27 million in losses to bankrupt commercial
airline carriers and a $15 million increase in consumer loan and
lease
increased personal bankruptcies
declared prior to the recently enacted reform legislation. Net
charge-offs as a percent of average loans and leases was .45% for
the years ended December 31, 2005 and 2004.
losses associated with
Refer to the Credit Risk Management section for further
information on the provision for loan and lease losses, net charge-
offs and other factors considered by the Bancorp in assessing the
credit quality of its loan and leases and the allowance for loan and
Noninterest Income
Overall noninterest income was flat relative to 2004 due to the
impact of the 2004 gain on the sales of certain third-party sourced
merchant processing contracts and the decline in operating lease
revenue. Excluding the impact of these items, noninterest income
increased $375 million, or 18%, over 2004 (comparison being
provided to supplement an understanding of the fundamental
revenue trends). On this basis, nine of the Bancorp’s affiliate
markets experienced high single digit or better percentage growth
in noninterest revenue.
Electronic payment processing revenue
increased $113
million, or 18%, in 2005 as FTPS realized growth across nearly all
of its product lines. Revenue comparisons are impacted by the
2004 sales of certain third-party sourced merchant processing
contracts. Exclusive of the impact of these transactions, electronic
payment processing revenue increased 23% (comparison being
provided to supplement an understanding of the fundamental
revenue trends). The Bancorp continues to realize strong sales
momentum from the addition of new customer relationships in
both its merchant services and EFT businesses. Merchant
processing revenue increased $46 million, or 15%, attributable to
the addition of new customers and resulting increases in merchant
transaction volumes, as well as an increase in transaction volume
growth on the existing customer base. Excluding the impact of the
revenue lost as a result of the 2004 sales of certain third-party
sourced merchant processing contracts, merchant processing
revenue increased 27% (comparison being provided to supplement
an understanding of the fundamental revenue trends). Compared
to 2004, EFT revenues, including debit and credit card interchange,
increased $67 million, or 21%, in 2005. The Bancorp now handles
electronic processing for over 127,000 merchant locations and
1,500 financial institutions.
Service charges on deposits increased $7 million over 2004
primarily due to sales success in corporate treasury management
products and retail deposit accounts and modest retail pricing
changes. Commercial deposit revenues were flat compared to last
year due to a 77% increase in earnings credits on compensating
balances as a result of higher short-term interest rates. The overall
TABLE 6: NONINTEREST INCOME
For the years ended December 31 ($ in millions)
Electronic payment processing revenue
Service charges on deposits
Mortgage banking net revenue
Investment advisory revenue
Other noninterest income
Operating lease revenue
Securities gains (losses), net
Securities gains, net – non-qualifying hedges on mortgage servicing rights
Total noninterest income
TABLE 7: COMPONENTS OF MORTGAGE BANKING NET REVENUE
For the years ended December 31 ($ in millions)
Total mortgage banking fees and loan sales
Net (losses) gains and mark-to-market adjustments on both settled and
outstanding free-standing derivative financial instruments
Net valuation adjustments and amortization on mortgage servicing rights
Mortgage banking net revenue
TABLE 8: COMPONENTS OF OTHER NONINTEREST INCOME
For the years ended December 31 ($ in millions)
Cardholder fees
Consumer loan and lease fees
Commercial banking revenue
Bank owned life insurance income
Insurance income
Gain on sale of branches
Gain on sale of property and casualty insurance product lines
Gain on sales of third-party sourced merchant processing contracts
Other
Total other noninterest income
30
Fifth Third Bancorp
2005
$735
522
174
355
620
55
39
-
$2,500
2005
$238
(24)
(40)
$174
2005
$59
50
213
91
31
-
-
-
176
$620
2004
622
515
178
360
671
156
(37)
-
2,465
2004
219
(9)
(32)
178
2004
48
57
174
61
31
-
-
157
143
671
2003
575
485
302
332
581
124
81
3
2,483
2003
466
14
(178)
302
2003
59
65
178
62
28
-
-
-
189
581
2002
512
431
188
325
580
-
114
33
2,183
2002
386
98
(296)
188
2002
51
70
157
62
55
7
26
-
152
580
2001
347
367
63
298
542
-
28
143
1,788
2001
354
20
(311)
63
2001
50
59
125
52
49
43
-
-
164
542
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
growth in commercial account relationships offset the negative
impact to deposit service charges realized from the increased
earnings credits provided to customers. Retail deposit revenues
increased three percent due to growth in net new consumer deposit
account production. Growth in the number of retail checking
account relationships and in deposit balances remains a key focus
for the Bancorp for the upcoming year.
Mortgage banking net revenue decreased to $174 million in
2005 from $178 million in 2004. The components of mortgage
banking net revenue are shown in Table 7. Mortgage originations
increased to $9.9 billion in 2005 compared to $8.4 billion in 2004,
resulting in an increase in core mortgage banking fees of $19
million, or nine percent. The general decrease in prepayment
speeds in 2005 led to the recovery of $33 million in temporary
impairment on the MSR portfolio, following a recovery of $60
million in 2004. Servicing rights are deemed impaired when a
borrower’s loan rate is distinctly higher than prevailing rates.
Impairment on servicing rights is reversed when the prevailing
rates return to a level commensurate with the borrower’s loan rate.
Contributing to the decrease in mortgage revenue, the Bancorp
recognized a net loss of $23 million in 2005 compared to a loss of
$10 million in 2004 related to changes in fair value and settlement
of free-standing derivatives purchased to economically hedge the
MSR portfolio.
The Bancorp maintains a non-qualifying hedging strategy to
manage a portion of the risk associated with changes in value of
the MSR portfolio. During 2005, the Bancorp primarily used
principal only swaps, interest rate swaps and swaptions to hedge
the economic risk of the MSR portfolio as they were deemed to be
the best available instruments for several reasons. Principal only
swaps hedge the mortgage-LIBOR spread because they appreciate
in value as a result of tightening spreads. They also provide
prepayment protection by increasing in value when prepayment
speeds increase, as opposed to MSRs that lose value in a faster
prepayment environment. Receive fixed/pay floating interest rate
swaps and swaptions increase in value when interest rates do not
increase as quickly as expected. As of December 31, 2005 and
2004, the Bancorp held a combination of free-standing derivatives,
including principal only swaps, swaptions and interest rate swaps
with a net negative fair value of $6 million and a net positive fair
value of $4 million, respectively, on outstanding notional amounts
of $1.5 billion and $1.9 billion, respectively. In addition to the
derivative positions used to economically hedge the MSR portfolio,
the Bancorp began to acquire various securities (primarily principal
only strips) during 2005 as an addition to its non-qualifying
hedging strategy. Principal only strips increase in value as
prepayments speeds increase, thus providing an economic hedge
for the MSR portfolio. As of December 31, 2005, the Bancorp’s
available-for-sale securities portfolio included $197 million of
securities related to the non-qualifying hedging strategy.
The Bancorp believes the 2005 level of mortgage banking
contribution to be sustainable with future growth in line with
growth in originations.
The Bancorp’s total residential mortgage loans serviced at the
end of 2005 and 2004 was $34.0 billion and $30.6 billion,
respectively, with $25.7 billion and $23.0 billion, respectively, of
residential mortgage loans serviced for others.
Investment advisory revenues were slightly down in 2005
compared to 2004 with increases in mutual fund revenues offset by
decreases in retail brokerage, private client and retirement planning
services. The Bancorp continues to focus its sales efforts on
integrating services across business lines and working closely with
retail and commercial team members to take advantage of a diverse
and expanding customer base. The Bancorp is one of the largest
money managers in the Midwest and as of December 31, 2005 had
over $196 billion in assets under care, $33 billion in assets under
management and $12 billion in its proprietary Fifth Third Funds.*
Operating lease revenue declined $101 million from 2004 to
$55 million. Operating lease revenues consist of commercial
operating lease revenues that increased 49% and consumer
operating lease revenues that decreased $103 million to $48 million.
Consumer revenues are the result of the consolidation of an SPE
in 2003 that was formed for the sole purpose of the sale and
subsequent leaseback of leased autos. The consolidation was the
result of the Bancorp’s early adoption of FASB Interpretation No.
46 (“FIN 46”). Declines in operating lease revenues will continue
in 2006, however to a lesser extent than 2005, as automobile leases
continue to mature and are offset by originations of commercial
operating leases.
The major components of other noninterest income for each
of the last five years are shown in Table 8. Other noninterest
income declined eight percent compared to last year as the 2004
results included the pretax gain of approximately $157 million on
the sale of certain third-party sourced merchant processing
contracts. Excluding the impact of the gain, other noninterest
income increased 20% (comparisons being provided to supplement
an understanding of the fundamental revenue trends). The
commercial banking revenue component of other noninterest
income grew 22% to $213 million led by growth in international
revenue, which includes foreign currency services and letter of
credit fee revenue, and syndication fees. Compared to 2004, total
international revenue
to $120 million and
increased 15%
syndication fees increased 49% to $69 million. Bank owned life
insurance (“BOLI”) income increased 48% to $91 million as a
result of the increase in the Bancorp’s BOLI investment. The
growth in the other component of other noninterest income was
primarily due to a $24 million increase in customer interest rate
derivative revenue.
Noninterest Expense
During 2005, the Bancorp has continued its investment in the
expansion of the retail distribution network, growth in the sales
force and in the information technology infrastructure. Operating
expense levels are often measured using the efficiency ratio
(noninterest expense divided by the sum of net interest income
(FTE) and noninterest income), which was 53.2% and 53.9% for
2005 and 2004, respectively. The Bancorp has continued to focus
on efficiency initiatives as part of its core emphasis on operating
leverage and views its recent investments, including in the
information technology infrastructure, as its platform for future
growth and increasing expense efficiency.
Total noninterest expense decreased two percent in 2005
compared to 2004. Comparison to the prior year is impacted by a
$247 million charge related to the early retirement of approximately
$2.8 billion of long-term debt in the fourth quarter of 2004 and a
$78 million charge related to the early retirement of approximately
$1 billion of Federal Home Loan Bank (“FHLB”) advances in the
second quarter of 2004. Exclusive of the impact of the debt
termination charges, total noninterest expense increased by $280
million, or 11%, over 2004 due to increases in marketing,
information technology, volume-related bankcard costs and the
significant investments in the sales force and retail distribution
network. Of the $280 million increase, 86% occurred in the
Florida, Chicago, Detroit and Tennessee markets, as the Bancorp
has focused investments in the markets with the greatest growth
*FIFTH THIRD FUNDS® PERFORMANCE DISCLOSURE
Fifth Third Funds investments are: NOT INSURED BY THE FDIC or any other government agency, are not deposits or obligations of, or guaranteed by,
any bank, the distributor or of the Funds any of their respective affiliates, and involve investment risks, including the possible loss of the principal amount
invested. An investor should consider the fund’s investment objectives, risks and charges and expenses carefully before investing or sending money. The Funds’ prospectus contains this and other
important information about the Funds. To obtain a prospectus or any other information about Fifth Third Funds, please call 1-800-282-5706 or visit www.53.com. Please read the prospectus
carefully before investing. Fifth Third Funds are distributed by Fifth Third Funds Distributor, Inc., 3435 Stelzer Road, Columbus, Ohio 43219.
Fifth Third Bancorp 31
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 9: NONINTEREST EXPENSE
For the years ended December 31 ($ in millions)
Salaries, wages and incentives
Employee benefits
Equipment expense
Net occupancy expense
Operating lease expense
Merger-related charges
Other noninterest expense
Total noninterest expense
TABLE 10: COMPONENTS OF OTHER NONINTEREST EXPENSE
For the years ended December 31 ($ in millions)
Marketing and communications
Postal and courier
Bankcard
Intangible and goodwill amortization
Franchise and other taxes
Loan and lease
Printing and supplies
Travel
Information technology and operations
Debt termination
Other
Total other noninterest expense
opportunities.
increased 11%
Salaries, wages and
in 2005
incentives
compared to 2004 due to sales force expansion and the addition of
First National employees. Compared to 2004, average sales
personnel increased by 1,400. As of December 31, 2005, the
Bancorp employed 22,901 employees, of which 5,741 were officers
and 2,820 were part-time employees. Full time equivalent
employees totaled 21,681 as of December 31, 2005 compared to
19,659 as of December 31, 2004.
Net periodic pension costs, included in employee benefits
expense on the Bancorp’s Consolidated Statements of Income,
declined to $14 million in 2005 compared to $16 million in 2004
primarily due to lower interest and settlement costs. The
Bancorp’s pension expense is based upon specific actuarial
assumptions, including the expected long-term rate of return on
plan assets and the discount rate. At the beginning of 2005, the
expected long-term rate of return was 8.00% and the discount rate
was 5.85%. Lowering both the expected rate of return on plan
assets and the discount rate by 0.25% would have increased the
2005 pension expense by approximately $1 million. See Note 23 of
the Notes to the Consolidated Financial Statements for further
discussion of the Bancorp’s pension plans.
Net occupancy expenses increased 19% in 2005 over 2004
due to the addition of 63 new banking centers that did not involve
the relocation or consolidation of existing facilities, in addition to
the 70 net additional banking centers added as a result of the First
National acquisition. Operating lease expense declined 65% from
2004. Declines in operating lease expenses will continue in 2006,
however to a lesser extent than 2005, as automobile leases continue
TABLE 11: APPLICABLE INCOME TAXES
For the years ended December 31 ($ in millions)
Income from continuing operations before income taxes, minority interest
and cumulative effect
Applicable income taxes
Effective tax rate
Applicable Income Taxes
The Bancorp’s income from continuing operations before income
taxes, applicable income tax expense and effective tax rate for each
of the periods indicated are shown in Table 11. Applicable income
tax expense for all periods includes the benefit from tax-exempt
income, tax-advantaged investments and general business tax
credits, partially offset by the effect of nondeductible expenses. In
2005, several factors caused the decrease in the effective tax rate,
tax
including
resolution of certain
favorable
income
the
32
Fifth Third Bancorp
2005
$1,133
283
105
221
40
-
1,145
$2,927
2005
$126
50
271
46
37
89
35
54
114
-
323
$1,145
2004
1,018
261
84
185
114
-
1,310
2,972
2004
99
49
224
29
32
82
33
41
87
325
309
1,310
2003
1,031
240
82
159
94
-
945
2,551
2003
99
49
197
40
33
106
35
35
76
20
255
945
2002
1,029
201
79
142
-
-
886
2,337
2002
96
48
170
37
30
91
37
38
54
-
285
886
2001
959
148
91
146
-
349
760
2,453
2001
102
50
117
71
18
62
40
34
56
1
209
760
to mature and are offset by originations of commercial operating
leases.
Total other noninterest expense decreased by 13% in 2005
compared to 2004. Excluding the impact of the debt termination
charges, total other noninterest expense increased by $160 million,
or 16%, from 2004 primarily due to increases in marketing and
communications, volume-related bankcard costs and information
technology expenses (comparison being provided to supplement an
understanding of fundamental expense trends). Marketing and
communications increased 27% compared to 2004 primarily due to
increased spending on deposit campaign initiatives through direct
mailings and media advertising. Bankcard expense increased 21%
compared to last year due to an increase in the number of
merchant and retail customers as well as continuing organic growth
in debit and credit card usage causing a corresponding increase in
Information
debit transaction costs and membership fees.
technology and operations costs increased 31% primarily due to
improving the Bancorp’s
continued
investment focused on
customer service capabilities and processes.
Information
technology investments included, among others, an improved
customer relationship management solution that creates a single
customer view across the Bancorp’s key operating systems, a new
teller automation platform that provides employees with better
access
improve customer service while
eliminating certain manual processes and paper forms and
customer service resolution tracking software.
information
to
to
Overall,
the Bancorp expects
percentage growth in expenses in 2006.
low
to mid-single digit
2005
$2,208
659
29.9 %
2004
2,237
712
31.8
2003
2,438
786
32.3
2002
2,299
734
31.9
2001
1,530
523
34.2
examinations and an increase in investments in a number of tax-
favored assets, which resulted in increases in general business tax
credits and tax-exempt income. In 2006, the Bancorp expects the
effective tax rate to return to a more normalized historical level.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Comparison of 2004 with 2003
Net income in 2004 decreased to $1.5 billion compared to $1.7
billion in 2003. Diluted earnings per common share were $2.68
compared to $2.87. In 2004, return on average assets was 1.61%
and return on average shareholders’ equity was 17.2% versus
1.90% and 19.0%, respectively, in 2003. Earnings in 2004 were
negatively impacted by initiatives undertaken to better position the
balance sheet for market conditions, including debt termination
charges and securities losses totaling $404 million pre-tax ($259
million after-tax). Earnings in 2004 were positively impacted by a
$157 million pre-tax ($91 million after-tax) gain resulting from the
sale of certain third-party sourced merchant processing contracts.
Net interest income (FTE) was $3.0 billion in 2004 compared
to $2.9 billion in 2003. The net interest margin decline to 3.48% in
2004 from 3.62% in 2003 was primarily attributable to the
prolonged low interest rate environment in the first half of 2004
and interest-bearing liabilities repricing more quickly than interest-
earning assets in response to rising interest rates in the second half
of 2004. The decline in net interest margin occurred despite an
eight percent increase in average interest-earning assets from 2003
to 2004.
BUSINESS SEGMENT REVIEW
The Bancorp operates four main business segments: Commercial
Banking, Retail Banking, Investment Advisors and Processing
Solutions. Further detailed financial information on each business
segment is included in Note 29 of the Notes to the Consolidated
Financial Statements. For acquisitions accounted for under the
purchase method, management “pools” historical results to
improve comparability with the current period. For the prior
periods presented, the income and average assets of First National
have been included in the respective segments and are then
eliminated in the Acquisitions caption to agree to the prior period’s
reported results.
Results of the Bancorp’s business segments are presented
based on its management structure and management accounting
practices. The structure and practices are specific to the Bancorp;
therefore, the financial results of the Bancorp’s business segments
are not necessarily comparable with similar information for other
financial institutions. The Bancorp refines its methodologies from
time to time as management accounting practices are improved and
businesses change. Revisions to the Bancorp’s methodologies are
applied on a retroactive basis.
The Bancorp manages interest rate risk centrally at the
corporate level by employing a funds transfer pricing (“FTP”)
methodology. This methodology insulates the lines of business
from interest rate risk, enabling them to focus on servicing
customers through loan originations and deposit taking. The FTP
system assigns charge rates and credit rates to classes of assets and
liabilities, respectively, based on expected duration. The Bancorp
has not changed the conceptual application of FTP during 2005 or
2004. The net impact of the FTP methodology is included in
Other/Eliminations.
The financial results of the business segments
include
allocations for shared services and headquarters expenses. Even
with these allocations, the financial results are not necessarily
indicative of the business segments’ financial condition and results
of operations as if they were to exist as independent entities.
Additionally, the business segments form synergies by taking
TABLE 12: BUSINESS SEGMENT NET INCOME
For the years ended December 31 ($ in millions)
Commercial Banking
Retail Banking
Investment Advisors
Processing Solutions
Other/Eliminations
Acquisitions
Net income
Noninterest income in 2004 was down slightly compared to
2003. Increases in service charges on deposits and electronic
payment processing and
investment advisory revenues were
mitigated by a decrease in mortgage banking net revenue. The
decrease in mortgage banking net revenue was a result of the
record high level of refinancing activity seen in 2003.
Noninterest expense totaled $3.0 billion in 2004 compared to
$2.6 billion in 2003. The increase primarily resulted from the
previously discussed debt termination charges in 2004 totaling $325
million. Remaining increases primarily resulted from the expansion
of the sales force and investment in additional banking centers.
The provision for loan and lease losses was $268 million in
2004 compared to $399 million in 2003. The decrease in the
provision is due to the $60 million decrease in net charge-offs,
leases
from $312 million, or
outstanding, in 2003 to $252 million, or .45% in 2004 as well as a
decrease in the overall assessed allowance for loan and lease losses
resulting from the consideration of historical and anticipated loss
rates in the portfolio. The total allowance for loan and lease losses
as a percent of total loans and leases was 1.19% at December 31,
2004 compared to 1.33% at December 31, 2003.
.63% of average
loans and
advantage of cross-sell opportunities and when funding operations
by accessing the capital markets as a collective unit. Net income by
business segment is summarized in Table 12.
Commercial Banking
Commercial Banking provides a comprehensive range of financial
services and products to large and middle-market businesses,
governments and professional customers. In addition to the
traditional lending and depository offerings, Commercial Banking
products and services include, among others, cash management,
foreign exchange and international trade finance, derivatives and
capital markets services, asset-based lending, real estate finance,
public finance, commercial leasing and syndicated finance.
Net income increased $79 million compared to 2004 largely as
a result of loan and deposit growth and success in customer
interest rate and foreign exchange derivative sales. Average loans
and leases included in the commercial banking segment increased
12% over 2004, to $30.0 billion, due to growth in commercial and
industrial loans, commercial mortgage loans and construction
loans. Average core deposits increased to $14.4 billion in 2005
from $12.3 billion in 2004. The increase in average core deposits
and loans and the related net FTP impact led to a $162 million
increase in net interest income compared to the same period last
year.
Noninterest income increased $85 million compared to 2004
largely due to an increase in customer interest rate derivative sales
and international service revenue. Revenue from customer interest
rate derivatives sales
increased $24 million over 2004 and
international service revenue, which includes letters of credit and
foreign currency services, increased $16 million. Increases in these
categories were partially offset by the impact of increased earnings
credits, as a result of higher short-term interest rates, on service
charges on deposits.
Noninterest expense increased $107 million in 2005 compared
to 2004 as a result of sales force additions and higher information
technology expenses. Investment in the sales force throughout
2004 and 2005 resulted in an 18% increase in total full-time
2005
$784
1,091
127
120
(573)
-
$1,549
2004
705
1,063
118
207
(556)
(12)
1,525
Fifth Third Bancorp 33
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
broker-dealer services. Fifth Third Securities, Inc., an indirect
wholly-owned subsidiary of the Bancorp, offers full service retail
brokerage services to individual clients. Fifth Third Asset
Management, Inc., an indirect wholly-owned subsidiary of the
Bancorp, provides asset management services and also advises the
Bancorp’s proprietary family of mutual funds.
Net income increased eight percent to $127 million compared
to 2004. The increase resulted from a 26% improvement in net
interest income due to strong average loan and core deposit
growth, up 23% and 13%, respectively. Total average loans were
$2.6 billion and total average core deposits were $4.0 billion in
2005.
Noninterest income declined three percent from 2004 due to
a decline in retail brokerage and retirement planning service
revenues. Noninterest expense increased five percent largely as a
result of
information technology
investments. In order to capitalize on an expanding customer base
and additional growth opportunities, 91 full-time equivalent sales
employees have been added since the end of 2004.
increased sales force and
Processing Solutions
Fifth Third Processing Solutions provides electronic funds transfer,
debit, credit and merchant transaction processing, operates the
Jeanie® ATM network and provides other data processing services
to affiliated and unaffiliated customers.
Net income decreased $87 million compared to 2004 largely
due to the $157 million pretax gain resulting from the sale of
certain third-party sourced merchant processing contracts in the
prior year. Excluding the impact of the sale, net income increased
by approximately 12% due to strong revenue growth across nearly
all lines of business (comparison being provided to supplement an
understanding of the fundamental trends). EFT revenue was up
19% over last year primarily due to new customer additions.
Merchant revenue increased 15% due to increased volume at
existing customers and new customer additions.
Noninterest expense was up largely due to sales force
additions and information technology investments. Trends seen in
2005 are representative of strong continuing momentum in
attracting new customer relationships and good results in the level
of retail sales activity. The Bancorp continues to see significant
opportunities to attract new financial institution customers and
retailers within this segment.
Other/Eliminations
Other/Eliminations
includes the unallocated portion of the
investment portfolio, certain non-core deposit funding, unassigned
equity and certain support activities and other items not attributed
to the business segments.
The results of Other/Eliminations were negatively impacted
by a decrease of $194 million in interest income from the
investment securities portfolio from 2004 due primarily to the sale
of approximately $6.4 billion in investment securities in the fourth
quarter of 2004 as a result of the balance sheet repositioning. A
$468 million increase in interest expense from wholesale funding
and other borrowings in 2005 from 2004 also negatively impacted
this category. The increase in interest expense resulted from the
average interest rate on wholesale funding and other borrowings
increasing from 1.98% in 2004 to 3.36% in 2005.
equivalent sales employees from 1,184 to 1,401 at the end of 2005.
The provision for loan and lease losses increased $23 million
over 2004 primarily as a result of the previously discussed losses to
bankrupt commercial airline carriers.
Retail Banking
Retail Banking provides a full range of deposit and loan and lease
products to individuals and small businesses, and includes the
branch network, consumer finance and mortgage banking.
Through 1,119 banking centers, Retail Banking offers depository
and loan products, such as checking and savings accounts, home
equity lines of credit, credit cards and loans for automobile and
other personal financing needs, as well as products designed to
meet the specific needs of small businesses, including cash
management services. Consumer finance services generally include
the Bancorp’s indirect lending activities, which include loans to
consumers through dealers and federal and private student
education
the
origination, retention and servicing of mortgage loans, sales and
securitizations of mortgage loans or pools of mortgage loans and
all associated hedging activities.
Mortgage banking activities
include
loans.
Net income increased $28 million compared to 2004. Average
loans and leases increased 12% to $33.5 billion compared to 2004
as a result of increases in direct installment and residential
mortgage, up 15% and 22%, respectively. Average core deposits
increased three percent to $37.8 billion compared to 2004 with
double-digit increases in savings, money market, demand deposits
and consumer time deposits mitigated by a 15% decrease in
interest checking. As a result of the growth in average loans and
core deposits and the related net FTP impact, net interest income
increased 11% compared to 2004.
Noninterest income declined seven percent from 2004.
Increases in electronic payment processing revenue from bankcard
interchange, up 35% over 2004, were offset by slight decreases in
consumer and business fees and mortgage banking net revenue and
a $103 million decrease in operating lease revenue from the
continued maturity of consumer automobile leases.
Noninterest expense increased four percent compared to 2004
as lower operating lease expenses partially offset the increased
employee related expenses, net occupancy costs resulting from the
increase in banking centers and higher information technology
expenses. Since 2004, acquisitions have accounted for 74 of the
108 net new banking centers that did not involve relocation or
consolidation of existing facilities, complementing the ongoing de-
novo growth. The Bancorp continues to position itself for
sustained long-term growth through new banking center additions
in key markets.
The retail business segment was also affected by increased
personal bankruptcies declared prior to the recently enacted reform
legislation, which resulted in an increase in net charge-offs of
approximately $15 million above recent trends. Overall, the
provision for loan and lease losses increased by $27 million over
2004.
Investment Advisors
investment
Investment Advisors provides a full range of
alternatives
and not-for-profit
organizations. Investment Advisors primary services include trust,
institutional, retirement, private client, asset management and
individuals, companies
for
34
Fifth Third Bancorp
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOURTH QUARTER REVIEW
The Bancorp’s 2005 fourth quarter earnings per diluted share were
$.60 compared to $.31 per diluted share for the same period in
2004. Fourth quarter net income totaled $332 million compared to
$176 million in the same quarter last year. Return on average assets
and return on average equity were 1.27% and 13.9%, respectively,
compared to 0.72% and 7.6% in 2004’s fourth quarter. Fourth
quarter 2004 earnings were negatively impacted by $326 million in
total pre-tax ($208 million after-tax) debt termination charges and
securities losses, or $.37 per diluted share, related to the balance
sheet initiatives undertaken. The Bancorp’s efficiency ratio was
55.6% in the fourth quarter compared to 76.0% last year and
53.5% in the previous quarter.
Compared to the fourth quarter of 2004, net interest income
(FTE) decreased two percent, despite five percent growth in
average earning assets, due to a 24 bp decline in the net interest
margin (FTE). Compared to the third quarter of 2005, net interest
income (FTE) decreased by $10 million due to five basis points of
contraction in net interest margin (FTE). The decline in net
interest margin in the fourth quarter was primarily the result of the
higher cost of wholesale funding relative to previous periods.
Improved performance in certain business line revenue
segments resulted in good noninterest income performance in the
fourth quarter of 2005. Overall noninterest income, excluding
operating lease revenues and securities gains and losses, increased
by 18% over the same quarter last year and 16% on an annualized
sequential basis.
Electronic payment processing revenues increased 16% over
the same quarter last year as a result of continuing momentum in
attracting new customer relationships and moderated by slower
growth in the level of retail sales transaction volumes in the fourth
quarter of 2005.
Sales of retail deposit accounts and corporate treasury
management products led to an increase in deposit service
revenues of six percent over the same quarter last year. Retail
deposit revenues strengthened in the latter half of 2005 and
increased by seven percent over the same quarter last year.
Commercial deposit revenues increased by three percent over the
same quarter last year with good growth in the number of
relationships mitigated by the impacts of higher earnings credits on
commercial deposit accounts. Compared to the third quarter of
2005, deposit service revenues declined modestly primarily due to a
decrease in consumer overdraft related revenues.
Investment advisory revenues increased by five percent over
the same quarter last year. The Bancorp continues to focus its
efforts on improving execution in retail brokerage and growing the
improving
institutional money management business by
penetration and cross-sell in our large middle market commercial
customer base.
Mortgage banking net revenue totaled $42 million in the
fourth quarter compared to $24 million in 2004’s fourth quarter.
Mortgage originations remained strong and totaled $2.5 billion in
the fourth quarter versus $2.9 billion last quarter and $2.0 billion in
the fourth quarter of last year. Fourth quarter mortgage banking
net service revenue was comprised of $65 million in total mortgage
banking fees and loan sales, less $13 million in amortization and
valuation adjustments on mortgage servicing rights and less $10
million of losses and mark-to-market adjustments on both settled
and outstanding free-standing derivative financial instruments.
Other noninterest income totaled $165 million in the fourth
quarter compared to $125 million in the same quarter last year.
Other noninterest income increased by 32% primarily due to
strong growth in commercial banking revenues, customer interest
rate derivative sales, bank owned life insurance and cardholder fees.
Compared to the third quarter of 2005, other noninterest income
increased by $20 million due to very strong growth in commercial
banking revenues and customer interest rate derivative sales.
Total noninterest expense decreased by 18% compared to the
same quarter last year. Comparisons to the prior year quarter are
impacted by the previously disclosed $247 million charge related to
the early retirement of approximately $2.8 billion of long-term debt
in the fourth quarter of 2004. Exclusive of the impact of this
termination charge, total noninterest expense increased by 11% in
the fourth quarter primarily due to increases in sales force
headcount, information technology and occupancy expenditures
related to the addition of 63 de-novo banking centers in 2005 that
did not involve relocation. Compared to the third quarter of 2005,
total noninterest expense increased by $31 million due to growth in
volume-related bankcard costs, approximately $9 million in fraud
related expenses and approximately $10 million in sales tax related
expense.
Fourth quarter credit quality trends reflect an elevated level of
net charge-offs associated with approximately $27 million in
previously discussed losses to bankrupt commercial airline carriers
and a $15 million increase in consumer loan and lease losses
associated with increased personal bankruptcies declared prior to
the recently enacted reform legislation. Net charge-offs as a
percentage of average loans and leases were 67 bp in the fourth
quarter, compared to 38 bp last quarter and 44 bp in the fourth
quarter of 2004. Net charge-offs were $117 million in the fourth
quarter, compared to $65 million in the same quarter last year and
$64 million in the third quarter of 2005. The provision for loan
and lease losses totaled $134 million in the fourth quarter
compared to $65 million in the same quarter last year and $69
million in the third quarter of 2005.
Fifth Third Bancorp 35
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BALANCE SHEET ANALYSIS
TABLE 13: COMPONENTS OF TOTAL LOANS AND LEASES (INCLUDING HELD FOR SALE)
As of December 31 ($ in millions)
Commercial loans and leases:
2004
2005
Commercial
Mortgage
Construction
Leases
Total commercial loans and leases
Consumer loans and leases:
Installment
Mortgage and construction
Credit card
Leases
Total consumer loans and leases
Total loans and leases
Loans and Leases
Total loans and leases increased 18% compared to December 31,
2004. The Bancorp has experienced 10% or better average loan
growth in both the consumer and commercial categories as well as
at more than half of its affiliate markets.
Table 13 summarizes the total commercial and consumer
loans and leases by major category as of the end of the last five
fiscal years. Total commercial loans and leases increased 22%
compared to December 31, 2004. Commercial loan comparisons
to the prior year are impacted by $2.8 billion of commercial loans
obtained in the First National acquisition in 2005. Excluding the
impact of the acquisition, commercial loans and leases increased
14% compared to December 31, 2004 (comparison being provided
to supplement an understanding of the fundamental lending
trends). The growth in commercial loans was partially the result of
an increase in overall line commitments, as line utilization remained
at a level similar to 2004.
Total consumer loans increased 13% compared to December
31, 2004. Consumer loan comparisons to the prior year are
impacted by the acquisition of $1.1 billion of consumer loans in the
First National acquisition. Excluding the acquired loans, consumer
loans and leases increased nine percent compared to December 31,
2004 (comparison being provided to supplement an understanding
of the fundamental lending trends). The Bancorp is continuing to
devote significant focus on producing retail-based loan originations
given the attractive yields available in these products. Residential
mortgage and construction loans, including held for sale, increased
14% compared to December 31, 2004. Excluding the impact of
the acquisition, residential mortgage and construction
loans
increased four percent compared
to December 31, 2004
(comparison being provided to supplement an understanding of
the fundamental lending trends). Comparisons to prior years are
dependent upon the volume and timing of originations as well as
the timing of loan sales. Residential mortgage originations totaled
$9.9 billion in 2005 compared to $8.4 billion in 2004.
TABLE 14: COMPONENTS OF AVERAGE TOTAL LOANS AND LEASES
For the years ended December 31 ($ in millions)
Commercial loans and leases:
$19,299
9,188
6,342
3,698
38,527
21,250
8,991
866
1,595
32,702
$71,229
16,058
7,636
4,348
3,426
31,468
18,093
7,912
843
2,051
28,899
60,367
2003
14,226
6,894
3,301
3,264
27,685
17,429
5,865
762
2,448
26,504
54,189
2002
12,786
5,885
3,009
3,019
24,699
14,584
7,123
537
2,343
24,587
49,286
2001
10,909
6,085
3,103
2,487
22,584
12,138
6,815
448
1,743
21,144
43,728
Consumer lease balances decreased 22% in 2005 compared to
2004 largely resulting from continued competition from captive
finance companies offering promotional lease rates and an overall
increased emphasis on growth in other elements of the consumer
lending business. The acquisition of First National did not have a
material impact on consumer lease balances.
On an average basis, commercial loans and leases increased
$6.8 billion, or 23%, compared to 2004 with the Bancorp
experiencing double-digit growth in the majority of its markets,
including 15% or greater growth in Chicago, Florida, Indianapolis,
Lexington and Ohio Valley. The increase in average commercial
loans and leases was primarily driven by strong growth in
commercial construction loans, commercial and industrial loans
and commercial mortgages. Commercial loan comparisons to the
prior year are impacted by the First National acquisition in 2005
and the Franklin Financial acquisition in 2004. Excluding the
impact of the acquisitions, average commercial loans and leases
increased $3.8 billion, or 13%, compared to 2004 (comparison
being provided
the
fundamental lending trends).
to supplement an understanding of
On an average basis, consumer loans and leases increased $3.9
billion, or 14%, compared to 2004 with the Bancorp experiencing
15% or greater growth in its Florida, Nashville, Cleveland and
Cincinnati markets. The growth in average consumer loans and
leases was a result of double-digit growth in residential mortgage
and construction loans and consumer installment loans mitigated
by decreases in consumer leases. Consumer loan comparisons to
the prior year are impacted by the First National acquisition in
2005,
the
securitization and sale of $750 million of automotive loans in 2004.
Excluding
loan
loans and
securitization, average consumer loans and leases increased $3.0
billion, or 11%, compared to 2004 (comparison being provided to
supplement an understanding of the fundamental lending trends).
the Franklin Financial acquisition
the automotive
in 2004 and
the acquired
Commercial
Mortgage
Construction
Leases
Total commercial loans and leases (including held for sale)
Consumer loans and leases:
Installment
Mortgage and construction
Credit card
Leases
Total consumer loans and leases (including held for sale)
Total loans and leases (including held for sale)
Total portfolio loans and leases (excluding held for sale)
36
Fifth Third Bancorp
2005
$18,241
8,923
5,525
3,495
36,184
19,952
8,982
797
1,822
31,553
$67,737
$66,685
2004
14,908
7,391
3,807
3,296
29,402
17,755
6,801
787
2,297
27,640
57,042
55,951
2003
13,672
6,299
3,097
3,037
26,105
16,343
6,880
591
2,495
26,309
52,414
49,700
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Investment Securities
As of December 31, 2005, total investment securities decreased
10% to $22.4 billion from $25.0 billion at December 31, 2004, as
the Bancorp continues its efforts to reduce the level of securities
on the balance sheet. The increased rate environment resulted in
net unrealized losses on the available-for-sale securities portfolio
increasing to $609 million at December 31, 2005 from $114 million
last year. The Bancorp continues to respond to the interest rate
environment by using cash flows from the security portfolio to
fund loan growth. At December 31, 2005, 17% of the debt
securities in the available-for-sale portfolio were adjustable-rate
instruments, compared to 14% at December 31, 2004. The
estimated weighted-average life of the debt securities in the
available-for-sale portfolio at December 31, 2005 was 4.3 years
compared to 4.4 years at December 31, 2004. At December 31,
2005, the fixed-rate securities within the available-for-sale securities
portfolio had an estimated weighted-average life of 4.2 years and a
weighted-average yield of 4.44%.
Information presented in Table 15 is on a weighted-average
life basis, anticipating future prepayments. Yield information is
presented on an FTE basis and is computed using historical cost
balances. Maturity and yield calculations for the total available-for-
sale and other securities portfolio exclude equity securities that
have no stated yield or maturity.
TABLE 15: CHARACTERISTICS OF AVAILABLE-FOR-SALE AND OTHER SECURITIES
As of December 31, 2005 ($ in millions)
U.S. Treasury and Government agencies:
Average life of one year or less
Average life 1 – 5 years
Average life 5 – 10 years
Average life greater than 10 years
Total
U.S. Government sponsored agencies:
Average life of one year or less
Average life 1 – 5 years
Average life 5 – 10 years
Average life greater than 10 years
Total
Obligations of states and political subdivisions (a):
Average life of one year or less
Average life 1 – 5 years
Average life 5 – 10 years
Average life greater than 10 years
Total
Agency mortgage-backed securities:
Average life of one year or less
Average life 1 – 5 years
Average life 5 – 10 years
Average life greater than 10 years
Total
Other bonds, notes and debentures (b):
Average life of one year or less
Average life 1 – 5 years
Average life 5 – 10 years
Average life greater than 10 years
Amortized Cost
Fair Value
Weighted-Average
Life (in years)
Weighted-Average
Yield
$3
-
498
5
506
105
1,577
352
-
2,034
84
439
131
3
657
40
11,581
4,506
-
16,127
$3
-
477
5
485
105
1,526
334
-
1,965
85
452
136
3
676
41
11,255
4,341
-
15,637
.2
-
7.4
13.2
7.4
.2
2.8
5.5
-
3.2
.6
3.2
6.1
11.7
3.5
.8
3.6
6.2
-
4.4
2.16 %
-
3.71
5.09
3.71
3.39
3.69
4.07
-
3.74
8.41
7.55
7.21
7.59
7.59
6.29
4.40
4.67
-
4.48
83
1,081
938
17
2,119
1,090
$22,533
84
1,060
916
17
2,077
1,084
$21,924
.2
3.0
6.8
22.6
4.8
8.37
4.52
5.02
3.74
4.89
Total
Other securities (c)
Total available-for-sale and other securities
4.53 %
(a) Taxable-equivalent yield adjustments included in above table are 2.83%, 2.54%, 2.43%, 2.56% and 2.55% for securities with an average life of one year or less, 1-5 years, 5-10 years, greater
4.3
than 10 years and in total, respectively.
(b) Other bonds, notes, and debentures consist of non-agency mortgage backed securities, certain other asset backed securities (primarily automobile and commercial loan backed securities) and
corporate bond securities.
(c) Other securities consist of FHLB and Federal Reserve Bank restricted stock holdings that are carried at cost, Federal Home Loan Mortgage Corporation (“FHLMC”) preferred stock holdings,
certain mutual fund holdings and equity security holdings.
TABLE 16: COMPONENTS OF INVESTMENT SECURITIES (AMORTIZED COST BASIS)
As of December 31 ($ in millions)
2004
Available-for-sale:
2005
U.S. Treasury and Government agencies
U.S. Government sponsored agencies
Obligations of states and political subdivisions
Agency mortgage-backed securities
Other bonds, notes and debentures
Other securities
Total available-for-sale and other securities
Held-to-maturity:
Obligations of states and political subdivisions
Other bonds, notes and debentures
Total held-to-maturity
$506
2,034
657
16,127
2,119
1,090
$22,533
$378
11
$389
503
2,036
823
17,571
2,862
1,006
24,801
245
10
255
2003
838
3,877
922
21,101
1,401
937
29,076
126
9
135
2002
303
2,308
1,033
19,328
1,084
734
24,790
52
-
52
2001
188
1,142
1,198
15,287
1,872
792
20,479
16
-
16
Fifth Third Bancorp 37
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 17: DEPOSITS
As of December 31 ($ in millions)
Demand
Interest checking
Savings
Money market
Other time
Certificates - $100,000 and over
Foreign office
Total deposits
Deposits
Deposit balances represent an important source of funding and
revenue growth opportunity. The Bancorp is continuing to focus
on transaction account deposit growth in its retail and commercial
franchises by enhancing its product offerings and providing
competitive rates. The Bancorp’s goal is to improve the core
deposit component of its funding profile.
Total deposits at December 31, 2005 increased 16% compared
to December 31, 2004. The increase was attributable to strong
growth in savings, money market, other time deposits and
certificates - $100,000 and over as well as the addition of $3.8
billion in deposits from the First National acquisition in the first
quarter of 2005, mitigated by decreases in interest checking and
foreign office deposits. Transaction deposits at December 31,
2005 increased 10% compared to 2004. Excluding the impact of
the $2.5 billion of transaction deposits obtained in the First
National acquisition, transaction deposits increased five percent
(comparison being provided to supplement an understanding of
the fundamental deposit trends). Overall, the Bancorp averaged
TABLE 18: BORROWINGS
As of December 31 ($ in millions)
Federal funds purchased
Short-term bank notes
Other short-term borrowings
Long-term debt
Total borrowings
is responsible for the
RISK MANAGEMENT
Managing risk is an essential component of successfully operating a
financial services company. The Bancorp’s risk management
function
identification, measurement,
monitoring, control and reporting of risk and avoidance of those
risks that are inconsistent with the Bancorp’s risk profile. The
Enterprise Risk Management division, led by the Bancorp Chief
Risk Officer, ensures consistency in the Bancorp’s approach to
managing and monitoring risk including, but not limited to, credit,
market, operational and regulatory compliance risk, within the
structure of Fifth Third’s affiliate operating model. In addition, the
Internal Audit division provides an independent assessment of the
Bancorp’s internal control structure and related systems and
processes. The Enterprise Risk Management division includes the
following key functions: (i) a Risk Policy function that ensures
consistency in the approach to risk management as the Bancorp’s
clearinghouse for credit, market and operational risk policies,
procedures and guidelines; (ii) an Operational Risk Management
function that is responsible for the risk self-assessment process, the
change control evaluation process, fraud prevention and detection,
and root cause analysis and corrective action plans relating to
identified operational losses; (iii) an Insurance Risk Management
function that is responsible for all property, casualty and liability
insurance policies including the claims administration process for
the Bancorp; (iv) a Capital Markets Risk Management function that
is responsible for establishing and monitoring proprietary trading
limits, monitoring liquidity and interest rate risk and utilizing value
at risk and earnings at risk models; (v) a Credit Risk Review
function that is responsible for evaluating the sufficiency of
underwriting, documentation and approval processes for consumer
and commercial credits; (vi) a Compliance Risk Management
38
Fifth Third Bancorp
2005
$14,609
18,282
11,276
6,129
9,313
4,343
3,482
$67,434
2004
13,486
19,481
8,310
4,321
6,837
2,121
3,670
58,226
2003
12,142
19,757
7,375
3,201
6,201
1,856
6,563
57,095
2002
10,095
17,878
10,056
1,044
7,638
1,723
3,774
52,208
2001
9,243
13,474
7,065
1,352
11,301
2,197
1,222
45,854
17% transaction deposit growth across the Detroit, Indianapolis,
Lexington, Louisville, Florida and Cincinnati markets.
Foreign office deposits represent U.S. dollar denominated
deposits of the Bancorp’s foreign branch located in the Cayman
Islands. The Bancorp utilizes these deposit balances as a method
to fund earning asset growth.
Borrowings
Given the expected continued rise in short-term interest rates, the
Bancorp continued to reduce
its dependence on overnight
wholesale borrowings as short-term borrowings declined to 39% of
total borrowings down from 42% at December 31, 2004. Long-
term debt increased $1.2 billion compared to December 31, 2004.
The Bancorp continues to explore additional alternatives regarding
the level and cost of various other sources of funding. Refer to the
Liquidity Risk Management section for discussion on
the
Bancorp’s liquidity management and Note 11 of the Notes to the
Consolidated Financial Statements for a comprehensive listing of
the components of long-term debt.
2005
$5,323
-
4,246
15,227
$24,796
2004
4,714
775
4,537
13,983
24,009
2003
6,928
500
5,742
9,063
22,233
2002
4,748
-
4,075
8,179
17,002
2001
2,544
34
4,875
7,030
14,483
function that is responsible for oversight of compliance with all
banking regulations and (vii) a Risk Strategies and Reporting
function that is responsible for quantitative analytics and Board of
Directors and senior management reporting on credit, market and
operational risk metrics.
Designated risk managers have been assigned to all business
lines reporting jointly to the senior executives within the division or
affiliate and to the Enterprise Risk Management division. Affiliate
risk management is handled by regional risk managers who are
responsible for multiple affiliates and who report jointly to affiliate
presidents and the Enterprise Risk Management division. In 2005,
the business
recovery
responsibilities were assumed by the risk manager for the
information technology and operating divisions.
continuity planning
and disaster
Risk management oversight and governance is provided by
the Risk and Compliance Committee of the Board of Directors and
through multiple management committees whose membership
includes a broad cross-section of line of business, affiliate and
support representatives. The Risk and Compliance Committee of
the Board of Directors consists of three outside directors and has
the responsibility for the oversight of credit, market, operational,
regulatory compliance and strategic risk management activities for
the Bancorp as well as for the Bancorp’s overall aggregate risk
profile. The Risk and Compliance Committee has approved the
formation of key management governance committees that are
responsible for evaluating risks and controls. These committees
include the Market Risk Committee, the Credit Risk Committee
and the Operational Risk Committee. There are also new products
and initiatives processes applicable to every line of business to
ensure an appropriate standard readiness assessment is performed
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 19: COMMERCIAL LOAN AND LEASE PORTFOLIO EXPOSURE (a)
Outstanding
2005
Exposure Nonaccrual
Outstanding
2004
Exposure
Nonaccrual
As of December 31 ($ in millions)
Exposure by industry:
Real estate
Construction
Manufacturing
Retail trade
Business services
Wholesale trade
Individuals
Transportation and warehousing
Healthcare
Financial services and insurance
Other
Accommodation and food
Other services
Public administration
Agribusiness
Communication and information
Entertainment and recreation
Utilities
Mining
Total
Exposure by loan size:
Less than $5 million
$5 million to $15 million
$15 million to $25 million
Greater than $25 million
Total
Exposure by state:
Ohio
Michigan
Indiana
Illinois
Florida
Kentucky
Tennessee
Pennsylvania
West Virginia
Out-of-footprint
$9,503
4,911
4,457
3,602
1,886
1,879
1,840
1,701
1,664
1,111
1,041
997
945
830
569
544
527
301
219
$38,527
58 %
26
10
6
100 %
26 %
22
10
10
10
6
3
1
-
12
11,689
8,094
9,975
5,962
3,351
3,540
2,371
1,993
2,844
3,069
1,596
1,396
1,260
1,004
752
1,119
749
1,001
419
62,184
47
25
14
14
100
32
49
47
18
13
9
12
6
10
1
3
9
9
-
2
4
3
-
-
227
81
8
-
11
100
7,287
3,654
3,970
2,957
1,751
1,619
1,673
1,382
1,355
744
781
850
748
796
509
478
443
237
234
31,468
62
25
9
4
100
8,620
5,823
9,034
4,903
3,124
3,178
2,135
1,678
2,245
2,348
1,335
1,237
1,027
911
676
971
639
729
413
51,026
49
26
13
12
100
28
26
22
11
27
6
11
6
5
1
4
14
5
-
4
1
3
-
-
174
86
14
-
-
100
29
21
10
10
9
6
2
1
-
12
100
30
21
25
8
4
6
3
-
1
2
100
30
25
11
10
2
6
3
1
-
12
100
33
23
10
10
2
6
2
1
1
12
100
36
28
12
13
2
4
3
-
-
2
100
Total
100 %
(a) Outstanding reflects total commercial customer loan and lease balances, including held for sale and net of unearned income, and exposure reflects total commercial customer lending commitments.
before launching a new product or initiative.
Significant risk policies approved by
the management
governance committees are also reviewed and approved by the
Board of Directors Risk and Compliance Committee.
underwriting,
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
collection
conservative
standards. The Bancorp’s credit risk management strategy also
emphasizes diversification on a geographic, industry and customer
level, 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. Lending activities are
largely decentralized, while the Enterprise Risk Management
division manages the policy process centrally. The Credit Risk
Review function, within the Enterprise Risk Management division,
provides objective assessments of the quality of underwriting and
documentation
and
documentation, the accuracy of risk grades and the charge-off and
allowance analysis process.
The Bancorp’s credit review process and overall assessment of
required allowances is based on ongoing quarterly assessments of
the probable estimated losses inherent in the loan and lease
portfolio. The Bancorp uses this ongoing assessment to promptly
identify potential problem loans or leases within the portfolio,
maintain an adequate allowance 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 current risk grading system utilized for allowance analysis
purposes encompasses ten categories. The Bancorp also maintains
a dual risk rating system that provides for 13 probability of default
grade categories and an additional six grade categories measuring
loss factors given an event of default. The probability of default
and loss given default components are not separated in the ten
grade risk rating system. The Bancorp is in the process of
completing significant validation and testing of the dual risk rating
system prior to implementation for allowance analysis purposes.
The dual risk rating system is consistent with Basel II expectations
and allows for more precision in the analysis of commercial credit
risk. Scoring systems and delinquency monitoring are used to
assess the credit risk in the Bancorp’s homogenous consumer loan
portfolios.
Fifth Third Bancorp 39
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 20: SUMMARY OF NONPERFORMING AND UNDERPERFORMING ASSETS
As of December 31 ($ in millions)
Commercial loans and leases
Commercial mortgages
Commercial construction
Residential mortgages and construction
Consumer loans and leases
Total nonaccrual loans and leases
Renegotiated loans and leases
Other assets, including other real estate owned
Total nonperforming assets
Commercial loans and leases
Commercial mortgages and construction
Credit card receivables
Residential mortgages and construction (a)
Consumer loans and leases
Total 90 days past due loans and leases
Total underperforming assets
Nonperforming assets as a percent of total loans, leases and other assets,
2005
$145
51
31
30
37
294
-
67
361
21
14
10
53
57
155
$516
2004
110
51
13
24
30
228
1
74
303
22
13
13
43
51
142
445
2003
129
42
19
25
27
242
8
69
319
15
12
13
51
54
145
464
.61
2002
159
41
14
18
15
247
-
26
273
29
18
9
60
46
162
435
.59
2001
122
57
26
11
-
216
-
19
235
25
24
8
56
51
164
399
.52
including other real estate owned
.52 %
.51
Underperforming assets as a percent of total loans, leases and other assets,
including other real estate owned
.96
265
Allowance for loan and lease losses as a percent of nonperforming assets (b)
265
Allowance for credit losses as a percent of nonperforming assets (b)
156
Allowance for loan and lease losses as a percent of underperforming assets (b)
Allowance for credit losses as a percent of underperforming assets (b)
156
(a) Information for all periods presented excludes advances made pursuant to servicing agreements to Government National Mortgage Association (“GNMA”) mortgage pools whose repayments are
insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs. As of December 31, 2005 and 2004, these advances were $13 million and $23 million,
respectively. Information prior to December 31, 2004 was not available.
.89
219
242
150
166
.74
206
225
144
158
.95
251
251
157
157
.74
235
259
160
176
(b) At December 31, 2004, the reserve for unfunded commitments was reclassified from the allowance for loan and lease losses to other liabilities. The 2003 year-end reserve for unfunded
commitments has been reclassified to conform to the current year presentation.
risk management
Portfolio Diversity
The Bancorp’s credit
includes
minimizing concentrations of risk through diversification. Table
19 provides breakouts of the commercial loan and lease portfolio,
including held for sale, by major industry classification, size of
credit and state, illustrating the diversity and granularity of the
Bancorp’s portfolio.
strategy
The commercial portfolio is further characterized by 88% of
outstanding balances and exposures concentrated within the
Bancorp’s primary market areas of Ohio, Kentucky, Indiana,
Michigan,
Illinois, Florida, Tennessee, West Virginia and
Pennsylvania. Exclusive of a national large-ticket leasing business,
the commercial portfolio is characterized by 95% of outstanding
balances and 92% of exposures concentrated within these nine
the
states.
commercial portfolio are characterized by 97% of outstanding
balances and exposures concentrated within these nine states.
The mortgage and construction segments of
Analysis of Nonperforming and Underperforming Assets
Nonperforming assets include: (i) nonaccrual loans and leases for
which ultimate collectibility of the full amount of the interest is
uncertain; (ii) loans and leases that have been renegotiated to
provide for a reduction or deferral of interest or principal because
of deterioration in the financial position of the borrower and (iii)
other assets, including other real estate owned and repossessed
equipment. Loans are placed on nonaccrual status when the
principal or interest is past due 90 days or more (unless the loan is
both well secured and in process of collection) and payment in full
of principal or interest under the contractual terms of the loan are
not expected or upon deterioration of the financial condition of
the borrower. When a loan is placed on nonaccrual status, the
accrual of interest, amortization of loan premium, accretion of loan
discount and amortization or accretion of deferred net loan fees or
costs are discontinued. Commercial loans on nonaccrual status are
reviewed for impairment at least quarterly. If the principal or a
portion of principal is deemed a loss, the loss amount is charged
off to the allowance for loan and lease losses.
40
Fifth Third Bancorp
Total nonperforming assets were $361 million at December
31, 2005, an increase of $58 million compared to $303 million at
December 31, 2004. Nonperforming assets remain a small
percentage of total loans, leases and other assets, including other
real estate owned at .52% as of December 31, 2005, compared to
.51% as of December 31, 2004.
Commercial nonaccrual credits as a percent of commercial
loans increased from .56% in 2004 to .59% in 2005, primarily
attributable to increases in the Columbus, Cincinnati, Evansville
and Naples markets. Consumer nonaccrual credits as a percent of
consumer loans decreased slightly from .21% in 2004 to .20% in
2005. Overall, nonaccrual credits continue to represent a small
portion of the portfolio at just .41% as of December 31, 2005,
compared to .38% as of December 31, 2004.
Underperforming assets include nonperforming assets and
loans and leases past due 90 days or more as to principal or
interest, which are not already accounted for as nonperforming
assets because they are well secured by collateral and in the process
of collection. Total loans and leases 90 days past due and not
accounted for as nonperforming assets have increased from $142
million as of December 31, 2004 to $155 million as of December
31, 2005.
At December 31, 2005, there were $58 million of loans and
leases currently performing in accordance with contractual terms,
but for which there were serious doubts as to the ability of the
borrower to comply with such terms. For the years 2005 and 2004,
interest income of $8 million and $6 million, respectively, was
recorded on nonaccrual and renegotiated loans and leases. For the
years ended 2005 and 2004, additional interest income of $53
million and $33 million, respectively, would have been recorded if
the nonaccrual and renegotiated loans and leases had been current
in accordance with the original terms. Table 19 provides an
analysis of the commercial nonaccrual loans and leases by major
industry classification, size of credit and state, further illustrating
the granularity of the Bancorp’s commercial loans and leases.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 21: SUMMARY OF CREDIT LOSS EXPERIENCE
For the years ended December 31 ($ in millions)
Losses charged off:
Commercial loans
Commercial mortgage loans
Construction loans
Residential mortgage loans
Consumer loans
Lease financing
Total losses
Recoveries of losses previously charged off:
Commercial loans
Commercial mortgage loans
Construction loans
Residential mortgage loans
Consumer loans
Lease financing
Total recoveries
Net losses charged off:
Commercial loans
Commercial mortgage loans
Construction loans
Residential mortgage loans
Consumer loans
Lease financing
2005
$(99)
(13)
(5)
(18)
(181)
(57)
(373)
24
4
1
-
39
6
74
(75)
(9)
(4)
(18)
(142)
(51)
$(299)
Total net losses charged off
Net charge-offs as a percent of average loans and leases (excluding held for sale):
Commercial loans
Commercial mortgage loans
Construction loans
Residential mortgage loans
Consumer loans
Lease financing
Total net losses charged off
.41 %
.10
.07
.25
.68
.96
.45
2004
(95)
(14)
(7)
(15)
(156)
(34)
(321)
14
5
-
-
41
9
69
(81)
(9)
(7)
(15)
(115)
(25)
(252)
.54
.12
.15
.27
.63
.46
.45
2003
(152)
(9)
(3)
(24)
(136)
(56)
(380)
16
2
1
-
40
9
68
(136)
(7)
(2)
(24)
(96)
(47)
(312)
1.00
.10
.09
.57
.58
.84
.63
2002
(81)
(18)
(6)
(10)
(115)
(43)
(273)
20
5
3
-
46
12
86
(61)
(13)
(3)
(10)
(69)
(31)
(187)
.52
.23
.12
.23
.49
.65
.43
2001
(106)
(12)
(2)
(7)
(117)
(65)
(309)
21
10
-
-
39
12
82
(85)
(2)
(2)
(7)
(78)
(53)
(227)
.79
.04
.06
.14
.65
1.13
.54
loans and
Analysis of Net Loan Charge-offs
leases
Net charge-offs as a percent of average
outstanding remained at .45% for 2005 and 2004. The ratio of
commercial loan net charge-offs to average commercial loans
outstanding decreased to .41% in 2005 compared to .54% in 2004
due to decreases in net charge-offs primarily in the Cincinnati,
Detroit and Louisville markets, partially offset by increases in the
Columbus and Grand Rapids markets. Commercial leasing net
charge-offs increased $30 million as a result of approximately $27
million in charge-offs related to bankrupt commercial airline
carriers during 2005. The ratio of commercial leasing net charge-
offs to average commercial leases outstanding increased 85 bp
from .21% in 2004 to 1.06% in 2005. Total consumer loan net
charge-offs in 2005 increased to $142 million compared to $115
million in 2004 primarily due to increased personal bankruptcies
associated with the recently enacted reform legislation. Overall, the
level of net charge-offs remains a small percentage of the total loan
and lease portfolio. Table 21 provides a summary of credit loss
experience and net charge-offs as a percentage of average loans and
leases outstanding by loan category.
Allowance for Credit Losses
The allowance for loan and lease losses provides coverage for
probable and estimable losses in the loan and lease portfolio. The
Bancorp evaluates the allowance each quarter to determine its
adequacy to cover inherent losses. In the current year, the Bancorp
has not substantively changed any aspect to its overall approach in
the determination of the allowance for loan and lease losses, and
there have been no material changes in assumptions or estimation
techniques as compared to prior periods that impacted the
determination of the current period allowance. In addition to the
allowance for loan and lease losses, the Bancorp maintains a
reserve for unfunded commitments. The methodology used to
determine the adequate reserve for unfunded commitments is
similar to the Bancorp’s methodology for determining the
allowance for loan and lease losses. Table 22 shows the changes in
the allowance for credit losses during 2005.
The allowance for loan and lease losses at December 31, 2005
decreased to 1.06% of the total portfolio loans and leases
compared to 1.19% at December 31, 2004. The decrease in the
allowance as a percentage of total portfolio loans and leases is
attributable to an overall improved assessment of inherent losses in
the portfolio from the consideration of historical and anticipated
TABLE 22: CHANGES IN ALLOWANCE FOR CREDIT LOSSES
For the years ended December 31 ($ in millions)
Balance, beginning of year
Net charge-offs
Allowance of acquired institutions and other
Provision for loan and lease losses
Merger-related provision
Net change in reserve for unfunded commitments
Balance, end of year
Components of allowance for credit losses (a):
2005
$785
(299)
-
330
-
(2)
$814
2004
770
(252)
-
268
-
(1)
785
2003
683
(312)
-
399
-
-
770
2002
624
(187)
-
246
-
-
683
2001
609
(227)
6
201
35
-
624
Allowance for loan and lease losses
Reserve for unfunded commitments
$744
70
$814
713
72
785
697
73
770
Total allowance for credit losses
(a) At December 31, 2004, the reserve for unfunded commitments was reclassified from the allowance for loan and lease losses to other liabilities. The 2003 year-end reserve for unfunded
commitments has been reclassified to conform to the current year presentation.
Fifth Third Bancorp 41
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 23: ATTRIBUTION OF ALLOWANCE FOR LOAN AND LEASE LOSSES TO PORTFOLIO LOANS AND LEASES
As of December 31 ($ in millions)
Allowance attributed to:
Commercial loans
Commercial mortgage loans
Construction loans
Residential mortgage loans
Consumer loans
Lease financing
Unallocated
2002(a)
2003
2005
2004
210
73
43
44
160
47
136
713
234
77
34
29
146
64
113
697
$201
78
47
37
183
56
142
$744
159
117
41
43
141
132
50
683
Total allowance for loan and lease losses
Portfolio loans and leases:
Commercial loans
Commercial mortgage loans
Construction loans
Residential mortgage loans
Consumer loans
Lease financing
Total portfolio loans and leases
Attributed allowance as a percent of respective portfolio loans:
$19,174
9,188
7,037
7,152
22,084
5,290
$69,925
16,058
7,636
4,726
6,988
18,923
5,477
59,808
14,209
6,894
3,636
4,425
17,432
5,712
52,308
12,743
5,885
3,327
3,495
15,116
5,362
45,928
2001(a)
118
102
32
31
132
101
108
624
10,807
6,085
3,356
4,505
12,565
4,230
41,548
Commercial loans
Commercial mortgage loans
Construction loans
Residential mortgage loans
Consumer loans
Lease financing
Unallocated (as a percent of total portfolio loans and leases)
1.09
1.69
.97
.69
1.05
2.38
.26
Total portfolio loans and leases
1.50
(a) The allowance for loan and lease losses in 2002 and 2001 includes funded and unfunded commitments. At December 31, 2004, the reserve for unfunded commitments was reclassified from the
.85
.67
.51
.83
1.06
.20
1.06 %
1.65
1.12
.94
.66
.84
1.12
.22
1.33
1.24
1.98
1.24
1.24
.93
2.46
.11
1.49
1.31
.96
.90
.63
.85
.86
.23
1.19
1.05 %
allowance for loan and lease losses to other liabilities. The 2003 year-end reserve for unfunded commitments has been reclassified to conform to the current period presentation.
loss rates as well as a less than five basis point impact from the
loans and leases obtained in the First National acquisition. The
loans and leases obtained in the First National acquisition were
recorded at fair value, which resulted in its previously existing
allowance not being carried over, as the credit default risk was
included in the determination of fair value.
Overall, the Bancorp’s long history of low exposure limits,
minimal exposure to national or sub-prime lending businesses,
centralized risk management and its diversified portfolio reduces
the likelihood of significant unexpected credit losses. Table 23
provides the amount of the allowance for loan and lease losses by
category.
Residential Mortgage Portfolio
Certain mortgage products have contractual features that may
increase credit exposure to the Bancorp in the event of a decline in
housing prices. These types of mortgage products offered by the
Bancorp include high loan-to-value (“LTV”) ratios, multiple loans
on the same collateral that when combined result in a high LTV
(“80/20”) and interest-only loans. Table 24 shows the Bancorp’s
TABLE 24: RESIDENTIAL MORTGAGE ORIGINATIONS
For the years ended December 31 ($ in millions)
Greater than 80% LTV with no mortgage insurance
Interest-only
Greater than 80% LTV and interest-only
80/20 loans
2005
$1,245
1,240
408
445
TABLE 25: RESIDENTIAL MORTGAGE OUTSTANDINGS
As of December 31 ($ in millions)
Greater than 80% LTV with no mortgage insurance
Interest-only
Greater than 80% LTV and interest-only
80/20 loans
2005
$1,773
899
361
28
2004
$2,143
214
40
22
Greater than 80% LTV with no mortgage insurance
Interest-only
Greater than 80% LTV and interest-only
80/20 loans
42
Fifth Third Bancorp
originations of these products in 2005 and 2004. The Bancorp
does not currently originate mortgage loans that permit principal
payment deferral or payments that are less than the accruing
interest.
Tables 25 provides the amount of these loans as a percent of
the residential mortgage loans in the Bancorp’s portfolio and the
delinquency and charge-off percentages of these loan products as
of December 31, 2005 and 2004, respectively.
The Bancorp also sells certain of these mortgage products in
the secondary market with recourse. The outstanding balances and
delinquency rates for these loans sold with recourse as of
December 31, 2005 and 2004 were $1.2 billion and 1.24% and $.4
billion and 0.84%, respectively.
The Bancorp manages credit risk in the mortgage portfolio
through conservative underwriting and documentation standards
and geographic and product diversification. The Bancorp may also
package and sell loans in the portfolio without recourse or may
purchase mortgage insurance for the loans sold in order to mitigate
credit risk.
% of total
13%
13
4
5
% of total
25%
13
5
-
% of total
31%
3
1
-
2004
$1,286
196
34
83
Delinquency %
3.11
.41
.07
-
Delinquency %
2.09
-
-
-
% of total
15%
2
-
1
Charge-off %
.10
-
.01
-
Charge-off %
.04
-
-
-
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 26: LOAN AND LEASE MATURITIES
As of December 31, 2005 ($ in millions)
Commercial loans
Commercial mortgage loans
Commercial construction loans
Residential mortgage and construction loans
Consumer loans
Lease financing
Total
Less than 1 year
$11,151
2,515
4,030
2,205
5,852
1,634
$27,387
1-5 years
6,668
5,249
1,976
3,580
11,676
2,754
31,903
TABLE 27: LOAN AND LEASE INTEREST RATE SENSITIVITY
Greater than 5
years
1,355
1,424
336
2,062
4,556
902
10,635
Interest Rate
Total
19,174
9,188
6,342
7,847
22,084
5,290
69,925
As of December 31, 2005 ($ in millions)
Commercial loans
Commercial mortgage loans
Commercial construction loans
Residential mortgage and construction loans
Consumer loans
Lease financing
Total
MARKET RISK MANAGEMENT
Market risk arises from the potential for fluctuations in interest
rates, foreign exchange rates and equity prices that may result in the
potential reduction of net income. Interest rate risk, a component
of market risk, is the exposure to adverse changes in net interest
income due to changes in interest rates. Management considers
interest rate risk a prominent market risk in terms of its potential
impact on earnings. Interest rate risk can occur for any one or
more of the following reasons: (i) assets and liabilities may mature
or reprice at different times; (ii) short-term and long-term market
interest rates may change by different amounts or (iii) the
remaining maturity of various assets or liabilities may shorten or
lengthen as interest rates change. In addition to the direct impact
of interest rate changes on net interest income, interest rates can
indirectly impact earnings through their effect on loan demand,
credit losses, mortgage origination fees, the value of servicing rights
and other sources of the Bancorp’s earnings. Consistency of the
Bancorp’s net interest income is largely dependent upon the
effective management of interest rate risk.
Net Interest Income Simulation Model
The Bancorp employs a variety of measurement techniques to
identify and manage its interest rate risk, including the use of an
earnings simulation model to analyze net interest income sensitivity
to changing interest rates. The model is based on actual cash flows
and repricing characteristics for all of the Bancorp’s financial
instruments and incorporates market-based assumptions regarding
the effect of changing interest rates on the prepayment rates of
certain assets and liabilities. The model also includes senior
management projections for activity levels in each of the product
lines offered by the Bancorp and incorporates the loss of free
funding resulting from the Bancorp’s share repurchase activity.
Actual results will differ from these simulated results due to timing,
magnitude and frequency of interest rate changes as well as
changes in market conditions and management strategies.
The Bancorp’s Asset/Liability Risk Management Committee
(“ALCO”), which includes senior management representatives and
is accountable to the Risk and Compliance Committee of the
Board of Directors, monitors and manages interest rate risk within
Board approved policy limits. In addition to the risk management
activities of ALCO,
the Bancorp created a Market Risk
Management function as part of the Enterprise Risk Management
division, which provides independent oversight of market risk
activities. The Bancorp’s current interest rate risk policy limits are
determined by measuring the anticipated change in net interest
income over a 12-month and 24-month horizon assuming a 200 bp
linear increase or decrease in all interest rates. In accordance with
the current policy, the rate movements are assumed to occur over
one year and are sustained thereafter. To further illustrate the
Predetermined
$2,424
2,332
386
2,514
7,327
3,656
$18,639
Floating or Adjustable
5,599
4,341
1,926
3,128
8,905
-
23,899
estimated sensitivity of interest rate changes, Table 28 includes the
percentage change in net interest income over the next 12 and 24
months given the implied market forward rates as well as 100 bp
and 200 bp linear increases or decreases in all interest rates. The
following table shows the Bancorp’s estimated earnings sensitivity
profile on the asset and liability positions as of December 31, 2005:
TABLE 28: ESTIMATED EARNINGS SENSITIVITY PROFILE
Change in Interest Rates (bp)
+200
+100
-100
-200
Implied Market Forward Rates
Change in Net Interest
Income
12 Months
(.72)%
(.57)
1.10
1.52
(1.79)
24 Months
.10
.41
.23
(2.44)
(2.62)
The Bancorp also utilizes the market value of equity (“MVE”)
as a measurement tool in managing interest rate sensitivity.
Whereas net interest income simulation highlights exposures over a
relatively short time horizon, the MVE analysis incorporates all
cash flows over the estimated remaining life of all balance sheet
and derivative positions. The MVE of the balance sheet, at a point
in time, is defined as the discounted present value of asset cash
flows and derivative cash flows less the discounted value of liability
cash flows. The sensitivity of MVE to changes in the level of
interest rates is a measure of the longer-term repricing risk. In
contrast to the net interest income simulation, which assumes
interest rates will change over a period of time, MVE uses
instantaneous changes in rates. MVE values only the current
balance sheet and does not incorporate the growth assumptions
that are used in the net interest income simulation model. As with
the net interest income simulation model, assumptions about the
timing and variability of balance sheet cash flows are critical in the
MVE analysis. Particularly important are the assumptions driving
prepayments and the expected changes in balances and pricing of
the indeterminate deposit portfolios. The following table shows
the Bancorp’s MVE sensitivity profile as of December 31:
TABLE 29: ESTIMATED MVE SENSITIVITY PROFILE
Change in MVE
Change in Interest Rates (bp)
+100
-100
2005
(4.08)%
3.17
2004
(4.82)
3.81
While an instantaneous shift in interest rates is used in this
analysis to provide an estimate of exposure, the Bancorp believes
that a gradual shift in interest rates would have a much more
modest impact. Since MVE measures the discounted present value
of cash flows over the estimated lives of instruments, the change in
MVE does not directly correlate to the degree that earnings would
be impacted over a shorter time horizon (i.e., the current fiscal
Fifth Third Bancorp 43
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 30: MATURITY DISTRIBUTION OF CERTIFICATES - $100,000 AND OVER
As of December 31, 2005 ($ in millions)
Three months or less
Over three months through six months
Over six months through one year
Over one year
Total
TABLE 31: AGENCY RATINGS
As of December 31, 2005
Fifth Third Bancorp:
Commercial paper
Senior debt
Fifth Third Bank and Fifth Third Bank (Michigan):
Short-term deposit
Long-term deposit
year). Further, MVE does not take into account factors such as
future balance sheet growth, changes in product mix, changes in
yield curve relationships and changing product spreads that could
mitigate the adverse impact of changes in interest rates. The net
interest income simulation and MVE analyses do not necessarily
include certain actions that management may undertake to manage
this risk in response to anticipated changes in interest rates.
Table 26 (on the previous page) shows a summary of the
remaining maturities of loans and leases held for investment based
upon expected repayments. Additionally, Table 27 (on the
previous page) shows a summary of expected repayments
exceeding one year segregated by sensitivity to interest rate
changes.
Use of Derivatives to Manage Interest Rate Risk
An
interest rate risk
integral component of the Bancorp’s
management strategy is its use of derivative instruments to
minimize significant unplanned fluctuations in earnings and cash
flows caused by market volatility. Examples of derivative
instruments that the Bancorp may use as part of its interest rate
risk management strategy include interest rate swaps, interest rate
floors, interest rate caps, forward contracts, principal only swaps,
options and swaptions.
The Bancorp also establishes derivative contracts with
reputable third parties to economically hedge significant exposures
assumed
in commercial customer accommodation derivative
contracts. Generally, these contracts have similar terms in order to
protect the Bancorp from the market volatility. See Note 8 of the
Notes to the Consolidated Financial Statements for further
discussion on derivatives.
Mortgage Servicing Rights and Interest Rate Risk
The net carrying amount of the MSR portfolio was $433 million as
of December 31, 2005. The Bancorp maintains a non-qualifying
hedging strategy relative to its mortgage banking activity, including
consultation with an independent third-party specialist, in order to
manage a portion of the risk associated with changes in value of its
MSR portfolio as a result of changing interest rates. The value of
servicing rights can fluctuate sharply depending on changes in
interest rates and other factors. Generally, as interest rates decline
and loans are prepaid to take advantage of refinancing, the total
value of existing servicing rights declines because no further
servicing fees are collected on repaid loans.
The volatility in longer-term interest rates during 2005 and the
resulting impact of changing prepayment speeds led to a recovery
of $33 million and $60 million of temporary impairment in 2005
and 2004, respectively. The servicing rights are deemed impaired
when a borrower’s loan rate is distinctly higher than prevailing
market rates. See Note 7 of the Notes to the Consolidated
Financial Statements for further discussion on servicing rights.
44
Fifth Third Bancorp
$1,288
700
1,736
619
$4,343
Fitch
F1+
AA-
F1+
AA
Moody’s
Standard and Poor’s
Prime-1
Aa2
Prime-1
Aa1
A-1
A+
A-1+
AA-
Foreign Currency Risk
The Bancorp enters into foreign exchange derivative contracts to
economically hedge certain foreign denominated loans. The
derivatives are classified as free-standing instruments with the
revaluation gain or loss being recorded within other noninterest
income on the Consolidated Statements of Income. The balance
of the Bancorp’s foreign denominated loans at December 31, 2005
is approximately $130 million. The Bancorp also enters into
foreign exchange derivative contracts for the benefit of commercial
customers involved in international trade to hedge their exposure
to foreign currency fluctuations. The Bancorp has several controls
in place to ensure excessive risk is not being taken in providing this
service to customers. These include an independent determination
of currency volatility and credit equivalent exposure on these
contracts, counterparty credit approvals and country limits.
LIQUIDITY RISK MANAGEMENT
The goal of liquidity management is to provide adequate funds to
meet changes in loan and lease demand or unexpected deposit
withdrawals. This goal is accomplished by maintaining liquid assets
in the form of investment securities, maintaining sufficient unused
borrowing capacity in the national money markets and delivering
consistent growth in core deposits. The primary source of asset
driven liquidity is provided by debt securities in the available-for-
sale securities portfolio. The estimated average life of the available-
for-sale portfolio was 4.3 years at December 31, 2005, based on
current prepayment expectations. Of the $21.9 billion (fair value
basis) of available-for-sale and other securities in the portfolio at
December 31, 2005, $3.8 billion in principal and interest is
expected to be received in the next 12 months, and an additional
$3.6 billion is expected to be received in the following 12 months.
In addition to the sale of securities in the available-for-sale
portfolio, asset-driven liquidity is provided by the Bancorp’s ability
to sell or securitize loan and lease assets. In order to reduce the
exposure to interest rate fluctuations and to manage liquidity, the
Bancorp has developed securitization and sale procedures for
several types of interest-sensitive assets. A majority of the long-
loans
term,
underwritten according to FHLMC or Federal National Mortgage
Association
(“FNMA”) guidelines are sold for cash upon
origination. Periodically, additional assets such as jumbo fixed-rate
residential mortgages, certain floating-rate short-term commercial
loans, certain floating-rate home equity loans, certain auto loans
and other consumer loans are also securitized, sold or transferred
off-balance sheet. For the years ended December 31, 2005 and
2004, a total of $9.5 billion and $6.7 billion, respectively, were sold,
securitized or transferred off-balance sheet.
residential mortgage
single-family
fixed-rate
The Bancorp also has in place a shelf registration with the
Securities and Exchange Commission permitting ready access to
the public debt markets. As of December 31, 2005, $1.5 billion of
debt or other securities were available for issuance under this shelf
registration. Additionally, the Bancorp has $15.1 billion of funding
available for issuance through private offerings of debt securities
pursuant to its bank note program. Such bank notes may be sold
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 32: CAPITAL RATIOS
As of December 31 ($ in millions)
Tier I capital
Total risk-based capital
Risk-weighted assets
Regulatory capital ratios:
Tier I capital
Total risk-based capital
Tier I leverage ratio
2005
$8,209
10,240
97,994
8.38 %
10.45
8.08
2004
8,522
10,176
82,633
10.31
12.31
8.89
2003
8,272
10,096
74,477
11.11
13.56
9.23
2002
7,747
8,935
65,444
11.84
13.65
9.84
2001
7,433
8,656
59,491
12.49
14.55
10.64
TABLE 33: SHARE REPURCHASES
For the years ended December 31
Shares authorized for repurchase at January 1
5,600,681
Additional authorizations
20,000,000
Shares repurchases (a)
(11,463,169)
Shares authorized for repurchase at December 31
14,137,512
57.13
Average price paid per share
(a) Excludes 134,435 and 40,850 shares repurchased during 2005 and 2004, respectively, in connection with various employee compensation plans. These repurchases are not included
35,685,112
20,000,000
(37,838,159)
17,846,953
$43.19
14,137,512
40,000,000
(18,452,400)
35,685,112
53.48
2004
2005
2003
against the maximum number of shares that may yet be repurchased under the Board of Directors’ authorization.
to qualified institutional buyers, financial institutions, banks,
insurance companies and similar entities in the ordinary course of
business from time to time. These sources, in addition to the
Bancorp’s equity capital base, provide a stable funding base.
Table 31 provides Moody’s, Standard and Poor’s and Fitch’s
deposit and debt ratings for the Bancorp, Fifth Third Bank and
Fifth Third Bank (Michigan). These debt ratings, along with capital
ratios above regulatory guidelines, provide the Bancorp with
additional access to liquidity.
Core customer deposits have historically provided the
Bancorp with a sizeable source of relatively stable and low-cost
funds. The Bancorp’s average core deposits and shareholders’
equity funded 64% of its average total assets during 2005. In
addition to core deposit funding, the Bancorp also accesses a
variety of other short-term and long-term funding sources, which
include the use of various regional Federal Home Loan Banks as a
funding source. Certificates carrying a balance of $100,000 or
more and deposits in the Bancorp’s foreign branch located in the
Cayman Islands are wholesale funding tools utilized to fund asset
growth. The maturity distribution of domestic certificates of
deposit of $100,000 and over as of December 31, 2005 is shown in
Table 30. Management does not rely on any one source of liquidity
and manages availability in response to changing balance sheet
needs.
CAPITAL MANAGEMENT
The Bancorp maintains a relatively high level of capital as a margin
of safety for its depositors and shareholders. At December 31,
2005, shareholders’ equity was $9.4 billion compared to $8.9 billion
at December 31, 2004, an increase of six percent. Average
shareholders’ equity as a percentage of average assets for the year
ended December 31, 2005 was 9.06%. See Note 27 of the Notes
to
for additional
information regarding capital ratios.
the Consolidated Financial Statements
Dividend Policy
The Bancorp’s common stock dividend policy reflects its earnings
outlook, desired payout ratios, the need to maintain adequate
capital levels and alternative investment opportunities. In 2005, the
Bancorp’s annual dividend increased to $1.46 from $1.31 in 2004.
Stock Repurchase Program
On January 10, 2005, the Bancorp repurchased 35.5 million shares
of
total
its common stock, approximately six percent of
outstanding shares, for $1.6 billion
in an overnight share
repurchase transaction, where the counterparty in the transaction
purchased shares in the open market over a period of time. This
program was completed by the counterparty during the third
quarter of 2005 and the Bancorp received a price adjustment of
$97 million in cash. The price adjustment represented the
difference between the original per share purchase price of $45.95
and the volume weighted-average price of $43.55 for actual shares
acquired by the counterparty during the purchase period, plus
interest.
On January 18, 2005, the Bancorp announced that its Board
of Directors had authorized management to purchase 20 million
shares of the Bancorp’s common stock through the open market
or in any private transaction. The timing of the purchases and the
exact number of shares to be purchased depends upon market
conditions. The authorization does not include specific price
targets or an expiration date.
The Bancorp’s stock repurchase program is an important
element of its capital planning activities and the Bancorp views
share repurchases as an effective means of delivering value to
shareholders. The Bancorp’s repurchase of equity securities is
shown in Table 33.
Off-Balance Sheet Arrangements
The Bancorp consolidates all of its majority-owned subsidiaries.
Other entities, including certain joint ventures, in which there is
greater than 20% ownership, but upon which the Bancorp does
not possess, nor can exert, significant influence or control, are
accounted for by equity method accounting and not consolidated.
Those entities in which there is less than 20% ownership and on
which the Bancorp does not possess, nor can exert, significant
influence or control, are generally carried at the lower of cost or
fair value.
The Bancorp does not participate in any trading activities
involving commodity contracts that are accounted for at fair value.
In addition, the Bancorp has no fair value contracts for which a
lack of marketplace quotations necessitates the use of fair value
estimation techniques. The Bancorp’s derivative product and
investment policies provide a framework within which the Bancorp
and its affiliates may use certain authorized financial derivatives as
an asset/liability management tool in meeting the Bancorp’s ALCO
capital planning directives, to hedge changes in fair value of its
largely fixed-rate mortgage servicing rights portfolio or to provide
qualifying commercial customers access to the derivative products
market. These policies are reviewed and approved annually by the
Risk and Compliance Committee of the Board of Directors.
As part of the Bancorp’s asset/liability management, the
Bancorp may transfer, subject to credit recourse, certain types of
individual financial assets to a non-consolidated qualified special
purpose entity (“QSPE”) that is wholly owned by an independent
third-party. The accounting for QSPEs is currently under review
by the FASB and the conditions for consolidation or non-
consolidation of such entities could change. During the year ended
December 31, 2005, certain commercial loans (primarily floating-
rate
loans) were
transferred to the QSPE. Generally, the loans transferred, due to
their investment grade nature, provide a lower yield and therefore
transferring these loans to the QSPE allows the Bancorp to reduce
these assets while maintaining customer
its exposure
investment-grade commercial
short-term
to
Fifth Third Bancorp 45
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
relationships. These individual loans are transferred at par with no
gain or loss recognized and qualify as sales, as set forth in SFAS
No. 140, “Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities – a Replacement of
At December 31, 2005, the
FASB Statement No. 125.”
outstanding balance of loans transferred was $2.8 billion with a
related loss reserve of $10 million.
The Bancorp had the following cash flows with these
unconsolidated QSPEs during the years ended December 31, 2005
and 2004:
TABLE 34: CASH FLOWS WITH UNCONSOLIDATED QSPEs
For the years ended December 31 ($ in millions)
Proceeds from transfers, including new securitizations
Proceeds from collections reinvested in revolving-
2005
$1,680
2004
1,379
period securitizations
Transfers received from QSPEs
Fees received
132
(18)
32
162
-
32
trusts
The Bancorp utilizes securitization
formed by
independent third parties to facilitate the securitization process of
residential mortgage loans, certain floating rate home equity lines
of credit, certain auto loans and other consumer loans. The cash
flows to and from the securitization trusts are principally limited to
the initial proceeds from the securitization trust at the time of sale
with subsequent cash flows relating to retained interests. The
retention of
Bancorp’s
securitization policy permits
the
subordinated tranches, servicing rights, interest-only strips, residual
interests, credit recourse, other residual interests and, in some
cases, a cash reserve account. At December 31, 2005, the Bancorp
had retained servicing assets totaling $441 million, subordinated
tranche security interests totaling $30 million and residual interests
totaling $35 million.
At December 31, 2005, the Bancorp had provided credit
recourse on approximately $1.3 billion of residential mortgage
loans sold to unrelated third parties. In the event of any customer
default, pursuant to the credit recourse provided, the Bancorp is
required to reimburse the third party. The maximum amount of
credit risk in the event of nonperformance by the underlying
borrowers is equivalent to the total outstanding balance of $1.3
billion. In the event of nonperformance, the Bancorp has rights to
the underlying collateral value attached to the loan. Consistent
with its overall approach in estimating credit losses for various
categories of residential mortgage loans held in its loan portfolio,
the Bancorp maintains an estimated credit loss reserve of $21
million relating to these residential mortgage loans sold.
Contractual Obligations and Commitments
The Bancorp has certain obligations and commitments to make
future payments under contracts. At December 31, 2005, the
aggregate contractual obligations and commitments were:
TABLE 35: CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS
As of December 31, 2005 ($ in millions)
Contractually obligated payments due by period:
Total deposits (a)
Long-term debt (b)
Short-term borrowings (c)
Noncancelable leases (d)
Partnership investment commitments (e)
Purchase obligations (f)
Total contractually obligated payments due by period
Other commitments by expiration period:
Letters of credit (g)
Commitments to extend credit (g)
Less than
1 year
1-3 years
4-5 years
Greater than
5 years
$63,519
3,669
9,569
65
170
14
$77,006
410
4,018
-
123
-
20
4,571
22
4,188
-
106
-
-
4,316
3,483
3,352
-
315
-
-
7,150
Total
67,434
15,227
9,569
609
170
34
93,043
$2,327
19,490
$21,817
3,114
16,234
19,348
1,533
-
1,533
326
-
326
7,300
35,724
43,024
Total other commitments by expiration period
(a) Includes demand, interest checking, savings, money market, other time, certificates- $100,000 and over and foreign office deposits. For additional information, see the Deposits discussion in the
Balance Sheet Analysis section of Management’s Discussion and Analysis.
(b) See Note 11 of the Notes to the Consolidated Financial Statements for additional information on these debt instruments.
(c) Includes federal funds purchased, bank notes, securities sold under repurchase agreements and borrowings with an original maturity of less than one year. For additional information, see Note 10 of
the Notes to the Consolidated Financial Statements.
(d) See Note 4 of the Notes to the Consolidated Financial Statements for additional information on these noncancelable leases.
(e) Includes low-income housing, historic tax and venture capital partnership investments.
(f) Represents agreements to purchase goods or services.
(g) See Note 12 of the Notes to the Consolidated Financial Statements for additional information on these commitments.
46
Fifth Third Bancorp
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
in
specified
CONTROLS AND PROCEDURES
The Bancorp maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the
Bancorp’s Securities Exchange Act of 1934 (“Exchange Act”)
reports is recorded, processed, summarized and reported within the
time periods
the Securities and Exchange
Commission’s rules and forms, and that such information is
accumulated and communicated to the Bancorp’s management,
including its Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required
disclosure based closely on the definition of “disclosure controls
and procedures” in Exchange Act Rules 13a-15(e) and 15d-15(e).
In designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no
matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives,
and management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and
procedures.
As of the end of the period covered by this report, the
Bancorp carried out an evaluation, under the supervision and with
the participation of the Bancorp’s management, including the
Bancorp’s Chief Executive Officer and Chief Financial Officer, of
the effectiveness of the design and operation of the Bancorp’s
disclosure controls and procedures. Based on the foregoing, the
Bancorp’s Chief Executive Officer and Chief Financial Officer
concluded that the Bancorp’s disclosure controls and procedures
were effective, in all material respects, to ensure that information
required to be disclosed in the reports the Bancorp files and
submits under
is recorded, processed,
summarized and reported as and when required.
the Exchange Act
The Bancorp’s management also conducted an evaluation of
internal control over financial reporting to determine whether any
changes occurred during the year covered by this report that have
materially affected, or are reasonably likely to materially affect, the
Bancorp’s internal control over financial reporting. Based on this
evaluation, there has been no such change during the year covered
by this report.
Fifth Third Bancorp 47
MANAGEMENT’S ASSESSMENT AS TO THE EFFECTIVENESS OF INTERNAL CONTROL OVER FINANCIAL REPORTING
The Management of Fifth Third Bancorp is responsible for establishing and maintaining adequate internal control, designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. Internal control over financial reporting of Fifth Third Bancorp and subsidiaries (“the Bancorp”) includes those
policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions of the
Bancorp; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of the Bancorp are being made only in accordance with authorizations of
management and directors of the Bancorp; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition,
use or disposition of the Bancorp’s assets that could have a material effect on the financial statements.
All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the
circumvention of overriding controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to financial
statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.
The Bancorp’s Management assessed the effectiveness of the Bancorp’s internal control over financial reporting as of December 31, 2005 as
required by Section 404 of the Sarbanes Oxley Act of 2002. Management’s assessment is based on the criteria established in the Internal Control —
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and was designed to provide reasonable
assurance that the Bancorp maintained effective internal control over financial reporting as of December 31, 2005. Based on this assessment,
Management believes that the Bancorp maintained effective internal control over financial reporting as of December 31, 2005.
The Bancorp’s independent registered public accounting firm, that audited the Bancorp’s consolidated financial statements included in this
annual report, has issued an attestation report on our internal control over financial reporting as of December 31, 2005 and Bancorp Management’s
assessment of the internal control over financial reporting. This report appears on the following page.
George A. Schaefer, Jr.
President and Chief Executive Officer
February 13, 2006
R. Mark Graf
Senior Vice President and Chief Financial Officer
February 13, 2006
48
Fifth Third Bancorp
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of Fifth Third Bancorp:
We have audited management’s assessment, included in the accompanying Management’s Assessment as to the Effectiveness of Internal Control
over Financial Reporting, that Fifth Third Bancorp and subsidiaries (the “Bancorp”) maintained effective internal control over financial reporting as of
December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. The Bancorp’s management is responsible for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and
an opinion on the effectiveness of the Bancorp’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s
assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and
principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel
to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of
management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition,
use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation
of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that the Bancorp maintained effective internal control over financial reporting as of December 31, 2005,
is fairly stated, in all material respects, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Also in our opinion, the Bancorp maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2005, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated
financial statements as of and for the year ended December 31, 2005 of the Bancorp and our report dated February 13, 2006 expressed an unqualified
opinion on those financial statements.
Cincinnati, Ohio
February 13, 2006
To the Shareholders and Board of Directors of Fifth Third Bancorp:
We have audited the accompanying consolidated balance sheets of Fifth Third Bancorp and subsidiaries (the “Bancorp”) as of December 31, 2005
and 2004, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for each of the three years in the period
ended December 31, 2005. These financial statements are the responsibility of the Bancorp’s management. Our responsibility is to express an opinion
on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Fifth Third Bancorp and
subsidiaries at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended
December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 1 – New Accounting Pronouncements, effective January 1, 2004, the Bancorp changed its method of accounting for stock-
based compensation by adopting the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-
Based Compensation,” using the retroactive restatement method. As further discussed in Note 1 – New Accounting Pronouncements, the Bancorp
adopted the provisions of Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities,” effective July 1,
2003.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the
Bancorp’s internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control—Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 13, 2006 expressed an unqualified
opinion on management’s assessment of the effectiveness of the Bancorp’s internal control over financial reporting and an unqualified opinion on the
effectiveness of the Bancorp’s internal control over financial reporting.
Cincinnati, Ohio
February 13, 2006
Fifth Third Bancorp 49
CONSOLIDATED STATEMENTS OF INCOME
For the years ended December 31 ($ in millions, except per share data)
Interest Income
Interest and fees on loans and leases
Interest on securities:
Taxable
Exempt from income taxes
Total interest on securities
Interest on other short-term investments
Total interest income
Interest Expense
Interest on deposits:
Interest checking
Savings
Money market
Other time
Certificates - $100,000 and over
Foreign office
Total interest on deposits
Interest on federal funds purchased
Interest on short-term bank notes
Interest on other short-term borrowings
Interest on long-term debt
Total interest expense
Net Interest Income
Provision for loan and lease losses
Net Interest Income After Provision for Loan and Lease Losses
Noninterest Income
Electronic payment processing revenue
Service charges on deposits
Mortgage banking net revenue
Investment advisory revenue
Other noninterest income
Operating lease revenue
Securities gains (losses), net
Securities gains, net - non-qualifying hedges on mortgage servicing rights
Total noninterest income
Noninterest Expense
Salaries, wages and incentives
Employee benefits
Equipment expense
Net occupancy expense
Operating lease expense
Other noninterest expense
Total noninterest expense
Income from Continuing Operations Before Income Taxes, Minority Interest
and Cumulative Effect
Applicable income taxes
Income from Continuing Operations Before Minority Interest and Cumulative Effect
Minority interest, net of tax
Income from Continuing Operations Before Cumulative Effect
Income from discontinued operations, net of tax
Income Before Cumulative Effect
Cumulative effect of change in accounting principle, net of tax
Net Income
Net Income Available to Common Shareholders (a)
Earnings per share from continuing operations
Earnings per share from discontinued operations, net
Earnings per share from cumulative effect of change in accounting principle, net
Earnings Per Share
Earnings per diluted share from continuing operations
Earnings per diluted share from discontinued operations, net
Earnings per diluted share from cumulative effect of change in accounting principle, net
Earnings Per Diluted Share
(a) Dividends on preferred stock are $.740 million for all years presented.
See Notes to Consolidated Financial Statements
50
Fifth Third Bancorp
2005
2004
2003
$3,918
2,847
2,711
1,032
39
1,071
6
4,995
1,217
45
1,262
5
4,114
1,226
51
1,277
3
3,991
174
58
39
162
48
58
539
77
15
78
393
1,102
189
314
64
176
32
140
196
263
63
129
44
126
588
1,148
80
138
-
6
55
138
363
600
2,030
1,086
2,965 3,012 2,905
330 268 399
2,635 2,744 2,506
735 622 575
522 515 485
174 178 302
355 360 332
620 671 581
55 156 124
(37) 81
39
- 3
-
2,500 2,465 2,483
1,133 1,018 1,031
283 261 240
105 84 82
221 185 159
40 114 94
1,145 1,310 945
2,927 2,972 2,551
-
-
2,208 2,237 2,438
659 712 786
1,549 1,525 1,652
(20)
1,549 1,525 1,632
44
-
-
1,676
1,525
1,549
-
-
(11)
$1,549
1,525 1,665
$1,548 1,524 1,664
$2.79 2.72 2.85
- 0.08
- (0.02)
$2.79 2.72 2.91
$2.77 2.68 2.81
0.08
(0.02)
2.87
-
-
2.68
-
-
$2.77
-
-
CONSOLIDATED BALANCE SHEETS
2005
2004
2,561
24,687
255
77
532
559
$3,078
21,924
389
117
158
1,304
19,174
7,037
9,188
4,852
7,152
22,084
1,751
(1,313)
69,925
(744)
69,181
1,726
143
511
2,169
208
441
3,876
$105,225
16,058
4,726
7,636
4,634
6,988
18,923
2,273
(1,430)
59,808
(713)
59,095
1,315
304
397
979
150
352
3,193
94,456
As of December 31 ($ in millions, except share data)
Assets
Cash and due from banks
Available-for-sale and other securities (amortized cost: 2005-$22,533 and 2004-$24,801)
Held-to-maturity securities (fair value: 2005-$389 and 2004-$255)
Trading securities
Other short-term investments
Loans held for sale
Portfolio loans and leases:
Commercial loans
Construction loans
Commercial mortgage loans
Commercial lease financing
Residential mortgage loans
Consumer loans
Consumer lease financing
Unearned income
Total portfolio loans and leases
Allowance for loan and lease losses
Total portfolio loans and leases, net
Bank premises and equipment
Operating lease equipment
Accrued interest receivable
Goodwill
Intangible assets
Servicing rights
Other assets
Total Assets
Liabilities
Deposits:
Demand
Interest checking
Savings
Money market
Other time
Certificates - $100,000 and over
Foreign office
Total deposits
Federal funds purchased
Short-term bank notes
Other short-term borrowings
Accrued taxes, interest and expenses
Other liabilities
Long-term debt
Total Liabilities
Shareholders’ Equity
1,295
Common stock (a)
9
Preferred stock (b)
1,934
Capital surplus
7,269
Retained earnings
(169)
Accumulated other comprehensive income
(1,279) (1,414)
Treasury stock
8,924
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
94,456
(a) Stated value $2.22 per share; authorized 1,300,000,000; outstanding at 2005 - 555,623,430 (excludes 27,803,674 treasury shares) and 2004 - 557,648,989 (excludes
$14,609
18,282
11,276
6,129
9,313
4,343
3,482
67,434
5,323
-
4,246
2,142
1,407
15,227
95,779
13,486
19,481
8,310
4,321
6,837
2,121
3,670
58,226
4,714
775
4,537
2,216
1,081
13,983
85,532
9,446
$105,225
1,295
9
1,827
8,007
(413)
25,802,702 treasury shares).
(b) 490,750 shares of undesignated no par value preferred stock are authorized of which none had been issued; 7,250 shares of 8.0% cumulative Series D convertible (at $23.5399 per share)
perpetual preferred stock with a stated value of $1,000 per share were authorized, issued and outstanding; 2,000 shares of 8.0% cumulative Series E perpetual preferred stock with a stated value
of $1,000 per share were authorized, issued and outstanding.
See Notes to Consolidated Financial Statements
Fifth Third Bancorp 51
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Common Preferred
Stock
9
$1,295
Stock
Accumulated
Other
Retained Comprehensive Treasury
Stock
Income
Earnings
369
(544)
(489)
($ in millions, except per share data)
Balance at December 31, 2002
Net income
Other comprehensive income
Comprehensive income
Cash dividends declared:
Common stock at $1.13 per share
Preferred stock
Shares acquired for treasury
Stock-based compensation expense
Stock-based awards exercised, including treasury shares issued
Loans issued related to the exercise of stock-based awards, net
Change in corporate tax benefit related to stock-based compensation
Other
Balance at December 31, 2003
Net income
Other comprehensive income
Comprehensive income
Cash dividends declared:
Common stock at $1.31 per share
Preferred stock
Shares acquired for treasury
Stock-based compensation expense
Restricted stock grants
Stock-based awards exercised, including treasury shares issued
Change in corporate tax benefit related to stock-based compensation
Shares issued in business combinations
Other
Balance at December 31, 2004
Net income
Other comprehensive income
Comprehensive income
Cash dividends declared:
Common stock at $1.46 per share
Preferred stock
Shares acquired for treasury
Stock-based compensation expense
Restricted stock grants
Stock-based awards exercised, including treasury shares issued
Loans repaid related to the exercise of stock-based awards, net
Change in corporate tax benefit related to stock-based compensation
Shares issued in business combinations
Retirement of shares
Other
Balance at December 31, 2005
1,295
1,295
11
(11)
$1,295
5,465
1,665
(645)
(1)
(3)
6,481
1,525
(735)
(1)
(1)
7,269
1,549
(810)
(1)
Capital
Surplus
2,010
110
(136)
(34)
18
(4)
1,964
87
(33)
(133)
11
36
2
1,934
97
65
(43)
(121)
11
6
85
(208)
1
1,827
9
9
9
(120)
(49)
(169)
(244)
Total
8,604
1,665
(489)
1,176
(645)
(1)
(655)
110
97
(34)
18
(3)
8,667
1,525
(49)
1,476
(655)
233
4
(962)
(987)
(735)
(1)
(987)
87
33 -
89
222
11
317
-
8,924
1,549
(244)
1,305
281
(1)
(1,414)
(1,746)
43
206
(810)
(1)
(1,649)
65
-
85
11
6
1,509
219 -
1
9,446
1,413
8,007
(413)
(1,279)
See Notes to Consolidated Financial Statements
52
Fifth Third Bancorp
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31 ($ in millions)
Operating Activities
Net Income
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan and lease losses
Minority interest in net income
Cumulative effect of change in accounting principle, net of tax
Depreciation, amortization and accretion
Stock-based compensation expense
(Benefit) provision for deferred income taxes
Realized securities gains
Realized securities gains - non-qualifying hedges on mortgage servicing rights
Realized securities losses
Proceeds from sales/transfers of residential mortgage and other loans held for sale
Net gains on sales of loans
Increase in residential mortgage and other loans held for sale
(Increase) decrease in trading securities
Net gain on divestitures
(Increase) decrease in accrued interest receivable
Increase in other assets
Increase (decrease) in accrued taxes, interest and expenses
Increase (decrease) in other liabilities
Net Cash Provided by Operating Activities
Investing Activities
Proceeds from sales of available-for-sale securities
Proceeds from calls, paydowns and maturities of available-for-sale securities
Purchases of available-for-sale securities
Proceeds from calls, paydowns and maturities of held-to-maturity securities
Purchases of held-to-maturity securities
Decrease (increase) in other short-term investments
Increase in loans and leases
Decrease in operating lease equipment
Purchases of bank premises and equipment
Proceeds from disposal of bank premises and equipment
Cash received on divestitures
Cash acquired in business combination
Net Cash Used In Investing Activities
Financing Activities
Increase in core deposits
Increase (decrease) in certificates - $100,000 and over, including foreign office
Increase (decrease) in federal funds purchased
(Decrease) increase in short-term bank notes
(Decrease) increase in other short-term borrowings
Proceeds from issuance of long-term debt
Repayment of long-term debt
Payment of cash dividends
Exercise of stock-based awards, net
Purchases of treasury stock
Other
Net Cash Provided by Financing Activities
Increase in Cash and Due from Banks
Cash and Due from Banks at Beginning of Year
Cash and Due from Banks at End of Year
Cash Payments
Interest
Federal income taxes
Supplemental Cash Flow Information
Transfer from portfolio loans to loans held for sale, net
Business Acquisitions:
Fair value of tangible assets acquired (noncash)
Goodwill and identifiable intangible assets acquired
Liabilities assumed
Stock options
Common stock issued
Securitizations:
Capitalized servicing rights
Residual interest
Available-for-sale securities retained
Reclassification of minority interest to long-term debt
Consolidation of special purpose entity:
Operating leases
Long-term debt
Other assets/liabilities, net
See Notes to Consolidated Financial Statements
2005
2004
2003
$1,549
1,525
1,665
330
-
-
405
65
(16)
(46)
-
7
9,697
(162)
(7,084)
(40)
-
(96)
(826)
48
355
4,186
5,912
5,271
(7,785)
48
(181)
402
(9,896)
124
(437)
56
-
242
(6,244)
3,874
1,491
130
(775)
(687)
4,665
(3,782)
(794)
96
(1,649)
6
2,575
517
2,561
$3,078
$1,952
659
3,399
5,149
1,297
(5,179)
(63)
(1,446)
-
-
-
-
-
-
-
268
-
-
459
87
(13)
(58)
-
95
6,824
(112)
(4,788)
259
(91)
16
(877)
(26)
(73)
3,495
11,331
6,234
(13,425)
42
(148)
(264)
(7,749)
357
(391)
23
233
29
(3,728)
3,327
(2,962)
(2,238)
275
(1,210)
11,128
(6,283)
(704)
89
(987)
-
435
202
2,359
2,561
1,096
693
399
20
11
550
110
295
(150)
(3)
69
16,280
(340)
(10,501)
(37)
(40)
45
(656)
253
135
8,105
22,522
9,264
(36,123)
18
(92)
33
(10,651)
214
(284)
26
67
-
(15,006)
1,908
2,978
2,180
500
2,093
1,095
(2,159)
(631)
63
(655)
(3)
7,369
468
1,891
2,359
1,112
432
605
3,959
921
282
(916)
(36)
(281)
9
21
21
-
-
-
-
-
-
-
-
-
9
28
-
482
1,068
1,109
25
Fifth Third Bancorp 53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
Nature of Operations
Fifth Third Bancorp (“Bancorp”), an Ohio corporation, conducts
its principal lending, deposit gathering, transaction processing and
service advisory activities through its banking and non-banking
subsidiaries from 1,119 banking centers located throughout Ohio,
Kentucky, Indiana, Michigan, Illinois, Florida, Tennessee, West
Virginia, Pennsylvania and Missouri.
is accounted for on the cash method thereafter, until qualifying for
return to accrual status. Generally, a loan is returned to accrual
status when all delinquent interest and principal payments become
current in accordance with the terms of the loan agreement or
when the loan is both well secured and in the process of collection.
Loan and lease origination and commitment fees and certain
direct loan and lease origination costs are deferred and the net
amount amortized over the estimated life of the related loans,
leases or commitments as a yield adjustment.
Basis of Presentation
The Consolidated Financial Statements include the accounts of the
Bancorp and its majority-owned subsidiaries. Other entities,
including certain joint ventures, in which there is greater than 20%
ownership, but upon which the Bancorp does not possess, nor can
it exert, significant influence or control, are accounted for by the
equity method and not consolidated; those in which there is less
than 20% ownership are generally carried at the lower of cost or
fair value. All material intercompany transactions and balances
have been eliminated. Certain prior period data has been
reclassified to conform to current period presentation.
Use of Estimates
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those
estimates.
Securities
Securities are classified as held-to-maturity, available-for-sale or
trading on the date of purchase. Only those securities classified as
held-to-maturity, and which management has the intent and ability
to hold to maturity, are reported at amortized cost. Available-for-
sale and trading securities are reported at fair value with unrealized
gains and losses, net of related deferred income taxes, included in
accumulated other comprehensive income and other noninterest
income, respectively. The fair value of a security is determined
based on quoted market prices. If quoted market prices are not
available, fair value is determined based on quoted prices of similar
instruments. Realized securities gains or losses are reported within
noninterest income in the Consolidated Statements of Income. The
cost of securities sold is based on the specific identification
method. Available-for-sale and held-to-maturity securities are
reviewed quarterly for possible other-than-temporary impairment.
The review includes an analysis of the facts and circumstances of
each individual investment such as the severity of loss, the length
of time the fair value has been below cost, the expectation for that
security’s performance, the creditworthiness of the issuer and the
Bancorp’s intent and ability to hold the security. A decline in value
that is considered to be other-than-temporary is recorded as a loss
within noninterest income in the Consolidated Statements of
Income.
Loans and Leases
Interest income on loans and leases is based on the principal
balance outstanding computed using the effective interest method.
The accrual of interest income for commercial, construction and
mortgage loans is discontinued when there is a clear indication the
borrower’s cash flow may not be sufficient to meet payments as
they become due. Such loans are also placed on nonaccrual status
when the principal or interest is past due ninety days or more,
unless the loan is well secured and in the process of collection.
Consumer loans and revolving lines of credit for equity lines that
have principal and interest payments that have become past due
one hundred and twenty days and credit cards that have principal
and interest payments that have become past due one hundred and
eighty days are charged off to the allowance for loan and lease
losses. When a loan is placed on nonaccrual status, all previously
accrued and unpaid interest is charged against income and the loan
54
Fifth Third Bancorp
Direct financing leases are carried at the aggregate of lease
payments plus estimated residual value of the leased property, less
unearned income. Interest income on direct financing leases is
recognized over the term of the lease to achieve a constant periodic
rate of return on the outstanding investment. Interest income on
leveraged leases is recognized over the term of the lease to achieve
a constant rate of return on the outstanding investment in the
lease, net of the related deferred income tax liability, in the years in
which the net investment is positive.
Conforming residential mortgage loans are typically classified
as held for sale upon origination based upon management’s intent
to sell all the production of these loans. Residential mortgage loans
held for sale are valued at the lower of aggregate cost or fair value.
Loans held for sale that qualify for fair value hedge accounting are
carried at fair value. Fair value is based on the contract price at
which the mortgage loans will be sold. The Bancorp generally has
commitments to sell residential mortgage loans held for sale in the
secondary market. Gains or losses on sales are recognized in
mortgage banking net revenue upon delivery.
Impaired loans and leases are measured based on the present
value of expected future cash flows discounted at the loan’s
effective interest rate or the fair value of the underlying collateral.
The Bancorp evaluates the collectibility of both principal and
interest when assessing the need for a loss accrual.
Other Real Estate Owned
Other real estate owned (“OREO”), which is included in other
assets, represents property acquired through foreclosure or other
proceedings. OREO is carried at the lower of cost or fair value,
less costs to sell. All property is periodically evaluated and
reductions in fair value are recognized in other noninterest expense
in the Consolidated Statements of Income.
Allowance for Loan and Lease Losses
The Bancorp maintains an allowance to absorb probable loan and
lease losses inherent in the portfolio. The allowance is maintained
at a level the Bancorp considers to be adequate and is based on
ongoing quarterly assessments and evaluations of the collectibility
and historical loss experience of loans and leases. Credit losses are
charged and recoveries are credited to the allowance. Provisions
for loan and lease losses are based on the Bancorp’s review of the
historical credit
in
management’s judgment, deserve consideration under existing
economic conditions in estimating probable credit losses. In
determining the appropriate level of the allowance, the Bancorp
estimates
losses using a range derived from “base” and
“conservative” estimates.
loss experience and such factors that,
Larger commercial loans that exhibit probable or observed
credit weaknesses are subject to individual review. Where
appropriate, allowances are allocated to individual loans based on
management’s estimate of the borrower’s ability to repay the loan
given the availability of collateral, other sources of cash flow and
legal options available to the Bancorp. The review of individual
loans includes those loans that are impaired as provided in
Statement of Financial Accounting Standard (“SFAS”) No. 114,
“Accounting by Creditors for Impairment of a Loan.” Any
allowances for impaired loans are measured based on the present
value of expected future cash flows discounted at the loan’s
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for allowance analysis purposes encompasses
effective interest rate or fair value of the underlying collateral. The
Bancorp evaluates the collectibility of both principal and interest
when assessing the need for loss accrual. Historical loss rates are
applied to other commercial loans not subject to specific allowance
allocations. The loss rates are derived from a migration analysis,
which computes the net charge-off experience sustained on loans
according to their internal risk grade. The risk grading system
utilized
ten
categories. The Bancorp also maintains a dual risk rating system
that provides for 13 probability of default grade categories and an
additional six grade categories measuring loss factors given an
event of default. The probability of default and loss given default
analyses are not separated in the ten grade risk rating system. The
Bancorp is in the process of completing significant validation and
testing of the dual risk rating system prior to implementation for
allowance analysis purposes. The dual risk rating system is
consistent with Basel II expectations and allows for more precision
in the analysis of commercial credit risk.
Homogenous loans and leases, such as consumer installment,
residential mortgage and automobile leases are not individually risk
graded. Rather, standard credit scoring systems and delinquency
monitoring are used to assess credit risks. Allowances are
established for each pool of loans based on the expected net
charge-offs for one year. Loss rates are based on the average net
charge-off history by loan category.
Historical loss rates for commercial and consumer loans may
be adjusted for significant factors that, in management’s judgment,
reflect the impact of any current conditions on loss recognition.
Factors that management considers in the analysis include the
effects of the national and local economies, trends in the nature
and volume of loans (delinquencies, charge-offs and nonaccrual
loans), changes in mix, credit score migration comparisons, asset
quality trends, risk management and loan administration, changes
in the internal lending policies and credit standards, collection
practices and examination results from bank regulatory agencies
and the Bancorp’s internal credit examiners.
An unallocated allowance is maintained to recognize the
imprecision in estimating and measuring loss when evaluating
allowances for individual loans or pools of loans. Allowances on
individual loans and historical loss rates are reviewed quarterly and
adjusted as necessary based on changing borrower and/or
collateral conditions and actual collection and charge-off
experience.
Loans acquired by the Bancorp through a purchase business
combination are evaluated for possible credit
impairment.
Reduction to the carrying value of the acquired loans as a result of
credit impairment is recorded as an adjustment to goodwill. The
Bancorp does not carry over the acquired company’s allowance for
loan and lease losses nor does the Bancorp add to its existing
allowance for the acquired loans as part of purchase accounting.
The Bancorp’s primary market areas for lending are Ohio,
Kentucky, Indiana, Michigan, Illinois, Florida, Tennessee, West
Virginia and Pennsylvania. When evaluating the adequacy of
allowances, consideration is given to this regional geographic
concentration and the closely associated effect changing economic
conditions have on the Bancorp’s customers.
In the current year, the Bancorp has not substantively changed
any aspect to its overall approach in the determination of allowance
for loan and lease losses. There have been no material changes in
assumptions or estimation techniques as compared to prior periods
that impacted the determination of the current period allowance
for loan and lease losses.
Reserve for Unfunded Commitments
The reserve for unfunded commitments is maintained at a level
believed by management to be sufficient to absorb estimated
to unfunded credit facilities. The
probable
determination of the adequacy of the reserve is based upon an
losses related
evaluation of the unfunded credit facilities, including an assessment
of historical commitment utilization experience, credit risk grading
and credit grade migration. Net adjustments to the reserve for
unfunded commitments are included in other noninterest expense.
Loan Sales and Securitizations
When the Bancorp sells loans through either securitizations or
individual loan sales in accordance with its investment policies, it
may retain one or more subordinated tranches, servicing rights,
interest-only strips, credit recourse, other residual interests and in
some cases, a cash reserve account, all of which are considered
retained interests in the securitized or sold loans. Gain or loss on
sale or securitization of the loans depends in part on the previous
carrying amount of the financial assets sold or securitized, allocated
between the assets sold and the retained interests based on their
relative fair value at the date of sale or securitization. To obtain fair
values, quoted market prices are used if available. If quotes are not
available for retained interests, the Bancorp calculates fair value
based on the present value of future expected cash flows using
both management’s best estimates and third-party data sources for
the key assumptions, including credit losses, prepayment speeds,
forward yield curves and discount rates commensurate with the
risks involved. Gain or loss on sale or securitization of loans is
reported as a component of noninterest
the
Consolidated Statements of Income. Retained interests from
securitized or sold loans, excluding servicing rights, are carried at
fair value. Adjustments to fair value for retained interests classified
as available-for-sale securities are included in accumulated other
the
comprehensive
Consolidated Statements of Income if the fair value has declined
below the carrying amount and such decline has been determined
to be other-than-temporary. Adjustments to fair value for retained
interests classified as trading securities are recorded within
noninterest income in the Consolidated Statements of Income.
in noninterest
income or
income
income
in
in
Servicing rights resulting from residential mortgage, home
equity line of credit and automotive loan sales are amortized in
proportion to and over the period of estimated net servicing
revenues and are reported as a component of mortgage banking
net revenue and other noninterest income, respectively, in the
Consolidated Statements of Income. Servicing rights are assessed
for impairment monthly, based on fair value, with temporary
impairment recognized
through a valuation allowance and
permanent impairment recognized through a write-off of the
servicing asset and related valuation allowance. Key economic
assumptions used in measuring any potential impairment of the
servicing rights include the prepayment speed of the underlying
loans, the weighted-average life of the loans, the discount rate and
the weighted-average default rate, as applicable. The primary risk of
material changes to the value of the servicing rights resides in the
potential volatility in the economic assumptions used, particularly
the prepayment speeds. The Bancorp monitors this risk and adjusts
its valuation allowance as necessary to adequately reserve for any
probable impairment in the portfolio. For purposes of measuring
impairment, the mortgage servicing rights are stratified based on
the financial asset type and interest rates. In addition, the Bancorp
obtains an independent third-party valuation of the mortgage
servicing portfolio on a quarterly basis. Fees received for servicing
loans owned by investors are based on a percentage of the
outstanding monthly principal balance of such loans and are
included in noninterest income as loan payments are received.
Costs of servicing loans are charged to expense as incurred.
Bank Premises and Equipment
Bank premises and equipment, including leasehold improvements,
are stated at cost less accumulated depreciation and amortization.
Depreciation is calculated using the straight-line method based on
estimated useful lives of the assets for book purposes, while
accelerated depreciation
tax purposes.
is used for
Amortization of leasehold improvements is computed using the
income
Fifth Third Bancorp 55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
straight-line method over the lives of the related leases or useful
lives of the related assets, whichever is shorter. In accordance with
the adoption of SFAS No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets,” the Bancorp tests its long-lived
assets for impairment through both a probability-weighted and
changes
primary-asset
in
circumstances
and minor
improvements are charged to noninterest expense as incurred.
approach whenever
dictate. Maintenance,
events or
repairs
those
fair value
instruments at
Derivative Financial Instruments
The Bancorp accounts for its derivatives under SFAS No. 133,
“Accounting for Derivative Instruments and Hedging Activities,”
as amended. The Statement requires recognition of all derivatives
as either assets or liabilities in the balance sheet and requires
through
measurement of
adjustments to accumulated other comprehensive income and/or
current earnings, as appropriate. On the date the Bancorp enters
into a derivative contract, the Bancorp designates the derivative
instrument as either a fair value hedge, cash flow hedge or as a
free-standing derivative instrument. For a fair value hedge, changes
in the fair value of the derivative instrument and changes in the fair
value of the hedged asset or liability or of an unrecognized firm
commitment attributable to the hedged risk are recorded in current
period net income. For a cash flow hedge, changes in the fair value
of the derivative instrument, to the extent that it is effective, are
recorded
income and
subsequently reclassified to net income in the same period(s) that
the hedged transaction impacts net income. For free-standing
derivative instruments, changes in fair values are reported in
current period net income.
in accumulated other comprehensive
Prior to entering a hedge transaction, the Bancorp formally
documents the relationship between hedging instruments and
hedged items, as well as the risk management objective and strategy
for undertaking various hedge transactions. This process includes
linking all derivative instruments that are designated as fair value or
cash flow hedges to specific assets and liabilities on the balance
sheet or to specific forecasted transactions along with a formal
assessment at both inception of the hedge and on an ongoing basis
as to the effectiveness of the derivative instrument in offsetting
changes in fair values or cash flows of the hedged item. If it is
determined that the derivative instrument is not highly effective as
a hedge, hedge accounting is discontinued and the adjustment to
fair value of the derivative instrument is recorded in net income.
Taxes
The Bancorp estimates income tax expense based on amounts
expected to be owed to the various tax jurisdictions in which the
Bancorp conducts business. On a quarterly basis, management
assesses the reasonableness of its effective tax rate based upon its
current estimate of the amount and components of net income, tax
credits and the applicable statutory tax rates expected for the full
year. The estimated income tax expense is recorded in the
Consolidated Statements of Income.
Deferred income tax assets and liabilities are determined using
the balance sheet method and are reported in accrued taxes,
interest and expenses in the Consolidated Balance Sheet. Under
this method, the net deferred tax asset or liability is based on the
tax effects of the differences between the book and tax basis of
assets and liabilities, and recognizes enacted changes in tax rates
and
Deferred tax assets are recognized subject to
management judgment that realization is more likely than not.
laws.
Accrued taxes represent the net estimated amount due or to
be received from taxing jurisdictions and are reported in accrued
taxes, interest and expenses in the Consolidated Balance Sheets.
The Bancorp evaluates and assesses the relative risks and
appropriate tax treatment of transactions and filing positions after
considering statutes, regulations, judicial precedent and other
information and maintains tax accruals consistent with
its
evaluation of these relative risks and merits. Changes to the
56
Fifth Third Bancorp
leasing
estimate of accrued taxes occur periodically due to changes in tax
rates, interpretations of tax laws, the status of examinations being
conducted by taxing authorities and changes to statutory, judicial
and regulatory guidance that impact the relative risks of tax
positions. These changes, when they occur, can affect deferred
taxes and accrued taxes as well as the current period’s income tax
expense and can be significant to the operating results of the
Bancorp. As described in greater detail in Note 13, the Internal
is currently challenging the Bancorp’s tax
Revenue Service
For additional
treatment of certain
information, see Note 22.
Earnings Per Share
In accordance with SFAS No. 128, “Earnings Per Share,” basic
earnings per share are computed by dividing net income available
to common shareholders by the weighted-average number of
shares of common stock outstanding during the period. Earnings
per diluted share are computed by dividing adjusted net income
available to common shareholders by the weighted-average number
of shares of common stock and common stock equivalents
outstanding during the period. Dilutive common stock equivalents
represent the assumed conversion of convertible preferred stock
and the exercise of stock-based awards.
transactions.
Other
Securities and other property held by Fifth Third Investment
Advisors, a division of the Bancorp’s banking subsidiaries, in a
fiduciary or agency capacity are not included in the Consolidated
Balance Sheets because such
items are not assets of the
subsidiaries. Investment advisory revenue in the Consolidated
Statements of Income
is recognized on the accrual basis.
Investment advisory service revenues are recognized monthly
based on a fee charged per transaction processed and a fee charged
on the market value of ending account balances associated with
individual contracts.
The Bancorp recognizes revenue from its electronic payment
processing services on an accrual basis as such services are
performed, recording revenues net of certain costs (primarily
interchange fees charged by credit card associations) not controlled
by the Bancorp.
Acquisitions of treasury stock are carried at cost. Reissuance
of shares in treasury for acquisitions, exercises of stock-based
awards or other corporate purposes is recorded based on the
specific identification method.
Advertising costs are generally expensed as incurred.
New Accounting Pronouncements
In December 2002, the FASB issued SFAS No. 148, “Accounting
for Stock-Based Compensation-Transition and Disclosure-an
Amendment of FASB Statement No. 123.” This Statement amends
SFAS No. 123, “Accounting for Stock-Based Compensation,” to
provide alternative methods of transition for a voluntary change to
the fair value method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure
requirements of SFAS No. 123 to require more prominent
disclosures about the method of accounting for stock-based
employee compensation and the effect of the method used on
reported results in both annual and interim financial statements.
This Statement was effective for financial statements for fiscal
years ending after December 15, 2002. Effective January 1, 2004,
the Bancorp adopted the fair value recognition provisions of SFAS
No. 123 using the retroactive restatement method described in
SFAS No. 148. As a result, financial information for all periods
prior to 2004 has been restated to reflect the compensation
expense that would have been recognized had the fair value
method of accounting been applied to all awards granted to
employees after January 1, 1995.
The weighted-average fair value of options granted was $9.31,
$14.11 and $18.27 in 2005, 2004 and 2003, respectively. The fair
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following
assumptions used for grants in 2005, 2004 and 2003: expected
option lives ranging from six to nine years for all three years;
expected dividend yield of 3.5%, 2.3% and 1.6%, respectively;
expected volatility of 26%, 28%, and 28%, respectively, and risk-
free interest rates of 4.3%, 3.9% and 4.4%, respectively.
In December 2004, the FASB issued SFAS No. 123 (Revised
2004),
requires
“Share-Based Payment.” This Statement
measurement of the cost of employee services received in exchange
for an award of equity instruments based on the grant-date fair
value of the award with the cost to be recognized over the service
period. This Statement is effective for financial statements as of
the beginning of the first interim or annual reporting period of the
first fiscal year that begins after June 15, 2005. As the Bancorp has
previously adopted the fair value recognition provisions of SFAS
No. 123 and the retroactive restatement method described in SFAS
No. 148, the adoption of this Statement will not have a material
impact on the Bancorp’s Consolidated Financial Statements. For
further information on stock-based compensation see Note 18.
In January 2003, the FASB issued Interpretation No. 46
(“FIN 46”), “Consolidation of Variable Interest Entities.” This
Interpretation clarifies
the application of ARB No. 51,
“Consolidated Financial Statements,” for certain entities in which
equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated
support from other parties. This Interpretation requires variable
interest entities (“VIEs”) to be consolidated by the primary
beneficiary which represents the enterprise that will absorb the
majority of the VIE’s expected losses if they occur, receive a
majority of the VIE’s residual returns if they occur, or both.
Qualifying Special Purpose Entities (“QSPEs”) are exempt from
the consolidation requirements of FIN 46. This Interpretation was
effective for VIEs created after January 31, 2003 and for VIEs in
which an enterprise obtains an interest after that date.
In December 2003, the FASB issued Interpretation No. 46R
(“FIN 46R”), “Consolidation of Variable Interest Entities-an
interpretation of ARB 51 (revised December 2003),” which
replaces FIN 46. FIN 46R was primarily issued to clarify the
required accounting for interests in VIEs. Additionally, this
Interpretation exempts certain entities from its requirements and
provides for special effective dates for enterprises that have fully or
partially applied FIN 46 as of December 24, 2003. Application of
FIN 46R is required in financial statements of public enterprises
that have interests in structures that are commonly referred to as
special-purpose entities, or SPEs, for periods ending after
December 15, 2003. Application by public enterprises, other than
small business issuers, for all other types of VIEs (i.e., non-SPEs) is
required in financial statements for periods ending after March 15,
2004, with earlier adoption permitted. The Bancorp early adopted
the provisions of FIN 46 on July 1, 2003. The Bancorp provided
full credit recourse to an unrelated and unconsolidated asset-
backed SPE in conjunction with the sale and subsequent leaseback
of leased autos. The unrelated and unconsolidated asset-backed
SPE was formed for the sole purpose of participating in the sale-
leaseback transactions with the Bancorp. Based on this credit
recourse, the Bancorp is deemed to be the primary beneficiary as it
maintains the majority of the variable interests in this SPE and was
therefore required to consolidate the entity. Early adoption of FIN
46 required the Bancorp to consolidate these operating lease assets
and a corresponding liability as well as recognize an after-tax
cumulative effect charge of $11 million ($.02 per diluted share)
representing the difference between the carrying value of the leased
autos sold and the carrying value of the newly consolidated
obligation as of July 1, 2003. As of December 31, 2005, the
outstanding balance of leased autos sold was approximately $54
million. Consolidation of these operating lease assets did not
impact risk-based capital ratios or net income trends; however lease
payments on the operating lease assets are now reflected as a
component of noninterest income and depreciation expense is now
reflected as a component of noninterest expense. The Bancorp also
early adopted the provisions of FIN 46 related to the consolidation
of two wholly-owned finance entities involved in the issuance of
trust preferred securities. Effective July 1, 2003, the Bancorp
deconsolidated the wholly owned issuing trust entities resulting in a
recharacterization of the underlying consolidated debt obligation
from the previous trust preferred securities obligations to the
junior subordinated debenture obligations that exist between the
Bancorp and the issuing trust entities. See Note 14 for discussion
of certain guarantees that the Bancorp has provided for the benefit
of the wholly-owned issuing trust entities related to their debt
obligations.
In May 2003, the FASB issued SFAS No. 150, “Accounting
for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity.” This Statement establishes standards for
how an entity classifies and measures certain financial instruments
with characteristics of both liabilities and equity. This Statement
requires that an issuer classify a financial instrument that is within
its scope as a liability. Many of those instruments were previously
classified as equity, or in some cases, presented between the
liabilities section and the equity section of the statement of
financial position. This Statement was effective for financial
instruments entered into or modified after May 31, 2003, and
otherwise was effective at the beginning of the first interim period
beginning after June 15, 2003. Adoption of this Statement on July
1, 2003 required a reclassification of a minority interest to long-
term debt and its corresponding minority interest expense to
interest expense, relating to preferred stock issued during 2001 by a
subsidiary of the Bancorp. The existence of the mandatory
redemption feature of this issue upon its mandatory conversion to
trust preferred securities necessitated these reclassifications and did
not result in any change in bottom line income statement trends.
issued Statement of Position
In December 2003, the Accounting Standards Executive
the American Institute of Certified Public
Committee of
(“SOP”) 03-3,
Accountants
“Accounting for Certain Loans and Debt Securities Acquired in a
Transfer.” SOP 03-3 addresses the accounting for acquired loans
that show evidence of having deteriorated in terms of credit quality
since their origination and for which a loss is deemed probable of
occurring. SOP 03-3 requires acquired loans to be recorded at
their fair value, defined as the present value of future cash flows
including interest income, to be recognized over the life of the
loan. SOP 03-3 prohibits the carryover of an allowance for loan
loss on certain acquired loans within its scope considered in the
future cash flows assessment. SOP 03-3 was effective for loans
acquired in fiscal years beginning after December 15, 2004 and has
not had a material effect on the Bancorp’s Consolidated Financial
Statements.
In March 2004, the Securities and Exchange Commission staff
released Staff Accounting Bulletin (“SAB”) No. 105, “Application
of Accounting Principles to Loan Commitments.” This SAB
disallows the inclusion of expected future cash flows related to the
servicing of a loan in the determination of the fair value of a loan
commitment. Further, no other internally developed intangible
asset should be recorded as part of the loan commitment
derivative. Recognition of
intangible assets would only be
appropriate in a third-party transaction, such as a purchase of a
loan commitment or in a business combination. The SAB is
effective for all loan commitments entered into after March 31,
2004, but does not require retroactive adoption for
loan
commitments entered into on or before March 31, 2004. Adoption
of this SAB did not have a material effect on the Bancorp’s
Consolidated Financial Statements.
In March 2004, the Emerging Issues Task Force (“EITF”)
reached a consensus on Issue 03-1, “The Meaning of Other-Than-
Fifth Third Bancorp 57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
and
Impairment
Impairment
Its Application
to Certain
Temporary
Investments.” The EITF reached a consensus on an other-than-
temporary impairment model for debt and equity securities
accounted for under SFAS No. 115, “Accounting for Certain
Investments in Debt and Equity Securities,” and cost method
investments. In September 2004, the FASB issued Staff Position
(“FSP”) No. EITF 03-01-1, “Effective Date of Paragraphs 10-20
of EITF 03-01.” This FSP delayed the effective date of the
measurement and recognition guidance contained in paragraphs
10-20 of Issue 03-01. In November 2005, the FASB issued FSP
FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-
Temporary
to Certain
Investments.” This FSP nullifies certain requirements of Issue 03-1
and supersedes EITF Abstracts, Topic No. D-44, “Recognition of
Other-Than-Temporary Impairment upon the Planned Sale of a
Security Whose Cost Exceeds Fair Value.” Based on the
clarification provided in FSP FAS 115-1 and FAS 124-1, the
amount of any other-than-temporary impairment that needs to be
recognized will continue to be dependent on market conditions,
the occurrence of certain events or changes in circumstances
relative to an investee and an entity’s intent and ability to hold the
impaired investment at the time of the valuation. FSP FAS 115-1
and FAS 124-1 is effective for reporting periods beginning after
December 15, 2005. Adoption of this FSP did not have a material
effect on the Bancorp’s Consolidated Financial Statements.
Its Application
and
in
In May 2005, the FASB issued SFAS No. 154, “Accounting
Changes and Error Corrections-a Replacement of APB Opinion
No. 20 and FASB Statement No. 3.” This Statement replaces APB
Opinion No. 20, “Accounting Changes,” and FASB Statement No.
3, “Reporting Accounting Changes
Interim Financial
Statements,” and changes the requirements for the accounting for
and reporting of a change in accounting principle. This Statement
requires retrospective application to prior periods’ financial
statements of changes
is
impracticable to determine either the period-specific effects or the
cumulative effect of the change. This Statement applies to all
voluntary changes in accounting principle. It also applies to
changes required by an accounting pronouncement in the unusual
instance that the pronouncement does not
include specific
transition provisions. This Statement is effective for accounting
changes and error corrections made in fiscal years beginning after
December 15, 2005. The adoption of this Statement is not
expected to have a material effect on the Bancorp’s Consolidated
Financial Statements.
in accounting principle, unless
it
important assumption that affects the periodic
In July 2005, the FASB released a proposed Staff Position
(“FSP”) FAS 13-a, “Accounting for a Change or Projected Change
in the Timing of Cash Flows Relating to Income Taxes Generated
the
by a Leveraged Lease Transaction,” which addresses
accounting for a change or projected change in the timing of lessor
cash flows, but not the total net income, relating to income taxes
generated by a leveraged lease transaction. This proposed FSP
would amend SFAS No. 13, “Accounting for Leases,” and would
apply to all transactions classified as leveraged leases. The timing of
cash flows relating to income taxes generated by a leveraged lease is
an
income
recognized by the lessor. Under the proposed FSP, if during the
lease term the expected timing of the income tax cash flows
generated by a leveraged lease is revised, the rate of return and the
allocation of income would be recalculated from the inception of
the lease. Upon adoption of the proposed FSP, the change in the
net investment balance resulting from the recalculation would be
recognized as a cumulative effect of a change in accounting
principle. On an ongoing basis following the adoption, a change in
the net investment balance resulting from a recalculation would be
recognized as a gain or a loss in the period in which the assumption
changed and included in income from continuing operations in the
same line item used when leveraged lease income is recognized.
These amounts would then be recognized back into income over
58
Fifth Third Bancorp
the remaining terms of the affected leases. During May 2005, the
Bancorp filed suit in the United States District Court for the
Southern District of Ohio related to a dispute with the Internal
Revenue Service concerning the timing of deductions associated
with certain leveraged lease transactions in its 1997 tax return. The
Internal Revenue Service has also proposed adjustments to the tax
effects of certain leveraged lease transactions in subsequent tax
return years. The proposed adjustments relate to the Bancorp’s
portfolio of lease-in lease-out transactions, service contract leases
and qualified technology equipment leases with both domestic and
foreign municipalities. The Bancorp is challenging the Internal
Revenue Service’s proposed treatment of all of these leasing
transactions. The Bancorp’s original net investment in these leases
totaled approximately $900 million. The Bancorp continues to
believe that its treatment of these leveraged leases was appropriate
and in compliance with applicable tax law and regulations. While
management cannot predict with certainty the result of the suit,
given the tax treatment of these transactions has been challenged
by the Internal Revenue Service, the Bancorp believes a resolution
may involve a projected change in the timing of these leveraged
lease cash flows. Accordingly, while a change in the projected
timing of cash flows, excluding interest assessments, pursuant to
the currently applicable literature under SFAS No. 13 would not
impact cumulative income recognized, this proposed amendment
to SFAS No. 13 in its current form would impact the timing of
cumulative income recognized. In December 2005, the effective
date of the proposed Exposure Draft was delayed from its original
effective date as of the end of the first fiscal year ending after
December 15, 2005. Although the FSP has not yet been finalized,
the Bancorp is currently in the process of evaluating the potential
impact on its Consolidated Financial Statements.
In July 2005, the FASB released an Exposure Draft of a
proposed interpretation, “Accounting for Uncertain Tax Positions
– an Interpretation of FASB Statement 109.” The Exposure Draft
contains proposed guidance on the recognition and measurement
of uncertain tax positions. Any initial de-recognition amounts will
be reported as a cumulative effect of a change in accounting
principle. In October 2005, the effective date of the Exposure
Draft was delayed and in January 2006, the FASB staff concluded it
will be effective as of the beginning of the first annual period
beginning after December 15, 2006. A final Interpretation is
expected to be issued during the first quarter of 2006. The
Bancorp has not yet evaluated the potential impact of the
Exposure Draft on its Consolidated Financial Statements.
In August 2005, the FASB issued an Exposure Draft,
“Accounting for Servicing of Financial Assets, an amendment of
FASB Statement No. 140.” This Exposure Draft would amend
FASB Statement No. 140, “Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities,” and would
require that all separately recognized servicing rights be initially
measured at fair value, if practicable. For each class of separately
recognized servicing assets and liabilities, this Exposure Draft
would permit the Bancorp to choose either to report servicing
assets and liabilities at fair value or at amortized cost. Under the
fair value approach, servicing assets and liabilities will be recorded
at fair value at each reporting date with changes in fair value
recorded in earnings in the period in which the changes occur.
Under the amortized cost method, servicing assets and liabilities
are amortized in proportion to and over the period of estimated
net servicing income or net servicing loss and are assessed for
impairment based on fair value at each reporting date. In
November 2005, the FASB announced the effective date of the
Exposure Draft had been delayed and would be effective for fiscal
years beginning after September 15, 2006. The Bancorp is
currently in the process of determining which methodology to use
to value recognized servicing assets and liabilities and therefore has
not yet determined the potential impact of the Exposure Draft on
its Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In August 2005, the FASB issued an Exposure Draft,
“Accounting for Transfers of Financial Assets, an amendment of
FASB Statement No. 140.” This Exposure Draft would amend
FASB Statement No. 140 by addressing the criteria necessary for
obtaining sales accounting on the transfer of all or a portion of
financial assets as well as the requirements for qualification as a
QSPE. The proposed changes to the criteria for obtaining sales
accounting
include a requirement that all arrangements or
agreements, including those entered into subsequent to the sale,
made in connection with the transfer of financial assets be
considered in the determination of whether the financial assets
were legally isolated from the transferor and its consolidated
affiliates, the establishment of additional conditions for obtaining
sales treatment on the transfer of a portion of a financial asset and
the requirement that a transferee maintain the right to pledge or
exchange the assets it receives and no condition exists that
constrains the transferee from taking advantage of its right to
pledge or exchange its assets, or provides more than a trivial
The proposed changes to the
benefit to the transferor.
requirements for qualifying as a QSPE include prohibiting a QSPE
from holding equity instruments, unless the equity instruments
were received as a result of the efforts to collect its financial assets,
as well as a requirement to evaluate whether a combination of
those
involvements with a QSPE provide
involvements with an opportunity to obtain a more than trivial
incremental benefit relative to the benefit that would be obtained if
separate parties had those same involvements. In December 2005,
the FASB announced the effective date of the Exposure Draft had
the holder of
been delayed. The final Statement is expected to be issued in the
second quarter of 2006. Although the Bancorp is still evaluating
the potential impact of the Exposure Draft on its Consolidated
Financial Statements, in its current form the Exposure Draft will
require the consolidation of an unconsolidated QSPE that is
wholly owned by an independent third-party, unless certain aspects
of the current operational nature of the QSPE are modified. The
outstanding balance of commercial loans transferred by the
Bancorp to the QSPE was approximately $2.8 billion at December
31, 2005.
In September 2005, the FASB issued an Exposure Draft,
“Earnings Per Share, an amendment of FASB Statement No. 128.”
This Exposure Draft would amend FASB Statement No. 128,
“Earnings Per Share,” to clarify guidance for mandatorily
convertible instruments, the treasury stock method, contracts that
may be settled in cash or shares and contingently issuable shares.
The proposed Exposure Draft as currently drafted would be
effective for interim and annual periods ending after June 15, 2006.
Retrospective application would be required for all changes to
FASB Statement No. 128, except that retrospective application
would be prohibited for contracts that were either settled in cash
prior to adoption or modified prior to adoption to require cash
settlement. Although the Bancorp does not expect adoption of
this Statement to have a material effect on its Consolidated
Financial Statements, this Exposure Draft, in its current form, will
impact the Bancorp’s calculation of basic and diluted earnings per
share.
2. SECURITIES
The following table provides a breakdown of the securities portfolio as of December 31:
Amortized
Cost
Unrealized
Gains
Unrealized
Losses
Fair Value
Amortized
Cost
Unrealized
Gains
Unrealized
Losses
Fair Value
2005
2004
($ in millions)
Available-for-sale and other:
U.S. Treasury and
Government agencies
U.S. Government sponsored
agencies
Obligations of states and
political subdivisions
Agency mortgage-backed
securities
Other bonds, notes and
debentures
Other securities(a)
Total
Held-to-maturity:
Obligations of states and
political subdivisions
Other debt securities
$506
2,034
657
16,127
2,119
1,090
$22,533
-
-
19
12
3
1
35
$378
11
$389
-
-
-
(21)
(69)
-
(502)
(45)
(7)
(644)
-
-
-
485
1,965
676
15,637
2,077
1,084
21,924
378
11
389
503
2,036
823
17,571
2,862
1,006
24,801
245
10
255
-
3
41
89
23
1
157
-
-
-
(12)
(26)
(1)
(215)
(9)
(8)
(271)
-
-
-
491
2,013
863
17,445
2,876
999
24,687
245
10
255
Total
(a) Includes FHLB and Federal Reserve Bank restricted stock holdings carried at cost.
The amortized cost and approximate fair value of securities at
December 31, 2005, by contractual maturity, are shown in the
following table. Actual maturities may differ from contractual
maturities when there exists a right to call or prepay obligations
with or without call or prepayment penalties.
($ in millions)
Debt securities:
Under 1 year
1-5 years
6-10 years
Over 10 years
Other securities
Total
Available-for-Sale & Other
Amortized
Cost
Fair Value
Held-to-Maturity
Amortized
Cost
Fair Value
$83
1,898
1,532
17,930
1,090
$22,533
83
1,852
1,502
17,403
1,084
21,924
7
25
292
65
-
389
7
25
292
65
-
389
Fifth Third Bancorp 59
The following table provides the gross unrealized loss and fair value, aggregated by investment category and length of time the individual
securities have been in a continuous unrealized loss position, as of December 31, 2005 and 2004:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ in millions)
2005
U.S. Treasury and Government agencies
U.S. Government sponsored agencies
Agency mortgage-backed securities
Other bonds, notes and debentures
Other securities
Total
2004
U.S. Treasury and Government agencies
U.S. Government sponsored agencies
Obligations of states and political subdivisions
Agency mortgage-backed securities
Other bonds, notes and debentures
Other securities
Total
Less than 12 months
12 months or more
Total
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
$-
654
7,523
1,800
64
$10,041
$-
1,092
13
7,510
1,234
47
$9,896
-
(21)
(205)
(39)
(7)
(272)
-
(8)
(1)
(84)
(8)
(5)
(106)
477
1,252
7,646
178
-
9,553
485
634
-
5,706
76
28
6,929
(21)
(48)
(297)
(6)
-
(372)
(12)
(18)
-
(131)
(1)
(3)
(165)
477
1,906
15,169
1,978
64
19,594
485
1,726
13
13,216
1,310
75
16,825
(21)
(69)
(502)
(45)
(7)
(644)
(12)
(26)
(1)
(215)
(9)
(8)
(271)
At December 31, 2005, 92% of the unrealized losses in the
available-for-sale security portfolio were comprised of securities
issued by the U.S. Treasury and Government agencies, U.S.
Government sponsored agencies and agency mortgage-backed
securities. The Bancorp believes the price movements in these
securities are dependent upon movements in market interest rates,
particularly given the negligible inherent credit risk for these
securities. At December 31, 2005, less than one percent of
unrealized losses in the available-for-sale security portfolio were
represented by non-rated securities.
At December 31, 2005 and 2004, securities with a fair value of
$14.5 billion and $17.8 billion, respectively, were pledged to secure
borrowings, public deposits, trust funds and for other purposes as
required or permitted by law.
Unrealized gains (losses) on trading securities held at
the
December 31, 2005 and 2004 were not material
Consolidated Financial Statements.
to
3. LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES
A summary of the total loans and leases as of December 31:
($ in millions)
Loans held for sale:
Commercial loans
Commercial leases
Residential mortgage
Other consumer loans
Total loans held for sale
Portfolio loans and leases (a):
Commercial:
Commercial loans
Construction loans
Commercial mortgage
Commercial lease financing
Total commercial
Consumer:
Residential mortgage
Residential construction loans
Credit card
Home equity
Other consumer loans
Consumer lease financing
2005
Gross
$125
3
1,144
32
$1,304
$19,174
6,342
9,188
4,852
39,556
Unearned
Income
-
-
-
-
-
-
-
-
(1,157)
(1,157)
Net
125
3
1,144
32
1,304
19,174
6,342
9,188
3,695
38,399
7,152
695
866
12,000
9,218
1,751
31,682
$71,238
-
-
-
-
-
(156)
(156)
(1,313)
7,152
695
866
12,000
9,218
1,595
31,526
69,925
Total consumer
Total portfolio loans and leases
(a) At December 31, 2005 and 2004, deposit overdrafts of $56 million and $57 million, respectively, were included in portfolio loans.
The following is a summary of the gross investment in lease financing at December 31:
($ in millions)
Direct financing leases
Leveraged leases
Total
60
Fifth Third Bancorp
2004
Unearned
Income
Gross
-
-
545
14
559
16,058
4,348
7,636
4,634
32,676
6,988
378
843
10,508
7,572
2,273
28,562
61,238
-
-
-
-
-
-
-
-
(1,208)
(1,208)
-
-
-
-
-
(222)
(222)
(1,430)
2005
$4,141
2,462
$6,603
Net
-
-
545
14
559
16,058
4,348
7,636
3,426
31,468
6,988
378
843
10,508
7,572
2,051
28,340
59,808
2004
4,474
2,433
6,907
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The components of the investment in lease financing at December 31:
($ in millions)
Rentals receivable, net of principal and interest on nonrecourse debt
Estimated residual value of leased assets
Gross investment in lease financing
Unearned income
Net investment in lease financing
2005
$4,620
1,983
6,603
(1,313)
$5,290
2004
4,749
2,158
6,907
(1,430)
5,477
At December 31, 2005, the minimum future lease payments receivable for each of the years 2006 through 2010 were $1.3 billion, $1.1
billion, $.8 billion, $.6 billion and $.4 billion, respectively.
Transactions in the allowance for loan and lease losses for the years ended December 31:
($ in millions)
Balance at January 1
Losses charged off
Recoveries of losses previously charged off
Net charge-offs
Provision for loan and lease losses
Reclassification of reserve for unfunded commitments
Balance at December 31
the
reserve
At December 31, 2004,
for unfunded
commitments was reclassified from the allowance for loan and
lease losses to other liabilities. The 2003 year-end reserve for
unfunded commitments was reclassified to conform to the current
presentation. See Note 1 for a discussion of the reserve for
unfunded commitments.
As of December 31, 2005, impaired loans, under SFAS No.
114, with a valuation allowance totaled $147 million and impaired
loans without a valuation allowance totaled $77 million. The total
valuation allowance on the impaired loans at December 31, 2005
4. BANK PREMISES AND EQUIPMENT
A summary of bank premises and equipment at December 31:
($ in millions)
Land and improvements
Buildings
Equipment
Leasehold improvements
Construction in progress
Accumulated depreciation and amortization
Total
2005
$713
(373)
74
(299)
330
-
$744
2004
697
(321)
69
(252)
268
-
713
2003
683
(380)
68
(312)
399
(73)
697
was $54 million. As of December 31, 2004, impaired loans with a
valuation allowance totaled $108 million and impaired loans
without a valuation allowance totaled $54 million. The total
valuation allowance on the impaired loans at December 31, 2004
was $28 million.
Average impaired loans, net of valuation allowances, were
$169 million in 2005, $140 million in 2004 and $166 million in
2003. Cash basis interest income recognized on those loans during
each of the years was immaterial.
Estimated Useful Life
5 to 50 yrs.
3 to 20 yrs.
3 to 30 yrs.
2005
$373
1,125
960
204
195
(1,131)
$1,726
2004
265
933
811
175
133
(1,002)
1,315
Depreciation and amortization expense related to bank
premises and equipment was $161 million in 2005, $130 million in
2004 and $106 million in 2003.
Occupancy expense has been reduced by rental income from
leased premises of $12 million in 2005, $12 million in 2004 and $14
million in 2003.
The Bancorp’s subsidiaries have entered into a number of
noncancelable lease agreements with respect to bank premises and
equipment. The minimum annual rental commitments under
lease agreements for
noncancelable
land and buildings at
December 31, 2005, exclusive of income taxes and other charges,
are $65 million in 2006, $63 million in 2007, $60 million in 2008,
$56 million in 2009, $50 million in 2010 and $315 million in 2011
and subsequent years.
Rental expense for cancelable and noncancelable leases was
$68 million for 2005, $57 million for 2004 and $56 million for
2003.
5. GOODWILL
Changes in the net carrying amount of goodwill by reporting segment for the years ended December 31, 2005 and 2004 were as follows:
($ in millions)
Balance at December 31, 2003
Acquisition
Divestiture
Balance at December 31, 2004
Acquisition
Balance at December 31, 2005
Commercial Banking
$188
185
-
373
498
$871
Retail Banking
Investment Advisors
Processing Solutions
234
78
-
312
668
980
99
4
-
103
24
127
217
-
(26)
191
-
191
Total
738
267
(26)
979
1,190
2,169
SFAS No. 142, “Goodwill and Other Intangible Assets,” issued in
June 2001, discontinued the practice of amortizing goodwill and
initiated an annual review for impairment. Impairment is to be
examined more frequently if certain indicators are encountered.
its most recent annual goodwill
The Bancorp completed
impairment test required by this Statement as of September 30,
2005 and determined that no impairment exists.
In the table above, acquisition activity includes acquisitions in
the respective year plus purchase accounting adjustments related to
previous acquisitions.
Fifth Third Bancorp 61
($ in millions)
Mortgage servicing rights
Other consumer and
commercial servicing rights
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. INTANGIBLE ASSETS
Intangible assets consist of servicing rights, core deposits, customer
lists and non-compete agreements. Intangibles, excluding servicing
rights, are amortized on either a straight-line or an accelerated basis
over their estimated useful lives, generally over a period of up to 25
years. The Bancorp reviews core deposit and other intangible
assets for possible impairment whenever events or changes in
circumstances
that carrying amounts may not be
recoverable.
indicate
Detail of the Bancorp’s intangible assets as of December 31:
Gross Carrying
Amount
$1,075
2005
Accumulated
Amortization (a)
(642)
Net Carrying
Amount
433
Gross Carrying
Amount
940
2004
Accumulated
Amortization (a)
(601)
Net Carrying
Amount
339
Core deposits
Other intangible assets
Total
(a) Accumulated amortization for mortgage servicing rights includes a $46 million and $79 million valuation allowance at December 31, 2005 and 2004, respectively.
(14)
(244)
(9)
(909)
8
188
20
649
22
432
29
$1,558
22
347
9
1,318
(9)
(204)
(2)
(816)
13
143
7
502
amortization expense, including servicing rights, is $110 million in
2006, $93 million in 2007, $81 million in 2008, $69 million in 2009
and $59 million in 2010.
temporary impairment on the MSR portfolio. In addition, the
Bancorp recognized a net loss of $23 million and $10 million in
2005 and 2004, respectively, related to changes in fair value and
settlement of free-standing derivatives purchased to economically
hedge the MSR portfolio. As of December 31, 2005 and 2004,
other assets included free-standing derivative instruments related to
the MSR portfolio with a fair value of $4 million and $7 million,
respectively, and other liabilities included a fair value of $10 million
and $3 million, respectively. The outstanding notional amounts on
the free-standing derivative instruments related to the MSR
portfolio totaled $1.5 billion and $1.9 billion as of December 31,
2005 and 2004, respectively. As of December 31, 2005, the
available-for-sale securities portfolio included $197 million in
instruments related to the non-qualified hedging strategy.
During the second quarter of 2004, interest rate movement
expectations and corresponding increased prepayment speeds
resulted in the Bancorp determining a portion of the MSR
portfolio was permanently impaired, resulting in a write-off of $13
million
the related valuation allowance.
Temporary changes in the MSR valuation allowance are captured
as a component of mortgage banking net revenue
in the
Consolidated Statements of Income.
in MSRs against
The estimated fair value of capitalized servicing rights was
$466 million and $353 million at December 31, 2005 and 2004,
respectively. The Bancorp serviced $25.7 billion and $23.0 billion
of residential mortgage loans and $.9 billion and $1.3 billion of
consumer loans for other investors at December 31, 2005 and
2004, respectively.
As of December 31, 2005, all of the Bancorp’s intangible
assets were being amortized. Amortization expense of $125
million, $130 million and $216 million, respectively, was recognized
on intangible assets (including servicing rights) for the years ended
December 31, 2005, 2004 and 2003, respectively. Estimated
7. SERVICING RIGHTS
Changes in capitalized servicing rights for the years ended
December 31:
($ in millions)
Balance at January 1
Amount capitalized
Amortization
Servicing valuation recovery
Balance at December 31
2005
$352
135
(79)
33
$441
2004
299
94
(101)
60
352
Changes in the servicing rights valuation allowance for the years
ended December 31:
($ in millions)
Balance at January 1
Servicing valuation recovery
Permanent impairment write-off
Balance at December 31
2005
$(79)
33
-
$(46)
2004
(152)
60
13
(79)
The Bancorp maintains a non-qualifying hedging strategy to
manage a portion of the risk associated with changes in value of
the MSR portfolio. This strategy includes the purchase of various
available-for-sale securities (primarily principal only strips) and
free-standing derivatives (principal only swaps, swaptions and
interest rate swaps).
income, mark-to-market
adjustments and gain or loss from sale activities associated with
these portfolios are expected to economically hedge a portion of
the change in value of the MSR portfolio caused by fluctuating
discount rates, earnings rates and prepayment speeds.
interest
The
The volatility of longer-term interest rates during 2005 and
2004 and the resulting impact of changing prepayment speeds led
to the recovery of $33 million and $60 million, respectively, in
62
Fifth Third Bancorp
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
involves modifying
8. DERIVATIVES
The Bancorp maintains an overall interest rate risk management
strategy that incorporates the use of derivative instruments to
minimize significant unplanned fluctuations in earnings and cash
flows caused by interest rate volatility. The Bancorp’s interest rate
risk management strategy
the repricing
characteristics of certain assets and liabilities so that changes in
interest rates do not adversely affect the net interest margin and
cash flows. Derivative instruments that the Bancorp may use as
part of its interest rate risk management strategy include interest
rate swaps, interest rate floors, interest rate caps, forward contracts,
options and swaptions. Interest rate swap contracts are exchanges
of interest payments, such as fixed-rate payments for floating-rate
payments, based on a common notional amount and maturity date.
Interest rate floors protect against declining rates, while rate caps
protect against rising interest rates. Forward contracts are
contracts in which the buyer agrees to purchase, and the seller
agrees to make delivery of, a specific financial instrument at a
predetermined price or yield. Options provide the purchaser with
the right, but not the obligation, to purchase or sell a contracted
item during a specified period at an agreed upon price. Swaptions,
which have the features of a swap and an option, allow, but do not
require, counterparties to exchange streams of payments over a
specified period of time.
The Bancorp enters into foreign exchange derivative contracts
to economically hedge certain foreign denominated
loans.
Derivative instruments that the Bancorp may use to economically
hedge these foreign denominated loans include foreign exchange
swaps and forward contracts.
As part of its overall risk management strategy relative to its
mortgage banking activity, the Bancorp may enter into various
free-standing derivatives (principal only swaps, swaptions, floors,
options and interest rate swaps) to economically hedge interest rate
lock commitments and changes in fair value of its largely fixed-rate
MSR portfolio. Principal only swaps are total return swaps based
on changes in the value of the underlying mortgage principal only
trust.
The Bancorp also enters into foreign exchange contracts and
interest rate swaps, floors and caps for the benefit of commercial
customers. The Bancorp may economically hedge significant
exposures related to these commercial customer free-standing
derivatives by entering into offsetting third-party contracts with
approved, reputable counterparties with substantially matching
terms and currencies. Credit risks arise from the possible inability
of counterparties to meet the terms of their contracts and from any
resultant exposure to movement in foreign currency exchange
rates, limiting the Bancorp’s exposure to the replacement value of
the contracts rather than the notional, principal or contract
amounts. The Bancorp minimizes the credit risk through credit
approvals, limits and monitoring procedures. The Bancorp hedges
its interest rate exposure on commercial customer transactions by
executing offsetting swap agreements with primary dealers.
Fair Value Hedges
The Bancorp enters into interest rate swaps to convert its fixed-
rate, long-term debt to floating-rate debt. Decisions to convert
fixed-rate debt to floating are made primarily by consideration of
the asset/liability mix of the Bancorp, the desired asset/liability
sensitivity and interest rate levels. For the years ended December
31, 2005 and 2004, certain interest rate swaps met the criteria
required to qualify for the shortcut method of accounting. Based
treatment, no
on
ineffectiveness is assumed. For interest rate swaps accounted for
as a fair value hedge, ineffectiveness is the difference between the
changes in the fair value of the interest rate swap and the long-term
debt. If any of the interest rate swaps do not qualify for the
shortcut method of accounting, the ineffectiveness is reported
within interest expense in the Consolidated Statements of Income.
shortcut method of
accounting
the
For the years ended December 31, 2005 and 2004, changes in the
fair value of any
interest rate swaps attributed to hedge
ineffectiveness were insignificant to the Bancorp’s Consolidated
Statements of Income.
During 2005 and 2004, the Bancorp terminated interest rate
swaps designated as fair value hedges and in accordance with SFAS
No. 133, an amount equal to the fair value of the swaps at the date
of termination was recognized as a premium or discount on the
previously hedged long-term debt and is being amortized as an
adjustment to yield.
The Bancorp also enters into forward contracts to hedge the
forecasted sale of its residential mortgage loans. For the years
ended December 31, 2005 and 2004, the Bancorp met certain
criteria to qualify for matched terms accounting as defined in SFAS
No. 133, on the hedged loans for sale. Based on this treatment,
fair value changes in the forward contracts are recorded as changes
in the value of both the forward contract and loans held for sale in
the Consolidated Balance Sheets.
As of December 31, 2005, there were no instances of
designated hedges no longer qualifying as fair value hedges. The
following table reflects the market value of all fair value hedges
included in the Consolidated Balance Sheets as of December 31:
($ in millions)
Included in other assets:
Interest rate swaps related to debt
Included in other liabilities:
Interest rate swaps related to debt
Forward contracts related to mortgage loans
held for sale
Total included in other liabilities
2005
2004
$21
103
3
$106
49
44
1
45
Cash Flow Hedges
The Bancorp enters into interest rate swaps to convert floating-rate
assets and liabilities to fixed rates and to hedge certain forecasted
transactions. The assets and liabilities are typically grouped and
share the same risk exposure for which they are being hedged. The
Bancorp may also enter into forward contracts to hedge certain
forecasted transactions. As of December 31, 2005 and 2004, $13
million and $33 million, respectively, in net deferred losses, net of
tax, related to cash flow hedges were recorded in accumulated
other comprehensive income. Gains and losses on derivative
accumulated other
contracts
comprehensive income to current period earnings are included in
the line item in which the hedged item’s effect in earnings is
recorded. As of December 31, 2005, $15 million in deferred losses,
net of tax, on derivative instruments included in accumulated other
comprehensive income are expected to be reclassified into earnings
during the next twelve months. All components of each derivative
instrument’s gain or loss are included in the assessment of hedge
effectiveness.
reclassified
from
that
are
The Bancorp has no outstanding cash flow hedges converting
floating-rate debt to fixed-rate as of December 31, 2005 and less
than $1 million included in other liabilities as of December 31,
2004. During the years ended December 31, 2005 and 2004, the
Bancorp terminated certain derivatives qualifying as cash flow
hedges. The fair value of these contracts, net of tax, is included in
accumulated other comprehensive income and is being amortized
over the designated hedging periods, which range from 5 months
to 13 years. For the year ended December 31, 2005, there were no
instances of designated hedges no longer qualifying as cash flow
hedges.
Free-Standing Derivative Instruments
The Bancorp enters into various derivative contracts that focus on
providing derivative products to commercial customers. These
derivative contracts are not designated against specific assets or
liabilities on the Consolidated Balance Sheets or to forecasted
transactions and, therefore, do not qualify for hedge accounting.
Fifth Third Bancorp 63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
These instruments include foreign exchange derivative contracts
entered into for the benefit of commercial customers involved in
international trade to hedge their exposure to foreign currency
fluctuations and various other derivative contracts for the benefit
of commercial customers. The Bancorp may economically hedge
significant exposures related to these derivative contracts entered
into for the benefit of customers by entering into offsetting
contracts with approved, reputable, independent counterparties
with substantially matching terms.
The Bancorp also enters into foreign exchange derivative
contracts to economically hedge certain foreign denominated loans.
The Bancorp does not designate these instruments against the
foreign denominated loans, and therefore, does not obtain hedge
accounting treatment.
Interest rate lock commitments issued on residential mortgage
loan commitments that will be held for resale are also considered
free-standing derivative instruments. The interest rate exposure on
these commitments is economically hedged with forward contracts.
The Bancorp also enters into a combination of free-standing
derivative instruments (principal only swaps, swaptions and interest
rate swaps) to economically hedge changes in fair value of its
largely fixed-rate MSR portfolio. Additionally, the Bancorp
occasionally may enter into free-standing derivative instruments
(options, swaptions and interest rate swaps) in order to minimize
significant fluctuations in earnings and cash flows caused by
interest rate volatility. Revaluation gains and losses on interest rate
lock commitments and free-standing derivative instruments related
to the MSR portfolio are recorded as a component of mortgage
banking net revenue, revaluation gains and losses on foreign
exchange derivative contracts, other customer derivative contracts
and interest rate risk derivative contracts are recorded within other
noninterest income in the Consolidated Statements of Income. The
net gains (losses) recorded in the Consolidated Statements of
Income relating to free-standing derivative instruments for the
years ended December 31 are summarized in the table below:
($ in millions)
Foreign exchange contracts
Interest rate lock commitments and forward contracts related to interest rate lock commitments
Derivative instruments related to MSR portfolio
Derivative instruments related to interest rate risk
2005
$52
(1)
(23)
3
2004
45
1
(10)
7
2003
35
(1)
15
6
The following table reflects the market value of all free-standing derivatives included in the Consolidated Balance Sheets as of December 31:
($ in millions)
Included in other assets:
Foreign exchange contracts
Interest rate contracts for customers
Interest rate lock commitments
Derivative instruments related to MSR portfolio
Total included in other assets
Included in other liabilities:
Foreign exchange contracts
Interest rate contracts for customers
Interest rate lock commitments
Forward contracts related to interest rate lock commitments
Derivative instruments related to MSR portfolio
Total included in other liabilities
2005
2004
$118
48
1
4
$171
$104
48
-
1
10
$163
168
46
1
7
222
137
46
1
-
3
187
The following table summarizes the Bancorp’s derivative instrument positions (excluding $20.3 billion in notional amount from the customer
accommodation program) at December 31, 2005:
($ in millions)
Interest rate swaps related to debt:
Receive fixed/pay floating
Mortgage lending commitments:
Forward contracts on mortgage loans held for sale
Mortgage servicing rights portfolio:
Principal only swaps
Interest rate swaps – Receive fixed/pay floating
Interest rate swaps – Receive floating/pay fixed
Written swaptions
Purchased swaptions
Total
Notional
Amount
Weighted-Average
Remaining Maturity
(in months)
$3,595
799
71
595
355
200
325
$5,940
82
1
12
91
111
2
4
Average Receive
Rate
Average Pay
Rate
4.51 %
4.40 %
4.72
4.39
5.15
4.18
4.38
4.85
4.85
64
Fifth Third Bancorp
9. OTHER ASSETS
The following table provides the components of other assets included in the Consolidated Balance Sheets as of December 31, 2005:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ in millions)
Bank owned life insurance
Accounts receivable and drafts-in-process
Partnership investments
Derivative instruments
Prepaid pension and other expenses
Other real estate owned
Other
Total
10. SHORT-TERM BORROWINGS
Borrowings with original maturities of one year or less are classified
as short term. Federal funds purchased are excess balances in
reserve accounts held at Federal Reserve Banks that the Bancorp
purchased from other member banks on an overnight basis. Bank
notes are promissory notes issued by the Bancorp’s subsidiary
($ in millions)
As of December 31:
Federal funds purchased
Short-term bank notes
Other short-term borrowings
Average for the years ending December 31:
Federal funds purchased
Short-term bank notes
Other short-term borrowings
Maximum month-end balance:
Federal funds purchased
Short-term bank notes
Other short-term borrowings
2005
$1,865
1,073
388
192
188
54
116
$3,876
2004
1,573
916
183
271
61
63
126
3,193
banks. Other short-term borrowings include securities sold under
repurchase agreements, Federal Home Loan Bank advances and
other borrowings with original maturities of one year or less. A
summary of short-term borrowings and weighted-average rates
follows:
2005
2004
2003
Amount
Rate
Amount
Rate
Amount
Rate
$5,323
-
4,246
$4,225
248
5,038
$6,378
775
6,531
3.93%
-
2.94
3.26%
2.60
2.74
$4,714
775
4,537
$5,896
1,003
6,640
$8,037
1,275
8,233
2.00%
2.30
1.71
1.30%
1.46
1.17
$6,928
500
5,742
$7,001
22
5,350
$7,768
500
6,907
.91%
1.05
.74
1.14%
1.06
1.03
As of December 31, 2005, the Bancorp had issued $2 million in commercial paper, with unused lines of credit of $98 million available to
support commercial paper transactions and other corporate requirements.
Fifth Third Bancorp 65
11. LONG-TERM DEBT
A summary of long-term borrowings at December 31:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ in millions)
Parent Company
Senior:
Extendable notes
Subordinated:
Fixed-rate notes (b)
Junior subordinated:
Fixed-rate debentures (b)
Subsidiaries
Senior:
Fixed-rate bank notes
Floating-rate bank notes
Extendable bank notes
Subordinated:
Fixed-rate bank notes (b)
Fixed-rate notes
FixFloat notes
Junior subordinated:
Floating-rate debentures (a)
Floating-rate debentures (a)
Mandatorily redeemable securities (a)
Federal Home Loan Bank advances
Securities sold under repurchase agreements
Commercial paper-backed obligations
Other
Total
(a) Qualify as Tier I capital for regulatory capital purposes.
(b) Qualify as Tier II capital for regulatory capital purposes.
The subordinated fixed-rate notes due in 2018 are the obligation of
the Bancorp. The Bancorp entered into an interest rate swap to
convert the fixed-rate note to a floating-rate. The rate paid on the
swap was 4.41% at December 31, 2005.
issued
the 8.136%
The Bancorp
junior subordinated
debentures due in 2027 to Fifth Third Capital Trust I (“FTCT1”).
The Bancorp has fully and unconditionally guaranteed all of
FTCT1’s obligations under trust preferred securities issued by
FTCT1. The trust preferred securities are redeemable beginning in
2007. The Bancorp entered into a swap to convert the fixed-rate
debt into floating. The interest rate paid on the swap was 4.99% at
December 31, 2005.
The three-month LIBOR plus 80 bp junior subordinated
debentures due in 2027 were issued to Old Kent Capital Trust 1
The Bancorp has fully and unconditionally
(“OKCT1”).
guaranteed all of OKCT1’s obligations under trust preferred
securities issued by OKCT1. The trust preferred securities are
redeemable beginning in 2007.
Upon the early adoption of FIN 46 effective July 1, 2003, the
Bancorp deconsolidated both FTCT1 and OKCT1 resulting in a
recharacterization of the underlying consolidated debt obligations
from the previous trust preferred securities obligations to junior
subordinated debenture obligations.
The three-month LIBOR plus 290 bp and the three-month
LIBOR plus 279 bp junior subordinated debentures due in 2033
and 2034, respectively, were assumed by a subsidiary of the
Bancorp in connection with the acquisition of First National. The
obligations were issued to FNB Statutory Trusts I and II (“STAT
I” and “STAT II”), respectively. The Bancorp has fully and
unconditionally guaranteed all obligations of STAT I and STAT II
under trust preferred securities issued by STAT I and STAT II,
respectively.
The senior fixed-rate bank notes due from 2007 to 2019 are
the obligations of a subsidiary bank. The maturities of the face
value of the senior fixed-rate bank notes is as follows: $375 million
in 2007, $500 million in 2008, $145 million in 2009 and $1.1 billion
in 2010 and thereafter. The Bancorp entered into swaps to convert
the fixed-rate debt into floating. At December 31, 2005, the rates
paid on these swaps ranged from 4.20% to 4.42%.
66
Fifth Third Bancorp
Maturity
Interest Rate
2005
2004
2007 - 2009
4.35%
$1,749
1,749
2018
2027
4.50%
8.136%
2007 - 2019
2006
2007 - 2014
2.70% - 5.20%
4.26%
4.22% - 4.43%
2015
4.75%
2027
2033 - 2034
2031
2006 - 2036
2007 - 2010
2007 - 2032
5.05%
7.29% - 7.43%
Varies
0% - 8.34%
3.54% - 7.57%
Varies
463
219
2,030
1,150
1,199
497
-
-
103
67
596
4,790
2,300
-
64
$15,227
469
229
2,565
1,100
1,199
-
354
151
103
-
548
3,888
1,300
286
42
13,983
The subordinated fixed-rate bank notes due in 2015 are the
obligations of a subsidiary bank. The Bancorp entered into swaps
to convert the fixed-rate debt into floating. At December 31, 2005,
the rate paid on the swaps ranged from 4.22% to 4.48%.
The mandatorily redeemable securities due 2031 relate to a
preferred stock obligation of a subsidiary of the Bancorp. The
preferred stock will be automatically exchanged for trust preferred
securities in 2031. Beginning five years from the date of issuance,
the Bancorp’s subsidiary has the option, subject to regulatory
approval, to exchange the preferred stock for trust preferred
securities or cash upon a change in the Bancorp’s senior debt rating
to or below BBB, a change in the investor’s tax elections or a
change to applicable tax law. Upon the adoption of SFAS No. 150
on July 1, 2003, the Bancorp reclassified its previous minority
interest obligation to long-term debt and its corresponding
minority interest expense to interest expense due to the existence
of the mandatory redemption feature.
At December 31, 2005, FHLB advances have rates ranging
from 0% to 8.34%, with interest payable monthly. The advances
were secured by certain residential mortgage loans and securities
totaling $7.8 billion. The advances mature as follows: $1.3 billion
in 2006, $1.8 billion in 2007, $20 million in 2008, $.5 billion in 2009
and $1.1 billion in 2010 and thereafter. The Bancorp entered into
interest rate swaps with a total notional value of $300 million to
convert certain fixed-rate FHLB advances into floating. The
interest rates paid on these swaps ranged from 4.37% to 4.38% at
December 31, 2005.
At December 31, 2005, securities sold under agreements to
repurchase have rates ranging from 3.54% to 7.57%, with interest
payable monthly. The repurchase agreements mature as follows:
$1.0 billion in 2007, $300 million in 2008, $500 million in 2009 and
$500 million in 2010 and thereafter.
Medium-term senior notes and subordinated bank notes with
maturities ranging from one year to 30 years can be issued by two
subsidiary banks, of which $4.9 billion was outstanding at
December 31, 2005 with $15.1 billion available for future issuance.
There were no other medium-term senior notes outstanding on
either of the two subsidiary banks as of December 31, 2005.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. COMMITMENTS AND CONTINGENT LIABILITIES
The Bancorp, in the normal course of business, uses derivatives
and other financial instruments to manage its interest rate risks and
prepayment risks and to meet the financing needs of its customers.
These financial instruments primarily include commitments to
extend credit, standby and commercial letters of credit, foreign
exchange contracts, commitments to sell residential mortgage
loans, principal only swaps, interest rate swap agreements, written
options and interest rate lock commitments. These instruments
involve, to varying degrees, elements of credit risk, counterparty
risk and market risk in excess of the amounts recognized in the
Bancorp’s Consolidated Balance Sheets. As of December 31, 2005,
100% of the Bancorp’s risk management derivatives exposure was
to investment grade companies. The contract or notional amounts
of these instruments reflect the extent of involvement the Bancorp
has in particular classes of financial instruments.
Commitments to extend credit are agreements to lend,
typically having fixed expiration dates or other termination clauses
that may require payment of a fee. Since many of the
commitments to extend credit may expire without being drawn
upon, the total commitment amounts do not necessarily represent
future cash flow requirements. The Bancorp is exposed to credit
risk in the event of nonperformance for the amount of the
contract. Fixed-rate commitments are also subject to market risk
resulting from fluctuations in interest rates and the Bancorp’s
exposure
those
commitments. As of December 31, 2005 and 2004, the Bancorp
had a reserve for probable credit losses totaling $69 million and
$53 million, respectively, included in other liabilities.
replacement value of
limited
the
to
is
Standby and commercial letters of credit are conditional
commitments issued to guarantee the performance of a customer
to a third party. At December 31, 2005, approximately $2.3 billion
of standby letters of credit expire within one year, $4.7 billion
expire between one to five years and $.3 billion expire thereafter.
At December 31, 2005, letters of credit of approximately $26
million were issued to commercial customers for a duration of one
year or less to facilitate trade payments in domestic and foreign
currency transactions. As of December 31 2005, the Bancorp had a
reserve for probable credit losses totaling $1 million included in
other liabilities. Approximately 69% of the total standby letters of
credit are secured and in the event of nonperformance by the
customers, the Bancorp has rights to the underlying collateral
provided including commercial real estate, physical plant and
property, inventory, receivables, cash and marketable securities.
As discussed in Note 8, the Bancorp’s policy is to enter into
derivative contracts to accommodate customers, to offset customer
accommodations and to offset its own market risk incurred in the
ordinary course of its business. Contingent obligations arising from
market risk assumed in derivatives are offset with additional rights
contained in other derivatives or contracts, such as loans or
borrowings. Certain derivatives provide the Bancorp rights without
contingent obligations (purchased options). Other derivatives
represent contingent obligations without additional rights (written
options, including interest rate lock commitments). Still other
derivatives provide additional rights combined with contingent
obligations (forward exchange spots and forwards, forward
contracts to sell mortgage loans, principal only swaps and interest
rate swap agreements). All derivatives that possess a contingent
obligation are shown in the table.
There are claims pending against the Bancorp and its
subsidiaries that have arisen in the normal course of business. See
Note 13 for additional information regarding these proceedings.
dispute with the Internal Revenue Service concerning the timing of
deductions associated with certain leveraged lease transactions in
its 1997 tax return. The Internal Revenue Service has also
proposed adjustments to the tax effects of certain leveraged lease
transactions in subsequent tax return years. The proposed
adjustments relate to the Bancorp’s portfolio of lease-in lease-out
transactions, service contract leases and qualified technology
equipment leases with both domestic and foreign municipalities.
The Bancorp
is challenging the Internal Revenue Service’s
proposed treatment of all of these leasing transactions. The
Bancorp’s original net
totaled
investment
approximately $900 million. The Bancorp continues to believe that
its treatment of these leveraged leases was appropriate and in
compliance with applicable tax law and regulations. While
management cannot predict with certainty the result of the suit,
given the tax treatment of these transactions has been challenged
by the Internal Revenue Service, the Bancorp believes a resolution
may involve a projected change in the timing of the leveraged lease
leases
these
in
Fifth Third Bancorp 67
Creditworthiness for all instruments is evaluated on a case-by-
case basis in accordance with the Bancorp’s credit policies. While
notional amounts are typically used to express the volume of these
transactions, it does not represent the much smaller amounts that
are potentially subject to credit risk. Entering into derivative
instruments involves the risk of dealing with counterparties and
their ability to meet the terms of the contract. The Bancorp
controls the credit risk of these transactions through adherence to
a derivatives products policy, credit approval policies and
monitoring procedures. Collateral, if deemed necessary, is based
on management’s credit evaluation of the counterparty and may
include business assets of commercial borrowers, as well as
personal property and real estate of individual borrowers and
guarantors.
A summary of significant commitments and contingent
liabilities at December 31:
($ in millions)
Commitments to extend credit
Letters of credit (including standby letters of
credit)
Foreign exchange contracts for customers:
Spots
Forwards
Written options
Forward contracts to sell mortgage loans
Principal only swaps
Interest rate swap agreements
Written options
Interest rate lock commitments
Contract or
Notional
Amount
2005
$35,724
2004
31,312
7,300
190
5,703
765
1,285
71
15,401
717
480
5,923
342
4,624
349
739
130
9,798
437
328
13. LEGAL AND REGULATORY PROCEEDINGS
During 2003, eight putative class action complaints were filed in
the United States District Court for the Southern District of Ohio
against the Bancorp and certain of its officers alleging violations of
federal securities laws related to disclosures made by the Bancorp
regarding its integration of Old Kent Financial Corporation and its
effect on the Bancorp’s infrastructure, including internal controls,
prospects and related matters. The complaints, which had been
consolidated, sought unquantified damages on behalf of putative
classes of persons who purchased the Bancorp’s common stock,
attorneys’ fees and other expenses. On March 31, 2005, the
Bancorp announced that it had settled this suit. The settlement
agreement was approved by the court on November 14, 2005 and
has become non-appealable. The Bancorp, along with its insurer
and other parties, have paid a total of $17 million to a fund to settle
the claims with the class members. The impact of the disposition
of this lawsuit is not material to the Bancorp.
During May 2005, the Bancorp filed suit in the United States
District Court for the Southern District of Ohio related to a
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
proposed FSP on its Consolidated Financial Statements.
The Bancorp and its subsidiaries are not parties to any other
material litigation other than those arising in the normal course of
business. While it is impossible to ascertain the ultimate resolution
or range of financial liability with respect to these contingent
matters, management believes any resulting liability from these
other actions would not have a material effect upon the Bancorp’s
consolidated financial position or results of operations.
the underlying collateral value attached to the loan. Consistent
with its overall approach in estimating credit losses for various
categories of residential mortgage loans held in its loan portfolio,
the Bancorp maintains an estimated credit
loss reserve of
approximately $21 million relating to these residential mortgage
loans sold.
As of December 31, 2005, the Bancorp has also fully and
unconditionally guaranteed $376 million of certain long-term
borrowing obligations issued by four wholly-owned issuing trust
entities that have been deconsolidated consistent with the
provisions of FIN 46R. See Note 1 for further discussion of the
adoption of FIN 46R.
The Bancorp, through its electronic payment processing
division, processes VISA® and MasterCard® merchant card
transactions. Pursuant to VISA® and MasterCard® rules, the
Bancorp assumes certain contingent liabilities relating to these
transactions which typically arise from billing disputes between the
merchant and cardholder that are ultimately resolved in the
cardholder’s favor. In such cases, these transactions are “charged
back” to the merchant and disputed amounts are refunded to the
cardholder. In the event that the Bancorp is unable to collect these
amounts from the merchant, it will bear the loss for refunded
amounts. The likelihood of incurring a contingent liability arising
from chargebacks is relatively low, as most products or services are
delivered when purchased and credits are issued on returned items.
For the year ended December 31, 2005, the Bancorp processed
approximately $100 million of chargebacks presented by issuing
banks, resulting in no material actual losses to the Bancorp. The
Bancorp accrues for probable losses based on historical experience
and did not carry a material credit loss reserve at December 31,
2005.
Fifth Third Securities, Inc (“FTS”), a subsidiary of the
Bancorp, guarantees the collection of all margin account balances
held by its brokerage clearing agent for the benefit of FTS
customers. FTS is responsible for payment to its brokerage
clearing agent for any loss, liability, damage, cost or expense
incurred as a result of customers failing to comply with margin or
margin maintenance calls on all margin accounts. The margin
account balance held by the brokerage clearing agent as of
December 31, 2005 was $55 million. In the event of any customer
default, FTS has rights to the underlying collateral provided. Given
the existence of the underlying collateral provided as well as the
negligible historical credit losses, FTS does not maintain any loss
reserve.
cash flows. Accordingly, while a change in the projected timing of
cash flows, excluding
interest assessments, pursuant to the
currently applicable literature under SFAS No. 13 would not
impact cumulative income recognized, the proposed FSP FAS 13-
a, an amendment to SFAS No. 13, in its current form would
impact the timing of cumulative income recognized. See additional
discussion of proposed FSP FAS 13-a in Note 1. The Bancorp is
currently in the process of evaluating the potential impact of the
14. GUARANTEES
The Bancorp has performance obligations upon the occurrence of
certain events under financial guarantees provided in certain
contractual arrangements. These various arrangements are
summarized below.
in
risk
At December 31, 2005, the Bancorp had issued approximately
$7.3 billion of financial and performance standby letters of credit
to guarantee the performance of various customers to third parties.
The maximum amount of credit
the event of
nonperformance by these parties is equivalent to the contract
amount and totals $7.3 billion. Upon issuance, the Bancorp
recognizes a liability equivalent to the amount of fees received
from the customer for these standby letter of credit commitments.
During 2005, the Bancorp refined its methodology for estimating
the credit loss reserve for these standby letters of credit, which
resulted in a decrease in the reserve. At December 31, 2005, the
reserve was approximately $1 million. Approximately 69% of the
total standby letters of credit are secured and in the event of
nonperformance by the customers, the Bancorp has rights to the
underlying collateral provided including commercial real estate,
physical plant and property, inventory, receivables, cash and
marketable securities.
Through December 31, 2005, the Bancorp had transferred,
subject to credit recourse, certain primarily floating-rate, short-term
investment grade commercial loans to an unconsolidated QSPE
that is wholly owned by an independent third-party. The
outstanding balance of such loans at December 31, 2005 was
approximately $2.8 billion. These loans may be transferred back to
the Bancorp upon the occurrence of an event specified in the legal
documents that established the QSPE. These events include
borrower default on the loans transferred, bankruptcy preferences
initiated against underlying borrowers and
loans
transferred by the Bancorp to the QSPE. The maximum amount
of credit risk in the event of nonperformance by the underlying
borrowers is approximately equivalent to the total outstanding
balance of $2.8 billion at December 31, 2005. In addition, the
Bancorp’s agreement to provide liquidity support to the QSPE
increased to $3.4 billion as of December 31, 2005. During 2005,
the Bancorp refined its methodology in determining the loss
reserve related to the liquidity support and credit enhancement
provided to the QSPE and at December 31, 2005, the Bancorp had
a reserve of $10 million.
ineligible
At December 31, 2005, the Bancorp had provided credit
recourse on approximately $1.3 billion of residential mortgage
loans sold to unrelated third parties. In the event of any customer
default, pursuant to the credit recourse provided, the Bancorp is
required to reimburse the third party. The maximum amount of
credit risk in the event of nonperformance by the underlying
borrowers is equivalent to the total outstanding balance of $1.3
billion. In the event of nonperformance, the Bancorp has rights to
68
Fifth Third Bancorp
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. RELATED PARTY TRANSACTIONS
At December 31, 2005 and 2004, certain directors, executive
officers, principal holders of Bancorp common stock and
associates of such persons were indebted, including undrawn
commitments to lend, to the Bancorp’s banking subsidiaries in the
aggregate amount, net of participations, of $307 million and $260
million, respectively. As of December 31, 2005 and 2004, the
outstanding balance on
related parties, net of
participations and undrawn commitments, was $81 million and $70
million, respectively.
loans
to
Commitments to lend to related parties as of December 31,
2005 and 2004, net of participations, were comprised of $296
16. OTHER COMPREHENSIVE INCOME
The Bancorp has elected to present the disclosures required by
SFAS No. 130, “Reporting Comprehensive Income,” in the
Consolidated Statements of Changes in Shareholders’ Equity and
in the table below. Disclosure of the reclassification adjustments,
($ in millions)
2005
Losses on available-for-sale securities
Reclassification adjustment for net gains recognized in net income
Gains (losses) on cash flow hedge derivatives
Reclassification adjustment for losses recognized in net income
Change in minimum pension liability
Total
2004
Losses on available-for-sale securities
Reclassification adjustment for net losses recognized in net income
Losses on cash flow hedge derivatives
Reclassification adjustment for gains recognized in net income
Change in minimum pension liability
Total
2003
Losses on available-for-sale securities
Reclassification adjustment for net gains recognized in net income
Gains (losses) on cash flow hedge derivatives
Change in minimum pension liability
Total
17. COMMON STOCK AND TREASURY STOCK
million and $244, respectively, in loans and guarantees for various
business and personal interests made to the Bancorp and subsidiary
directors and $11 million and $16 million, respectively, to certain
executive officers. This indebtedness was incurred in the ordinary
course of business on substantially the same terms as those
prevailing at the time of comparable transactions with unrelated
parties.
None of the Bancorp’s affiliates, officers, directors or
employees has an interest in or receives any remuneration from any
special purpose entities or qualified special purpose entities with
which the Bancorp transacts business.
related tax effects allocated to other comprehensive income and
accumulated other comprehensive income as of and for the years
ended December 31:
Current Period Activity
Accumulated Balance
Pre-Tax
Tax Effect
Net
Pre-Tax Tax Effect
Net
$(455)
(39)
9
21
90
$(374)
$(74)
37
(39)
(1)
(1)
$(78)
$(667)
(84)
14
(17)
$(754)
158
13
(3)
(7)
(31)
130
27
(13)
15
-
-
29
234
30
(5)
6
265
(297)
(26)
6
14
59
(244)
(47)
24
(24)
(1)
(1)
(49)
(433)
(54)
9
(11)
(489)
(608)
(22)
(8)
(638)
(114)
(52)
(98)
(264)
(77)
(12)
(97)
(186)
213
9
3
225
42
19
34
95
28
4
34
66
(395)
(13)
(5)
(413)
(72)
(33)
(64)
(169)
(49)
(8)
(63)
(120)
The following is a summary of the share activity within common stock issued and treasury stock for the years ended December 31:
($ and shares in millions)
Shares at December 31, 2002
Shares acquired for treasury
Stock-based awards exercised, including treasury shares issued
Other
Shares at December 31, 2003
Shares acquired for treasury
Stock-based awards exercised, including treasury shares issued
Restricted stock grants
Shares issued in business combinations
Other
Shares at December 31, 2004
Shares acquired for treasury
Stock-based awards exercised, including treasury shares issued
Restricted stock grants
Shares issued in business combinations
Retirement of shares
Shares at December 31, 2005
Common Stock
Value
$1,295
-
-
-
1,295
-
-
-
-
-
1,295
-
-
-
11
(11)
$1,295
Shares
583
-
-
-
583
-
-
-
-
-
583
-
-
-
5
(5)
583
Treasury Stock
Value
$544
655
(233)
(4)
962
987
(222)
(33)
(281)
1
1,414
1,746
(206)
(43)
(1,413)
(219)
$1,279
Shares
9
12
(4)
-
17
19
(4)
(1)
(5)
-
26
38
(4)
(1)
(26)
(5)
28
On January 10, 2005 the Bancorp repurchased 35.5 million shares
its common stock, approximately six percent of total
of
outstanding shares, for $1.6 billion in an overnight share
repurchase transaction, where the counterparty in the transaction
purchased shares in the open market over a period of time. This
program was completed by the counterparty during the third
quarter of 2005 and the Bancorp received a price adjustment of
$97 million in cash. The price adjustment represented the
difference between the original per share purchase price of $45.95
and the volume weighted-average price of $43.55 for actual shares
acquired by the counterparty during the purchase period, plus
interest.
Fifth Third Bancorp 69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
18. STOCK-BASED COMPENSATION
The Bancorp has historically emphasized employee stock
further
ownership. Accordingly,
ownership
to
approximately 28% of its employees, including approximately 5,700
officers. Based on total stock-based awards outstanding and shares
remaining for future grants under the Incentive Compensation
stock-based compensation
through granting
the Bancorp
encourages
Plan, the Bancorp’s total overhang is approximately ten percent.
The following table provides detail of the number of shares to be
issued upon exercise of outstanding stock-based awards and
remaining shares available for future issuance under all of the
Bancorp’s equity compensation plans, as of December 31, 2005:
Number of Shares
to Be Issued Upon
Exercise
Weighted-Average
Exercise Price
Shares Available
for Future Issuance
(a)
Plan Category (shares in thousands)
Equity compensation plans approved by shareholders
Options
Restricted stock
Performance units
Stock appreciation rights (“SARs”)
Equity compensation plans not approved by shareholders
Employee stock purchase plan
Total (g)
(a) Excludes shares to be issued upon exercise of outstanding options.
(b) Under the Incentive Compensation Plan, 20.0 million shares of stock were authorized for issuance as nonqualified and incentive stock options, SARs, restricted stock and restricted stock units,
28,546
1,482
(d)
(e)
$48.02
(c)
(c)
(e)
430(f)
16,989(h)
(b)
(b)
(b)
(b)
30,028
$48.02
performance shares and performance units and stock awards. As of December 31, 2005, 16.2 million shares remain available for future issuance.
(c) Not applicable
(d) The number of shares to be issued is dependent upon the Bancorp achieving certain predefined performance targets and ranges from zero shares to approximately 182 thousand shares, dependent on
relative performance.
(e) At December 31, 2005, approximately 7.5 million SARs were outstanding at a weighted-average grant price of $47.51. The number of shares to be issued upon exercise will be determined at
vesting based on the difference between the grant price and the market price at the date of exercise.
(f) Represents remaining shares of Fifth Third common stock under the Bancorp’s 1993 Stock Purchase Plan, as amended and restated.
(g) Excludes 3.0 million outstanding options awarded under plans assumed by the Bancorp in connection with certain mergers and acquisitions. The Bancorp has not made any awards under these
plans and will make no additional awards under these plans. The weighted-average exercise price of the outstanding options is $31.76 per share.
(h) Includes .4 million shares issuable relating to deferred stock compensation plans.
Stock-based awards are eligible for issuance under the
Bancorp’s Incentive Compensation Plan to key employees and
directors of the Bancorp and its subsidiaries. The Incentive
Compensation Plan was approved by shareholders on March 23,
2004. The plan authorized the issuance of up to 20 million shares
as equity compensation. Options and SARs are issued at fair
market value at the date of grant, have up to ten-year terms and
vest and become fully exercisable at the end of three to four years
of continued employment. Currently, all SARs outstanding are to
be settled with stock. Restricted stock grants vest after four years
of continued employment and include dividend and voting rights.
The Bancorp applies the provisions of SFAS No. 123 in
accounting for stock-based compensation plans. Under SFAS No.
123, the Bancorp recognizes compensation expense for the fair
value of stock-based compensation issued over its service period.
Stock-based compensation expense was $65 million, $87 million
and $110 million for the years ended December 31, 2005, 2004 and
2003, respectively. The following tables include a summary of
stock-based compensation transactions for the previous three fiscal
years:
2005
2004
2003
Average
Option Price
Options (shares in thousands)
$45.31
Outstanding at January 1
21.16
Exercised
54.30
Canceled
22.90
Granted (a)
$46.49
Outstanding at December 31
Exercisable at December 31
$46.01
(a) 2005 options granted include 2,514 options assumed as part of the First National acquisition completed on January 1, 2005. These options were granted under a First National plan assumed
by the Bancorp. 2004 options granted include 1,021 options assumed as part of the Franklin Financial acquisition completed on June 11, 2004. These options were granted under a Franklin
Financial plan assumed by the Bancorp.
Average
Option Price
$44.40
25.41
58.07
19.81
$45.31
$43.57
Average
Option Price
$41.85
27.25
58.61
51.88
$44.40
$40.46
Shares
39,030
(3,843)
(958)
6,498
40,727
30,574
Shares
40,727
(4,248)
(1,422)
1,105
36,162
30,912
Shares
36,162
(4,830)
(2,301)
2,515
31,546
29,364
Stock Appreciation Rights (shares in thousands)
Outstanding at January 1
Exercised
Canceled
Granted
Outstanding at December 31
Exercisable at December 31
Restricted Stock (shares in thousands)
Outstanding at January 1
Vested
Canceled
Granted
Outstanding at December 31
70
Fifth Third Bancorp
2005
Average
Grant Price
$54.37
-
48.88
42.82
$47.51
$54.37
2004
Average
Grant Price
$-
-
54.40
54.37
$54.37
$54.40
Shares
-
-
(187)
3,716
3,529
1
Shares
-
-
-
-
-
-
2003
Average
Grant Price
$-
-
-
-
$-
$-
2005
2004
2003
Average
Market Price
at Grant
$54.01
50.62
48.19
42.31
$46.16
Shares
48
(18)
(41)
607
596
Average
Market Price
at Grant
$58.11
59.16
54.26
53.86
$54.01
Average
Market Price
at Grant
$62.54
62.81
-
56.90
$58.11
Shares
18
(8)
-
38
48
Shares
3,529
-
(880)
4,892
7,541
4
Shares
596
(29)
(171)
1,086
1,482
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2005, there were 11.9 million incentive options,
19.6 million non-qualified options outstanding, 7.5 million SARs, .2
million shares reserved for performance unit awards and 1.5
million restricted stock awards outstanding and 16.2 million shares
available for grant. Options, SARs and restricted stock outstanding
represent seven percent of the Bancorp’s
issued shares at
December 31, 2005.
Outstanding Stock Options
Exercisable Stock Options
Exercise Price
per Share
Lowest
Price
Under $11
$11-$25
$25-$40
$40-$55
Over $55
All options
$4.27
11.12
25.44
40.17
55.01
$4.27
Highest
Price
$10.50
24.90
39.96
54.99
68.76
$68.76
Number of
Options at Year
End (000’s)
57
3,515
4,779
17,569
5,626
31,546
Weighted-Average
Exercise Price
$7.95
20.36
35.84
48.34
66.45
$46.49
Average
Remaining
Contractual Life
(in years)
3.98
2.01
2.93
5.01
6.27
4.58
Number of
Options (000’s)
57
3,515
4,772
15,570
5,450
29,364
Weighted-Average
Exercise Price
$7.95
20.36
35.84
47.94
66.73
$46.01
thousand
In addition, approximately 101
shares of
performance-based awards were granted during 2005. These
awards are payable in stock and cash contingent upon the Bancorp
achieving certain predefined performance targets over the three-
year measurement period. These performance targets are based on
the Bancorp’s performance relative to a defined peer group. The
performance-based awards were granted at an average fair value of
$43.73 per share.
The Bancorp sponsors a Stock Purchase Plan that allows
qualifying employees to purchase shares of the Bancorp’s common
stock with a 15% match. During the years ended December 31,
2005, 2004 and 2003, respectively, there were 333,472, 236,115 and
194,133 shares purchased by participants and the Bancorp
recognized compensation expense of $2 million, $2 million and $1
million in 2005, 2004 and 2003, respectively.
19. OTHER NONINTEREST INCOME AND OTHER NONINTEREST EXPENSE
The major components of other noninterest income and other noninterest expense for the years ended December 31:
($ in millions)
Other noninterest income:
Cardholder fees
Consumer loan and lease fees
Commercial banking revenue
Bank owned life insurance income
Insurance income
Gain on sale of third-party sourced merchant processing contracts
Other
Total
Other noninterest expense:
Marketing and communication
Postal and courier
Bankcard
Intangible amortization
Franchise and other taxes
Loan and lease
Printing and supplies
Travel
Information technology and operations
Debt termination
Other
Total
2005
$59
50
213
91
31
-
176
$620
$126
50
271
46
37
89
35
54
114
-
323
$1,145
2004
2003
48
57
174
61
31
157
143
671
99
49
224
29
32
82
33
41
87
325
309
1,310
59
65
178
62
28
-
189
581
99
49
197
40
33
106
35
35
76
20
255
945
Fifth Third Bancorp 71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
20. SALES AND TRANSFERS OF LOANS
The Bancorp sold fixed and adjustable rate residential mortgage
loans during 2005 and 2004. The Bancorp also securitized and
sold certain automotive loans in 2004 and securitized and sold
certain home equity lines of credit in 2003. In all of those sales, the
Bancorp retained servicing responsibilities. In addition, the
Bancorp retained a residual interest and an interest only strip (“IO
strip”) in the home equity lines of credit securitization and a
residual interest and a subordinated tranche in the automotive
loans securitization. The Bancorp receives annual servicing fees at a
percentage of the outstanding balance and rights to future cash
flows arising after the investors in the securitization trusts have
received the return for which they contracted. The investors and
the securitization trusts have no recourse to the Bancorp’s other
assets for failure of debtors to pay when due. The Bancorp’s
retained interests are subordinate to investor’s interests. Their
value is subject to credit, prepayment and interest rate risks on the
sold financial assets. In 2005 and 2004, the Bancorp recognized
pretax gains of $162 million and $112 million, respectively, on the
sales of residential mortgage loans, home equity lines of credit,
student loans and automotive loans. Total proceeds from the loan
sales in 2005 and 2004 were $8.0 billion and $6.1 billion,
respectively.
Initial carrying values of retained interests recognized during
2005 and 2004 were as follows:
($ in millions)
Mortgage servicing assets
Other consumer and commercial servicing assets
Consumer residual interests
Subordinated interests
2005
$134
1
5
-
2004
83
11
26
21
The subordinated interests recognized in 2004 are securities
retained from the automotive loan securitization. These securities
are investment grade and are carried at their market value. Key
economic assumptions used in measuring other retained interests
at
the date of securitization resulting from securitizations
completed during 2005 and 2004 were as follows:
2005
2004
Weighted-
Average
Life
(in years)
Rate
Prepayment
Speed
Assumption
Discount
Rate
Weighted-
Average
Default
Rate
Weighted-
Average
Life
(in years)
Prepayment
Speed
Assumption
Discount
Rate
Weighted-
Average
Default Rate
Residential mortgage loans:
Servicing assets
Servicing assets
Home equity line of credit:
Servicing assets
Residual interest
Automotive loans:
Servicing assets
Residual interest
Fixed
Adjustable
Adjustable
Adjustable
Fixed
Fixed
7.1
3.7
2.4
2.0
-
-
12.6%
27.5
35
35
-
-
10.3%
11.6
11.7
11.7
-
-
N/A
N/A
N/A
.35%
-
-
7.0
4.4
2.0
2.0
2.9
2.9
16.1%
25.6
38.8
38.8
1.55
1.55
9.5%
10.7
11.7
11.7
12.0
12.0
N/A
N/A
N/A
.35%
N/A
1.25
Expected credit losses and the effect of an unfavorable change in credit losses for servicing rights have been deemed to be immaterial
based on historical credit experience. At December 31, 2005, key economic assumptions and the sensitivity of the current fair value of residual
cash flows to immediate 10% and 20% adverse changes in those assumptions are as follows:
Rate
Fixed
Adjustable
Adjustable
Adjustable
($ in millions)
Residential mortgage loans:
Servicing assets
Servicing assets
Home equity line of credit:
Servicing assets
Residual interest
Automotive Loans:
Servicing assets
Residual interest
Fixed
Fixed
Fair
Value
$413
45
5
24
3
11
Prepayment Speed
Assumption
Impact of Adverse
Change on Fair
Value
Rate
10%
20%
Weighted-
Average
Life (in
years)
Residual Servicing Cash Flows
Impact of Adverse
Change on Fair
Value
Weighted-Average Default
Impact of Adverse
Change on Fair
Value
10%
20%
Rate
10%
20%
Discount
Rate
7.8
3.5
2.2
1.9
1.0
1.0
9.8 %
26.2
$16
3
$32
6
9.7 %
11.4
$15
1
$29
2
- %
-
35.0
35.0
1.55
1.55
-
1
-
-
1
2
1
-
11.7
11.7
12
12
-
-
-
-
-
1
-
-
-
.35
-
1.25
$-
-
-
-
-
-
$-
-
-
1
-
1
These sensitivities are hypothetical and should be used with
caution. As the figures indicate, changes in fair value based on a
10% variation in assumptions typically cannot be extrapolated
because the relationship of the change in assumption to the change
in fair value may not be linear. Also, in the above table, the effect
of a variation in a particular assumption on the fair value of the
retained
is calculated without changing any other
assumption; in reality, changes in one factor may result in changes
in another (for example, increases in market interest rates may
result in lower prepayments and increased credit losses), which
interest
might magnify or counteract the sensitivities.
In addition to the retained interests listed above, the Bancorp
retains certain investment grade securities from securitizations.
The fair value of these retained securities was $30 million and $34
million at December 31, 2005 and 2004, respectively. The
securities are valued using quoted market prices.
The following table provides a summary of the total loans and
leases managed by the Bancorp, including loans securitized for the
years ended December 31:
72
Fifth Third Bancorp
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Balance
2005
$19,299
9,188
3,698
7,037
8,353
22,987
1,595
72,157
2004
16,058
7,636
3,426
4,726
7,629
20,222
2,051
61,748
Balance of Loans 90 Days or
More Past Due
2005
$20
8
1
11
49
65
3
$157
2004
21
8
1
9
44
62
3
148
Net Credit
Losses
2005
$75
9
37
4
19
147
14
$305
2004
81
9
7
6
15
118
19
255
($ in millions)
Commercial loans
Commercial mortgage
Commercial leases
Construction loans
Residential mortgage
Other consumer loans
Consumer leases
Total loans and leases managed and securitized (a)
Less:
Loans securitized
Loans held for sale
Total portfolio loans and leases
(a) Excluding securitized assets that the Bancorp continues to service but with which it has no other continuing involvement.
928
1,304
$69,925
1,381
559
59,808
Static pool credit losses are calculated by aggregating the
actual and projected future credit losses for a securitization and
dividing these losses by the original balance in each pool of assets.
For the home equity lines of credit securitized in 2003, the static
pool credit losses were .70% and .78% as of December 31, 2005
and 2004, respectively. For the automotive loans securitized in
2004, the static pool credit losses were 1.00% and 1.14% as of
December 31, 2005 and 2004, respectively.
floating-rate,
recourse, certain primarily
During 2005 and 2004, the Bancorp transferred, subject to
credit
short-term,
investment grade commercial loans to an unconsolidated QSPE
that is wholly owned by an independent third-party. Generally, the
loans transferred provide a lower yield due to their investment
grade nature, and therefore transferring these loans to the QSPE
allows the Bancorp to reduce its exposure to these lower yielding
loan assets while maintaining the customer relationships. At
December 31, 2005 and 2004, the outstanding balance of loans
transferred was $2.8 billion and $1.9 billion, respectively. These
loans may be transferred back to the Bancorp upon the occurrence
of an event specified in the legal documents that established the
QSPE. These events include borrower default on the loans
transferred, bankruptcy preferences initiated against underlying
borrowers and ineligible loans transferred by the Bancorp to the
QSPE. These commercial loans are transferred at par with no gain
or loss recognized. The Bancorp receives rights to future cash
flows arising after the investors in the securitization trust have
received the return for which they contracted. No value has been
assigned to this retained future stream of fees to be received. As of
December 31, 2005, the $2.8 billion balance of outstanding loans
had a weighted-average remaining maturity of 2.5 years.
During 2004, the Bancorp securitized and sold $750 million in
automotive loans to an unconsolidated QSPE that is wholly owned
by an independent third party. The Bancorp retained servicing
($ in millions)
Proceeds from transfers, including new securitizations
Proceeds from collections reinvested in revolving-period securitizations
Transfers received from QSPEs
Fees received
21. DISCONTINUED OPERATIONS
In November 2003, the Bancorp announced an agreement to sell
its corporate trust business, a component of the Commercial
Banking segment. The transaction closed in December 2003. The
Bancorp recognized an after tax gain of $40 million on the sale,
($ in millions)
Total revenues
Gain on sale
Total expenses
Income before income taxes
Applicable income taxes
Net income from discontinued operations
Total assets
rights and receives a servicing fee based on a percentage of the
outstanding balance.
Additionally, the Bancorp retained a
subordinated tranche of securities and rights to future cash flows
arising after investors in the securitization trust have received the
return for which
investors and the
they contracted. The
securitization trust have no recourse to the Bancorp’s other assets
for failure of debtors to pay when due. The Bancorp’s retained
interest is subordinate to investor’s interests and its value is subject
to credit, prepayment and interest rate risks on the sold automotive
loans. As of December 31, 2005, the remaining balance of sold
automotive loans was $316 million.
During 2003, the Bancorp securitized and sold $903 million in
home equity lines of credit to an unconsolidated QSPE that is
wholly owned by an independent third party. The Bancorp
retained servicing rights and receives a servicing fee based on a
percentage of the outstanding balance. Additionally, the Bancorp
retained rights to future cash flows arising after investors in the
securitization trust have received the return for which they
contracted. The investors and the securitization trust have no
recourse to the Bancorp’s other assets for failure of debtors to pay
when due. The Bancorp’s retained interest is subordinate to
investor’s interests and its value is subject to credit, prepayment
and interest rate risks on the sold home equity lines of credit.
During 2005, pursuant to the terms of the sales and servicing
agreement, $18 million in fixed-rate home equity line of credit
balances were putback to the Bancorp. As of December 31, 2005,
the remaining balance of sold home equity lines of credit was $555
million.
The Bancorp had
following
unconsolidated QSPEs during 2005 and 2004:
the
cash
flows with
2005
$1,680
132
(18)
32
2004
1,379
162
-
32
which is captured as a component of income from discontinued
operations, net of tax, in the Consolidated Statements of Income.
Financial
summarized below:
information
for discontinued operations
is
2003
$12
62
6
68
24
$44
$2
Fifth Third Bancorp 73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
22. INCOME TAXES
The Bancorp and its subsidiaries file a consolidated Federal income tax return. A summary of applicable income taxes included in the
Consolidated Statements of Income at December 31:
($ in millions)
Current income taxes:
U.S. income taxes
State and local income taxes
Total current tax
Deferred income taxes:
U.S. income taxes
State and local income taxes
Total deferred taxes
Applicable income taxes
2005
2004
2003
$654
21
675
(7)
(9)
(16)
$659
691
34
725
(12)
(1)
(13)
712
482
9
491
264
31
295
786
Deferred income taxes are included as a component of accrued taxes, interest and expenses in the Consolidated Balance Sheets and are
comprised of the following temporary differences at December 31:
($ in millions)
Deferred tax assets:
Allowance for credit losses
Deferred compensation
Other comprehensive income
State net operating losses
Other
Total deferred tax assets
Deferred tax liabilities:
Lease financing
State deferred taxes
Bank premises and equipment
Other
Total deferred tax liabilities
Total net deferred tax liability
A reconciliation between the statutory U.S. income tax rate and the Bancorp’s effective tax rate for the years ended December 31:
Statutory tax rate
Increase (decrease) resulting from:
State taxes, net of federal benefit
Tax-exempt income
Credits
Other, net
Effective tax rate
2005
35.0%
.4
(2.3)
(2.3)
(.9)
29.9%
2004
35.0
1.0
(2.0)
(1.7)
(.5)
31.8
Retained earnings at December 31, 2005 includes $157 million
in allocations of earnings for bad debt deductions of former thrift
subsidiaries for which no income tax has been provided. Under
current tax law, if certain of the Bancorp’s subsidiaries use these
bad debt reserves for purposes other than to absorb bad debt
losses, they will be subject to Federal income tax at the current
corporate tax rate.
74
Fifth Third Bancorp
2005
2004
$260
149
225
129
127
890
1,786
203
61
285
2,335
$1,445
250
141
95
153
122
761
1,819
236
75
231
2,361
1,600
2003
35.0
1.0
(1.8)
(1.2)
(.8)
32.2
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
23. RETIREMENT AND BENEFIT PLANS
The measurement date for all of the Bancorp’s defined benefit
retirement plans is December 31. A combined summary of the
defined benefit retirement plans as of and for the years ended
December 31:
($ in millions)
Projected benefit obligation at January 1
Service cost
Interest cost
Settlement
Acquisitions
Actuarial loss
Benefits paid
Projected benefit obligation at December 31
Fair value of plan assets at January 1
Actual return on assets
Contributions
Settlement
Benefits paid
Fair value of plan assets at December 31
Funded status
Unrecognized prior service cost
Unrecognized net actuarial loss
Net amount recognized
Amounts recognized in the Consolidated Balance
Sheets consist of:
Prepaid benefit cost
Accrued benefit liability
Intangible asset
Deferred tax asset
Accumulated other comprehensive income
Net amount recognized
2005
$254
1
14
(26)
10
14
(9)
$258
$201
11
63
(28)
(9)
$238
$(20)
3
107
$90
$119
(37)
-
3
5
$90
2004
264
1
15
(17)
-
1
(10)
254
223
7
3
(22)
(10)
201
(53)
3
101
51
-
(51)
4
34
64
51
($ in millions)
Components of net periodic pension cost:
Service cost
Interest cost
Expected return on assets
Amortization and deferral of transition
amount
Amortization of actuarial loss
Amortization of unrecognized prior
service cost
Settlement
Net periodic pension cost
2005
2004
2003
$1
14
(18)
-
8
-
9
$14
1
15
(18)
(2)
9
1
10
16
1
16
(15)
(2)
15
1
15
31
Net periodic pension cost is recorded as a component of
employee benefits in the Consolidated Statements of Income. The
Plan assumptions are evaluated annually and are updated as
necessary. The discount rate assumption reflects the yield of a
portfolio of high quality fixed-income instruments that have a
similar duration to the Plan’s liabilities. The expected long-term
rate of return assumption reflects the average return expected on
the assets invested to provide for the Plan’s liabilities. In
determining the expected long-term rate of return assumption, the
Bancorp evaluated actuarial and economic inputs, including long-
term inflation rate assumptions and broad equity and bond indices
long-term return projections, as well as actual long-term historical
Plan performance.
2005
2004
2003
Weighted-average assumptions
For disclosure:
Discount rate
Rate of compensation increase
Expected return on plan assets
For measuring net periodic pension cost:
Discount rate
Rate of compensation increase
Expected return on plan assets
5.375 %
5.00
8.45
5.65-5.85
5.00
8.00
5.85
5.10
8.00
6.00
5.00
8.75
6.00
5.00
8.75
6.75
5.10
9.00
In March 2005, the Bancorp contributed $50 million to its
defined benefit plan. As a result of the contribution, the
assumptions used to measure net periodic pension cost for 2005
were reevaluated and the assumed discount rate was lowered to
5.65% from 5.85%. The expected rate of compensation increase
and the expected return on plan assets were not changed.
Plan assets consist primarily of common trust and mutual
funds (equities and fixed income) managed by Fifth Third Bank, a
subsidiary of the Bancorp, and Bancorp common stock securities.
The following table provides the Bancorp’s weighted-average asset
allocations by asset category for 2005 and 2004:
Weighted-average asset allocation
Equity securities
Bancorp common stock
Total equity securities
Total fixed income securities
Cash
Total
2005
69%
6
75
23
2
100%
2004
65
10
75
25
-
100
The Bancorp’s policy for the investment of Plan assets is to
employ investment strategies that achieve a weighted-average target
asset allocation of 70% to 80% in equity securities, 20% to 25% in
fixed income securities and up to five percent in cash.
The accumulated benefit obligation for all defined benefit
plans was $254 million and $251 million at December 31, 2005 and
December 31, 2004, respectively. For the Bancorp’s defined
benefit plans with an accumulated benefit obligation exceeding
assets, the total projected benefit obligation, accumulated benefit
obligation and fair value of plan assets were $38 million, $38
million and $0, respectively, as of December 31, 2005 and $254
million, $251 million and $201 million, respectively, as of
December 31, 2004.
In 2005, the decrease in the additional minimum pension
liability, recorded as an increase to shareholders’ equity, was $59
million, net of deferred taxes of $31 million. The reduction was
due to the Bancorp’s $50 million contribution to the Plan in March
2005. In 2004, the increase in the additional minimum pension
liability, recorded as a reduction to shareholders’ equity, was $1
million, net of deferred tax of less than $1 million.
Based on the actuarial assumptions, the Bancorp expects to
contribute approximately $10 million to the Plan
in 2006.
Estimated pension benefit payments, which reflects expected
future service, are $20 million in 2006, $21 million in 2007, $20
million in 2008, $19 million in 2009 and $20 million in 2010. The
total estimated payments for the years 2011 through 2015 is $86
million.
The Bancorp’s profit sharing plan expense was $62 million for
2005, $69 million for 2004 and $48 million for 2003. Expenses
recognized during the years ended December 31, 2005, 2004 and
2003 for matching contributions to the Bancorp’s defined
contribution savings plans were $33 million, $28 million and $12
million, respectively.
Fifth Third Bancorp 75
24. EARNINGS PER SHARE
Reconciliation of earnings per share to earnings per diluted share for the years ended December 31:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in millions, except per share data)
EPS
Income from continuing operations before
cumulative effect
Net income from continuing operations
available to common shareholders(a)
Income from discontinued operations, net of tax
Cumulative effect of change in accounting
principle, net of tax
Net income available to common shareholders
Diluted EPS
Net income from continuing operations
available to common shareholders
Effect of dilutive securities
Income from continuing operations plus
assumed conversions (b)
Income from discontinued operations, net of tax
Cumulative effect of change in accounting
principle, net of tax
Net income available to common
2005
2004
Income
Average
Shares
Per Share
Amount
Income
Average
Shares
Per Share
Amount
Income
2003
Average
Shares
Per
Share
Amount
$1,549
1,548
-
-
$1,548
$1,548
1,549
-
-
554
554
554
4
558
$2.79
-
-
$2.79
$1,525
1,524
-
-
$1,524
$1,524
$2.77
-
1,525
-
-
-
561
561
561
7
568
$2.72
-
-
$2.72
$1,632
1,631
44
(11)
$1,664
$1,631
$2.68
-
1,632
44
-
(11)
572
572
572
8
580
$2.85
.08
(.02)
$2.91
$2.81
.08
(.02)
shareholders plus assumed conversions
$1,548
558
$2.77
$1,525
568
$2.68
$1,665
580
$2.87
(a) Dividends on preferred stock are $.740 million for the years ended December 31, 2005, 2004 and 2003.
(b) The effect of dividends on convertible preferred stock is $.580 million for the years ended December 31, 2005, 2004 and 2003.
Options to purchase 28.1 million, 16.2 million and 7.0 million shares outstanding at December 31, 2005, 2004 and 2003, respectively,
were not included in the computation of net income per diluted share because the effect would be antidilutive.
25. FAIR VALUE OF FINANCIAL INSTRUMENTS
Carrying amounts and estimated fair values for financial instruments as of December 31:
($ in millions)
Financial assets:
Cash and due from banks
Available-for-sale and other securities
Held-to-maturity securities
Trading securities
Other short-term investments
Loans held for sale
Portfolio loans and leases, net
Derivative assets
Bank owned life insurance assets
Financial liabilities:
Deposits
Federal funds purchased
Short-term bank notes
Other short-term borrowings
Long-term debt
Derivative liabilities
Short positions
Other financial instruments:
Commitments to extend credit
Letters of credit
2005
2004
Carrying
Amount Fair Value
Carrying
Amount
Fair Value
$3,078
21,924
389
117
158
1,304
69,181
192
1,865
67,434
5,323
-
4,246
15,227
269
29
69
13
3,078
21,924
389
117
158
1,305
69,039
192
1,865
67,361
5,323
-
4,246
15,458
269
29
69
13
2,561
24,687
255
77
532
559
59,095
271
1,573
58,226
4,714
775
4,537
13,983
232
15
53
10
2,561
24,687
255
77
532
562
59,708
271
1,573
58,221
4,714
775
4,537
14,232
232
15
53
10
Fair values for financial instruments, which were based on
various assumptions and estimates as of a specific point in time,
represent liquidation values and may vary significantly from
amounts that will be realized in actual transactions. In addition,
certain non-financial instruments were excluded from the fair value
disclosure requirements. Therefore, the fair values presented in the
table above should not be construed as the underlying value of the
Bancorp.
The following methods and assumptions were used in
determining the fair value of selected financial instruments:
Short-term financial assets and
liabilities: For financial
instruments with a short-term or no stated maturity, prevailing
market rates and limited credit risk, carrying amounts approximate
76
Fifth Third Bancorp
fair value. Those financial instruments include cash and due from
banks, other short-term investments, certain deposits (demand,
interest checking, savings and money market), federal funds
purchased,
short-term
short-term bank notes and other
borrowings.
Available-for-sale, held-to-maturity,
trading and other
securities, including short positions: Fair values were based on
prices obtained from an independent nationally recognized pricing
service.
Portfolio loans and leases, net: Fair values were estimated by
discounting the future cash flows using the current rates at which
similar loans would be made to borrowers with similar credit
ratings and for the same remaining maturities.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Loans held for sale: The fair value of loans held for sale was
estimated based on outstanding commitments from investors or
current investor yield requirements.
Deposits: Fair values for other time, certificates of deposit–
$100,000 and over and foreign office were estimated using a
discounted cash flow calculation that applies interest rates currently
being offered for deposits of similar remaining maturities.
Long-term debt: Fair value of long-term debt was based on
quoted market prices, when available, and a discounted cash flow
calculation using prevailing market rates for borrowings of similar
terms.
Commitments
commitments were based on estimated probable credit losses.
to extend credit: Fair values of
loan
26. BUSINESS COMBINATIONS
On January 1, 2005, the Bancorp acquired in a merger 100% of the
outstanding stock of First National, a bank holding company
headquartered in Naples, Florida. First National operated 77 full-
service banking centers located primarily in Orlando, Tampa,
Sarasota, Naples and Fort Myers. The acquisition of First National
allows the Bancorp to expand its presence in the rapidly expanding
Florida market.
Under the terms of the transaction, each share of First
National common stock was exchanged for .5065 shares of the
Bancorp’s common stock, resulting in the issuance of 30.6 million
shares of common stock. The common stock issued to effect the
transaction was valued at $47.30 per share, the closing price of the
Bancorp’s common stock on the previous trading day, for a total
transaction value of $1.5 billion. The total purchase price also
included the fair value of stock awards issued in exchange for stock
awards held by First National employees, for which the aggregate
fair value was $63 million.
The assets and liabilities of First National were recorded on
the balance sheet at their respective fair values as of the closing
date. The results of First National’s operations were included in
the Bancorp’s Consolidated Statements of Income from the date of
acquisition. In addition, the Bancorp realized charges against its
earnings for acquisition related expenses of $8 million during 2005.
The acquisition related expenses consisted primarily of travel and
relocation costs, printing, closure of duplicate facilities, supplies
and other costs associated with the conversion.
The transaction resulted in total goodwill and intangible assets
of $1.3 billion based upon the purchase price, the fair values of the
acquired assets and assumed liabilities and applicable purchase
accounting adjustments. Of this total intangibles amount, $85
million was allocated to core deposit intangibles, $7 million was
allocated to customer lists and $13 million was allocated to
noncompete agreements. The core deposit intangible and the
customer lists are being amortized using an accelerated method
over ten years. The noncompete agreements are being amortized
using the straight-line method over the duration of the agreements.
The remaining $1.2 billion of intangible assets was recorded as
Letters of credit: Fair values of letters of credit were based on
unamortized fees on the letters of credit.
Derivative assets and derivative liabilities: Fair values were
based on the estimated amount the Bancorp would receive or pay
to terminate the derivative contracts, taking into account the
current
the
counterparties. The fair values represent an asset or liability at
December 31, 2005.
creditworthiness of
interest
rates
and
the
Bank owned life insurance assets: Fair values of insurance
policies owned by the Bancorp were based on the insurance
contract’s cash surrender value, net of any policy loans.
goodwill. Goodwill recognized in the First National acquisition is
not deductible for income tax purposes.
On June 11, 2004, the Bancorp completed the acquisition of
Franklin Financial, a bank holding company located in the
Nashville, Tennessee metropolitan market.
Under the terms of the transaction, each share of Franklin
Financial common stock was exchanged for .5933 shares of the
Bancorp’s common stock, resulting in the issuance of 5.1 million
shares of common stock. The common stock issued to effect the
transaction was valued at $55.52 per share for a total transaction
value of $317 million. The total purchase price also includes the
fair value of stock awards issued in exchange for stock awards held
by Franklin employees, for which the aggregate fair value was $36
million.
The assets and liabilities of Franklin Financial were recorded
on the balance sheet at their respective fair values as of the closing
date. The results of Franklin Financial’s operations were included
in the Bancorp’s Consolidated Statements of Income from the date
of acquisition. The transaction resulted in total intangible assets of
$281 million based upon the purchase price, the fair values of the
acquired assets and assumed liabilities and applicable purchase
accounting adjustments. Of this total intangibles amount, $7
million was allocated to core deposit intangibles, $6 million was
allocated to customer lists and $2 million was allocated to
noncompete agreements. The core deposit intangible and the
customer lists are being amortized using an accelerated method
over seven and five years, respectively.
The noncompete
agreements are being amortized using the straight-line method over
the duration of the agreements. The remaining $266 million of
intangible assets was recorded as goodwill. Goodwill recognized in
the Franklin Financial acquisition is not deductible for income tax
purposes.
The pro forma effect of the financial results of First National
and Franklin Financial excluded from the results of operations
prior to the dates of acquisition were not material to the Bancorp’s
financial condition and operating results for the periods presented.
Fifth Third Bancorp 77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
27. CERTAIN REGULATORY REQUIREMENTS AND CAPITAL RATIOS
The principal source of income and funds for the Bancorp (parent
company) are dividends from its subsidiaries. During 2005, the
amount of dividends the bank subsidiaries can pay to the Bancorp
without prior approval of regulatory agencies was limited to their
2005 eligible net profits, as defined, and the adjusted retained 2004
and 2003 net income of those subsidiaries.
characteristics. Average assets for this purpose does not include
goodwill and any other intangible assets and investments that the
FRB determines should be deducted from Tier I capital.
Both the FRB and the Office of Comptroller of the Currency
(“OCC”) have issued regulations regarding the capital adequacy of
subsidiary banks. These requirements are substantially similar to
those adopted by the FRB regarding bank holding companies, as
described above. In addition, the federal banking agencies have
issued substantially similar regulations to implement the system of
prompt corrective action established by Section 38 of the Federal
Deposit Insurance Act. Under the regulations, a bank generally
shall be deemed to be well-capitalized if it has a Total risk-based
capital ratio of 10.0% or more, a Tier I capital ratio of 6.0% or
more, a Tier I leverage ratio of 5.0% or more and is not subject to
any written capital order or directive. If an institution becomes
undercapitalized, it would become subject to significant additional
oversight, regulations and requirements as mandated by the Federal
Deposit Insurance Act. The Bancorp and each of its subsidiary
banks had Tier I, Total risk-based capital and Tier I leverage ratios
above the well-capitalized levels at December 31, 2005 and 2004.
As of December 31, 2005, the most recent notification from the
FRB categorized the Bancorp and each of its subsidiary banks as
well-capitalized under the regulatory framework for prompt
corrective action. To continue to qualify for financial holding
company status pursuant to the Gramm-Leach-Bliley Act of 1999,
the Bancorp’s subsidiary banks must, among other things, maintain
“well capitalized” capital ratios.
U.S. bank regulatory authorities and
international bank
supervisory organizations, principally the Basel Committee on
Banking Supervision, are currently considering changes to the risk-
based capital adequacy framework for banks, including emphasis
on credit, market and operational risk components, which
ultimately could affect the appropriate capital guidelines for bank
holding companies such as the Bancorp.
Capital and risk-based capital and leverage ratios for the
Bancorp and its significant subsidiary banks at December 31:
2005
2004
Amount
Ratio
Amount
Ratio
$10,240
6,237
5,352
177
10.45 %
12.61
11.04
12.04
$10,176
5,772
4,164
161
12.31 %
12.85
10.72
13.57
8,209
4,973
4,922
167
8,209
4,973
4,922
167
8.38
10.05
10.16
11.31
8.08
8.77
10.75
12.24
8,522
5,009
3,617
153
8,522
5,009
3,617
153
10.31
11.15
9.31
12.89
8.89
8.48
9.39
14.44
The Bancorp’s subsidiary banks must maintain cash reserve
balances when total reservable deposit liabilities are greater than
the regulatory exemption. These reserve requirements may be
satisfied with vault cash and noninterest-bearing cash balances on
reserve with a Federal Reserve Bank. In 2005 and 2004, the banks
were required to maintain average cash reserve balances of $211
million and $192 million, respectively.
The FRB adopted guidelines pursuant to which it assesses the
adequacy of capital in examining and supervising a bank holding
company and in analyzing applications to it under the Bank
Holding Company Act of 1956, as amended. These guidelines
include quantitative measures that assign risk weightings to assets
and off-balance sheet items, as well as define and set minimum
regulatory capital requirements. All bank holding companies are
required to maintain core capital (Tier I) of at least 4% of risk-
weighted assets and off-balance sheet items (Tier I capital ratio),
total capital of at least 8% of risk-weighted assets and off-balance
sheet items (Total risk-based capital ratio) and Tier I capital of at
least 3% of adjusted quarterly average assets (Tier I leverage ratio).
Failure to meet the minimum capital requirements can initiate
certain actions by regulators that could have a direct material effect
on the Consolidated Financial Statements of the Bancorp.
Tier I capital consists principally of shareholders’ equity
including Tier I qualifying subordinated debt but excluding
unrealized gains and losses on securities available-for-sale, less
goodwill and certain other intangibles. Tier II capital consists
principally of perpetual and trust preferred stock that is not eligible
to be
included as Tier I capital, term subordinated debt,
intermediate-term preferred stock and, subject to limitations,
general allowances for loan and lease losses. Assets are adjusted
under the risk-based guidelines to take into account different risk
($ in millions)
Total risk-based capital (to risk-weighted assets):
Fifth Third Bancorp (Consolidated)
Fifth Third Bank (Ohio)
Fifth Third Bank (Michigan)
Fifth Third Bank, N.A.
Tier I capital (to risk-weighted assets):
Fifth Third Bancorp (Consolidated)
Fifth Third Bank (Ohio)
Fifth Third Bank (Michigan)
Fifth Third Bank, N.A.
Tier I leverage (to average assets):
Fifth Third Bancorp (Consolidated)
Fifth Third Bank (Ohio)
Fifth Third Bank (Michigan)
Fifth Third Bank, N.A.
78
Fifth Third Bancorp
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2005
28. PARENT COMPANY FINANCIAL STATEMENTS
($ in millions)
Condensed Statements of Income (Parent Company Only)
For the years ended December 31
Income
Dividends from subsidiaries
Interest on loans to subsidiaries
Other
Total income
Expenses
Interest
Other
Total expenses
Income Before Income Taxes and
$1,270
32
1
1,303
1,262
27
24
1,313
682
32
1
715
77
23
100
31
3
34
15
9
24
2003
2004
Change in Undistributed Earnings of
Subsidiaries
Applicable income taxes
Income Before Change in Undistributed
Earnings of Subsidiaries
Increase in undistributed earnings of
subsidiaries
Net Income
1,203
(25)
691
1
1,279
5
1,228
690
1,274
321
$1,549
835
1,525
391
1,665
Condensed Balance Sheets (Parent Company Only)
As of December 31
Assets
Cash
Loans to subsidiaries
Investment in subsidiaries
Goodwill
Other assets
Total assets
Liabilities
Commercial paper
Accrued expenses and other liabilities
Long-term debt
Total Liabilities
Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
2005
2004
$666
529
10,753
137
36
$12,121
$2
242
2,431
2,675
9,446
$12,121
33
2,340
9,034
137
102
11,646
28
247
2,447
2,722
8,924
11,646
29. SEGMENTS
The Bancorp’s business segments are Commercial Banking, Retail
Banking, Investment Advisors and Fifth Third Processing
Solutions. Commercial Banking offers banking, cash management
and financial services to large and middle-market businesses,
government and professional customers. Retail Banking provides a
full range of deposit products and loans and leases to individuals
and small businesses. Investment Advisors provides a full range of
investment alternatives for individuals, companies and not-for-
profit organizations. Fifth Third Processing Solutions provides
electronic funds transfer, debit, credit and merchant transaction
processing, operates the Jeanie® ATM network and provides other
data processing services to affiliated and unaffiliated customers.
The Other/Eliminations column includes the unallocated portion
of the investment portfolio, certain non-core deposit funding,
unassigned equity and certain support activities and other items not
attributed to the business segments.
The Bancorp manages interest rate risk centrally at the
corporate level by employing a funds transfer pricing methodology.
This methodology insulates the segments from interest rate risk,
enabling them to focus on serving customers through loan
originations and deposit taking. The FTP system assigns charge
rates and credit rates to classes of assets and liabilities, respectively,
based on expected duration. The condensed statements of income
in the table below are on an FTP basis. In addition to the
previously mentioned
items, the Other/Eliminations column
includes the net effect of the FTP methodology.
Results of the Bancorp’s business segments are presented
based on its management structure and management accounting
practices. The structure and practices are specific to the Bancorp;
Condensed Statements of Cash Flows (Parent Company Only)
For the years ended December 31
2004
Operating Activities
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
$1,549
1,525
2005
Stock-based compensation expense
Benefit for deferred income taxes
Increase in other assets
(Decrease) increase in accrued expenses
and other liabilities
Increase in undistributed earnings of
subsidiaries
Other, net
Net Cash Provided by Operating
Activities
Investing Activities
Decrease (increase) in loans to subsidiaries
Net Cash Provided by (Used in)
Investing Activities
Financing Activities
(Decrease) increase in other short-term
borrowings
Proceeds from issuance of long-term debt
Payment of cash dividends
Exercise of stock-based awards
Purchases of treasury stock
Other
Net Cash (Used in) Provided by
Financing Activities
Increase (Decrease) in Cash
Cash at Beginning of Year
Cash at End of Year
2003
1,665
1
(5)
(39)
54
-
(1)
(24)
(84)
(835)
-
(391)
-
-
(1)
(4)
(29)
(321)
1
1,195
581
1,285
1,811
(759)
(471)
1,811
(759)
(471)
(26)
-
(794)
96
(1,649)
-
(2,373)
633
33
$666
24
1,749
(704)
89
(987)
-
171
(7)
40
33
(89)
497
(631)
97
(655)
7
(774)
40
-
40
therefore, the financial results of the Bancorp’s business segments
are not necessarily comparable with similar information for other
financial institutions. The Bancorp refines its methodologies from
time to time as management accounting practices are improved and
businesses change. Revisions to the Bancorp’s methodologies are
applied on a retroactive basis. Prior periods have been conformed
to the current period presentation.
The financial results of the business segments
include
allocations for shared services and headquarters expenses. Even
with these allocations, the financial results are not necessarily
indicative of the business segments’ financial condition and results
of operations as if they were to exist as independent entities.
Additionally, the business segments form synergies by taking
advantage of cross-sell opportunities and when funding operations
by accessing the capital markets as a collective unit. The financial
information for each segment is reported on the basis used
internally by the Bancorp’s management to evaluate performance
and allocate resources. The allocation has been consistently
applied for all periods presented. Revenues from affiliated
transactions are typically charged at rates available to and
transacted with unaffiliated customers.
Fifth Third Bancorp 79
Results of operations and average assets by segment for each of the three years ended December 31:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ in millions)
2005
Net interest income (b)
Provision for loan and lease losses
Net interest income after provision for loan
and lease losses
Noninterest income
Noninterest expense
Income before income taxes
Applicable income taxes (b)
Net income
Average assets
2004
Net interest income (b)
Provision for loans and lease losses
Net interest income after provision for loan
and lease losses
Noninterest income
Noninterest expense
Income before income taxes
Applicable income taxes (b)
Net income
Average assets
2003
Net interest income (b)
Provision for loan and lease losses
Net interest income after provision for loan
Commercial
Banking
Retail
Banking
Investment
Advisors
Processing
Solutions
Other/
Eliminations
Acquisitions
(a)
$1,491
136
1,355
494
717
1,132
348
$784
$31,849
$1,329
113
1,216
409
610
1,015
310
$705
$27,977
$1,052
182
2,274
214
2,060
1,004
1,380
1,684
593
1,091
61,525
2,052
187
1,865
1,075
1,330
1,610
547
1,063
58,709
1,811
202
216
10
206
376
386
196
69
127
4,679
171
9
162
386
368
180
62
118
3,995
130
10
32
17
15
633
463
185
65
120
1,146
33
10
23
697
407
313
106
207
1,009
42
9
(1,017)
(47)
(970)
(7)
(19)
(958)
(385)
(573)
3,677
(357)
(45)
(312)
(59)
429
(800)
(244)
(556)
8,882
90
10
-
-
-
-
-
-
-
-
-
(180)
(6)
(174)
(43)
(172)
(45)
(33)
(12)
(5,676)
(181)
(14)
Total
2,996
330
2,666
2,500
2,927
2,239
690
1,549
102,876
3,048
268
2,780
2,465
2,972
2,273
748
1,525
94,896
2,944
399
870
394
528
1,609
1,187
1,268
and lease losses
Noninterest income
Noninterest expense
Income from continuing operations before
income taxes, minority interest and
discontinued operations
Applicable income taxes (b)
Minority interest, net
Discontinued operations, net
Cumulative effect, net
Net income
Average assets
(a) In acquisitions accounted for under the purchase method, management “pools” historical results to improve comparability with the current period. The adjusted results of First National (excluding
736
221
-
44
-
$559
$22,561
1,528
519
-
-
(11)
998
54,685
2,477
825
(20)
44
(11)
1,665
87,481
8
16
(20)
-
-
(28)
6,910
122
41
-
-
-
81
3,218
(68)
(23)
-
-
-
(45)
(879)
151
51
-
-
-
100
986
2,545
2,483
2,551
(167)
(51)
(150)
80
92
164
120
349
347
33
512
394
the divested First National insurance business) and Franklin Financial have been included in the segments and are eliminated in the Acquisitions column.
(b) Includes taxable-equivalent adjustments of $31 million, $36 million and $39 million for the years ended December 31, 2005, 2004 and 2003, respectively.
80
Fifth Third Bancorp
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
10-K Cross Reference Index
PART I
Item 1. Business
ANNUAL REPORT ON FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
Commission file number 0-8076
FIFTH THIRD BANCORP
Incorporated in the State of Ohio
I.R.S. Employer Identification #31-0854434
Address: 38 Fountain Square Plaza
Cincinnati, Ohio 45263
Telephone: (513) 534-5300
Securities registered pursuant to Section 12(g) of the Act:
Common Stock Without Par Value
Indicate by checkmark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. Yes: ⌧ No: (cid:133)
Indicate by checkmark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the Act.
Yes: (cid:133) No: ⌧
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes: ⌧ No: (cid:133)
Indicate by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K(§229.405 of this chapter) is not
contained herein, and will not be contained, to the best of
information
registrant’s knowledge,
statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. (cid:133)
in definitive proxy or
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition
of “accelerated filer and large accelerated filer” in Rule 12b-2 of the
Exchange Act. (Check one):
Large accelerated filer: ⌧
Accelerated filer: (cid:133)
Non-accelerated filer: (cid:133)
Indicate by check mark whether the registrant is a shell company
(as defined in Rule 12b-2 of the Act). Yes: (cid:133) No: ⌧
There were 555,933,944 shares of the Bancorp’s Common Stock,
without par value, outstanding as of January 31, 2006. The
Aggregate Market Value of the Voting Stock held by non-affiliates
of the Bancorp was $19,542,100,581 as of June 30, 2005.
DOCUMENTS INCORPORATED BY REFERENCE
This report incorporates into a single document the requirements
of the Securities and Exchange Commission (“SEC”) with respect
to annual reports on Form 10-K and annual reports to
shareholders. The Bancorp’s Proxy Statement for the 2006 Annual
Meeting of Shareholders is incorporated by reference into Part III
of this report.
Only those sections of this 2005 Annual Report to Shareholders
that are specified in this Cross Reference Index constitute part of
the Registrant’s Form 10-K for the year ended December 31, 2005.
No other information contained in this 2005 Annual Report to
Shareholders shall be deemed to constitute any part of this Form
10-K nor shall any such information be incorporated into the
Form 10-K and shall not be deemed “filed” as part of the
Registrant’s Form 10-K.
Employees
Segment Information
Average Balance Sheets
Analysis of Net Interest Income and Net Interest
Income Changes
Investment Securities Portfolio
Loan and Lease Portfolio
Risk Elements of Loan and Lease Portfolio
Deposits
Return on Equity and Assets
Short-term Borrowings
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2. Properties
Item 3. Legal Proceedings
Item 4.
Submission of Matters to a Vote of Security Holders
Executive Officers of the Bancorp
PART II
Item 5. Market for Registrant’s Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities
Selected Financial Data
Item 6.
Item 7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
PART III
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions
Item 14. Principal Accounting Fees and Services
PART IV
Item 15. Exhibits, Financial Statement Schedules
SIGNATURES
23-24, 82-84
32
33-34, 79-80
29
28-30
37, 59-60
36, 60-61
39-43
38,44
22
38, 65
26-27
none
85
67-68
none
85
85
22
22-46
38-46
50-80
none
47
none
86
86
70-71, 86
86
86
86-87
88
AVAILABILITY OF FINANCIAL INFORMATION
The Bancorp files reports with the SEC. Those reports include the
annual report on Form 10-K, quarterly reports on Form 10-Q,
current event reports on Form 8-K and proxy statements, as well
as any amendments to those reports. The public may read and copy
any materials the Bancorp files with the SEC at the SEC’s Public
Reference Room at 450 Fifth Street, NW, Washington, DC 20549.
The public may obtain information on the operation of the Public
Reference Room by calling the SEC at 1-800-SEC-0330. The SEC
maintains an internet site that contains reports, proxy and
information statements and other information regarding issuers
that file electronically with the SEC at www.sec.gov. The Bancorp’s
annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and amendments to those reports
filed or furnished pursuant to section 13(a) or 15(d) of the
Exchange Act are accessible at no cost on the Bancorp’s web site
at www.53.com on a same day basis after they are electronically
filed with or furnished to the SEC.
Fifth Third Bancorp 81
ANNUAL REPORT ON FORM 10-K
PART I
ITEM 1. BUSINESS
General Information
Fifth Third Bancorp, an Ohio corporation organized in 1975, is a
bank holding company as defined by the Bank Holding Company
Act of 1956, as amended (the “BHCA”), and is registered as such
with the Board of Governors of the Federal Reserve System
(“FRB”). The Bancorp’s principal office is located in Cincinnati,
Ohio.
to
The Bancorp’s subsidiaries provide a wide range of financial
products and services
the retail, commercial, financial,
governmental, educational and medical sectors, including a wide
variety of checking, savings and money market accounts, and credit
products such as credit cards, installment loans, mortgage loans
and leasing. Each of the banking subsidiaries has deposit insurance
provided by the Federal Deposit Insurance Corporation (“FDIC”)
through the Bank Insurance Fund (“BIF”) and/or the Savings
Association Insurance Fund (“SAIF”). Refer to Exhibit 21 filed as
an attachment to this Annual Report on Form 10-K for a list of all
the subsidiaries of the Bancorp.
Additional information regarding the Bancorp’s businesses is
included in Management’s Discussion and Analysis of Financial
Condition and Results of Operations.
Competition
The Bancorp competes for deposits, loans and other banking
services in its principal geographic markets as well as in selected
national markets as opportunities arise. In addition to the challenge
of attracting and retaining customers for traditional banking
services, the Bancorp’s competitors include securities dealers,
brokers, mortgage bankers, investment advisors and insurance
companies. These competitors, with focused products targeted at
highly profitable customer segments, compete across geographic
boundaries and provide customers increasing access to meaningful
alternatives to banking services in nearly all significant products.
The increasingly competitive environment is a result primarily of
changes in regulation, changes in technology, product delivery
systems and the accelerating pace of consolidation among financial
service providers. These competitive trends are likely to continue.
Acquisitions
The Bancorp’s strategy for growth includes strengthening its
presence in core markets, expanding into contiguous markets and
broadening its product offerings while taking into account the
integration and other risks of growth. The Bancorp evaluates
strategic acquisition opportunities and conducts due diligence
activities in connection with possible transactions. As a result,
discussions, and in some cases, negotiations may take place and
future acquisitions involving cash, debt or equity securities may
occur. These typically involve the payment of a premium over
book value and current market price, and therefore, some dilution
of book value and net income per share may occur with any future
transactions.
Additional information regarding acquisitions is included in
the Regulation and Supervision section in addition to Note 26 of
the Notes to Consolidated Financial Statements.
the Bancorp and
Regulation and Supervision
In addition to the generally applicable state and federal laws
governing businesses and employers,
its
subsidiary banks are subject to extensive regulation by federal and
state laws and regulations applicable to financial institutions and
their parent companies. Virtually all aspects of the business of the
Bancorp and
to specific
requirements or restrictions and general regulatory oversight. The
principal objectives of state and federal banking laws are the
maintenance of the safety and soundness of financial institutions
and the federal deposit insurance system and the protection of
consumers or classes of consumers, rather than the specific
its subsidiary banks are subject
82
Fifth Third Bancorp
protection of shareholders of a bank or the parent company of a
bank, such as the Bancorp. In addition, the supervision, regulation
and examination of the Bancorp and its subsidiaries by the bank
regulatory agencies is not intended for the protection of the
Bancorp’s security holders. To the extent the following material
describes statutory or regulatory provisions, it is qualified in its
entirety by reference to the particular statute or regulation.
The Bancorp is subject to regulation and supervision by the
FRB and the Ohio Division of Financial Institutions (the
“Division”). The Bancorp is required to file various reports with,
and is subject to examination by, the FRB and the Division. The
FRB has the authority to issue orders to bank holding companies
to cease and desist from unsound banking practices and violations
of conditions imposed by, or violations of agreements with, the
FRB. The FRB is also empowered to assess civil money penalties
against companies or individuals who violate the BHCA or orders
or regulations thereunder, to order termination of non-banking
activities of non-banking subsidiaries of bank holding companies,
and to order termination of ownership and control of a non-
banking subsidiary by a bank holding company.
The BHCA requires the prior approval of the FRB, for a bank
holding company to acquire substantially all the assets of a bank or
acquiring direct or indirect ownership or control of more than 5%
of any class of the voting shares of any bank, bank holding
company or savings association, or increasing any such non-
majority ownership or control of any bank, bank holding company
or savings association, or merging or consolidating with any bank
holding company.
The Riegle-Neal Interstate Banking and Branching Efficiency
Act of 1994 generally authorizes bank holding companies to
acquire banks located in any state, subject to certain state-imposed
age and deposit concentration limits, and also generally authorizes
interstate bank holding company and bank mergers and to a lesser
extent, interstate branching.
the FRB,
The Gramm-Leach-Bliley Act of 1999 (“GLBA”) permits a
qualifying bank holding company to become a financial holding
company (“FHC”) and thereby to engage directly or indirectly in a
broader range of activities than had previously been permitted for a
bank holding company under the BHCA. Permitted activities
include securities underwriting and dealing, insurance underwriting
and brokerage, merchant banking and other activities that are
the Treasury
declared by
Department, to be “financial in nature or incidental thereto” or are
declared by the FRB unilaterally to be “complementary” to
financial activities. In addition, a FHC is allowed to conduct
permissible new financial activities or acquire permissible non-bank
financial companies with after-the-fact notice to the FRB. A bank
holding company may elect to become a FHC if each of its
subsidiary banks is “well capitalized,” is “well managed” and has at
least a “Satisfactory” rating under the Federal Community
Reinvestment Act (“CRA”). In 2000, the Bancorp elected and
qualified for FHC status under the GLBA.
in cooperation with
Unless a bank holding company becomes a FHC under
GLBA, the BHCA also prohibits a bank holding company from
acquiring a direct or indirect interest in or control of more than 5%
of any class of the voting shares of a company that is not a bank or
a bank holding company and from engaging directly or indirectly in
activities other than those of banking, managing or controlling
banks or furnishing services to its subsidiary banks, except that it
may engage in and may own shares of companies engaged in
certain activities the FRB has determined to be so closely related to
banking or managing or controlling banks as to be proper incident
thereto.
The FRB has authority to prohibit bank holding companies
from paying dividends if such payment is deemed to be an unsafe
or unsound practice. The FRB has indicated generally that it may
be an unsafe or unsound practice for bank holding companies to
ANNUAL REPORT ON FORM 10-K
pay dividends unless a bank holding company’s net income is
sufficient to fund the dividends and the expected rate of earnings
retention is consistent with the organization’s capital needs, asset
quality and overall financial condition. The Bancorp depends in
part upon dividends received from its subsidiary banks to fund its
activities, including the payment of dividends. Each of the
subsidiary banks is subject to regulatory limitations on the amount
of dividends it may declare and pay.
Under FRB policy, a bank holding company is expected to act
as a source of financial and managerial strength to each of its
subsidiary banks and to commit resources to their support. This
support may be required at times when the bank holding company
may not have the resources to provide it. Similarly, under the
cross-guarantee provisions of the Federal Deposit Insurance Act
(“FDIA”), the FDIC can hold any FDIC-insured depository
institution liable for any loss suffered or anticipated by the FDIC in
connection with (1) the “default” of a commonly controlled FDIC-
insured depository institution; or (2) any assistance provided by the
FDIC to a commonly controlled FDIC-insured depository
institution “in danger of default.”
The Bancorp owns two state banks, Fifth Third Bank and
Fifth Third Bank (Michigan), chartered under the laws of Ohio and
Michigan, respectively. These banks are subject to extensive state
regulation and examination by the appropriate state banking agency
in the particular state or states where each state bank is chartered,
by the FRB, and by the FDIC, which insures the deposits of each
of the state banks to the maximum extent permitted by law. The
federal and state laws and regulations that are applicable to banks
regulate, among other matters, the scope of their business, their
investments, their reserves against deposits, the timing of the
availability of deposited funds, the amount of loans to individual
and related borrowers and the nature, amount of and collateral for
certain loans, and the amount of interest that may be charged on
loans. Various state consumer laws and regulations also affect the
operations of the state banks.
The Bancorp’s national subsidiary bank, Fifth Third Bank,
N.A. is subject to regulation and examination primarily by the
OCC and secondarily by the FRB and the FDIC, which insures the
deposits to the maximum extent permitted by law. The federal laws
and regulations that are applicable to national banks regulate,
among other matters,
their
the scope of
investments, their reserves against deposits, the timing of the
availability of deposited funds, the amount of loans to individual
and related borrowers and the nature, amount of and collateral for
certain loans, and the amount of interest that may be charged on
loans.
their business,
The Bancorp’s subsidiary banks pay deposit
insurance
premiums to the FDIC generally based on an assessment rate
established by the FDIC for Bank Insurance Fund-member
institutions. The FDIC has established a risk-based assessment
system under which institutions are classified, and generally pay
premiums according to their perceived risk to the federal deposit
insurance funds. FDIA does not require the FDIC to charge all
banks deposit insurance premiums when the ratio of deposit
insurance reserves to
is maintained above
insured deposits
specified levels and, at the present time, the ratio is above the
minimum level and, accordingly all banks are not required to pay
premiums. However, as a result of general economic conditions
and recent bank failures, it is possible that the ratio of deposit
insurance reserves to insured deposits could fall below the
minimum ratio that FDIA requires, which would result in the
FDIC setting deposit insurance assessment rates sufficient to
increase deposit insurance reserves to the required ratio. A
resumption of assessments of deposit insurance premiums charged
to all institutions would have an adverse effect on net earnings.
Federal law, Sections 23A and 23B of the Federal Reserve Act,
restricts transactions between a bank and an affiliated company,
including a parent bank holding company. The subsidiary banks are
subject to certain restrictions on loans to affiliated companies, on
investments in the stock or securities thereof, on the taking of such
stock or securities as collateral for loans to any borrower, and on
the issuance of a guarantee or letter of credit on their behalf.
Among other things, these restrictions limit the amount of such
transactions, require collateral in prescribed amounts for extensions
of credit, prohibit the purchase of low quality assets and require
that the terms of such transactions be substantially equivalent to
terms of similar transactions with non-affiliates. One result of these
restrictions is a limitation on the subsidiary banks to fund the
Bancorp. Generally, each subsidiary bank is limited in its
extensions of credit to any affiliate to 10% of the subsidiary bank’s
capital and its extension of credit to all affiliates to 20% of the
subsidiary bank’s capital.
The CRA generally requires insured depository institutions to
identify the communities they serve and to make loans and
investments and provide services that meet the credit needs of
these communities. Furthermore, the CRA requires the FRB to
evaluate the performance of each of the subsidiary banks in helping
to meet the credit needs of their communities. As a part of the
CRA program, the Subsidiary Banks are subject to periodic
examinations by the FRB, and must maintain comprehensive
records of their CRA activities for this purpose. During these
examinations, the FRB rates such institutions’ compliance with
CRA as “Outstanding,” “Satisfactory,” “Needs to Improve" or
"Substantial Noncompliance.” Failure of an institution to receive
at least a “Satisfactory” rating could inhibit such institution or its
holding company from undertaking certain activities, including
engaging in activities newly permitted as a financial holding
company under the GLBA and acquisitions of other financial
institutions, or, as discussed above, require divestitures. The FRB
must take into account the record of performance of banks in
meeting the credit needs of the entire community served, including
low-and moderate-income neighborhoods. Each of the subsidiary
banks has a CRA rating of “Satisfactory.” Because the Bancorp is
an FHC, with limited exceptions, the Bancorp may not commence
any new financial activities or acquire control of any companies
engaged in financial activities in reliance on the GLBA if any of the
subsidiary banks receives a CRA rating of less than “Satisfactory.”
The FRB has established capital guidelines for financial
holding companies. The FRB and the OCC have also issued
regulations establishing capital requirements for banks. Failure to
meet capital requirements could subject the Bancorp and its
subsidiary banks to a variety of restrictions and enforcement
actions. In addition, as discussed above, each of the Bancorp’s
subsidiary banks must remain well capitalized for the Bancorp to
retain its status as a financial holding company.
thereof,
to create,
The FRB, the FDIC and other bank regulatory agencies have
adopted final guidelines (the “Guidelines”) for safeguarding
confidential, personal customer
information. The Guidelines
require each financial institution, under the supervision and
ongoing oversight of its Board of Directors or an appropriate
committee
implement and maintain a
comprehensive written information security program designed to
ensure the security and confidentiality of customer information,
protect against any anticipated threats or hazards to the security or
integrity of such information and protect against unauthorized
access to or use of such information that could result in substantial
harm or inconvenience to any customer. The Bancorp has adopted
a customer information security program that has been approved
by the Bancorp’s Board of Directors (the “Board”).
The GLBA requires financial institutions to implement
policies and procedures regarding the disclosure of nonpublic
personal information about consumers to non-affiliated third
parties. In general, the statute requires explanations to consumers
on policies and procedures regarding the disclosure of such
Fifth Third Bancorp 83
ANNUAL REPORT ON FORM 10-K
nonpublic personal information, and, except as otherwise required
by law, prohibits disclosing such information except as provided in
the subsidiary banks policies and procedures. The subsidiary banks
have implemented a privacy policy effective since the GLBA
became law, pursuant to which all of its existing and new
customers are notified of the privacy policies.
The Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism
Act of 2001 (the “Patriot Act”), designed to deny terrorists and
others the ability to obtain access to the United States financial
system, has significant implications for depository institutions,
brokers, dealers and other businesses involved in the transfer of
money. The Patriot Act, as implemented by various federal
regulatory agencies, requires financial institutions, including the
Bancorp and its subsidiaries, to implement new policies and
procedures or amend existing policies and procedures with respect
to, among other matters, anti-money laundering, compliance,
suspicious activity and currency transaction reporting and due
diligence on customers. The Patriot Act and its underlying
regulations also permit information sharing for counter-terrorist
purposes between federal law enforcement agencies and financial
institutions, as well as among financial institutions, subject to
certain conditions, and require the FRB (and other federal banking
agencies) to evaluate the effectiveness of an applicant in combating
money laundering activities when considering applications filed
under Section 3 of the BHCA or the Bank Merger Act. The
Bancorp’s Board has approved policies and procedures that are
believed to be compliant with the USA Patriot Act.
the
thereunder prescribe
Certain mutual fund and unit investment trust custody and
administrative clients are regulated as “investment companies” as
that term is defined under the Investment Company Act of 1940,
as amended (the “ICA”), and are subject to various examination
and reporting requirements. The provisions of the ICA and the
regulations promulgated
type of
institution that may act as a custodian of investment company
assets, as well as the manner in which a custodian administers the
assets in its custody. As a custodian for a number of investment
company clients, these regulations require, among other things,
that certain minimum aggregate capital, surplus and undivided
profit levels are maintained by the subsidiary banks. Additionally,
arrangements with clearing agencies or other securities depositories
for segregation of assets,
must meet
identification of assets and client approval. Future legislative and
regulatory changes in the existing laws and regulations governing
custody of investment company assets, particularly with respect to
custodian qualifications, may have a material and adverse impact
on the Bancorp. Currently, management believes the Bancorp is in
compliance with all minimum capital and securities depository
requirements. Further, the Bancorp is not aware of any proposed
or pending regulatory developments, which, if approved, would
adversely affect its ability to act as custodian to an investment
company.
requirements
ICA
Investment companies are also subject to extensive record
keeping and reporting requirements. These requirements dictate
the type, volume and duration of the record keeping the Bancorp
undertakes, either in the role as custodian for an investment
company or as a provider of administrative services to an
investment company. Further, specific ICA guidelines must be
followed when calculating the net asset value of a client mutual
fund. Consequently, changes
in the statutes or regulations
governing record keeping and reporting or valuation calculations
will affect the manner in which operations are conducted.
New legislation or regulatory requirements could have a
significant impact on the information reporting requirements
applicable to the Bancorp and may in the short term adversely
affect the Bancorp’s ability to service clients at a reasonable cost.
Any failure to provide such support could cause the loss of
84
Fifth Third Bancorp
customers and have a material adverse effect on financial results.
Additionally, legislation or regulations may be proposed or enacted
to regulate the Bancorp in a manner that may adversely affect
financial results. Furthermore, the mutual fund industry may be
significantly affected by new laws and regulations following
revelations about timing trading and late trading.
The GLBA amended the federal securities laws to eliminate
the blanket exceptions that banks traditionally have had from the
definition of “broker” and “dealer.” The GLBA also required that
there be certain transactional activities that would not be
“brokerage” activities, which banks could effect without having to
register as a broker. In a series of orders, the SEC delayed the
effective date of the repeal of the “broker” exemption for banks
until, most recently, September 30, 2006. As currently proposed,
banks will have one year to comply by either registering as a
broker-dealer or “pushing out” brokerage activities to affiliated
broker-dealers. The transactional exemptions will permit, without
broker-dealer registration, banks to enter into a de minimis number
of riskless principal transactions, certain asset-backed transactions
and certain securities lending transactions. The Bancorp is currently
evaluating alternatives to ensure that its subsidiary banks will not
be required to register as a broker upon the effective date.
The Sarbanes-Oxley Act of 2002,
(“Sarbanes-Oxley”)
implements a broad range of corporate governance and accounting
measures for public companies (including publicly-held bank
holding companies such as the Bancorp) designed to promote
honesty and transparency in corporate America. Sarbanes-Oxley’s
principal provisions, many of which have been interpreted through
regulations, provide for and include, among other things: (i) the
creation of an independent accounting oversight board; (ii) auditor
independence provisions that restrict non-audit services that
accountants may provide to their audit clients; (iii) additional
corporate governance and responsibility measures, including the
requirement that the chief executive officer and chief financial
officer of a public company certify financial statements; (iv) the
forfeiture of bonuses or other incentive-based compensation and
profits from the sale of an issuer’s securities by directors and senior
officers in the twelve month period following initial publication of
any financial statements that later require restatement; (v) an
increase
in the oversight of, and enhancement of certain
requirements relating to, audit committees of public companies and
how they interact with the Bancorp’s independent auditors; (vi)
requirements that audit committee members must be independent
and are barred from accepting consulting, advisory or other
compensatory fees from the
issuer; (vii) requirements that
companies disclose whether at least one member of the audit
committee is a ‘financial expert’ (as such term is defined by the
SEC) and if not discussed, why the audit committee does not have
a financial expert; (viii) expanded disclosure requirements for
corporate
including accelerated reporting of stock
transactions by insiders and a prohibition on insider trading during
pension blackout periods; (ix) a prohibition on personal loans to
directors and officers, except certain loans made by insured
financial institutions on nonpreferential terms and in compliance
with other bank regulatory requirements; (x) disclosure of a code of
ethics and filing a Form 8-K for a change or waiver of such code;
(xi) requirements that management assess the effectiveness of
internal control over financial reporting and the Bancorp’s
Independent Registered Public Accounting Firm attest to the
assessment; and (xii) a range of enhanced penalties for fraud and
other violations.
insiders,
Additional
is
included in Note 27 of the Notes to Consolidated Financial
Statements.
regulatory matters
information
regarding
ANNUAL REPORT ON FORM 10-K
located on Fountain Square Plaza
ITEM 2. PROPERTIES
The Bancorp’s executive offices and the main office of Fifth Third
Bank are
in downtown
Cincinnati, Ohio in a 32-story office tower, a five-story office
building with an attached parking garage and a separate ten-story
office building known as the Fifth Third Center, the William S.
Rowe Building and the 530 Building, respectively. The Bancorp’s
main operations center is located in Cincinnati, Ohio, in a three-
story building with an attached parking garage known as the
Madisonville Operations Center. A subsidiary of the Bancorp owns
100 percent of these buildings.
At December 31, 2005, the Bancorp, through its banking and
non-banking subsidiaries, operated 1,119 banking centers, of which
739 were owned, 302 were leased and 78 for which the buildings
are owned but the land is leased. The banking centers are located
in the states of Ohio, Kentucky, Indiana, Michigan, Illinois,
Florida, Tennessee, West Virginia, Pennsylvania and Missouri. The
Bancorp’s significant owned properties are owned free from
mortgages and major encumbrances.
EXECUTIVE OFFICERS OF THE BANCORP
Officers are appointed annually by the Board of Directors at the
meeting of Directors immediately following the Annual Meeting of
Shareholders. The names, ages and positions of the Executive
Officers of the Bancorp as of February 16, 2006 are listed below
along with their business experience during the past 5 years:
George A. Schaefer, Jr., 60. President and Chief Executive
Officer of the Bancorp and Fifth Third Bank since 1990.
Greg D. Carmichael, 44. Executive Vice President and Chief
Information Officer of the Bancorp since June 2003. Previously,
Mr. Carmichael was the Chief Information Officer of Emerson
Electric Company.
David J. DeBrunner, 39. Senior Vice President and Controller of
the Bancorp since September 2004 and January 2002, respectively.
Previously, Mr. DeBrunner was Vice President of the Bancorp and
Fifth Third Bank since January 2002 and 1997, respectively.
Charles D. Drucker, 42. Executive Vice President of the Bancorp
since June 2005 and President of Fifth Third Processing Solutions
since July 2004. Previously, Mr. Drucker was Executive Vice
President and Chief Operating Officer of STAR ® Debit Services,
a division of First Data Corporation.
R. Mark Graf, 41. Senior Vice President of the Bancorp since
January 2003 and Chief Financial Officer since April 2004.
Previously, Mr. Graf was Treasurer of the Registrant since January
2002 and of Fifth Third Bank since July 2001. Mr. Graf joined the
Registrant in July 2001 after serving in various management
capacities at AmSouth Bancorporation since 1998.
Malcolm D. Griggs, 45. Executive Vice President and Chief Risk
Officer of the Bancorp since June 2003. Previously, Mr. Griggs
was the Director of Risk Policy for Wachovia Corporation.
Kevin T. Kabat, 49. Executive Vice President of the Bancorp
since December 2003. Previously, Mr. Kabat was President and
CEO of Fifth Third Bank (Michigan) since April 2001 as well as
Vice Chairman of Old Kent Financial Corporation and President
and CEO of Old Kent Bank prior to its acquisition by Fifth Third
Bancorp in 2001.
Bruce K. Lee, 45. Executive Vice President of the Bancorp since
June 2005. Previously, Mr. Lee was President and CEO of Fifth
Third Bank (Northwestern Ohio) since July 2002 and Executive
Vice President, Commercial Banking Division, Fifth Third Bank
(Northwestern Ohio) since March 2001 as well as Executive Vice
President and Chief Credit Officer of Capital Holding, Inc. prior to
its acquisition by Fifth Third Bancorp in 2001.
Ronald D. Marks, 51. Senior Vice President and Treasurer of the
Bancorp since September 2004 and April 2004, respectively. Mr.
Marks joined the Bancorp in September 2003. Previously, Mr.
Marks was Senior Vice President and Treasurer of Comerica
Incorporated since 1997.
Peter Pesce, 57. Executive Vice President of the Bancorp since
June 2005. Mr. Pesce joined the Registrant in December 2004.
Previously, Mr. Pesce was Chief People Officer for Diamond
Cluster International and prior to that he was Managing Partner of
Human Resources & Partner Matters with Arthur Andersen.
Daniel T. Poston, 47. Executive Vice President of the Bancorp
since June 2003 and Auditor of the Bancorp and Fifth Third Bank
since October 2001. Senior Vice President of the Bancorp and
Fifth Third Bank since January 2002. Previously, Mr. Poston was a
partner at Arthur Andersen since 1994.
Paul L. Reynolds, 44. Executive Vice President, Secretary and
General Counsel of the Bancorp since September 1999, January
2002 and January 2002, respectively. Previously, Mr. Reynolds was
Senior Vice President of the Bancorp and Fifth Third Bank since
March 1997. Assistant Secretary of the Bancorp since March 1995,
General Counsel and Assistant Secretary of Fifth Third Bank since
January 1995.
Robert A. Sullivan, 51. Executive Vice President of the Bancorp
since December 2002. Previously, Mr. Sullivan was President and
CEO of Fifth Third Bank (Northwestern Ohio) since March 9,
2001 and President and Chief Operating Officer of Capital
Holding, Inc. prior to its acquisition by Fifth Third Bancorp
effective March 9, 2001. Mr. Sullivan was Co-Founder, President
and Chief Operating Officer of Capital Holding, Inc. since 1989.
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON
EQUITY AND RELATED STOCKHOLDER MATTERS
The information required by this item is included in the Corporate
Information found on the inside of the back cover and in the
discussion of dividend limitations that the subsidiaries can pay to
the Bancorp discussed in Note 27 of the Notes to the Consolidated
Financial Statements. Additionally, as of December 31, 2005, the
Bancorp had approximately 60,043 shareholders of record.
Issuer Purchases of Equity Securities
Shares
Purchased
as Part of
Publicly
Announced
Plans or
Programs
-
-
-
-
Shares
Purchased
(a)
24,561
11,147
646
36,354
Period
October 2005
November 2005
December 2005
Total
Maximum
Shares that May
Be Purchased
Under the Plans
or Programs (b)
17,846,953
17,846,953
17,846,953
17,846,953
Average
Price
Paid
Per
Share
$38.80
38.98
46.37
$38.99
(a) All of the common shares purchased by the Bancorp during the fourth
quarter of 2005 were in connection with various employee compensation and
incentive plans of the Bancorp. These purchases are not included against the
maximum number of shares that may yet be purchased under the Board of
Directors authorization.
(b) On January 18, 2005, the Bancorp announced that its Board of Directors
had authorized management to purchase up to 20 million shares of the
Bancorp’s common stock through the open market or any private transaction.
The timing of the purchases and the exact number of shares to be purchased
depends upon market conditions. The authorization does not include specific
price targets or an expiration date.
Fifth Third Bancorp 85
ANNUAL REPORT ON FORM 10-K
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF
THE REGISTRANT
The information required by this item relating to the Executive
in PART I under
is
Officers of the Registrant
“EXECUTIVE OFFICERS OF THE BANCORP.”
included
The information required by this item concerning Directors is
incorporated herein by reference under the caption “ELECTION
OF DIRECTORS” of the Bancorp’s Proxy Statement for the 2006
Annual Meeting of Shareholders.
The information required by this item concerning Audit
Committee financial expert and Code of Business Conduct and
Ethics is incorporated herein by reference under the caption
“BOARD OF DIRECTORS, ITS COMMITTEES, MEETINGS
AND FUNCTIONS” of the Bancorp’s Proxy Statement for the
2006 Annual Meeting of Shareholders.
The information required by this item concerning Section 16
(a) Beneficial Ownership Reporting Compliance is incorporated
herein by reference under the caption “SECTION 16 (a)
BENEFICIAL OWNERSHIP REPORTING COMPLIANCE”
of the Bancorp’s Proxy Statement for the 2006 Annual Meeting of
Shareholders.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by
reference under the caption “EXECUTIVE COMPENSATION”
and “FINANCIAL PERFORMANCE” of the Bancorp’s Proxy
Statement for the 2006 Annual Meeting of Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Security ownership information of certain beneficial owners and
management is incorporated herein by reference under the captions
“CERTAIN BENEFICIAL OWNERS, ELECTION OF
DIRECTORS AND EXECUTIVE COMPENSATION” of the
Bancorp’s Proxy Statement for the 2006 Annual Meeting of
Shareholders.
The information required by this item concerning Equity
Compensation Plan information is included in Note 18 of the
Notes to the Consolidated Financial Statements.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS
The information required by this item is incorporated herein by
reference under the caption “CERTAIN TRANSACTIONS” of
the Bancorp’s Proxy Statement for the 2006 Annual Meeting of
Shareholders.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND
SERVICES
The information required by this item is incorporated herein by
reference under the caption “PRINCIPAL INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM FEES” of the
Bancorp’s Proxy Statement for the 2006 Annual Meeting of
Shareholders.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT
SCHEDULES
Financial Statements Filed
Report of Independent Registered Public Accounting Firm
Fifth Third Bancorp and Subsidiaries Consolidated Financial
Statements
Notes to Consolidated Financial Statements
Pages
49
50-53
54-80
The schedules for the Bancorp and its subsidiaries are omitted
because of the absence of conditions under which they are
required, or because the information is set forth in the consolidated
financial statements or the notes thereto.
86
Fifth Third Bancorp
4.2
4.1
4.4
4.3
3(ii)
The following lists the Exhibits to the Annual Report on Form 10-K.
Second Amended Articles of Incorporation of Fifth Third Bancorp, as
3(i)
amended. Incorporated by reference to Registrant’s Quarterly Report
on Form 10-Q for the quarter ended March 31, 2001.
Code of Regulations of Fifth Third Bancorp, as amended.
Incorporated by reference to Registrant’s Quarterly Report on Form
10-Q for the quarter ended March 31, 2005.
Junior Subordinated Indenture, dated as of March 20, 1997 between
Fifth Third Bancorp and Wilmington Trust Company, as Debenture
Trustee. Incorporated by reference to Registrant’s Current Report on
Form 8-K filed with the Securities and Exchange Commission on
March 26, 1997.
Certificate Representing the 8.136% Junior Subordinated Deferrable
Interest Debentures, Series A, of Fifth Third Bancorp. Incorporated
by reference to Registrant’s Current Report on Form 8-K filed with the
Securities and Exchange Commission on March 26, 1997.
Amended and Restated Trust Agreement, dated as of March 20, 1997
of Fifth Third Capital Trust II, among Fifth Third Bancorp, as
Depositor, Wilmington Trust Company, as Property Trustee, and the
Administrative Trustees named therein. Incorporated by reference to
Registrant’s Current Report on Form 8-K filed with the Securities and
Exchange Commission on March 26, 1997.
Certificate Representing the 8.136% Capital Securities, Series A, of
Fifth Third Capital Trust I. Incorporated by reference to Registrant’s
Current Report on Form 8-K filed with the Securities and Exchange
Commission on March 26, 1997.
Guarantee Agreement, dated as of March 20, 1997 between Fifth Third
Bancorp, as Guarantor, and Wilmington Trust Company, as Guarantee
Trustee. Incorporated by reference to Registrant’s Current Report on
Form 8-K filed with the Securities and Exchange Commission on
March 26, 1997.
Agreement as to Expense and Liabilities, dated as of March 20, 1997
between Fifth Third Bancorp, as the holder of the Common Securities
of Fifth Third Capital Trust I and Fifth Third Capital Trust II.
Incorporated by reference to Registrant’s Current Report on Form 8-K
filed with the Securities and Exchange Commission on March 26, 1997.
Old Kent Capital Trust I Floating Rate Subordinated Capital Income
Securities. Incorporated by reference to the Exhibits to Old Kent
Financial Corporation’s Form S-4 Registration Statement filed July 19,
1997.
Form of Fifth Third Bancorp, as successor to Old Kent Financial
Corporation, Floating Rate Junior Subordinated Debentures Due 2027.
Incorporated by reference to the Exhibits to Old Kent Financial
Corporation’s Form S-4 Registration Statement filed July 19, 1997.
Indenture, dated as of January 31, 1997 between Fifth Third Bancorp,
as successor to Old Kent Financial Corporation, and Bankers Trust
Company. Incorporated by reference to the Exhibits to Old Kent
Financial Corporation’s Current Report on Form 8-K filed with the
Securities and Exchange Commission on March 5, 1997.
4.10 Guarantee Agreement, dated as of January 31, 1997, between Fifth
4.6
4.9
4.5
4.8
4.7
Third Bancorp, as successor to Old Kent Financial Corporation.
Incorporated by reference to the Exhibits to Old Kent Financial
Corporation’s Current Report on Form 8-K filed with the Securities
and Exchange Commission on March 4, 1998.
4.11 Amended and Restated Declaration of Trust dated as of January 31,
1997, between Fifth Third Bancorp, as successor to Old Kent Financial
Corporation, and Bankers Trust Company. Incorporated by reference
to the Exhibits to Old Kent Financial Corporation’s Current Report on
Form 8-K filed with the Securities and Exchange Commission on
March 5, 1997.
Indenture, dated as of May 23, 2003, between Fifth Third Bancorp and
Wilmington Trust Company, as Trustee, defining the rights of the
4.50% Subordinated Notes due 2018. Incorporated by reference to
Registrant’s Current Report on Form 8-K filed with the Securities and
Exchange Commission on May 22, 2003.
4.12
4.13 Global security representing Fifth Third Bancorp’s $500,000,000 4.50%
Subordinated Notes due 2018. Incorporated by reference to
Registrant’s Current Report on Form 8-K filed with the Securities and
Exchange Commission on May 22, 2003.
10.1 Fifth Third Bancorp Unfunded Deferred Compensation Plan for Non-
Employee Directors. Incorporated by reference to Registrant’s Annual
Report on Form 10-K filed for fiscal year ended December 31, 1985. *
10.2 Fifth Third Bancorp 1990 Stock Option Plan. Incorporated by
reference to Registrant’s filing with the Securities and Exchange
Commission as an exhibit to the Registrant’s Registration Statement on
Form S-8, Registration No. 33-34075. *
ANNUAL REPORT ON FORM 10-K
10.3 Fifth Third Bancorp 1987 Stock Option Plan. Incorporated by
reference to Registrant’s filing with the Securities and Exchange
Commission as an exhibit to the Registrant’s Registration Statement on
Form S-8, Registration No. 33-13252. *
10.4 Indenture effective November 19, 1992 between Fifth Third Bancorp,
Issuer and NBD Bank, N.A., Trustee. Incorporated by reference to
Registrant’s Current Report on Form 8-K filed with the Securities and
Exchange Commission on November 18, 1992 and as Exhibit 4.1 to
the Registrant’s Registration Statement on Form S-3, Registration No.
33-54134.
10.5 Fifth Third Bancorp Master Profit Sharing Plan, as Amended.
Incorporated by reference to Registrant’s Annual Report on Form 10-
K filed for the fiscal year ended December 31, 2004. *
10.6 Fifth Third Bancorp Incentive Compensation Plan. Incorporated by
reference to Registrant’s Proxy Statement dated February 19, 2004. *
10.7 Amended and Restated Fifth Third Bancorp 1993 Stock Purchase Plan.
Incorporated by reference to Registrant’s Annual Report on Form 10-
K filed for the fiscal year ended December 31, 2003. *
10.8 Fifth Third Bancorp 1998 Long-Term Incentive Stock Plan, as
Amended. Incorporated by reference to the Exhibits to Registrant’s
Quarterly Report on Form 10-Q for the quarter ended June 30, 2003. *
10.9 Fifth Third Bancorp Non-qualified Deferred Compensation Plan, as
Amended and Restated. Incorporated by reference to Registrant’s
Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 4, 2006. *
10.10 CNB Bancshares, Inc. 1999 Stock Incentive Plan, 1995 Stock Incentive
Plan, 1992 Stock Incentive Plan and Associate Stock Option Plan; and
Indiana Federal Corporation 1986 Stock Option and Incentive Plan.
Incorporated by reference to Registrant’s filing with the Securities and
Exchange Commission as an exhibit to a Registration Statement on
Form S-4, Registration No. 333-84955 and by reference to CNB
Bancshares Annual Report on Form 10-K, as amended, for the fiscal
year ended December 31, 1998. *
10.11 Fifth Third Bancorp Stock Option Gain Deferral Plan. Incorporated
by reference to Registrant’s Proxy Statement dated February 9, 2001. *
10.12 Amendment No. 1 to Fifth Third Bancorp Stock Option Gain Deferral
Plan. Incorporated by reference to Registrant’s Current Report on
Form 8-K filed with the Securities and Exchange Commission on May
26, 2005. *
10.13 Old Kent Executive Stock Option Plan of 1986, as Amended.
Incorporated by reference to the following filings by Old Kent
Financial Corporation with the Securities and Exchange Commission:
Exhibit 10 to Form 10-Q for the quarter ended September 30, 1995;
Exhibit 10.19 to Form 8-K filed on March 5, 1997; Exhibit 10.3 to
Form 8-K filed on March 2, 2000. *
10.14 Old Kent Stock Option Incentive Plan of 1992, as Amended.
Incorporated by reference to the following filings by Old Kent
Financial Corporation with the Securities and Exchange Commission:
Exhibit 10(b) to Form 10-Q for the quarter ended June 30, 1995;
Exhibit 10.20 to Form 8-K filed on March 5, 1997; Exhibit 10(d) to
Form 10-Q for the quarter ended June 30, 1997; Exhibit 10.3 to Form
8-K filed on March 2, 2000. *
10.15 Old Kent Executive Stock Incentive Plan of 1997, as Amended.
Incorporated by reference to Old Kent Financial Corporation’s Annual
Meeting Proxy Statement dated March 1, 1997. *
10.16 Old Kent Stock Incentive Plan of 1999. Incorporated by reference to
Old Kent Financial Corporation’s Annual Meeting Proxy Statement
dated March 1, 1999. *
10.17 Schedule of Director Compensation Arrangements. *
10.18 Schedule of Executive Officer Compensation Arrangements. *
10.19 Notice of Grant of Performance Units and Award Agreement.
Incorporated by reference to Registrant’s Annual Report on Form 10-
K filed for the fiscal year ended December 31, 2004. *
10.20 Notice of Grant of Restricted Stock and Award Agreement (for
Executive Officers). Incorporated by reference to Registrant’s Annual
Report on Form 10-K filed for the fiscal year ended December 31,
2004. *
10.21 Notice of Grant of Stock Appreciation Rights and Award Agreement.
Incorporated by reference to Registrant’s Annual Report on Form 10-
K filed for the fiscal year ended December 31, 2004. *
10.22 Notice of Grant of Restricted Stock and Award Agreement (for
Directors). Incorporated by reference to Registrant’s Annual Report
on Form 10-K filed for the fiscal year ended December 31, 2004. *
10.23 Franklin Financial Corporation 1990 Incentive Stock Option Plan.
Incorporated by reference to Franklin Financial Corporation’s Annual
Report on Form 10-K for the year ended December 31, 1989. *
10.24 Franklin Financial Corporation 2000 Incentive Stock Option Plan.
Incorporated by reference to Franklin Financial Corporation’s
Registration Statement on Form S-8, Registration No. 333-52928. *
10.26
10.25 Amended and Restated First National Bankshares of Florida, Inc. 2003
Incentive Plan. Incorporated by reference to First National Bankshares
of Florida, Inc.’s Annual Report on Form 10-K for the year ended
December 31, 2003. *
Southern Community Bancorp Equity Incentive Plan. Incorporated by
reference to Southern Community Bancorp’s Registration Statement on
Form SB-2, Registration No. 333-35548. *
Southern Community Bancorp Director Statutory Stock Option Plan. .
Incorporated by reference to Southern Community Bancorp’s
Registration Statement on Form SB-2, Registration No. 333-35548. *
10.28 Peninsula Bank of Central Florida Key Employee Stock Option Plan.
Incorporated by reference to Southern Community Bancorp’s Annual
Report on Form 10-K for the year ended December 31, 2003. *
10.29 Peninsula Bank of Central Florida Director Stock Option Plan.
10.27
Incorporated by reference to Southern Community Bancorp’s Annual
Report on Form 10-K for the year ended December 31, 2003. *
10.30 First Bradenton Bank Amended and Restated Stock Option Plan.
Incorporated by reference to Registrant’s Annual Report on Form 10-
K for the fiscal year ended December 31, 2004. *
10.31 Letter Agreement with R. Mark Graf. Incorporated by reference to the
Exhibits to Registrant’s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2005. *
10.33
10.32 Amendment Dated January 16, 2006 to the Letter Agreement with R.
Mark Graf. Incorporated by reference to Registrant’s Current Report
on Form 8-K filed with the Securities and Exchange Commission on
January 17, 2006.
Separation Agreement between Fifth Third Bancorp and Neal E.
Arnold dated as of December 14, 2005. Incorporated by reference to
Registrant’s Current Report on Form 8-K filed with the Securities and
Exchange Commission on December 22, 2005. *
Stipulation and Agreement of Settlement dated March 29, 2005, as
Amended. Incorporated by reference to Registrant’s Current Report
on Form 8-K filed with the Securities and Exchange Commission on
November 18, 2005.
10.34
10.35 Amendment to Stipulation dated May 10, 2005. Incorporated by
10.36
reference to Registrant’s Current Report on Form 8-K filed with the
Securities and Exchange Commission on November 18, 2005.
Second Amendment to Stipulation dated August 12, 2005.
Incorporated by reference to Registrant’s Current Report on Form 8-K
filed with the Securities and Exchange Commission on November 18,
2005.
10.37 Order and Final Judgment of the United States District Court for the
Southern District of Ohio. Incorporated by reference to Registrant’s
Current Report on Form 8-K filed with the Securities and Exchange
Commission on November 18, 2005.
12.1 Computations of Consolidated Ratios of Earnings to Fixed Charges.
12.2
Computations of Consolidated Ratios of Earnings to Combined Fixed
Charges and Preferred Stock Dividend Requirements.
14
Code of Ethics. Incorporated by reference to Exhibit 14 of the
Registrant’s Current Report on Form 8-K filed with the Securities and
Exchange Commission on December 22, 2004.
21
23
Fifth Third Bancorp Subsidiaries, as of December 31, 2005.
Consent of Independent Registered Public Accounting Firm-Deloitte
& Touche LLP.
31(i)
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 by Chief Executive Officer.
31(ii) Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 by Chief Financial Officer.
32(i)
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 by Chief Executive
Officer.
32(ii) Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 by Chief Financial
Officer.
* Denotes management contract or compensatory plan or arrangement
Fifth Third Bancorp 87
ANNUAL REPORT ON FORM 10-K
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
FIFTH THIRD BANCORP
Registrant
George A. Schaefer, Jr.
President and CEO
Principal Executive Officer
February 16, 2006
Pursuant to requirements of the Securities Exchange Act of 1934, this report
has been signed on February 16, 2006 by the following persons on behalf of the
Registrant and in the capacities indicated.
OFFICERS:
George A. Schaefer, Jr.
Director, President, and CEO
Principal Executive Officer
R. Mark Graf
Senior Vice President and CFO
Principal Financial Officer
David J. DeBrunner
Senior Vice President and Controller
Principal Accounting Officer
DIRECTORS:
Darryl F. Allen
John F. Barrett
James P. Hackett
Allen M. Hill
Mitchel D. Livingston, Ph.D.
Kenneth W. Lowe
Hendrik G. Meijer
Robert B. Morgan
James E. Rogers
John J. Schiff, Jr.
Dudley S. Taft
Thomas W. Traylor
88
Fifth Third Bancorp
AVERAGE ASSETS ($ IN MILLIONS)
CONSOLIDATED TEN YEAR COMPARISON
Year
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
Loans and
Leases
$67,737
57,042
52,414
45,539
44,888
42,690
38,652
36,014
33,850
30,742
Interest-Earning Assets
Interest-Bearing
Deposits in
Banks (a)
$105
195
215
184
132
82
103
135
186
211
Federal Funds
Sold (a)
$88
120
92
155
69
118
224
241
327
325
Securities
$24,806
30,282
28,640
23,246
19,737
18,630
16,901
16,090
15,425
14,959
Total
$92,736
87,639
81,361
69,124
64,826
61,520
55,880
52,480
49,788
46,237
Cash and Due
from Banks
$2,758
2,216
1,600
1,551
1,482
1,456
1,628
1,566
1,367
1,401
Other
Assets
$8,102
5,763
5,250
5,007
5,000
4,229
3,344
2,782
2,495
2,212
Total
Average
Assets
$102,876
94,896
87,481
75,037
70,683
66,611
60,292
56,306
53,161
49,367
AVERAGE DEPOSITS AND SHORT-TERM BORROWINGS ($ IN MILLIONS)
Deposits
Year
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
Demand
$13,868
12,327
10,482
8,953
7,394
6,257
6,079
5,627
4,932
4,492
Interest
Checking
$18,884
19,434
18,679
16,239
11,489
9,531
8,553
7,030
6,209
5,559
Savings
$10,007
7,941
8,020
9,465
4,928
5,799
6,206
6,332
4,548
4,237
Money
Market
$5,170
3,473
3,189
1,162
2,552
939
1,328
1,471
2,508
2,909
INCOME ($ IN MILLIONS, EXCEPT PER SHARE DATA)
Other
Time
$8,491
6,208
6,426
8,855
13,473
13,716
13,858
15,117
15,887
15,171
Certificates
- $100,000
and Over
$4,001
2,403
3,832
2,237
3,821
4,283
4,197
3,856
4,173
4,186
Foreign
Office
$3,967
4,449
3,862
2,018
1,992
3,896
952
270
441
569
Total
$64,388
56,235
54,490
48,929
45,649
44,421
41,173
39,703
38,698
37,123
Short-Term
Borrowings
$9,511
13,539
12,373
7,191
8,799
9,725
8,573
7,095
6,113
4,837
Total
$73,899
69,774
66,863
56,120
54,448
54,146
49,746
46,798
44,811
41,960
Year
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
Interest
Income
$4,995
4,114
3,991
4,129
4,709
4,947
4,199
4,052
3,933
3,621
Interest
Expense
$2,030
1,102
1,086
1,430
2,278
2,697
2,026
2,047
2,030
1,853
Noninterest
Income
$2,500
2,465
2,483
2,183
1,788
1,476
1,335
1,161
901
746
Noninterest
Expense
$2,927
2,972
2,551
2,337
2,453
2,027
1,987
1,826
1,486
1,423
Per Share (b)
Originally Reported
Net Income
Available to
Common
Shareholders Earnings
$1,548
1,524
1,664
1,530
1,001
1,054
871
759
756
646
$2.79
2.72
2.91
2.64
1.74
1.86
1.55
1.36
1.35
1.15
Diluted
Earnings
$2.77
2.68
2.87
2.59
1.70
1.83
1.53
1.34
1.33
1.13
Dividends
Declared Earnings
$1.46
1.31
1.13
.98
.83
.70
.582/3
.471/3
.379/10
.324/7
$2.79
2.72
2.91
2.64
1.74
1.70
1.32
1.09
1.10
.93
Diluted
Earnings
$2.77
2.68
2.87
2.59
1.70
1.68
1.29
1.06
1.08
.91
Dividend
Payout
Ratio
52.7 %
48.9
39.4
37.8
48.8
41.7
45.5
44.6
35.2
35.8
MISCELLANEOUS AT DECEMBER 31 ($ IN MILLIONS, EXCEPT SHARE DATA)
Shareholders’ Equity
Year
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
Common Shares
Outstanding (b)
555,623,430
557,648,989
566,685,301
574,355,247
582,674,580
569,056,843
565,425,468
557,438,774
556,356,059
564,561,419
Common
Stock
$1,295
1,295
1,295
1,295
1,294
1,263
1,255
1,238
1,235
1,253
Preferred
Stock
$9
9
9
9
9
9
9
9
9
9
Capital
Surplus
$1,827
1,934
1,964
2,010
1,943
1,454
1,090
887
812
755
Retained
Earnings
$8,007
7,269
6,481
5,465
4,502
3,982
3,551
3,179
3,000
2,663
Accumulated
Other
Comprehensive
Income
$(413)
(169)
(120)
369
8
28
(302)
135
140
17
Treasury
Stock
$(1,279)
(1,414)
(962)
(544)
(4)
(1)
-
(58)
(184)
-
Book Value
Per
Share (b)
$17.00
16.00
15.29
14.98
13.31
11.83
9.91
9.67
9.00
8.32
Allowance
for Loan
and Lease
Losses
$744
713
697
683
624
609
573
532
509
484
Total
$9,446
8,924
8,667
8,604
7,752
6,735
5,603
5,390
5,005
4,695
(a) Federal funds sold and interest-bearing deposits in banks are combined in other short-term investments in the Consolidated Financial Statements.
(b) Adjusted for stock splits in 2000, 1998, 1997 and 1996.
Fifth Third Bancorp 89
FIFTH THIRD BANCORP
BOARD COMMITTEES
Executive Committee
George A. Schaefer, Jr.,
Chairman
Allen M. Hill
Robert L. Koch II
John J. Schiff, Jr.
Dudley S. Taft
Compensation Committee
Allen M. Hill, Chairman
Kenneth W. Lowe
James E. Rogers
Audit Committee
Robert B. Morgan, Chairman
Darryl F. Allen, Vice Chairman
John F. Barrett
James P. Hackett
Joan R. Herschede
Nominating and Corporate
Governance Committee
Dudley S. Taft, Chairman
Darryl F. Allen
Robert L. Koch II
James E. Rogers
Risk and Compliance
Committee
John F. Barrett, Chairman
Hendrik G. Meijer
Thomas W. Traylor
Trust Committee
Mitchel D. Livingston, Ph.D.,
Chairman
Joan R. Herschede
Kenneth W. Lowe
George A. Schaefer, Jr.
DIRECTORS AND OFFICERS
DIRECTORS EMERITI
Neil A. Armstrong
Philip G. Barach
Vincent H. Beckman
J. Kenneth Blackwell
Milton C. Boesel, Jr.
Douglas G. Cowan
Thomas L. Dahl
Ronald A. Dauwe
Gerald V. Dirvin
Thomas B. Donnell
Nicholas M. Evans
Richard T. Farmer
Louis R. Fiore
John D. Geary
Ivan W. Gorr
Joseph H. Head, Jr.
William G. Kagler
William J. Keating
Jerry L. Kirby
Michael H. Norris
David E. Reese
Brian H. Rowe
C. Wesley Rowles
Donald B. Shackelford
David B. Sharrock
Stephen Stranahan
Dennis J. Sullivan, Jr.
N. Beverley Tucker, Jr.
Alton C. Wendzel
FIFTH THIRD BANCORP
OFFICERS
George A. Schaefer, Jr.
President & CEO
Greg D. Carmichael
Executive Vice President &
Chief Information Officer
David J. DeBrunner
Senior Vice President & Controller
Charles D. Drucker
Executive Vice President
R. Mark Graf
Senior Vice President &
Chief Financial Officer
Malcolm D. Griggs
Executive Vice President &
Chief Risk Officer
Kevin T. Kabat
Executive Vice President
Bruce K. Lee
Executive Vice President
Ronald D. Marks
Senior Vice President & Treasurer
Pete Pesce
Executive Vice President
Daniel T. Poston
Executive Vice President & Auditor
Paul L. Reynolds
Executive Vice President, Secretary &
General Counsel
Robert A. Sullivan
Executive Vice President
AFFILIATE CHAIRMEN
H. Lee Cooper
Southern Indiana
Gordon E. Inman
Nashville
R. Daniel Sadlier
Dayton
Donald B. Shackelford
Columbus
John S. Szuch
Toledo
Gary L. Tice
South Florida
AFFILIATE PRESIDENTS &
CEOs
Samuel G. Barnes
Lexington
David A. Call
Ohio Valley
Todd F. Clossin
Cleveland
John N. Daniel
Southern Indiana
Robert M. Eversole
Columbus
Dan W. Hogan
Nashville
Gary S. Howlett
Orlando
Brian P. Keenan
Tampa Bay
Gregory L. Kosch
Detroit
Robert W. LaClair
Toledo
Philip R. McHugh
Louisville
John E. Pelizzari
Northern Michigan
Thomas R. Quinn, Jr.
South Florida
Timothy P. Rawe
Northern Kentucky
Maurice J. Spagnoletti
Indianapolis
Robert A. Sullivan
Cincinnati
Michelle L. VanDyke
Western Michigan
Raymond J. Webb
Dayton
Terry E. Zink
Chicago
FIFTH THIRD BANCORP
DIRECTORS
George A. Schaefer, Jr.
President & CEO
Fifth Third Bancorp and
Fifth Third Bank
Darryl F. Allen
Retired Chairman
President & CEO
Aeroquip-Vickers, Inc.
John F. Barrett
Chairman, President & CEO
Western & Southern Financial
Group
James P. Hackett
President & CEO
Steelcase, Inc.
Joan R. Herschede
Retired President & CEO
The Frank Herschede Company
Allen M. Hill
Retired President & CEO
DPL, Inc.
Robert L. Koch II
President & CEO
Koch Enterprises, Inc.
Mitchel D. Livingston, Ph.D.
Vice President for Student Affairs
and Services
University of Cincinnati
Kenneth W. Lowe
President & CEO
The E.W. Scripps Company
Hendrik G. Meijer
Co-Chairman & CEO
Meijer, Inc.
Robert B. Morgan
Executive Counselor
Cincinnati Financial Corporation &
Cincinnati Insurance Company
James E. Rogers
Chairman & CEO
Cinergy Corp.
John J. Schiff, Jr.
Chairman, President & CEO
Cincinnati Financial Corporation &
Cincinnati Insurance Company
Dudley S. Taft
President
Taft Broadcasting Company
Thomas W. Traylor
Chairman, President & CEO
Traylor Bros., Inc.
90
Fifth Third Bancorp
corporate information
Independent Registered
Public Accounting Firm
Deloitte & Touche LLP
250 East Fifth Street
Cincinnati, OH 45202
Transfer Agent
Computershare Investor Services LLC
PO Box 2388
Chicago, IL 60690-2388
(888) 294-8285
Investordirect.53.com
Stock Trading
The common stock of Fifth Third Bancorp
is traded in the over-the-counter market
and is listed under the symbol “FITB” on
the NASDAQ® National Market.
Corporate Office
Fifth Third Center
Cincinnati, Ohio 45263
(513) 579-5300
Website
www.53.com
Investor Relations
R. Mark Graf
Senior Vice President &
Chief Financial Officer
(513) 534-6936
(513) 534-3945 (fax)
Bradley S. Adams
Vice President &
Investor Relations Officer
(513) 534-0983
(513) 534-0629 (fax)
Press Releases
For copies of current press
releases, please visit our
website at www.53.com.
stock data
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
©Fifth Third Bank 2006
Member F.D.I.C. – Federal Reserve System
®Reg. U.S. Pat. & T.M. Office
2005
Low
$35.04
$36.38
$40.24
$42.05
Dividends
Paid Per
Share
$.38
$.38
$.35
$.35
High
$52.34
$54.07
$57.00
$60.00
2004
Low
$45.32
$46.59
$51.13
$53.27
Dividends
Paid Per
Share
$.35
$.32
$.32
$.32
High
$42.50
$43.99
$44.67
$48.12
www.53.com