building an even better
tomorrow.
2006 ANNUAL REPORT
Traverse
City
Grand Rapids
Detroit
Chicago
Toledo
Cleveland
Pittsburgh
Columbus
Indianapolis
Dayton
Cincinnati
St. Louis
Evansville
Florence
Huntington
Louisville
Lexington
Nashville
Tampa Bay
Orlando
Naples
Corporate Profile
Fifth Third Bancorp is a diversified financial services company head-
quartered in Cincinnati, Ohio. The Company has $101 billion in assets
and operates 19 affiliates with 1,150 full-service banking centers,
including 111 Bank Mart® locations open seven days a week inside
select grocery stores, and 2,096 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 Aa2 from Moody’s, AA from Fitch
and DBRS, and AA- from Standard & Poor’s. Fifth Third operates
five main businesses: Commercial Banking; Branch Banking;
Consumer Lending; Investment Advisors; and Fifth Third Processing
Solutions. Fifth Third is among the largest money managers in the
Midwest and, as of December 31, 2006, has $220 billion in assets
under care, of which it manages $34 billion for individuals, corpora-
tions 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®
Global Select Market System under the symbol “FITB.”
Fifth Third Bancorp FINANCIAL HIGHLIGHTS
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
2006
2005
Percent
Change
$ 1,188
880
$ 1,549
810
$ 2.14
$ 2.79
2.13
1.58
18.02
2.77
1.46
17.00
$ 100,669
$ 105,225
75,503
69,380
10,022
40.93
22,767
1.13
12.1
3.06
60.5
9.32
556,253
1,150
21,362
71,229
67,434
9,446
37.72
20,958
1.50
16.6
3.23
53.2
9.06
555,623
1,119
21,681
(23)
9
(23)
(23)
8
6
(4)
6
3
6
9
9
(25)
(27)
(5)
14
3
--
3
(1)
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
Aa3
Prime-1
Aa2
A-1
A+
A-1+
AA-
F1+
AA-
F1+
AA
1
The actions we’ve taken relative to the balance sheet, combined
with a stabilization of the interest rate environment, should create
the conditions for our historically strong core performance to
re-emerge. Fifth Third’s competitive position is very strong. Our
tangible capital levels are among the highest in the industry. I have
tremendous confidence in the strength and depth of our
management team.
As a result, I have made the decision to step down as Chief
Executive Officer. I couldn’t feel more comfortable in handing over
the chief executive position to Kevin Kabat, our current president,
whom our Board has chosen to succeed me effective April 17,
2007, the date of our annual shareholders meeting. Kevin is
absolutely the right person to head this Company. Kevin has been
a terrific leader at Fifth Third since joining us with the Old Kent
acquisition in 2001, serving as head of our Western Michigan
affiliate, head of Retail Banking and Affiliate Administration, and
then most recently taking on the role of President last year. I have
asked him to address you with his views on our future in a separate
letter following this one.
I am very proud of my years with Fifth Third and my 16 years as
Fifth Third’s Chief Executive Officer, and it has been an honor to
serve the Company in this important role. I will continue to hold the
position of Chairman, but I believe it’s time for a new generation of
leadership to provide the Company with a new vitality, a new level
of energy, and a new direction.
2006 Results
2006 was a challenging year for the industry and for Fifth Third.
In June the Federal Reserve concluded its most significant
tightening campaign since the early 1980s, which resulted in an
inverted yield curve for most of the second half of 2006. As a
result, our borrowing costs rose for much of the year while the
yield on our investment securities portfolio was relatively flat.
In November, we decided to reduce the size of our balance sheet in
order to reduce our exposure to this interest rate environment and
to future potential adverse rate movements. These actions resulted
in the realization of a pre-tax loss of $454 million, or $291 million
after tax ($0.52 per share). We expect net interest income to
benefit from our improved positioning by $110 million to $120
million on an annualized basis, before hedging costs. Additionally,
we realized a 65 basis points benefit to our already very strong
tangible equity to tangible assets ratio.
The interest rate environment, combined with the loss resulting
from our balance sheet actions, took a toll on reported results for
the year. Earnings per diluted share for 2006 were $2.13, down
from $2.77 in 2005. Return on average assets and return on
Dear Shareholders and Friends,
2006 marked an important transition year for Fifth Third, one that I
believe has us positioned well as we head into 2007 and beyond.
First, and perhaps foremost, we added a number of new executives
to our team, and promoted others. This gives us the strongest slate
of leaders, I believe, in the Company’s history. This team reflects a
mix of long and successful tenures at Fifth Third, complemented by
a number of executives brought in from other large and successful
competitors, giving us a nice balance of outside perspective,
continuity, and entrepreneurial drive.
Second, I point to the actions we chose to take in the fourth
quarter of 2006 to address the positioning of our balance sheet
during the current difficult interest rate environment, characterized
by an inverted yield curve (an environment in which short-term
rates are higher than long-term rates). From June 2004 to 2006,
the Federal Reserve raised rates 17 consecutive times totaling 4.25
percentage points, which created significant headwinds obscuring
core performance in our businesses. In November of 2006, we
made the decision to reduce the size of our balance sheet and
neutralize our exposure to significant future adverse changes in
interest rates. This decision was costly, but we believe it was the
right thing to do, and I believe it represents the final step in
resolving the issues that developed following the regulatory
difficulties we experienced in 2002 and 2003.
Over the last several years, we’ve made significant investments in
our information technology platform, in our risk management
capabilities and personnel, and in our core operations capabilities.
These steps are substantially complete, although we continue to
make new additions to front-end technologies and improvements
to infrastructure to make the Company more responsive to
customer needs.
2
Fifth Third Bancorp LETTER FROM THE CHAIRMAN & CEO
average equity were 1.13 percent and 12.1 percent, respectively,
significantly below what we would normally expect and below
the 1.50 percent and 16.6 percent, respectively, that we realized
in 2005.
Net interest income of $2.9 billion on a tax-equivalent basis
declined 3 percent from 2005. This result reflected our previous
negative sensitivity to rising short-term rates, offset by solid
average loan and core deposit growth of 8 percent and 5 percent,
respectively. During 2006, we saw a continuation of strong average
commercial loan growth, up 10 percent. Average consumer loan
growth remained solid, up 6 percent, though below the levels we
and the industry experienced several years ago with a more
favorable rate environment. Going forward, we expect continued
strong loan and core deposit growth, combined with the benefits
of our balance sheet actions, to drive improved net interest income
performance despite an expected continued flat to inverted yield
curve.
Noninterest income of $2.2 billion declined 14 percent from 2005,
reflecting net securities losses of $364 million in 2006 — primarily
the result of our fourth-quarter balance sheet actions — compared
with net securities gains of $39 million in 2005. We continued to
experience strong growth in electronic payment processing
revenue — our largest noninterest income category — up 15
percent from 2005. Corporate banking revenue also grew a solid
7 percent.
Noninterest expense of $3.1 billion grew 4 percent from 2005
levels, despite the inclusion of $49 million in expenses related to
the extinguishment of financing agreements in the third and fourth
quarters to reduce interest rate sensitivity. Expense growth was
otherwise held to 3 percent, reflecting continued strong growth in
our processing business offset by expense controls.
Credit costs remained consistent with the levels of 2005, with
provision expense up 4 percent over the prior year and net charge-
offs up 6 percent, though declining slightly as a percentage of
average loans to 0.44 percent from 0.45 percent in 2005.
As we look into 2007, we would expect to see upward pressure on
credit. We don’t have a crystal ball, but at this point we don’t see
significant economic deterioration on the near horizon, and don’t
expect a significant upward move in credit costs. Given Fifth Third’s
strong presence in Midwest markets, we have been experiencing
slower economic growth and higher levels of credit losses than
banks in other regions for some time. Fifth Third is a lending
company, and we are in the risk business. The ebbs and flows of
the credit cycle are to be expected and do not change our attitude
on that front.
Commitment to our Shareholders and our Communities
We at Fifth Third are deeply aware that you, our shareholders,
own the Company, and that we are accountable to you. Thus,
we are proud to maintain among the very highest corporate
governance ratings in the industry. Our Corporate Governance
Quotient, as published by Institutional Shareholder Services, is
in the top 4 percent of companies in the S&P 500 and in the top
1 percent of all U.S. banks.
I have always believed that Fifth Third and the cities and regions it
serves are mutually dependent — and we have always acted upon
that belief. Thus, I am especially proud that Fifth Third’s Ohio and
Michigan banks each received an “Outstanding” rating on our most
recent Community Reinvestment Act performance evaluation by
the Federal Reserve Bank.
Commitment to the Future
I’d like to take this opportunity to express my deep appreciation to
all the constituents that make Fifth Third a great company — our
customers, our 21,362 employees, our board members, and the
citizens of the communities served by our 19 affiliates. Our
employees, in particular, have accomplished tremendous things
at Fifth Third during my tenure, never more so than during the
past year.
2006 was a difficult year for Fifth Third — make no mistake about
it. But I believe the Company as it enters 2007 is in its strongest
position ever. Our balance sheet is very strong and well-capitalized.
We have the broadest and deepest management team we’ve ever
had. Our technology platform is robust and scalable. And we have
strong positions in our Midwest markets, with solid footholds in
growth markets. We are better positioned to deliver organic
growth than ever before in our history, through our strong sales
culture and increased focus on customer service and satisfaction,
and through our successful de novo activities. And we are well
positioned to participate in what will continue to be a consolidating
industry for many years ahead.
Thank you for the opportunity to have served you for the last
36 years.
Sincerely,
George A. Schaefer, Jr.
Chairman & Chief Executive Officer
February 2007
3
But the last three years we haven’t met our own expectations,
or yours. We know it is time to show results, and that’s what we are
prepared to do. We have the right team in place, having promoted
or hired new leaders who are bringing a fresh perspective and new
energy. We are united as a team and feel an urgency to return to
the head of the pack.
Our Model
We are fortunate to have many strengths to build on. Our affiliate
model allows us to deliver big-company results on a local scale. We
have local management with full accountability in each market,
making decisions locally that affect our customers. This model may
not be the least expensive way to organize a company. But
efficiencies, standardization and a common technology platform
combine with personal, high-touch service in each affiliate to create
real benefit. This is perhaps our biggest competitive differentiator.
Where decentralization does not add value, for us or for our
customers, we will continue to look for ways to enhance efficiency,
but we remain committed to the essence of the model. We provide
more information on our affiliate model, our regions and affiliates,
and their leadership on page 10 of this report.
Overlaying our affiliate structure are five lines of business: Branch
Banking; Commercial Banking; Processing Solutions; Consumer
Lending; and Investment Advisors. These lines of business are
areas of expertise whose products and services are delivered to
customers through the affiliates in a way that ensures that
customer relationships are viewed as a whole. Below I discuss
some of the key strategies under way in our lines of business. Our
businesses are described in more detail on pages 11 through 15.
Key Strategies and Focus Areas
One of our key strategies is our commitment to Everyday Great
Rates, implemented in the summer of 2005. We believe this
strategy for deposit growth strikes an optimal balance between
growth and profitability. Everyday Great Rates is what it says —
very competitive rates, in every product category, every day. It’s
simple but powerful. It’s helped us attract new customers while
also leading our existing customers to realize they don’t need to
shop for weekly rate promotions. That, in turn, has reduced
attrition and reduced the temptation for customers to shift to
higher-rate, less liquid products like CDs, keeping our overall
deposit costs low and in line with our competitors.
We believe Everyday Great Rates has significantly helped us with
deposit growth. Based on FDIC data for the most recent reporting
period ended June 2006, Fifth Third had the third highest deposit
growth among large banks in branches open more than one year.
Dear Shareholders and Friends,
I am deeply honored to address you as President of Fifth Third
Bancorp and as George Schaefer’s successor. Having competed
with him earlier in my career, and then having the good fortune to
work for him the past five years, I believe he is one of the giants of
the banking industry. We are fortunate that he will remain with us
as Chairman, to provide us with his wise counsel and good sense.
When George became President and Chief Executive Officer of
Fifth Third at the end of 1990, the Company had $8 billion in assets
and a market capitalization of a little over $1 billion. We’ve grown to
over $100 billion in assets in the succeeding 16 years with a market
value of nearly $23 billion. During that period, Fifth Third has
generated a total shareholder return of 17.5 percent on a
compound annual basis, driven by strong growth in originally
reported earnings per share and rising dividends. That return
compares with 12 percent for the S&P 500 over that period. This is
truly an enviable track record, one that we aspire to continue.
Building an Even Better Tomorrow
The title of this year’s annual report — “Building an Even Better
Tomorrow” — aptly describes what we are about here at Fifth
Third. The title is adapted from the new brand that we introduced
this February.
That’s what we are aiming for — building an even better tomorrow.
This Company was built upon an incredibly strong sales culture, a
winning attitude and very high standards and expectations. We
don’t play for average. During the past 16 years, our performance
topped the industry, even when you include the past three sub-par
years. Whether measured by originally reported earnings per share,
asset growth, market capitalization growth or total return, we’ve
outperformed our peers.
4
Fifth Third Bancorp LETTER FROM THE PRESIDENT
Another important retail focus over the past three years — and one
we are augmenting in 2007 — has been de novo branching activity.
Since 2003, we have built 212 new banking centers. These
branches accounted for 36 percent of our core deposit growth in
2006. We conduct market segmentation analysis and use
predictive modeling to target locations in key growth markets with
the demographics and business activity that has proven successful
for us. Our success with our new locations has led us to plan to
build approximately 70 new branches in 2007, with expectations
that they will break even in about 18 months and produce an
internal rate of return of better than 20 percent. De novo activity is
costly in the near term, but it’s the right thing to do to sustain
organic growth into the future.
I’m enthusiastic about recent developments in our business
banking efforts. We are already pretty good at this business — and
were proud to be ranked fifth among large U.S. banks in J. D.
Power’s 2006 Small Business Banking Satisfaction Study — but we
can become much better. As a next step, we are assigning most of
our customers to a designated business banking relationship
manager, armed with customized and bundled product offerings, a
standardized underwriting process, and automated portfolio
management.
Commercial Banking has long been one of our strengths. We enjoy
a strong position with middle-market commercial customers
(companies with $10 million to $500 million in sales) within our
footprint. Fifth Third gained more new customers over the past
two years among middle-market companies in our footprint than
any competitor, with more than two-thirds of our affiliates
increasing penetration in the middle market. Fifteen percent of
such companies are Fifth Third customers, and we are the lead
bank for nearly two-thirds of them.
An exciting development during the past year has been the
electronic deposit product. This is an important area in which Fifth
Third has taken a leadership position in commercial banking. This
product transforms the payment landscape, enabling truncation of
paper checks at the point of receipt. Our business customers no
longer need to take checks to a branch to make a deposit. And, in
driving paper to electronic transformation, we are able to gain
control over one of the most manual processes remaining in cash
management. Customers using this product are able to save time,
optimize their working capital and consolidate their banking
relationships. We’ve experienced rapid growth in 2006, particularly
the latter half, and are receiving deposits from locations in 35
states. Continuing to capitalize on this opportunity is a priority
for 2007.
We continue to experience increased demand among our middle-
market customers for capital markets products as Fifth Third has
expanded in size and capabilities. We’ve recently introduced, or are
introducing a number of such products to meet this demand, and
we’re going after industry sectors and geographies where we are
under-represented given our market position.
Our Processing Solutions business continues to produce strong
results. The industry is seeing increasing adaptation of electronic
payment vehicles and Check 21 electronic item processing. Our
industry leadership in providing value-added processing solutions
through consultation with customers will continue to allow us to
outperform our peers. And we’ve seen strong growth in our credit
card business, with average receivables growth of 18 percent
during 2006.
However, despite our success over the past several years, only 13
percent of our retail customers have our credit cards. We are
taking steps to expand our penetration through improved point-of-
sale technology, bundled product offerings through banking
centers and call centers, and enhanced sales management
processes. We’re also modestly expanding our risk spectrum where
we can achieve attractive risk-adjusted returns. Current portfolio
FICO scores average over 740, with a very low 3.49 percent
charge-off rate, so we have the ability to better align our offerings
with our current clients while, at the same time, maintaining high
credit quality standards.
The Consumer Lending business had a very difficult year, given the
drop-off in mortgage originations industry-wide and more sluggish
auto sales. We believe improved industry conditions and new
products we’ve launched will lead us toward better results in 2007.
For example, in the latter part of the year, we launched an Alt-A
nonconforming mortgage product that accounted for over $350
million in originations in just a few months. These loans are being
sold following origination to third parties for distribution to the
capital markets, allowing us to originate volume that we’ve been
unwilling to hold historically.
Our Investment Advisors business had a mixed 2006. Our largest
investment business, the Private Client Group, continues to perform
very well. Brokerage results have not been as strong, primarily
reflecting net attrition of financial advisors. We recently instituted a
targeted recruiting program that we expect to result in net hiring
going forward. And we are in the process of rolling out new
financial planning and customer relationship management tools,
which we expect to be key catalysts for results in 2007. In the asset
management business, our continued efforts to open our
architecture across all client segments have made growth of Fifth
Third managed funds more challenging. Meeting our customers’
5
needs is paramount to success in this business and broadening our
offerings is the right thing to do. We’ve recently brought in new
leadership to drive improved results, and we are already seeing a
positive impact to our strategies.
Technology for Tomorrow
As we’ve discussed here for the past several years, Fifth Third has
taken significant strides in elevating the level of our infrastructure
and front-end technology. Frankly, we were underinvested in our
infrastructure three or four years ago. Today, we have the systems,
security and capabilities that are necessary for an institution of our
size, and that will allow us to continue to grow.
During the past 36 months, we’ve replaced or upgraded 80
percent of our technology systems. With much of our
infrastructure investments behind us, further progress in this area
will be evolutionary. We are leveraging our technology spending
into improvements in our product offerings and our services.
Examples would include our placement of more than 1,000
remote-capture deposit scanners with our business customers,
deploying an enterprise problem resolution platform, developing a
new customer experience portal, and creating performance
management tools and dashboards.
A Better Customer Experience and a New Brand Promise
Customers are more demanding than ever, and we must continue
to meet and exceed a bar that is continually being raised — by
customers and our competitors. Fifth Third has long been known
for our sales culture and our ability to bring customers in the door.
But we have not been world-class in keeping them. This is one of
our biggest opportunities.
And, while our sales culture is terrific, there has been a large dose
of hard work and hustle associated with that. Historically, we’ve
been more transaction-oriented than is ideal. Focusing on our
relationships with customers — not just today’s relationship, but our
future relationship — will help us increase retention and increase
wallet share with our customers.
What our customers tell us they need is a trusted advisor for the
long haul. To deliver, we must understand our customers’ needs
tomorrow to properly address the need today that brought them
into our banking center or caused them to pick up the phone. In
our service delivery, we must prove we care about our relationship
tomorrow when we’re dealing with today’s issues.
In February 2007, we began rolling out a new brand — a brand that
will encompass visual changes in Fifth Third’s marketing but, more
important, a brand that changes the promises we make to our
customers. We are aligning everything toward fulfilling our brand
commitment and building a better tomorrow. Later in this report,
you will see further discussion of developments at Fifth Third
related to consultative sales training, customer experience
enhancements and key brand elements.
Ultimately, I believe our renewed focus on the customer experience,
and a brand that supports it, are the most exciting developments
under way at Fifth Third.
Closing
I’m excited about our prospects for 2007 and the future. And I’m
honored to have been chosen to lead Fifth Third into that future.
This is a great company — a company full of people who are
hard-working, passionate about Fifth Third and passionate about
winning — and I have every confidence that we will deliver for you,
for our employees and for our communities…That is what Fifth
Third is all about.
Sincerely,
Kevin T. Kabat
President
February 2007
6
Fifth Third Bancorp CORPORATE LEADERSHIP
Bottom row, left to right: George A. Schaefer, Jr., chairman and Chief Executive Officer, Fifth Third Bancorp; Kevin T. Kabat, president, Fifth Third Bancorp;
Paul L. Reynolds, executive vice president and General Counsel; Terry E. Zink, executive vice president, Affiliate Administration.
Second row, left to right: Christopher G. Marshall, executive vice president and Chief Financial Officer; Malcolm D. Griggs, executive vice president,
Enterprise Risk Management. Third row, left to right: Charles Drucker, executive vice president and president, Fifth Third Processing Solutions;
Greg D. Carmichael, executive vice president and Chief Operating Officer; Carlos Winston Wilkinson, executive vice president, Consumer and Retail Banking;
Daniel T. Poston, executive vice president, Audit. Fourth row: Bruce K. Lee, executive vice president, Commercial Banking.
Fifth row: Robert A. Sullivan, senior executive vice president and president, Fifth Third Bank (Cincinnati).
Creating a higher standard.
• We have publicly disclosed governance guidelines.
• Independent outside directors constitute 13 of 15 directors
(87 percent), with a named lead independent director.
• The Nominating and Corporate Governance, Compensation,
Audit, and Risk and Compliance committees are comprised
solely of independent outside directors.
• Outside directors meet regularly without the CEO present.
• Directors receive a significant portion of their compensation
in the form of equity.
• Directors and executives are subject to stock ownership
guidelines, with mandatory holding periods for restricted stock
and stock acquired through the exercise of options.
• Our board is “declassified” — all directors are elected annually.
• We have eliminated the super-majority voting provision in our
Code of Regulations.
• We have no “poison pill”.
7
Branding & Customer Experience
Moving ahead with you.
As you glance at the cover of this year’s annual report, you may
notice that something looks different. The traditional red and blue
logo that has been the symbol of Fifth Third for nearly 20 years is
gone, replaced by a new mark and a new color palette — a brighter
shade of blue, signaling dependability and trust, and green that
emphasizes growth and optimism. The new mark also is symbolic
of a horizon, the place where today and tomorrow converge. It
reminds us to look beyond today’s transaction and find ways to
widen our relationship with our customers.
This updated mark is just one outcome of a nearly two-year brand
development process undertaken by Fifth Third and conducted by
Cincinnati-based Deskey, one of the country’s leading branding
firms.
A brand is a collection of experiences, the sum total or cumulative
effect of many touch points over a period of time. Successful
brands engage customers, and engaged customers buy much more
from the brands they prefer. Successful brands are aligned with —
and in fact are part of — a business strategy to produce results.
To develop a relevant brand, it was important that we understand
our customers, understand our competitors and understand
8
ourselves. The brand development process involved extensive
research with consumers and business customers across the
Fifth Third footprint and with all levels of Fifth Third employees.
We also conducted research to understand exactly how the
existing brand is perceived today.
We learned much from this process, including that our customers
don’t feel they are spending enough time — or taking the right
steps — to address their future needs. And both consumers and
businesses want their bank to shoulder some of the responsibility
for suggesting smart ways to protect their future.
The outcome of this research is that we intend to be the bank for
today and for tomorrow. We want to help our customers gain
confidence in their financial decisions because, with our help, they
understand how their current decisions affect them over the long
haul.
An important cornerstone of our new brand development is
customer engagement. In order to be our customers’ bank today
and tomorrow, we must provide excellent customer service with
each and every transaction.
In recognition of this, we’ve begun implementing consultative sales
training for our retail and call center employees. This training and
ongoing sales coaching is designed around four key drivers
customers find important. They include friendliness, ease of doing
business, individualized attention, and the degree of knowledge
about the bank’s products and services. The goal is to ensure that
the totality of our customers’ needs are being evaluated and met
every time we interact with them. This, we hope and expect, will
lead to stronger relationships with our customers and will earn us
trusted advisor status with our customers.
We also are implementing a new performance management system
in 2007, again focused on key customer demands and requirements
for satisfaction. Compensation will be tied to how well employees
perform on the four key drivers mentioned previously. They also will
be evaluated on sales production and net income growth measured
down to the individual level. In addition, beginning this year, we will
track every banking center’s Gallup customer satisfaction and
loyalty scores, with branch personnel compensation tied directly to
these measures.
Finally — and it may prove the most important step we take in this
area — in 2007 we will roll out a problem resolution platform that
extends first to the retail and call center channels, then later across
all lines of business. There is nothing that tests a customer’s loyalty
more than the way you handle issues. We need to be able to track,
to respond, and — ideally — to correct on first contact, such
problems as they arise in a way that demonstrates we value our
relationship with our customers.
To deliver on our new brand promise, the customer experience is
vital. We are developing technological requirements necessary to
deliver an outstanding customer experience. We are establishing
customer experience councils in every affiliate and line of business,
consisting of senior executives throughout the Company. And,
we’ve done a great deal of work over the past two years to survey
the engagement levels of our employees and align their goals with
the goals and objectives of the Company and its customers.
Engaged employees are the most critical aspect of delivering a
customer experience that is satisfying.
9
Affiliate Model
Maintaining competitive advantage.
The affiliate model is at the core of Fifth Third and is what
differentiates us from other large financial institutions. We operate
each affiliate with local management. Each affiliate has an
experienced president and senior management team, resident in
each market, driving the business. And each affiliate has a board of
directors comprised of local business and community leaders. This
means that we have local decision-makers, able to view customer
relationships in holistic ways, making local decisions.
This model gives us a tremendous competitive advantage in our
responsiveness to customers; in attracting employees who want to
control the customer relationship locally; and in giving us 19 “mini-
incubators” for new ideas and best practices. Our entrepreneurial
and sales cultures are at the heart of the affiliate model, and
contribute tremendously to Fifth Third’s success.
Affiliate Leadership
Overlaying the affiliate structure are our lines of business. These are
essentially areas of product expertise — Branch Banking, Consumer
Lending, Commercial Banking, Processing Solutions and Investment
Advisors — whose products and services are delivered to customers
through the affiliates in a way that ensures customer relationships
are viewed as a whole.
As an example of the kind of success we can produce with this
model, we have 19 affiliates plus our Pittsburgh and St. Louis
de novo markets. For the year ended June 2006 (most recent FDIC
data), 20 of these 21 markets (including the de novo markets) grew
deposits. Excluding branches with over $1 billion in deposits, all
21 markets grew deposits and 17 of the 21 markets grew deposit
market share (18 of 21 excluding $1 billion branches).
Affiliate*
President
Banking Centers
Deposits % of Deposits
Chicago Region
Chicago
Central Indiana
Southern Indiana
Tennessee
Terry Zink
Terry Zink
John Pelizzari
John Daniel
Dan Hogan
Western Michigan Region
Western Michigan
Eastern Michigan
Northern Michigan
Tampa Bay
Michelle VanDyke
Michelle VanDyke
Greg Kosch
Mark Eckhoff
Brian Keenan
Cincinnati Region
Cincinnati
Louisville
Central Kentucky
Northern Kentucky
Cleveland Region
Northeastern Ohio
Northwestern Ohio
South Florida
Columbus Region
Central Ohio
Western Ohio
Ohio Valley
Central Florida
Bob Sullivan
Bob Sullivan
Phil McHugh
Sam Barnes
Tim Rawe
Todd Clossin
Todd Clossin
Robert LaClair
Tom Quinn
Bob Eversole
Bob Eversole
Ray Webb
David Call
John Bultema
312
$17.3B
25%
273
$15.2B
22%
205
$12.6B
18%
187
$10.9B
16%
173
$ 9.4B
14%
10
*Bancorp deposits also include $4 billion in National and non-affiliate deposits.
Exceeding customer expectations.
Branch Banking
Business Description
Fifth Third Bank provides a full range of deposit and lending
products to individuals and small businesses in 10 states in the
Midwest, Tennessee and Florida. Our 2.7 million households can
transact business 24 hours a day, seven days a week through our
Jeanie® ATM network and our comprehensive online banking
service. Through these channels, Fifth Third strives to provide
exceptional products, convenience and service to our customers.
2006 Highlights
• $2.1 billion total revenue
• $570 million net income
• 52.2 percent efficiency ratio
• $15.7 billion average loans
• $39.3 billion average core deposits
• 1,150 full-service banking centers
• 2,096 full-service ATMs
• 1.1 million online banking customers
Customer Focus
Branch Banking provides deposit, lending and investing products
and services for customers at every stage in life or career. Branch
Banking’s 9,000 employees provide knowledgeable and reliable
guidance, whether customers meet with them personally or via any
of our automated banking solutions. Our business bankers can
provide full solutions to a small business customer including loans,
treasury management products, employee savings plans, or
employee banking needs. Whether saving for a home, a child’s
education, planning for retirement or building a business, our
associates consult with our customers, help determine their needs
and provide solutions that meet today’s goals — as well as
tomorrow’s.
Strategy
Fifth Third expects to continue recent de novo branch banking
expansion activities with the planned addition of approximately 50
net new de novos in 2007. Areas of heaviest de novo activity
continue to be primarily in the Florida, Chicago, Detroit and
Nashville markets. Our business banking business now incorporates
341 business bankers calling on customers with up to $10 million in
sales throughout our footprint, and we are adding relationship
managers in this area. We continue to make improvements in sales
management processes and customer service to build productivity
and customer satisfaction and to enhance client retention.
11
Consumer Lending
Evolving with the marketplace.
Business Description
Consumer Lending provides loan products to branch and other
customers, primarily within Fifth Third’s footprint. Consumer
Lending partners with a network of auto dealers that originate loans
on the Bank’s behalf, otherwise know as indirect lending.
Additionally, Consumer Lending provides loan and lease products to
individuals including mortgages and home equity loans and lines, as
well as federal and private student education loans.
2006 Highlights
• $609 million total revenue
• $137 million net income
• 49.8 percent efficiency ratio
• $20.4 billion average loans
• $436 million average core deposits
• $28.7 billion mortgage servicing portfolio
• 8,700 dealer indirect auto lending network
Customer Focus
Recognizing that personal loans are often a vital element for the
prosperity of our customers, we offer a broad range of loans that
correspond to the financial situation of our customers. Whether for
a first car or a retirement home, Fifth Third provides loans that fit
our customers’ needs, today and tomorrow.
Strategy
Fifth Third understands that not every customer needs the same
loan product to fulfill his or her needs. In order to evolve with the
marketplace and meet the changing needs of customers as they
progress through life, we continue to refine and develop our
lending solutions. Whether customers need a first mortgage or a
loan to send their children to college, we intend to be there with
the right solution for them. And by using products like our new
Alt-A mortgage product we have been able to facilitate home
ownership for a larger segment of our customer population. We’ve
also expanded our auto dealer network to 24 states, including the
10 in our banking footprint, with an expectation that we’ll continue
to add states over the next several years.
12
Investment Advisors
Strengthening relationships.
Business Description
With over 100 years of experience helping our clients build and
manage their wealth, Fifth Third Investment Advisors provides
integrated solutions to meet the financial goals of individuals,
families and institutional investors. Investment Advisors provides
wealth management, asset management and brokerage services to
retail and institutional clients, as well as retirement plan and custody
services to businesses, pension and profit-sharing plans, foundations
and endowments.
2006 Highlights
• $511 million total revenue
• $81 million net income
• 74.9 percent efficiency ratio
• $3.1 billion average loans
• $4.5 billion average core deposits
• $34 billion assets under management
• $220 billion assets under care
• 1,500 registered representatives
• 338 private client relationship managers
• 83,000 private client relationships
Customer Focus
Clients receive specialized advice from one or more of our four
business lines: Fifth Third Securities, Private Client Group, Fifth
Third Institutional Client Group and Fifth Third Asset Management.
Fifth Third’s Private Client Group uses specialized teams to leverage
our clients’ financial resources and provide holistic strategies in
wealth planning, investment services, trust services, private banking
and wealth protection. Fifth Third Securities offers a suite of
products from full-service brokerage to self-managed investing to
provide our clients customized programs to meet today’s needs, as
well as tomorrow’s. Fifth Third Asset Management provides asset
management services to institutional clients and also advises the
Company’s proprietary family of mutual funds, Fifth Third Funds.
Fifth Third’s Institutional Client Group, in conjunction with Fifth
Third Asset Management, provides advisory services for 379
institutional clients including states and municipalities, Taft-Hartley
plans, pension and profit-sharing plans, and foundations and
endowments.
Strategy
Fifth Third continues to strengthen customer relationships by
providing an open architecture framework to ensure that clients
have access to the best products to meet their needs, whether
those products are Fifth Third’s or from another financial service
provider. We continue to employ new technologies to improve
client access to their accounts and products. We provide complete
financial solutions to Fifth Third clients by leveraging partnerships
throughout the Company to provide powerful solutions across the
financial spectrum.
13
Commercial Banking
Committed to innovation.
Business Description
Fifth Third’s 1,100 commercial bankers serve clients ranging from
middle-market companies with $10 million in annual revenue to
some of the largest companies in the world. In addition to the
traditional lending and depository offerings, our products and
services include 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.
Customer Focus
Fifth Third has over 150 years of commercial banking experience,
and throughout our history we have always believed in keeping
decision-making local. Through our affiliate model, keeping close to
the communities we serve, Fifth Third is able to offer the high level
of service of a local bank while maintaining the financial strength
and capabilities that come with being one of the largest banks in
the country.
We strive to offer complete financial solutions to our clients and we
believe that the focus should be on our total relationship with our
clients — not just meeting today’s needs but working with clients to
identify tomorrow’s requirements as they grow.
Strategy
Fifth Third remains committed to offering innovative and effective
solutions for our customers. We recently began offering electronic
depository services that allow customers to scan checks and
deposit them electronically from whatever location they choose.
This has allowed our clients to focus more time on improving their
business rather than on routine banking tasks and has permitted us
to serve as our customers’ depository anywhere in the country.
During 2006, we processed 5.7 million electronic deposit
transactions totaling $10.4 billion. We received deposits from 944
locations as of year-end. We continue to add value to all of our
relationships by combining our depth of experience with complete
solutions that will best meet our clients’ evolving needs.
2006 Highlights
• $1.8 billion total revenue
• $651 million net income
• 43.0 percent efficiency ratio
• $33.6 billion average loans
• $15.2 billion average core deposits
• 485 large corporate client relationships
• 4,700 middle market client relationships
• 112,000 treasury management relationships
14
Creating solutions and reducing costs.
Processing Solutions
Business Description
Fifth Third Processing Solutions provides electronic funds transfer,
debit, credit and merchant transaction processing for Fifth Third and
Fifth Third customers. Processing Solutions specializes in providing
our clients with the highest quality transaction solutions available
through a complete global payments solution. Our in-house systems
and development teams continue to create new technology to offer
unmatched flexibility and customization to not only fulfill our clients’
current needs, but their future needs as well. Processing Solutions
also manages Fifth Third’s debit and credit card businesses and
operates the Jeanie® ATM network.
2006 Highlights
• $815 million total revenue
• $180 million net income
• 71.6 percent efficiency ratio*
• 20 billion ATM and point of sale transactions
• $216 billion debit and credit card
sales volume
• 33 million debit cards processed
• 142,000 merchant locations
• 12,000 automated teller machines
supported in 43 U.S. states and 11 countries
• 2,300 financial institution clients
*excluding pre-tax gains on sale
of MasterCard® stock of $78 million
Customer Focus
Fifth Third Processing Solutions operates three primary businesses
— Merchant Services, Financial Institutions Services and Card
Services. For more than three decades, the nation’s top retailers
and businesses have trusted Fifth Third’s Merchant Services Group
to provide superior card acceptance solutions. We have developed
flexible system architecture with a wealth of technological options
and processing features capable of meeting the individual
requirements of any business. Our Financial Institution and Card
Services groups combine to 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.
Strategy
Fifth Third is able to leverage our significant market position and
distribution capabilities to assist existing customers and gain new
ones. We are creating a more effective cross-selling and product-
bundling platform to strengthen current customer relationships and
capture the complete processing business from new customers.
We are able to demonstrate exceptional value by leveraging our
in-house expertise and working with clients to help them run their
merchant and electronic funds transfer businesses more efficiently
and productively, while our scale enables us to be highly price-
competitive.
15
Community Giving
Supporting our communities.
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 Fifth Third Foundation made over 560 grants
totaling $4 million in the areas of arts & culture, community
development, education and health & human services in 2006. The
Fifth Third Foundation also funded 17 scholarships of $2,500 each
to children of Fifth Third employees and matched $122,000 in
employees’ personal gifts to institutes of higher learning.
Our Community Affairs department identified 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
programs, and through the creation of the Young Bankers Club,
a nationally recognized program that promotes financial literacy in
elementary schools across our footprint.
2006 Employee & Corporate Giving
Over the past five years, Fifth Third
corporate and employee contributions
to the United Way have totaled
$50.1 million, including more than $9.6 million
contributed in 2006.
In 2006, grants from the Fifth Third Foundation, the George and
Betty Ann Schaefer Foundation and Fifth Third Bank provided
funding for a Veteran’s Day performance of the United States
Military Academy at West Point Cadet Gospel Choir at the National
Underground Railroad Freedom Center in Cincinnati. The event was
one part of day-long festivities to honor military veterans.
Fifth Third’s Community Development Corporation (CDC) invests in
low-income housing, historic tax credits and economic development
projects to support community revitalization in neighborhoods
throughout the Fifth Third footprint. In 2006, the CDC approached
a milestone — the lending of nearly $1 billion since its inception in
1989.
16
2006 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
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 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
Annual Report on Form 10-K
Consolidated Ten Year Comparison
Directors and Officers
Corporate Information
54
59
61
62
62
62
63
63
66
66
67
68
68
69
Related Party Transactions
Other Comprehensive Income
Common Stock and Treasury Stock
Stock-Based Compensation
Other Noninterest Income and Other Noninterest Expense
Sales and Transfers of Loans
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
18
19
20
20
22
25
31
34
35
38
48
49
50
51
52
53
70
70
71
72
74
74
76
77
78
79
79
80
81
82
84
95
96
97
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) 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; (2) political developments, wars or other hostilities may disrupt or increase volatility in securities markets or other economic
conditions; (3) changes in the interest rate environment reduce interest margins; (4) prepayment speeds, loan origination and sale volumes, charge-offs and loan loss
provisions; (5) changes and trends in capital markets; (6) competitive pressures among depository institutions increase significantly; (7) effects of critical accounting
policies and judgments; (8) changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board or other regulatory agencies;
(9) 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; (10) ability to maintain favorable ratings from rating agencies;
(11) fluctuation of Fifth Third’s stock price; (12) ability to attract and retain key personnel; (13) ability to receive dividends from its subsidiaries; (14) potentially dilutive
effect of future acquisitions on current shareholders' ownership of Fifth Third; (15) difficulties in combining the operations of acquired entities; (16) ability to secure
confidential information through the use of computer systems and telecommunications network; and (17) the impact of reputational risk created by these developments
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
Financial Ratios
Return on average assets
Return on average equity
Average equity as a percent of average assets
Tangible equity
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
2006
$2,899
2,153
5,052
343
3,056
1,188
$2.14
2.13
1.58
18.02
74.2 %
1.13 %
12.1
9.32
7.79
3.06
60.5
$316
.44 %
1.04
1.14
.61
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
6.87
3.23
53.2
299
.45
1.06
1.16
.52
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
8.35
3.48
53.9
252
.45
1.19
1.31
.51
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
8.56
3.62
47.0
312
.63
1.33
1.47
.61
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
9.54
3.96
47.5
187
.43
1.49
1.49
.59
Average Balances
Loans and leases, including held for sale
Total securities and other short-term investments
Total assets
Transaction deposits
Core deposits
Wholesale funding
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”). The taxable equivalent adjustments for years ending December 31, 2006, 2005, 2004, 2003 and 2002 are $26 million, $31
$73,493
21,288
105,238
48,946
59,446
32,423
9,811
67,737
24,999
102,876
47,929
56,420
33,863
9,317
57,042
30,597
94,896
43,175
49,383
33,714
8,860
52,414
28,947
87,481
40,370
46,796
28,814
8,754
45,539
23,585
75,037
35,819
44,674
19,086
8,317
8.39 %
11.07
8.44
8.35
10.42
8.08
10.31
12.31
8.89
10.97
13.42
9.11
11.70
13.51
9.73
million, $36 million, $39 million and $39 million, respectively.
(b) At December 31, 2004, the reserve for unfunded commitments was reclassified from the allowance for loan and lease losses to other liabilities. The 2003 year-end reserve for unfunded commitments
has been reclassified to conform to the current year presentation. The allowance for credit losses is the sum of the allowance for loan and lease losses and the reserve for unfunded commitments.
TABLE 2: QUARTERLY INFORMATION
For the three months ended ($ in millions, except per share data)
Net interest income (FTE)
Provision for loan and lease losses
Noninterest income
Noninterest expense
Income before cumulative effect
Cumulative effect of change in accounting principle, net of tax
Net income
Earnings per share, basic
Earnings per share, diluted
12/31
$744
107
219
798
66
-
66
.12
.12
2006
9/30
719
87
662
767
377
-
377
.68
.68
6/30
716
71
655
759
382
-
382
.69
.69
3/31
718
78
617
731
359
4
363
.66
.65
12/31
735
134
636
763
332
-
332
.60
.60
2005
9/30
745
69
622
732
395
-
395
.71
.71
6/30
758
60
635
728
417
-
417
.75
.75
3/31
759
67
607
705
405
-
405
.73
.72
18
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.
trends, events,
For a more complete understanding of
commitments, uncertainties, liquidity, capital resources 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. At December 31, 2006, the
Bancorp had $100.7 billion in assets, operated 19 affiliates with
1,150 full-service Banking Centers including 111 Bank Mart®
locations open seven days a week inside select grocery stores and
2,096 Jeanie® ATMs in Ohio, Kentucky, Indiana, Michigan,
Illinois, Florida, Tennessee, West Virginia, Pennsylvania and
Missouri. The Bancorp reports on five business segments:
Commercial Banking, Branch Banking, Consumer Lending,
Investment Advisors and Fifth Third Processing Solutions
(“FTPS”). During the first quarter of 2006, the Bancorp began
separating its Retail line of business into the Branch Banking and
Consumer Lending business segments. All prior year information
has been updated to reflect this presentation.
The Bancorp 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. Its affiliate
operating model provides a competitive advantage by keeping the
decisions close to the customer and by emphasizing individual
relationships. Through its 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 2006, net
interest income, on a fully taxable equivalent (“FTE”) basis, and
noninterest income provided 57% and 43% of total revenue,
respectively. Excluding fourth quarter balance sheet actions
discussed later in this section, net interest income (FTE) and
noninterest income provided 53% and 47% of total revenue,
respectively; comparison being provided to supplement an
understanding of fundamental revenue trends.
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 Risk Management section,
risk
identification, measurement, monitoring, control and
reporting are important to the management of risk and to the
financial performance and capital strength of the Bancorp.
Net interest income 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 to 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.
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 presentation to be the preferred
industry measurement of net interest income as it provides a
relevant comparison between taxable and non-taxable amounts.
Noninterest income is derived primarily from electronic
funds transfer (“EFT”) and merchant transaction processing fees,
card interchange, fiduciary and investment management fees,
corporate banking revenue, service charges on deposits and
mortgage banking revenue.
Earnings Summary
The Bancorp’s net income was $1.19 billion or $2.13 per diluted
share in 2006, a 23% decrease compared to $1.55 billion and $2.77
per diluted share in 2005. These results reflect the impact of the
balance sheet actions announced and completed during the fourth
quarter of 2006, which resulted in a pretax loss of $454 million.
Specifically, these balance sheet actions included:
•
Sale of $11.3 billion in available-for-sale securities with a
weighted-average yield of 4.30%;
• Reinvestment of approximately $2.8 billion in available-
for-sale securities that are more efficient when used as
collateral for pledging purposes;
• Repayment of $8.5 billion in wholesale borrowings at a
weighted-average rate paid of 5.30%; and
• Termination of approximately $1.1 billion of repurchase
and reverse repurchase agreements.
collateral
These actions were taken to improve the asset/liability profile of
the Bancorp and reduce the size of the Bancorp’s available-for-
sale securities portfolio to a size that is more consistent with its
risk management
interest
liquidity,
requirements; improve the composition of the balance sheet with
a lower concentration in fixed-rate assets; lower wholesale
borrowings to reduce leverage; and better position the Bancorp
for an uncertain economic and interest rate environment. The
pretax losses consisted of:
rate
and
•
•
•
$398 million in losses on the sale of securities;
$17 million in losses on derivatives to hedge the price of
the securities sold, recorded
in other noninterest
income; and
$39 million in charges related to the termination of
certain repurchase and reverse repurchase financing
agreements, recorded in other noninterest expense.
Net interest income (FTE) decreased three percent compared to
2005. Net interest margin decreased to 3.06% in 2006 from
3.23% in 2005 largely due to rising short-term interest rates, the
impact of the primarily fixed-rate securities portfolio and mix
shifts within the core deposit base from demand deposit and
interest checking categories to savings, money market and other
time deposit categories paying higher rates of interest.
Noninterest income decreased 14% in 2006 compared to
2005 primarily due to the securities and related derivative losses
from the balance sheet actions taken in the fourth quarter of 2006
totaling $415 million. Excluding these losses, noninterest income
increased $68 million, or three percent, compared to 2005 due to
continued strong growth in electronic payment processing and
corporate banking revenue offset by a $19 million decline in
mortgage banking revenue. Noninterest expense increased four
percent compared to 2005 primarily due to increases in volume-
related bankcard expenditures, equipment expenditures and
Fifth Third Bancorp 19
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
occupancy expense related to the addition of de novo banking
centers, investments in technology and the $39 million in charges
related to the termination of certain repurchase and reverse
repurchase agreements. Excluding the $39 million, noninterest
expense increased by three percent.
In 2006, net charge-offs as a percent of average loans and
leases were 44 basis points (“bp”) compared to 45 bp in 2005. At
December 31, 2006, nonperforming assets as a percent of loans
and leases increased to .61% from .52% at December 31, 2005.
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, 2006, the Tier I
capital ratio was 8.39% and the total risk-based capital ratio was
11.07%.
The Bancorp continues to invest in the geographic areas that
offer the best growth prospects, as it believes this investment is
the most cost efficient method of expansion within its largest
affiliate markets. During 2006, the Bancorp opened 51 net new
banking centers (excluding relocations and consolidations of
existing facilities) with plans to add a similar amount in high-
growth markets during 2007.
2007 Outlook
The following outlook represents management’s expectations for
key financial statement results in 2007. The outlook reflects
expectations for growth rates in 2007 compared to the full year
2006 or for a range of expected results in 2007. Our outlook is
based on current expectations as of the date of this report for
results within our businesses; prevailing views related to economic
RECENT ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board
(“FASB”) issued Statement of Financial Accounting Standard
(“SFAS”) No. 123 (Revised 2004), “Share-Based Payment.” This
Statement 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 using the retroactive restatement method described in
SFAS No. 148, “Accounting for Stock-Based Compensation –
Transition and Disclosure – an Amendment of FASB Statement
No. 123.” The adoption of this Statement did not have a material
impact on the Bancorp’s Consolidated Financial Statements.
In September 2006, the FASB issued SFAS No. 158,
“Employer’s Accounting for Defined Benefit Pension and Other
Postretirement Plans – An Amendment of FASB Statements No.
87, 88, 106, and 132(R).” This Statement amends the current
accounting for pensions and postretirement benefits by requiring
an entity to recognize the overfunded or underfunded status of a
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 loss experience and such factors
that, 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
20
Fifth Third Bancorp
growth, inflation, unemployment and other economic factors; and
market forward interest rate expectations. These expectations are
inherently subject to risks and uncertainties. Please refer to the
forward-looking statements on page 17 and the risk factors on
pages 22-24 for more information.
Management expects that the annualized net charge-off ratio
in the first quarter of 2007 will be below the range expected for
the full year 2007. Management also expects that noninterest
expense in the first quarter of 2007 will include a seasonal increase
of approximately $15 million to $20 million in FICA and
unemployment insurance expense compared to the fourth quarter
of 2006. These first quarter expectations are included in the full-
year outlook provided below.
Growth, Percentage
or bp range
Category
High single digits
Net interest income
3.35-3.45%
Net interest margin
High single digits
Noninterest income*
Mid single digits
Noninterest expense**
High single digits
Loans
Mid single digits
Core deposits
Low to mid 50 bp
Net charge-offs
29-30%
Effective tax rate
Tangible equity/tangible asset ratio
2007 year-end target 7%
*Comparison with the prior year excludes $415 million of losses recorded in noninterest
income related to fourth quarter of 2006 balance sheet actions.
**Comparison with the prior year excludes $49 million of charges: $10 million in third
quarter of 2006 related to the early retirement of debt and $39 million in fourth quarter of
2006 related to termination of financing agreements.
defined benefit postretirement plan as an asset or liability in its
statement of financial position and to recognize changes in that
funded status in the year in which the changes occur through
comprehensive income. This Statement also requires recognition,
as a component of other comprehensive income (net of tax), of
the actuarial gains and losses and the prior service costs and
credits that arise during the period, but are not recognized as
components of net periodic benefit cost pursuant to SFAS No. 87
and No. 106. Additionally, this Statement requires an entity to
measure defined benefit plan assets and obligations as of the date
of the employer’s fiscal year-end statement of financial position.
The Bancorp adopted this Statement on December 31, 2006. The
effect of this Statement was to recognize $59 million, after-tax, of
net actuarial losses and prior service cost as a reduction to
accumulated other comprehensive income.
See Note 1 of the Notes to Consolidated Financial
issued accounting
Statements for a discussion of recently
pronouncements.
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 weakness are subject to individual review. When individual
loans are
impaired, allowances are allocated 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 the fair value of the underlying
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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, which
are not impaired and thus not subject to specific allowance
allocations. The loss rates are derived from a migration analysis,
which tracks the net charge-off experience sustained on loans
according to their internal risk grade. The risk grading system
currently utilized for allowance analysis purposes encompasses ten
categories.
Homogenous loans and leases, such as consumer installment,
residential mortgage and automobile leases are not individually
Rather, standard credit scoring systems and
risk graded.
delinquency monitoring are used
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.
to assess credit
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.
The Bancorp’s current methodology for determining the
allowance for loan and lease losses is based on historical loss rates,
current credit grades, specific allocation on impaired commercial
credits and other qualitative adjustments.
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. An unallocated allowance is maintained to recognize
the imprecision in estimating and measuring loss when evaluating
allowances for individual loans or pools of loans.
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 allowance
The Bancorp’s determination of
for
commercial loans is sensitive to the risk grade it assigns to these
loans. In the event that 10% of commercial loans in each risk
category would experience a downgrade of one risk category, the
allowance for commercial loans would increase by approximately
$76 million at December 31, 2006. 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 would increase by 10%, the allowance for residential and
retail loans would increase by approximately $30 million at
December 31, 2006. As 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 grades 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 grades 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, Pennsylvania and Missouri. 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 material aspect of its overall approach to determine
its 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 $771 million was adequate, but not excessive, to
absorb estimated credit losses associated with the loan and lease
portfolio at December 31, 2006.
in
income
Valuation of 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 are reported at amortized cost. Available-for-sale
and trading securities are reported at fair value with unrealized
gains and losses included in accumulated other comprehensive
income, net of related deferred income taxes, on the Consolidated
Balance Sheets and noninterest income in the Consolidated
Statements of 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
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 to recovery. 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.
At December 31, 2006, 95% of the unrealized losses in the
available-for-sale security portfolio were comprised of securities
issued by U.S. Treasury and Government agencies, U.S.
Government sponsored agencies and states and political
subdivisions as well as agency mortgage-backed securities. The
Bancorp believes the price movements in these securities are
dependent upon the movement in market interest rates. The
Bancorp’s management also maintains the intent and ability to
hold securities in an unrealized loss position to the earlier of the
recovery of losses or maturity.
Reserve for Unfunded Commitments
The reserve for unfunded commitments is maintained at a level
believed by management to be sufficient to absorb estimated
probable losses related to unfunded credit facilities. The
determination of the adequacy of the reserve is based upon an
evaluation of
including an
the unfunded credit facilities,
assessment of historical commitment utilization experience, credit
risk grading and credit grade migration. Net adjustments to the
reserve for unfunded commitments are
in other
noninterest expense.
included
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.
Fifth Third Bancorp 21
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 Sheets. 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 laws. Deferred tax assets are recognized to the extent they
exist and are subject to a valuation allowance based on
management’s judgment that realization is more-likely-than-not.
Accrued taxes represent the net estimated amount due to
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 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. See Note 1
of the Notes to Consolidated Financial Statements for a
discussion of the recently issued accounting statement, which
clarifies the accounting for uncertainty in income taxes. As
described
in Note 13 of the Notes to
Consolidated Financial Statements, the Internal Revenue Service
is currently challenging the Bancorp’s tax treatment of certain
leasing transactions. For additional information, see Note 21 of
the Notes to Consolidated Financial Statements.
in greater detail
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
RISK FACTORS
Fifth Third’s results depend on general economic conditions
within its operating markets.
Fifth Third is affected by general economic conditions in the
United States as a whole and, in particular, the Midwest and
Florida. An economic downturn within these markets 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
volume generated by
institution
customers. This transaction volume 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 liabilities
related to the processing of Visa® and MasterCard® merchant
card transactions. These liabilities typically arise from billing
disputes between the merchant and the cardholder that are
22
Fifth Third Bancorp
loans, the weighted-average life, 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
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.
independent
The change in the fair value of MSRs at December 31, 2006,
due to immediate 10% and 20% adverse changes in the current
prepayment assumption would be approximately $23 million and
$45 million, respectively, and due to immediate 10% and 20%
favorable changes in the current prepayment assumption would
be approximately $25 million and $53 million, respectively. The
change in the fair value of the MSR portfolio at December 31,
2006, due to immediate 10% and 20% adverse changes in the
discount rate assumption would be approximately $19 million and
$37 million, respectively, and due to immediate 10% and 20%
favorable changes in the discount rate assumption would be
approximately $20 million and $42 million, respectively. Sensitivity
analysis related to other consumer and commercial servicing rights
is not material
the Bancorp’s Consolidated Financial
Statements.
to
the
relationship of
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
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.
the change
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, FTPS will bear the loss.
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
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.
Changes in interest rates could affect Fifth Third’s income
and cash flows.
Fifth Third’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
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Fifth Third’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 Fifth
Third does not effectively manage the relative sensitivity of its
interest rates.
assets and
Fluctuations in these areas may adversely affect Fifth Third and its
shareholders.
to changes
in market
liabilities
If Fifth Third does not adjust to rapid changes in the
financial services industry, its financial performance may
suffer.
Fifth Third’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 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, Fifth Third’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 or may not be currently able or
allowed to offer. This increasingly competitive environment is
primarily a result of changes in regulation, changes in technology
and product delivery systems, as well as the accelerating pace of
consolidation among financial service providers.
Legislative or regulatory compliance, changes or actions or
significant litigation, could adversely impact Fifth Third or
the businesses in which Fifth Third is engaged.
Fifth Third is subject to extensive state and federal regulation,
supervision and legislation that govern almost all aspects of its
operations and limit the businesses in which Fifth Third may
engage. These 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 Fifth Third or its ability to increase
the value of its business. Additionally, actions by regulatory
agencies or significant litigation against Fifth Third could cause it
to devote significant time and resources to defending itself and
may lead to penalties that materially affect Fifth Third and its
shareholders. Future changes in the laws, including tax laws, or
regulations or their interpretations or enforcement may also be
materially adverse to Fifth Third and its shareholders or may
require Fifth Third to expend significant time and resources to
comply with such requirements.
Fifth Third is exposed to operational risk.
Fifth Third is exposed to many types of operational risk, including
reputational risk, legal and compliance risk, the risk of fraud or
theft by employees, customers or outsiders, unauthorized
transactions by employees or operational errors.
Negative public opinion can result from Fifth Third’s actual
or alleged conduct in activities, such as lending practices, data
security, corporate governance and acquisitions, and may damage
Fifth Third’s
taken by
government regulators and community organizations may also
damage Fifth Third’s reputation. This negative public opinion can
adversely affect Fifth Third’s ability to attract and keep customers
and can expose it to litigation and regulatory action.
Additionally, actions
reputation.
Fifth Third’s necessary dependence upon automated systems
to record and process its transaction volume poses the risk that
tampering or
technical system
flaws or employee errors,
manipulation of those systems will result in losses and may be
difficult to detect. Fifth Third may also be subject to disruptions of
its operating systems arising from events that are beyond its
control
(for example, computer viruses or electrical or
telecommunications outages). Fifth Third is further exposed to the
risk that its outside service providers may be unable to fulfill their
contractual obligations (or will be subject to the same risk of fraud
or operational errors as Fifth Third). These disruptions may
interfere with service to Fifth Third’s customers and result in a
financial loss or liability.
Material breaches in security of Fifth Third’s systems may
have a significant effect on Fifth Third’s business.
Fifth Third collects, processes and stores sensitive consumer data
by utilizing computer systems and telecommunications networks
operated by both Fifth Third and third party service providers.
Fifth Third has security, backup and recovery systems in place, as
well as a business continuity plan to ensure the system will not be
inoperable. Fifth Third also has security to prevent unauthorized
access to the system. In addition, Fifth Third requires its third party
service providers to maintain similar controls. However, Fifth
Third cannot be certain that the measures will be successful. A
security breach in the system and loss of confidential information
such as credit card numbers and related information could result in
losing the customers’ confidence and thus the loss of their
business.
Changes and trends in the capital markets may affect Fifth
Third’s income and cash flows.
Fifth Third enters into and maintains trading and investment
positions in the capital markets on its own behalf and on behalf of
its customers. These investment positions also include derivative
financial instruments. The revenues and profits Fifth Third derives
from its trading and investment positions are dependent on market
prices. If it does not correctly anticipate market changes and
trends, Fifth Third may experience investment or trading losses
that may materially affect Fifth Third and its shareholders. Losses
on behalf of its customers could expose Fifth Third to litigation,
credit risks or loss of revenue from those customers. Additionally,
substantial losses in Fifth Third’s trading and investment positions
could lead to a loss with respect to those investments 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
Fifth Third’s consolidated financial statements. These changes can
be hard to predict and can materially impact how Fifth Third
records and reports
its financial condition and results of
operations. In some changes, Fifth Third could be required to
apply a new or revised standard retroactively, which would result in
the restatement of Fifth Third’s 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 Fifth Third’s most critical
estimates are the level of the allowance for loan and lease losses
and the valuation of mortgage servicing rights. Due to the inherent
nature of these estimates, Fifth Third cannot provide absolute
assurance that it will not significantly increase the allowance for
loan and lease 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, please refer to the Critical Accounting Policies section.
Fifth Third Bancorp 23
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Fifth Third’s ability to receive dividends from its subsidiaries
accounts for most of its revenue and could affect its liquidity
and ability to pay dividends.
Fifth Third Bancorp is a separate and distinct legal entity from its
subsidiaries. Fifth Third Bancorp receives substantially all of its
revenue from dividends from its subsidiaries. These dividends are
the principal source of funds to pay dividends on Fifth Third
Bancorp’s stock and interest and principal on its debt. Various
federal and/or state laws and regulations limit the amount of
dividends that Fifth Third’s bank and certain nonbank subsidiaries
may pay. Also, Fifth Third Bancorp’s right to participate in a
distribution of assets upon a subsidiary’s
liquidation or
reorganization is subject to the prior claims of that subsidiary’s
creditors. Limitations on Fifth Third Bancorp’s ability to receive
dividends from its subsidiaries could have a material adverse effect
on Fifth Third Bancorp’s liquidity and ability to pay dividends on
stock or interest and principal on its debt.
Future acquisitions may 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 Fifth Third 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 Fifth Third 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.
Inherent uncertainties exist in integrating the operations of an
acquired entity. Fifth Third may not be able to fully achieve its
strategic objectives and operating efficiencies in an acquisition. In
addition, the markets and industries in which Fifth Third and its
potential acquisition targets operate are highly competitive. Fifth
Third may lose customers or the customers of acquired entities as a
result of an acquisition. Future acquisition and integration activities
may require Fifth Third to devote substantial time and resources
and as a result Fifth Third may not be able to pursue other
business opportunities. These factors could contribute to Fifth
Third not achieving the expected benefits from its acquisitions
within desired time frames, if at all.
Fifth Third could suffer if it fails to attract and retain skilled
personnel.
As Fifth Third continues to grow, its success depends, in large part,
on its ability to attract and retain key individuals. Competition for
qualified candidates in the activities and markets that Fifth Third
serves is great and Fifth Third may not be able to hire these
candidates and retain them. If Fifth Third is not able to hire or
retain these key individuals, Fifth Third may be unable to execute
its business strategies and may suffer adverse consequences to its
business, operations and financial condition.
Fifth Third and/or the holders of its securities could be
adversely affected by unfavorable ratings from rating
agencies.
Fifth Third’s ability to access the capital markets is important to its
overall funding profile. This access is affected by the ratings
assigned by rating agencies to Fifth Third, certain of its affiliates
and particular classes of securities they issue. The interest rates
that Fifth Third pays on its securities are also influenced by, among
other things, the credit ratings that it, its affiliates and/or its
securities receive from recognized rating agencies. A downgrade to
Fifth Third’s, or its affiliates’, credit rating will affect its ability to
access the capital markets, increase its borrowing costs and
negatively impact its profitability. A ratings downgrade to Fifth
Third, its affiliates or their securities could also create obligations
or liabilities to Fifth Third under the terms of its outstanding
securities that could increase Fifth Third’s costs or otherwise have
a negative effect on Fifth Third’s results of operations or financial
condition. Additionally, a downgrade of the credit rating of any
particular security issued by Fifth Third or its affiliates could
negatively affect the ability of the holders of that security to sell the
securities and the prices at which any such securities may be sold.
Fifth Third’s stock price is volatile.
Fifth Third’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;
•
Fifth Third’s announcements of developments related to
its businesses;
• Operating and stock performance of other companies
deemed to be peers;
• Actions by government regulators;
• New technology used or services offered by traditional
and non-traditional competitors; and
• News reports of trends, concerns and other issues related
to the financial services industry.
Fifth Third’s stock price may fluctuate significantly in the future,
and these fluctuations may be unrelated to Fifth Third’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 of such stock may not be indicative of
future market prices.
24
Fifth Third Bancorp
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
STATEMENTS OF INCOME ANALYSIS
Net Interest Income
Net interest income is the interest earned on debt securities, loans
and leases (including yield-related fees) and other interest-earning
assets less the interest paid for core deposits and wholesale
funding. The net interest margin is calculated by dividing net
interest income by average interest-earning assets. Net interest
spread is the difference between the average rate earned on
interest-earning assets and the average rate paid on interest-
bearing liabilities. Net interest margin is greater than net interest
rate spread due to the interest income earned on those assets that
are funded by non-interest bearing liabilities, or free funding, such
as demand deposits or shareholders’ equity.
The continued increases in short-term rates during the first
half of 2006 and the subsequent inverted interest rate yield curve
negatively impacted Fifth Third as well as other financial
institutions in 2006. The average interest rate spread between the
3-month Treasury bill and the 10-year Treasury note compressed
from 107 bp in 2005 to negative 6 bp in 2006. At December 31,
2006, this interest rate spread declined to negative 31 bp. This
significant decline illustrates the relative pressure between shorter-
term and
longer-term funding costs and general securities
portfolio reinvestment opportunities.
Net interest income declined three percent to $2.9 billion as a
result of the net interest margin contracting 17 bp to 3.06%. The
decline in the net interest margin occurred despite an increase in
average loans and leases of eight percent and an increase in
average core deposits of five percent. In terms of mix between
volume and yield, net interest income decreased eight percent due
to the impact of changes in interest rates. The decline in net
interest margin largely resulted from the decrease in net interest
spread, from 2.76% in 2005 to 2.37% in 2006, attributable to the
increased cost of deposits and wholesale funding, the impact of
the primarily fixed-rate securities portfolio and the change in mix
within the core deposit base. The decrease in net interest spread
was partially offset by an increased benefit from free funding of
69 bp in 2006, up 22 bp over 2005. The relatively large increase in
the benefit of free funding was the result of higher funding costs
and an improvement in the net free funding position of the
Bancorp, calculated as total noninterest-bearing liabilities and
shareholders’ equity
less noninterest-earning assets, which
increased two percent to $16.7 billion.
In light of the Bancorp’s asset/liability considerations and
changing market conditions, the Bancorp’s Board of Directors
approved several actions on November 20, 2006 to strategically
shift the composition of its balance sheet. These actions reduced
the size of the Bancorp’s available-for-sale securities portfolio to a
size that is more consistent with its liquidity, collateral and interest
rate risk management requirements; improved the composition of
the balance sheet with a lower concentration of fixed-rate assets;
lowered wholesale borrowings to reduce leverage; and better
positioned the Bancorp for an uncertain economic and interest
rate environment. Specifically, these actions included (i) the sale
of $11.3 billion in available-for-sale securities with a weighted-
average yield of 4.30%; (ii) reinvestment of approximately $2.8
billion in available-for-sale securities that are more efficient when
used as collateral; (iii) repayment of $8.5 billion in wholesale
borrowings at an average rate paid of 5.30%; and (iv) the
termination of approximately $1.1 billion of repurchase and
reverse repurchase agreements. These actions are expected to
result in a benefit to net interest income in 2007, given current
market expectations, of approximately $110 million to $120
million, and a benefit to the net interest margin in 2007 of
approximately 35-40 bp.
The growth in average loans and leases in 2006 outpaced
core deposit growth by $2.7 billion. The funding shortfall was
more than offset by a $4.0 billion reduction in the average
available-for-sale securities portfolio. In addition to the fourth
quarter sale of available-for-sale securities mentioned above,
throughout 2006, the Bancorp continued to use cash flows from
its securities portfolio to reduce its reliance on wholesale funding.
In the third quarter of 2006, the Bancorp also sold approximately
$726 million from its securities portfolio, which represented nearly
all of its position in Federal Home Loan Mortgage Corporation
(“FHLMC”) callable debt, in order to manage its credit exposure
to FHLMC. In 2006, wholesale funding represented 41% of
interest-bearing liabilities, down from 44% in 2005.
During 2006, the Bancorp continued its deposit pricing
strategy of moving away from promotional rates and towards
highly competitive daily rates. As part of this strategy, the
Bancorp maintains competitive deposit rates in all of its affiliate
markets and across all of its deposit products. Additionally,
interest-checking balances have continued to migrate into money
market, savings and time deposit accounts. During 2006, interest-
checking balances were 36% of average interest-bearing core
deposits and savings and money market combined to represent
41%, compared to 44% and 36%, respectively, in 2005.
TABLE 3: CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the years ended December 31 ($ 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
2006
$5,981
3,082
2,899
343
2,556
2,153
3,056
1,653
26
443
1,184
-
1,184
-
1,184
4
$1,188
$2.14
2.13
1.58
2005
5,026
2,030
2,996
330
2,666
2,500
2,927
2,239
31
659
1,549
-
1,549
-
1,549
-
1,549
2.79
2.77
1.46
2004
4,150
1,102
3,048
268
2,780
2,465
2,972
2,273
36
712
1,525
-
1,525
-
1,525
-
1,525
2.72
2.68
1.31
2003
4,030
1,086
2,944
399
2,545
2,483
2,551
2,477
39
786
1,652
(20)
1,632
44
1,676
(11)
1,665
2.91
2.87
1.13
2002
4,168
1,430
2,738
246
2,492
2,183
2,337
2,338
39
734
1,565
(38)
1,527
4
1,531
-
1,531
2.64
2.59
.98
Fifth Third Bancorp 25
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 4: CONSOLIDATED AVERAGE BALANCE SHEETS AND ANALYSIS OF NET INTEREST INCOME (FTE)
For the years ended December 31
2006
Revenue/
Cost
Average
Yield/Rate
Average
Balance
Average
Yield/Rate
Average
Balance
2005
Revenue/
Cost
($ in millions)
Assets
Interest-earning assets:
Loans and leases (a):
Commercial loans
Commercial mortgage
Commercial construction
Commercial leases
Subtotal - commercial
Residential mortgage
Residential construction
Other consumer loans
Consumer leases
Subtotal - consumer
Total loans and leases
Securities:
Taxable
Exempt from income taxes (a)
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
Average
Balance
$20,400
9,797
6,015
3,730
39,942
8,855
719
22,649
1,328
33,551
73,493
20,306
604
378
94,781
2,495
8,713
(751)
$105,238
$16,650
12,189
6,366
10,500
5,795
3,711
4,148
-
4,522
14,247
78,128
13,741
3,558
95,427
9,811
$105,238
$1,479
700
460
185
7.25 %
7.15
7.64
4.97
2,824 7.07
5.93
6.02
6.87
4.72
6.52
6.82
525
43
1,556
63
2,187
5,011
904
45
21
5,981
4.45
7.38
5.52
6.31
$18,241
8,923
5,525
3,495
36,184
8,396
586
20,749
1,822
31,553
67,737
24,017
789
193
92,736
2,758
8,102
(720)
$102,876
$1,063
551
342
179
5.83 %
6.17
6.19
5.11
2,135 5.90
5.52
5.48
5.86
4.59
5.69
5.80
463
32
1,216
84
1,795
3,930
1,032
58
6
5,026
4.30
7.39
2.89
5.42
$14,908
7,391
3,807
3,296
29,402
6,454
347
18,542
2,297
27,640
57,042
29,365
917
315
87,639
2,216
5,763
(722)
$94,896
$398
363
261
433
278
177
208
-
194
770
3,082
2.39 %
2.98
4.10
4.12
4.80
4.76
5.02
-
4.28
5.40
3.94
$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
$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
$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
2004
Revenue/
Cost
Average
Yield/Rate
$682
387
181
181
1,431
357
17
947
108
1,429
2,860
1,217
68
5
4,150
4.57 %
5.23
4.76
5.49
4.87
5.52
4.99
5.10
4.71
5.17
5.01
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
Total interest-bearing liabilities
Demand deposits
Other liabilities
Total liabilities
Shareholders’ equity
Total liabilities and shareholders’ equity
Net interest income margin
Net interest rate spread
Interest-bearing liabilities to interest-earning assets
(a) The net taxable-equivalent adjustments included in the above table are $26 million, $31 million and $36 million for the years ended December 31, 2006, 2005 and 2004, respectively.
3.23%
2.76
82.40
3.06%
2.37
82.43
$2,899
$3,048
$2,996
3.48%
3.17
80.75
The cost of interest-bearing core deposits was 3.18% in 2006,
up from 2.10% in 2005. Despite the increasing deposit rates, the
relative cost advantage of interest-bearing core deposits compared
to wholesale funding increased from 126 bp in 2005 to 183 bp in
2006. Due to the increasing relative cost advantage of core
deposits, the Bancorp has continued to expand its branching
network to increase its presence in markets that offer the best
growth prospects. In 2006, the Bancorp added 51 net new
banking centers with plans to add a similar amount in 2007.
Interest income (FTE) from loans and leases increased $1.1
billion, or 28%, compared to 2005. The increase resulted from
the growth in average loans and leases of eight percent as well as a
102 bp increase in average rates. Average commercial loans and
leases grew 10% in 2006 due to growth in all subcategories. The
yield on commercial loans and leases expanded by 117 bp to
7.07% in 2006. The yield expansion was greatest in commercial
loans and commercial construction due to the increase in short-
term interest rates and the subsequent repricing. Average
consumer loans and leases increased by six percent in 2006 driven
primarily by the 23% increase in residential construction and nine
percent increase in other consumer loans. Other consumer loans
primarily consist of direct and indirect home equity lines and
26
Fifth Third Bancorp
loans, direct and indirect auto loans and credit cards. The average
consumer loan and lease yield increased 83 bp to 6.52%.
Interest income (FTE) from investment securities and short-
term investments decreased $126 million to $970 million in 2006
compared to 2005 due to the previously mentioned reduction of
the investment securities portfolio. The average yield on taxable
securities increased by only 15 bp as a result of the relative
stability in longer-term interest rates.
Average
The interest on core deposits increased $562 million, or 63%,
in 2006 over 2005 due to increases in short-term interest rates and
increasing average balances.
interest-bearing core
deposits increased $3.2 billion, or seven percent, compared to
2005. The Bancorp continues to focus on growing its core
deposit balances in order to improve the funding mix and
improve net interest margin trends. The growth in noninterest-
bearing funds and other core deposits is a critical component in
the growth of net interest income.
The interest on wholesale funding increased by $490 million,
or 43%, in 2006 compared to 2005 due to increasing short-term
interest rates partially offset by a $1.4 billion, or four percent,
decrease in average balances. Throughout 2006, the Bancorp used
the proceeds from the securities portfolio to lessen its reliance on
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
wholesale funding in order to reduce leverage and better position
the Bancorp for the uncertain rate environment.
Table 4 presents the components of net interest income, net
interest margin and net interest spread for 2006, 2005 and 2004.
Nonaccrual loans and leases and loans held for sale have been
included in the average loan and lease balances. Average
outstanding securities balances are based on amortized cost with
any unrealized gains or losses on available-for-sale securities
included in other assets. Table 5 provides the relative impact of
changes in the balance sheet and changes in interest rates on net
interest income.
TABLE 5: CHANGES IN NET INTEREST INCOME (FTE) ATTRIBUTED TO VOLUME AND YIELD/RATE (a)
For the years ended December 31
($ in millions)
Increase (decrease) in interest income:
2006 Compared to 2005
Yield/Rate
Volume
Volume
Total
2005 Compared to 2004
Yield/Rate
Loans and leases:
Commercial loans
Commercial mortgage
Commercial construction
Commercial leases
Subtotal - commercial
Residential mortgage
Residential construction
Other consumer loans
Consumer leases
Subtotal - consumer
Total loans and leases
Securities:
Taxable
Exempt from income taxes
Other short-term investments
Total change in interest income
Increase (decrease) in interest expense:
$136
57
32
11
236
26
8
118
(23)
129
365
(164)
(13)
8
196
280
92
86
(5)
453
36
3
222
2
263
716
36
-
7
759
416
149
118
6
689
62
11
340
(21)
392
1,081
(128)
(13)
15
955
171
88
96
10
365
106
13
120
(22)
217
$582
(228)
(10)
(2)
342
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
(5)
18
26
68
42
(7)
(27)
(9)
(23)
103
186
Total change in interest expense
156
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.
125
142
83
99
78
60
73
-
71
256
987
(228)
84
187
121
170
149
51
70
(6)
56
170
1,052
(97)
(41)
45
38
71
71
(9)
(3)
(6)
(15)
(86)
65
$131
210
76
65
(12)
339
-
2
149
(2)
149
488
43
-
3
534
145
100
75
33
39
75
88
-
83
104
742
(208)
Total
381
164
161
(2)
704
106
15
269
(24)
366
1,070
(185)
(10)
1
876
140
118
101
101
81
68
61
(9)
60
207
928
(52)
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 period charge-offs less
recoveries in the current period on previously charged off assets.
The provision for loan and lease losses increased to $343
million in 2006 compared to $330 million in 2005. The $13
million increase from the prior year is due to both the increase in
nonperforming assets from $361 million in 2005 to $455 million
in 2006 and increased loan growth throughout the year. As of
December 31, 2006, the allowance for loan and lease losses as a
percent of loans and leases declined modestly to 1.04% from
1.06% at December 31, 2005.
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 the loan portfolio and the allowance for loan and
lease losses.
Noninterest Income
In 2006, the Bancorp refined its presentation of noninterest
income in order to provide more granularity around its revenue
streams.
The primary result of this refinement was the
consolidation of the Bancorp’s interest rate derivative sales,
international service fees, institutional sales and loan and lease
syndication fees into a new income statement line item titled
corporate banking revenue.
Total noninterest income decreased 14% compared to 2005
primarily due to the impact of the previously mentioned balance
sheet actions taken in the fourth quarter of 2006. Excluding the
income
$415 million
increased $68 million, or three percent, over 2005. The
components of noninterest income are shown in Table 6.
impact of these actions, noninterest
Electronic payment processing revenue
increased $109
million, or 15%, in 2006 as FTPS realized growth in each of its
three product lines. Merchant processing revenue increased $45
million, or 13%, to $395 million due to the addition of new
national merchant customers and resulting increases in merchant
transaction volumes. EFT revenue increased $41 million, or 16%,
to $297 million as a result of continued success in attracting
financial institution customers. Card issuer interchange increased
$23 million, or 16%, to $165 million on sales volume increases of
15%. The Bancorp continues to see significant opportunities in
attracting new financial institution customers and retailers. The
Bancorp handles electronic processing for over 142,000 merchant
locations and 2,300 financial institutions worldwide, including The
Kroger Co., Nordstrom, Inc., the Armed Forces Financial
Network and, during 2006, added Talbots and Gregg Appliances,
Inc.
Fifth Third Bancorp 27
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 6: NONINTEREST INCOME
For the years ended December 31 ($ in millions)
Electronic payment processing revenue
Service charges on deposits
Mortgage banking net revenue
Investment advisory revenue
Corporate banking revenue
Other noninterest income
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)
Origination fees and gains on loan sales
Servicing revenue:
Servicing fees
Servicing rights amortization
Net valuation adjustments on servicing rights and free-standing
derivatives entered into to economically hedge MSR
Net servicing revenue
Mortgage banking net revenue
2006
$857
517
155
367
318
300
(364)
3
$2,153
2006
$92
121
(68)
10
63
$155
2005
748
522
174
358
299
360
39
-
2,500
2005
128
109
(73)
10
46
174
2004
631
515
178
363
228
587
(37)
-
2,465
2004
112
109
(93)
50
66
178
2003
593
485
302
335
241
443
81
3
2,483
2003
353
114
(176)
11
(51)
302
2002
528
431
188
325
195
369
114
33
2,183
2002
252
132
(156)
(40)
(64)
188
Service charges on deposits were relatively flat compared to
2005. Commercial deposit revenues were comparable to the prior
year as the overall growth in commercial account relationships
was offset by a 34% increase in earnings credits on compensating
balances as a result of the higher interest rate environment. Retail
deposit revenues were flat in 2006 compared to 2005. Net new
consumer deposit account production increased by 40% during
2006 compared to 2005. However, the production increase was
offset by lower consumer overdraft fees. Growth in the number
of customer deposit account relationships and deposit generation
continues to be a primary focus of the Bancorp.
Mortgage banking net revenue decreased to $155 million in
2006 from $174 million in 2005. The components of mortgage
banking net revenue are shown in Table 7. Origination fees and
gains on loans sales decreased $36 million due to lower origination
volume, the increasingly competitive nature of the business and
the effects of the inverted yield curve. Originations in 2006 were
$9.4 billion compared to $9.9 billion in 2005.
Mortgage net servicing revenue increased by $17 million
compared to 2005. Net servicing revenue is comprised of gross
servicing fees and related amortization as well as valuation
adjustments on mortgage servicing rights and mark-to-market
adjustments on both settled and outstanding free-standing
derivative financial instruments. The Bancorp’s total residential
mortgage loans serviced at December 31, 2006 and 2005 were
$37.9 billion and $34.0 billion, respectively, with $28.7 billion and
$25.7 billion, respectively, of residential mortgage loans serviced
for others.
The increase in interest rates and the resulting decrease in
changing prepayment speeds led to a recovery in temporary
impairment of $19 million in 2006 and $33 million in 2005.
impaired when a
Servicing rights are deemed temporarily
borrower’s loan rate is distinctly higher than prevailing rates.
Temporary impairment on servicing rights is reversed when the
prevailing rates return to a
level commensurate with the
borrower’s loan rate. Further detail on the valuation of mortgage
servicing rights can be found in Note 7 of the Notes to
Consolidated Financial Statements. The Bancorp maintains a
non-qualifying hedging strategy to manage a portion of the risk
associated with the impact of changes in interest rates on the MSR
portfolio. The Bancorp recognized a net loss of $9 million and
$23 million in 2006 and 2005, respectively, related to changes in
fair value and settlement of free-standing derivatives purchased to
economically hedge the MSR portfolio. See Note 8 of the Notes
to Consolidated Financial Statements for more information on the
free-standing derivatives used to hedge the MSR portfolio. 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 a
component of its non-qualifying hedging strategy. A gain of $3
million was recognized in 2006 on the sale of securities used to
hedge the MSR portfolio.
Investment advisory revenues were up modestly in 2006
compared to 2005. Private client revenues increased $10 million,
or eight percent due to growth in nearly all subcategories on the
strength of cross-sell initiatives within the private client group.
This increase was partially offset by a decrease in mutual fund fees
of $7 million, or 10%, reflecting the effects of a shift toward a
greater open architecture framework where investors are provided
with other mutual fund options in addition to the family of Fifth
Third Funds.* The Bancorp continues to focus its sales efforts on
improving execution in retail brokerage and retail mutual funds
and on growing the institutional money management business by
improving penetration and cross-sell in its large middle-market
commercial customer base. The Bancorp is one of the largest
money managers in the Midwest and as of December 31, 2006
had approximately $220 billion in assets under care, $34 billion in
assets under management and $12 billion in its proprietary Fifth
Third Funds.*
Compared to 2005, corporate banking revenue increased $19
million primarily due to a $13 million, or 13%, increase in
commercial syndication fees. Other increases included a $4
million, or five percent, increase in derivative product revenues
and $2 million, or six percent, increase in underwriting revenues.
The Bancorp is committed to providing a comprehensive range of
financial services to large and middle-market businesses and
continues to see opportunities to expand its product offering.
The major components of other noninterest income for each
of the last five years are shown in Table 8. Other noninterest
income declined 17% compared to the prior year. The decrease
was primarily attributable to the continued planned run off in the
consumer operating lease portfolio and a $17 million loss in mark-
to-market free-standing derivatives related to the balance sheet
actions taken in the fourth quarter. Operating lease revenues in
*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.
28
Fifth Third Bancorp
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
2006 consisted of commercial operating lease revenues that
increased $10 million to $18 million and consumer operating lease
revenues that decreased $39 million to $8 million compared to
2005. Operating lease revenues will moderate throughout 2007 as
leases continue to mature and are offset by
automobile
originations of commercial operating leases.
TABLE 8: COMPONENTS OF OTHER NONINTEREST INCOME
For the years ended December 31 ($ in millions)
Cardholder fees
Consumer loan and lease fees
Operating lease income
Bank owned life insurance income
Insurance income
Gain on sales of third-party sourced merchant processing contracts
Other
Total other noninterest income
Noninterest Expense
The Bancorp continued to focus on expense control during 2006
and expects growth in noninterest expenses to be consistent with
recent trends through 2007. Cost savings initiatives will continue
to be somewhat mitigated by investments in certain high
opportunity markets, as evidenced by the de novo banking centers
added in 2006.
During 2006, the Bancorp continued its investment in the
expansion of the retail distribution network and in its information
technology infrastructure. The efficiency ratio (noninterest
expense divided by the sum of net interest income (FTE) and
noninterest income) was 60.5% and 53.2% for 2006 and 2005,
respectively, and was affected by the balance sheet actions during
the fourth quarter of 2006. Excluding fourth quarter balance
sheet actions, the efficiency ratio for 2006 was 55.2%; comparison
being provided to supplement an understanding of fundamental
trends. Total noninterest expense increased four percent in 2006
compared to 2005. This comparison is impacted by $49 million
of debt and other financing agreement termination charges.
Exclusive of these charges, total noninterest expense increased by
$80 million, or three percent, over 2005 primarily due to increases
in volume-related bankcard costs and occupancy expenditures
related to the addition of de novo banking centers.
Total personnel cost (salaries, wages and incentives plus
employee benefits) increased by four percent in 2006 compared to
2005. The increases are related to employee incentives, increased
medical insurance costs and a change in accounting for retirement
TABLE 9: NONINTEREST EXPENSE
For the years ended December 31 ($ in millions)
Salaries, wages and incentives
Employee benefits
Equipment expense
Net occupancy expense
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
Loan and lease
Travel
Information technology and operations
Operating lease
Debt and other financing agreement termination
Other
Total other noninterest expense
The Bancorp recognized net securities losses of $364 million
in 2006. Securities losses in 2006 primarily consisted of losses
resulting from balance sheet actions taken during the fourth
quarter of 2006 partially offset by a $78 million gain from the sale
of MasterCard, Inc. shares.
2006
$49
47
26
86
28
-
64
$300
2005
46
50
55
91
27
-
91
360
2004
39
57
156
61
28
157
89
587
2003
41
65
124
62
25
-
126
443
2002
36
70
-
62
55
-
146
369
eligible stock compensation as a result of the implementation of
SFAS 123(R). See Note 18 of the Notes to Consolidated
Financial Statements for additional information regarding stock-
based compensation. As of December 31, 2006, the Bancorp
employed 22,385 employees, of which 6,140 were officers and
2,715 were part-time employees. Full time equivalent employees
totaled 21,362 as of December 31, 2006 compared to 21,681 as of
December 31, 2005.
Net occupancy expenses increased 11% in 2006 over 2005
due to the addition of 51 net new banking centers. The Bancorp
remains focused on expanding its retail franchise through de novo
growth with plans to open approximately 50 net new banking
centers in 2007.
Total other noninterest expense increased three percent in
2006 compared to 2005 primarily due to volume-related bankcard
costs and previously mentioned debt and other financing
agreement termination charges. Exclusive of these termination
charges, other noninterest income decreased $11 million, or one
percent. Marketing expense was stable compared to the prior
year and remains primarily focused on deposit generation.
Bankcard expense increased 16% compared to last year due to an
increase in the number of merchant and retail customers as well as
continuing growth in debit and credit card usage. Operating lease
expense declined 55% from 2005 as a result of the continued
planned run off of the automobile operating lease portfolio as
noted above.
2006
$1,174
292
122
245
1,223
$3,056
2006
$124
49
317
93
52
112
18
49
409
$1,223
2005
1,133
283
105
221
1,185
2,927
2005
126
50
271
89
54
114
40
-
441
1,185
2004
1,018
261
84
185
1,424
2,972
2004
99
49
224
82
41
87
114
325
403
1,424
2003
1,031
240
82
159
1,039
2,551
2003
99
49
197
106
35
76
94
20
363
1,039
2002
1,029
201
79
142
886
2,337
2002
96
48
170
91
38
54
-
-
389
886
Fifth Third Bancorp 29
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 11: APPLICABLE INCOME TAXES
For the years ended December 31 ($ 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
2006, the lower pretax income combined with tax credits at a level
consistent with the prior years and favorable resolution of certain
tax examinations resulted in a decrease in the effective tax rate. In
2007, the Bancorp expects the effective tax rate to be approximately
29%-30%.
Cumulative Effect of Change in Accounting Principle
In the first quarter of 2006, the Bancorp recognized a benefit of
approximately $4 million, net of $2 million of tax, related to the
adoption of SFAS No. 123(R). The benefit recognized relates to
the Bancorp’s estimate of forfeiture experience to be realized for all
unvested stock-based awards outstanding.
Comparison of 2005 with 2004
Net income in 2005 increased $24 million compared to 2004.
Diluted earnings per common share were $2.77 compared to $2.68.
In 2005, return on average assets was 1.50% and return on average
shareholders’ equity was 16.6% versus 1.61% and 17.2%,
respectively, in 2004. Net income in 2004 was negatively impacted
by balance sheet actions, which included debt termination charges
and securities losses totaling $404 million pretax. Earnings were
positively impacted by a $157 million pretax gain resulting from the
sale of certain third-party sourced merchant processing contracts in
2004 and securities gains totaling $39 million pretax in 2005.
2006
$1,627
443
27.2 %
2005
2,208
659
29.9
2004
2,237
712
31.8
2003
2,438
786
32.3
2002
2,299
734
31.9
Net interest income (FTE) decreased $52 million in 2005
compared to 2004. The net interest margin decline to 3.23% in
2005 from 3.48% in 2004 was primarily attributable 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. The
decline in net interest margin occurred despite a six percent increase
in average interest-earning assets from 2004 to 2005.
Noninterest income increased $35 million in 2005 compared to
2004. The comparison to 2004 is impacted by the gain on sale of
certain third-party sourced merchant processing contracts in 2004.
Exclusive of this gain, noninterest income increased eight percent
compared to 2005. The increase in noninterest income was
attributable to increased electronic payment processing revenue and
corporate banking revenue offset by a decrease in operating lease
revenue as a result of the run off of the automobile operating lease
portfolio.
Noninterest expense decreased $45 million in 2005 compared
to 2004. Increases in salaries, wages and incentives were offset by
the previously discussed debt termination charges in 2004 totaling
$325 million. The increased salaries, wages and incentives were a
result of the sales force expansion and the addition of employees
from the acquisition of First National Bankshares of Florida, Inc.
on January 1, 2005.
The provision for loan and lease losses was $330 million in
2005 compared to $268 million in 2004. The increase in the
provision was due to the increase in nonperforming assets as well as
a 17% portfolio loan growth. The total allowance for loan and lease
losses as a percent of total loans and leases was 1.06% at December
31, 2005 compared to 1.19% at December 31, 2004.
30
Fifth Third Bancorp
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS SEGMENT REVIEW
The Bancorp reports on five business segments: Commercial
Banking, Branch Banking, Consumer Lending, Investment
Advisors and Processing Solutions. During the first quarter of
2006, the Bancorp began reporting its Retail line of business as two
business segments, Branch Banking and Consumer Lending. All
prior year
this
presentation. Further detailed financial information on each
business segment is included in Note 28 of the Notes to
Consolidated Financial Statements.
information has been updated
to reflect
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. During the fourth quarter of 2006,
the Bancorp changed its application of the provision for loan and
lease losses to the segments to include only actual net charge-offs.
The Bancorp manages interest rate risk centrally at the
corporate level by employing a funds transfer pricing (“FTP”)
methodology. This methodology insulates the business segments
from interest rate volatility, 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 and the
Treasury swap curve. Matching the duration, or the effective term
until an instrument can be repriced, allocates interest income and
interest expense to each segment so its resulting net interest
income is insulated from interest rate risk. In a rising rate
environment, the Bancorp benefits from widening spread between
deposit costs and wholesale funding costs.
However, the
Bancorp’s FTP system credits this benefit to deposit providing
businesses, such as Branch Banking and Investment Advisors, on a
duration-adjusted basis. The net impact of the FTP methodology,
including the benefit from the widening spread between deposit
costs and wholesale funding, is captured in Other/Eliminations.
During the fourth quarter of 2006, the Bancorp made certain
changes to the average duration of indeterminate-lived deposits
and corresponding changes to the FTP crediting rates assigned to
those deposits. This change more closely aligns the crediting rates
to the expected economic benefit while continuing to insulate the
segments from interest rate volatility. Prior period results have
been conformed to current period presentation.
The financial results of the business segments
include
allocations for shared services and headquarter 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. Net income by
business segment is summarized in the table below.
2006
TABLE 12: BUSINESS SEGMENT NET INCOME
For the years ended December 31
($ in millions)
Income Statement Data
Commercial Banking
Branch Banking
Consumer Lending
Investment Advisors
Processing Solutions
Other/Eliminations
Acquisitions
Net income
$651
570
137
81
180
(431)
-
$1,188
2005
2004
614
548
160
76
117
34
-
1,549
563
620
211
96
204
(157)
(12)
1,525
Commercial Banking
Commercial Banking provides a comprehensive range of financial
services and products to large and middle-market businesses,
governments and professional customers. In addition to the
traditional lending and depository offerings, Commercial Banking
products and services include, among others, cash management,
foreign exchange and international trade finance, derivatives and
capital markets services, asset-based lending, real estate finance,
public finance, commercial leasing and syndicated finance. The
table below contains selected financial data for the Commercial
Banking segment.
TABLE 13: COMMERCIAL BANKING
For the years ended December 31
($ in millions)
Income Statement Data
Net interest income (FTE) (a)
Provision for loan and lease losses
Noninterest income:
Corporate banking revenue
Service charges on deposits
Other noninterest income
Noninterest expense:
Salaries, incentives and benefits
Other noninterest expenses
2006
2005
2004
$1,254
105
1,190
97
1,104
82
304
147
64
287
153
54
240
521
903
252
$651
239
478
870
256
614
217
155
37
196
414
821
258
563
Income before taxes
Applicable income taxes (a)
Net income
Average Balance Sheet Data
Commercial loans
Demand deposits
Interest checking
Savings and money market
Certificates over $100,000
(a) Includes taxable-equivalent adjustments of $13 million for 2006, 2005 and 2004.
$33,559
6,153
3,888
5,181
1,734
30,373
6,291
3,165
4,958
1,099
27,267
6,197
2,455
3,642
647
Net income increased $37 million, or six percent, compared to
2005 largely as a result of loan and deposit growth and success in
the sale of corporate banking services. Average loans and leases
increased 11% over 2005, to $33.6 billion, with growth occurring
across all loan categories. The moderate decrease in average
demand deposits from the prior year primarily due to lower relative
compensating balance requirements was more than offset by
increases in interest checking and savings and money market
deposits. Average core deposits increased to $15.2 billion in 2006
from $14.4 billion in 2005. The increase in average core deposits
and loans and leases and the related net FTP impact led to a $64
million increase in net interest income compared to the prior year.
The provision for loan and lease losses, which now equals net
charge-offs, increased $8 million over 2005. Net charge-offs as a
percent of average loans remained flat at 31 bp in 2006 compared
to 32 bp in 2005 and 30 bp in 2004.
Noninterest income increased $21 million, or four percent,
compared to 2005 largely due to an increase in corporate banking
revenue of $17 million, or six percent. Increases in corporate
banking revenue occurred in nearly all sub captions. Other
noninterest income fee lines displayed mixed results compared to
the prior year, as operating lease income grew from $8 million to
$18 million, while service charges on deposits decreased four
percent due largely to increased earnings credits.
Noninterest expense increased $44 million, or six percent, in
2006 compared to 2005 primarily due to volume-related increases
in loan, bankcard, operating lease and data processing expenses.
Fifth Third Bancorp 31
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
lending activities
Consumer Lending
Consumer Lending includes the Bancorp’s mortgage and home
equity lending activities and other indirect lending activities.
Mortgage and home equity
the
origination, retention and servicing of mortgage and home equity
loans or lines of credit, sales and securitizations of those loans or
pools of loans or lines of credit and all associated hedging
activities. Other indirect lending activities include loans to
consumers through mortgage brokers, auto dealers and federal and
private student education loans. The table below contains selected
financial data for the Consumer Lending segment.
include
TABLE 15: CONSUMER LENDING
For the years ended December 31
($ in millions)
Income Statement Data
Net interest income
Provision for loan and lease losses
Noninterest income:
Mortgage banking net revenue
Other noninterest income
Noninterest expense:
Salaries, incentives and benefits
Other noninterest expenses
Income before taxes
Applicable income taxes
Net income
Average Balance Sheet Data
Consumer loans
2006
2005
2004
$380
94
148
81
101
202
212
75
$137
397
90
165
125
98
252
247
87
160
421
84
167
227
102
309
320
109
211
$20,430
19,161
17,536
Net income decreased $23 million, or 14%, compared to 2005.
Net interest income decreased $17 million, or four percent, despite
average loans and leases increasing seven percent, due to a 17 bp
decline in the spread between loan yields and the related FTP
charge as a result of the shift in the mix of loans and the
increasingly competitive environment in which this segment
competes. The Bancorp is focused on meeting its customers’
varying financial needs by offering new consumer products while
maintaining its current credit quality profile.
The Bancorp had mortgage originations of $9.4 billion, $9.9
and $8.4 billion in 2006, 2005 and 2004, respectively. As a result of
the decrease in originations and the corresponding decrease in
gains on sales of mortgages, mortgage banking net revenue
decreased $17 million, or 10%. Decreases in other noninterest
income and expense were largely a result of the planned run off of
the consumer operating lease portfolios. Operating lease income
and expense decreased from 2005 by $39 million and $29 million,
respectively. As the operating lease portfolio is nearing maturity,
operating lease income and expense should have an immaterial
effect on 2007 results.
Branch Banking
Branch Banking provides a full range of deposit and loan and lease
products to individuals and small businesses through 1,150 banking
centers. Branch Banking offers depository and loan products, such
as checking and savings accounts, home equity lines of credit,
credit cards and loans for automobile and other personal financing
needs, as well as products designed to meet the specific needs of
small businesses, including cash management services. The table
below contains selected financial data for the Branch Banking
segment.
TABLE 14: BRANCH BANKING
For the years ended December 31
($ in millions)
Income Statement Data
Net interest income
Provision for loan and lease losses
Noninterest income:
Electronic payment processing
Service charges on deposits
Investment advisory revenue
Other noninterest income
Noninterest expense:
Salaries, incentives and benefits
Net occupancy and equipment
expenses
Other noninterest expenses
Income before taxes
Applicable income taxes
Net income
Average Balance Sheet Data
Consumer loans
Commercial loans
Demand deposits
Interest checking
Savings and money market
Time deposits
2006
2005
2004
$1,290
101
1,251
91
1,247
70
195
358
87
123
451
153
468
880
310
$570
164
359
86
107
456
137
437
846
298
548
132
365
86
99
398
128
393
940
320
620
$11,391
4,297
5,602
10,552
11,755
11,352
10,687
3,995
5,649
13,452
9,045
9,173
9,382
3,416
5,048
15,928
7,807
7,554
Net income increased $22 million, or four percent, compared
to 2005. Net interest income increased $39 million as increases in
average loans and leases and total deposits were partially offset by a
deposit mix shift toward higher paying deposit account types.
Average loans and leases increased seven percent to $15.7 billion,
led by growth in credit cards of 21% and small business loans of
eight percent. Branch Banking continued to realize a shift to
higher-rate deposit products throughout 2006. Interest checking
and demand deposits decreased $2.9 billion, or 15%, and savings,
money market and other time deposits increased $4.9 billion, or
27%, compared to 2005. The provision for loan and lease losses
increased $10 million over 2005. Net charge-offs as a percent of
average loans and leases increased slightly from 62 bp to 64 bp.
Noninterest income increased seven percent from 2005.
Electronic payment processing revenue increased due to a $27
million, or 20%, increase in card issuer interchange and a $7
million, or 26%, increase in cardholder fees. The Bancorp expects
interchange and cardholder fees to continue to grow due to the
increased emphasis on cross-selling credit cards to its existing
customer base.
Noninterest expense increased by four percent compared to
2005 as costs were contained despite the effect from the Bancorp’s
continued de novo banking center growth strategy. Net occupancy
and equipment expenses increased 11% compared to 2005 as a
result of the continued opening of new banking centers. 51
banking centers were opened in 2006, and 63 in 2005, that did not
involve the relocation or consolidation of existing facilities. The
Bancorp will continue to position itself for sustained long-term
growth through new banking center additions. Card processing
expenses increased $15 million on greater sales volumes, and
marketing expenses increased $8 million primarily related to
attracting new core deposit accounts.
32
Fifth Third Bancorp
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
for
services
individuals, companies
The Bancorp’s primary
Investment Advisors
investment
Investment Advisors provides a full range of
and not-for-profit
alternatives
organizations.
include
investments, trust, asset management, retirement plans and
custody. Fifth Third Securities, Inc., an indirect wholly-owned
subsidiary of the Bancorp, offers full service retail brokerage
services to individual clients and broker dealer services to the
institutional marketplace. Fifth Third Asset Management, Inc., an
indirect wholly-owned subsidiary of the Bancorp, provides asset
management services and also advises the Bancorp’s proprietary
family of mutual funds. The table below contains selected financial
data for the Investment Advisors segment.
TABLE 16: INVESTMENT ADVISORS
For the years ended December 31
($ in millions)
Income Statement Data
Net interest income
Provision for loan and lease losses
Noninterest income:
Investment advisory revenue
Other noninterest income
Noninterest expense:
Salaries, incentives and benefits
Other noninterest expenses
Income before taxes
Applicable income taxes
Net income
Average Balance Sheet Data
Loans and leases
Core deposits
2006
2005
2004
$125
3
367
19
172
211
125
44
$81
131
4
360
16
170
215
118
42
76
129
2
367
19
148
220
145
49
96
$3,068
4,499
2,684
3,976
2,176
3,487
Net income increased $5 million, or six percent, compared to
2005 as a result of modest growth in investment advisory revenue
and a decline in noninterest expense. Net interest income declined
four percent to $125 million due to the decline in interest rate
spread as a result of the continued mix shift to higher cost deposit
products. The negative impact of the shift in deposit mix more
than offset the $384 million, or 14%, increase in average loans and
leases in 2006.
Noninterest income increased three percent from 2005 as the
$7 million increase in private client revenues was mitigated by a
decrease in mutual fund revenue of $3 million. The decrease in
mutual fund revenue was primarily the result of the deployment of
an open architecture on proprietary fund sales. Noninterest
expenses decreased modestly compared to the prior year due to the
focus on expense control. Employee compensation is expected to
increase in 2007 as the Bancorp looks to expand its sales force
throughout its footprint, particularly in retail brokerage.
Processing Solutions
Fifth Third Processing Solutions provides electronic funds transfer,
debit, credit and merchant transaction processing, operates the
Jeanie® ATM network and provides other data processing services
to affiliated and unaffiliated customers. The table below contains
selected financial data for the Processing Solutions segment.
TABLE 17: PROCESSING SOLUTIONS
For the years ended December 31
($ in millions)
Income Statement Data
Net interest income
Provision for loan and lease losses
Noninterest income:
Merchant processing
EFT processing
Other noninterest income
Noninterest expense:
Salaries, incentives and benefits
Net occupancy and equipment
expenses
Transaction processing
Other noninterest expenses
Income before taxes
Applicable income taxes
Net income
2006
2005
2004
$33
10
397
297
88
71
13
303
140
278
98
$180
28
18
351
257
25
53
6
253
150
181
64
117
29
10
305
219
173
50
7
205
145
309
105
204
Net income increased $63 million versus the prior year.
Excluding the $78 million of pretax securities gains from the sale
of the Bancorp’s MasterCard, Inc. shares, included in other
noninterest income, net income increased 10% compared to 2005,
as electronic payment processing revenues continued to produce
double-digit increases. Merchant and EFT revenues increased by
13% and 15% primarily due to new customer additions and related
increased volume. 2004 results are affected by the sale of certain
third-party sourced merchant processing contracts that resulted in
a pretax gain of $157 million. The Bancorp continues to see
opportunities to attract new financial institution customers and
retailers within this business segment.
The strong increase in noninterest income was mitigated by a
14% increase in noninterest expense due to headcount additions,
investment in information technology and transaction processing
costs. Salaries, incentives and benefits increased 33% with the
addition of over 300 employees. The 20% increase in transaction
processing costs compared to 2005 primarily resulted from
network membership fees and volume-related costs as the number
of merchant transactions processed increased 17% over 2005.
Other/Eliminations
includes the unallocated portion of the
Other/Eliminations
funding,
investment
unassigned equity and certain support activities, provision expense
in excess of net charge-offs and other items not attributed to the
business segments.
securities portfolio, certain wholesale
The results of Other/Eliminations were primarily impacted by
the balance sheet actions in the fourth quarter of 2006 and the
related loss on the sale of securities. Other/Eliminations was also
impacted by wholesale funding repricing at a faster rate than
securities as a result of rising short-term rates in the first half of
2006. The Bancorp experienced an increase in the average interest
rate on wholesale funding from 3.36% in 2005 to 5.02% in 2006
compared to an increase in the average interest rate on securities
from 4.36% in 2005 to 4.56% in 2006.
Fifth Third Bancorp 33
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOURTH QUARTER REVIEW
The Bancorp’s 2006 fourth quarter earnings per diluted share were
$.12 compared to $.60 per diluted share for the same period in
2005. Fourth quarter net income totaled $66 million compared to
$332 million in the same quarter last year. Fourth quarter 2006
earnings and ratios were negatively impacted by $454 million in
total pretax losses and charges related to balance sheet actions
taken to improve the asset/liability profile of the Bancorp. The
pretax losses and charges consisted of $398 million in losses on the
sale of $11.3 billion in available-for-sale securities; $17 million in
losses on derivatives related to the securities sold, recorded in other
noninterest income; and $39 million in charges related to the
termination of the repurchase and reverse agreements, recorded in
other noninterest expense. Return on average assets and return on
average equity were .25% and 2.6%, respectively, compared to
1.27% and 13.9% in 2005’s fourth quarter. The Bancorp’s
efficiency ratio was 82.9% in the fourth quarter compared to 55.6%
last year and 55.5% in the previous quarter.
Compared to the fourth quarter of 2005, net interest income
(FTE) increased one percent, reflecting a two percent decline in
earning assets and 5 bp improvement of the net interest margin
(FTE). Compared to the third quarter of 2006, net interest income
(FTE) increased by $25 million and was primarily driven by the sale
of available-for-sale securities and repayment of $8.5 billion in
wholesale borrowings. Solid trends in loan growth and greater
stability in deposit pricing also contributed to the increase. The
improvement in net interest margin in the fourth quarter was
primarily due to the sales of securities, stronger core deposit
growth and improved loan yields.
Overall noninterest income, excluding balance sheet actions
taken in the fourth quarter, remained flat compared to the same
quarter last year and increased three percent on a sequential basis.
Electronic payment processing revenues increased 14% over
the same quarter last year reflecting double-digit growth in
merchant processing and card interchange, though growth was
mitigated by the effects of slower consumer spending throughout
2006.
Deposit service revenue decreased eight percent compared to
the same quarter last year. Retail deposit revenue decreased 10%
reflecting significantly lower consumer overdraft fees. The
Bancorp has been encouraging its customers to enroll in overdraft
protection as a means to establish stronger relationships and
improve account retention. Commercial deposit revenue decreased
five percent due to increased earnings credits on compensating
balances.
Mortgage banking net revenue totaled $30 million in the
fourth quarter compared to $42 million in the prior year fourth
quarter. The decline was primarily due to decreased origination
fees and lower gains on loan sales, reflecting lower market spreads.
Mortgage originations were $2.3 billion in the fourth quarter and
$2.5 billion in the fourth quarter of last year. Fourth quarter
mortgage banking net servicing revenue totaled $7 million and was
comprised of $31 million in total mortgage servicing fees, less $19
million in amortization and $5 million in net valuation adjustments
on mortgage servicing rights.
Investment advisory revenues increased by four percent over
the same quarter last year. The increase was driven by strong
growth in private banking and moderate growth in the retail
securities and institutional businesses, partially offset by lower
mutual fund fees reflecting the ongoing effect of open architecture
on proprietary fund sales.
Corporate banking revenue for the fourth quarter 2006
decreased 11% compared to the same quarter last year. The
decrease was primarily due to unusually strong fourth quarter 2005
lease syndication fees, as well as lower letter of credit and customer
interest rate derivative income.
Other noninterest income totaled $58 million in the fourth
quarter compared to $77 million in the same quarter last year. The
decrease from the prior year quarter was a result of the $17 million
in losses on derivatives related to securities sold as part of the
balance sheet actions taken in this year’s fourth quarter. Other
noninterest income decreased by $29 million compared to the third
quarter of 2006. Comparisons to the third quarter reflect the losses
on derivatives mentioned above, in addition to $11 million in gains
related to the third quarter sales of three Indiana branches and a
small out-of-footprint credit card portfolio.
Total noninterest expense increased by five percent compared
to the same quarter last year. Comparisons reflect a $39 million
charge
in the fourth quarter of 2006 associated with the
termination of financing agreements as part of the balance sheet
actions taken and approximately $9 million in fraud-related
expenses and approximately $10 million in tax-related expense in
the fourth quarter 2005. Excluding the above-mentioned items,
noninterest expense increased two percent due to higher personnel
expense and de novo related occupancy expense. Compared to the
third quarter of 2006, total noninterest expense increased by $31
million primarily due to higher processing volume-related expenses
and the $39 million in termination of financing agreements
mentioned above, offset by $11 million in charges for the early
retirement of debt and $8 million in pension settlement expenses
incurred in the third quarter.
Net charge-offs as a percentage of average loans and leases
were 52 bp in the fourth quarter, compared to 43 bp last quarter
and 67 bp in the fourth quarter of 2005. Net charge-offs were $97
million in the fourth quarter, compared to $79 million in the third
quarter of 2006 and $117 million in the same quarter last year. The
increase from the last quarter resulted from two large commercial
credits totaling $9 million, higher small business charge-offs and
higher indirect consumer losses. Fourth quarter 2005 numbers
reflect an elevated level of net charge-offs associated with
approximately $27 million in losses from bankrupt commercial
airline carriers and a $15 million increase in consumer loan and
lease
increased personal bankruptcies
declared prior to enacted reform legislation in 2005. The provision
for loan and lease losses totaled $107 million in the fourth quarter
compared to $87 million in the third quarter of 2006 and $134
million in the same quarter last year.
losses associated with
34
Fifth Third Bancorp
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BALANCE SHEET ANALYSIS
TABLE 18: COMPONENTS OF TOTAL LOANS AND LEASES (INCLUDING HELD FOR SALE)
As of December 31 ($ in millions)
Commercial:
2005
2006
Commercial loans
Commercial mortgage
Commercial construction
Commercial leases
Total commercial loans and leases
Consumer:
Residential mortgage
Residential construction
Credit card
Home equity
Other consumer loans
Consumer leases
Total consumer loans and leases
Total loans and leases
$20,725
10,405
6,168
3,841
41,139
9,226
679
1,110
12,365
9,911
1,073
34,364
$75,503
19,299
9,188
6,342
3,698
38,527
8,296
695
866
12,000
9,250
1,595
32,702
71,229
2004
16,058
7,636
4,348
3,426
31,468
7,533
378
843
10,508
7,586
2,051
28,899
60,367
2003
14,226
6,894
3,301
3,264
27,685
5,530
335
762
8,993
8,436
2,448
26,504
54,189
2002
12,786
5,885
3,009
3,019
24,699
6,804
319
537
8,675
5,909
2,343
24,587
49,286
leases
loans and
Loans and Leases
increased six percent compared to
Total
December 31, 2005. Table 18 presents the Bancorp’s total
commercial and consumer loan and lease portfolio by the primary
purpose of the loan. During 2006, the Bancorp reviewed its loan
classifications, which resulted in a reclassification of approximately
$450 million of commercial loans to commercial mortgage. The
impact to average loans was immaterial as the reclassification took
place at the end of 2006. Prior year balances were not restated.
Total loans and leases grew in over half of its affiliates with double-
digit growth in the Cleveland, Detroit, Lexington, Nashville,
Orlando and Tampa markets.
Total commercial loans and leases increased $2.6 billion, or
seven percent, compared to the prior year. Excluding the impact
of the 2006 reclassification, commercial loans increased $1.9 billion
or 10%, and commercial mortgage increased by approximately
$800 million, or eight percent, compared to December 31, 2005.
The mix of commercial loans was consistent with the prior year.
Total consumer loans and leases increased five percent
compared to December 31, 2005 as a result of the introduction of
new residential mortgage products and increased promotion of
credit cards. Residential mortgage loans increased $930 million, or
11%, compared to 2005. 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
$9.4 billion in 2006 compared to $9.9 billion in 2005. Credit card
balances increased 28% to $1.1 billion. A key focus for the
Bancorp in 2007 is increasing its penetration of credit cards within
in its retail footprint. Consumer lease balances decreased 33%
from December 31, 2005 largely due to continued competitive
pricing from captive financing companies.
Average commercial loans and leases increased $3.8 billion, or
10%, compared to the December 31, 2005. The Bancorp
experienced double-digit growth in more than half of its affiliates,
including 15% in the Florida markets, 18% in Tennessee and
Chicago and 26% in Cleveland.
The growth in average consumer loans and leases was a result
of strong growth in each category mitigated by a decline in
consumer auto leases. Average consumer loans and leases
increased $2.0 billion, or six percent, compared to 2005,
highlighted by 33% growth in both the Florida and Tennessee
markets.
TABLE 19: COMPONENTS OF AVERAGE TOTAL LOANS AND LEASES
As of December 31 ($ in millions)
Commercial:
2006
Commercial loans
Commercial mortgage
Commercial construction
Commercial leases
Total commercial loans and leases (including held for sale)
Consumer:
Residential mortgage
Residential construction
Credit card
Home equity
Other consumer loans
Consumer 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)
$20,400
9,797
6,015
3,730
39,942
8,855
719
942
12,268
9,439
1,328
33,551
$73,493
$72,447
2005
18,241
8,923
5,525
3,495
36,184
8,396
586
797
11,463
8,489
1,822
31,553
67,737
66,685
2004
14,908
7,391
3,807
3,296
29,402
6,454
347
787
9,797
7,958
2,297
27,640
57,042
55,951
2003
13,672
6,299
3,097
3,037
26,105
6,565
315
591
9,084
7,259
2,495
26,309
52,414
49,700
2002
11,665
5,834
3,023
2,640
23,162
6,100
277
478
8,444
5,017
2,061
22,377
45,539
43,529
Fifth Third Bancorp 35
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
are
classified
Investment Securities
As of December 31, 2006, total investment securities were $11.6
billion compared to $22.4 billion at December 31, 2005.
Securities
in
management’s judgment, they may be sold in response to or in
anticipation of changes in market conditions. The Bancorp’s
management has evaluated the securities in an unrealized loss
position in the available-for-sale portfolio and maintains the intent
and ability to hold these securities to the earlier of the recovery of
the losses or maturity.
available-for-sale when,
as
During the fourth quarter of 2006, the Bancorp evaluated its
overall balance sheet composition and took certain actions with
respect to its available-for-sale securities portfolio. The Bancorp’s
objective was to improve the asset/liability profile of the Bancorp
and reduce the size of its available-for-sale securities portfolio to a
size that is more consistent with its liquidity, collateral and interest
rate risk management requirements, improve composition of the
balance sheet with a lower concentration in fixed-rate assets, lower
wholesale borrowings to reduce leverage and better position the
Bancorp for an uncertain economic and interest rate environment.
On November 20, 2006, the Bancorp’s Board of Directors
approved the following actions with respect to the Bancorp’s
available-for-sale securities portfolio: (i) sales of $11.3 billion in
available-for-sale securities, with a weighted-average yield of
approximately 4.30% and (ii) reinvestment of approximately $2.8
billion in available-for-sale securities that are more efficient when
used as collateral for pledging purposes. The subsequent sale of
available-for-sale securities later in the fourth quarter resulted in
pretax losses of $398 million. Additionally, during the third
TABLE 20: CHARACTERISTICS OF AVAILABLE-FOR-SALE AND OTHER SECURITIES
quarter of 2006, the Bancorp sold $726 million of FHLMC
callable debt, which represented nearly all of its position in these
securities, in order to reduce its credit exposure as a result of
recent market events.
Net unrealized losses on the available-for-sale securities
portfolio were $183 million at December 31, 2006 compared to
$609 million at December 31, 2005. As of December 31, 2006,
95% of the unrealized losses in the available-for-sale securities
portfolio were comprised of securities issued by U.S. Treasury and
Government agencies, U.S. Government sponsored agencies and
states and political subdivisions as well as agency mortgage-backed
securities. The Bancorp believes the price movements in these
securities were the result of movement in market interest rates.
On an amortized cost basis, at the end of 2006, available-for-
sale securities decreased $11.3 billion since December 31, 2005.
At December 31, 2006, available-for-sale securities have decreased
to 13% of interest-earning assets, compared to 24% at December
31, 2005. The estimated weighted-average life of the debt
securities in the available-for-sale portfolio was 4.3 years at
December 31, 2006 and 2005. At December 31, 2006, the fixed-
rate securities within the available-for-sale securities portfolio had
a weighted-average yield of 5.13%.
Information presented in Table 20 is on a weighted-average
life basis, anticipating future prepayments. Yield information is
presented on an FTE basis and is computed using historical cost
balances. Maturity and yield calculations for the total available-
for-sale portfolio exclude equity securities that have no stated
yield or maturity.
Amortized Cost
Fair Value
Weighted-Average
Life (in years)
Weighted-Average
Yield
As of December 31, 2006 ($ 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 (c):
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 securities (e)
Total available-for-sale and other securities
$1,392
4
-
-
1,396
-
100
-
-
100
57
403
106
37
603
7
2,980
5,012
-
7,999
$1,392
4
-
-
1,396
-
95
-
-
95
57
411
109
37
614
7
2,928
4,881
-
7,816
7
155
10
-
172
966
$11,236
8
153
10
-
171
961
$11,053
.1
2.6
-
-
.1
-
4.9
-
-
4.9
.5
3.2
6.4
11.7
4.0
.7
3.5
5.9
-
5.0
.6
2.7
9.0
-
3.1
4.83 %
6.53
-
-
4.83
-
4.20
-
-
4.20
7.81
7.30
7.12(b)
8.55(b)
7.33
6.73
5.03
5.09
-
5.07
35.56(d)
5.59
5.60
-
6.75
5.18 %
(a) Taxable-equivalent yield adjustments included in the above table are 2.57%, 2.42%, 2.95%, 2.25% and 2.42% for securities with an average life of one year or less, 1-5 years, 5-10 years,
4.3
greater than 10 years and in total, respectively.
(b) Weighted-average yield excludes $18 million and $35 million of securities with an average life of 5-10 years and greater than 10 years, respectively, related to qualified zone academy bonds
whose yields are realized through income tax credits. The weighted-average effective yield of these instruments is 6.77%.
(c) 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.
(d) Amount includes residual interest in an auto securitization with a cost of $5 million and fair market value of $6 million, which is expected to mature in 2007.
(e) Other securities consist of Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank restricted stock holdings that are carried at cost, FHLMC preferred stock holdings, certain
mutual fund holdings and equity security holdings.
36
Fifth Third Bancorp
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 21: COMPONENTS OF INVESTMENT SECURITIES (AMORTIZED COST BASIS)
As of December 31 ($ in millions)
2005
Available-for-sale and other:
2006
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
TABLE 22: DEPOSITS
As of December 31 ($ in millions)
Demand
Interest checking
Savings
Money market
Transaction deposits
Other time
Core deposits
Certificates - $100,000 and over
Foreign office
Total deposits
$1,396
100
603
7,999
172
966
$11,236
$345
11
$356
2006
$14,331
15,993
13,181
6,584
50,089
10,987
61,076
6,628
1,676
$69,380
506
2,034
657
16,127
2,119
1,090
22,533
378
11
389
2005
14,609
18,282
11,276
6,129
50,296
9,313
59,609
4,343
3,482
67,434
2004
503
2,036
823
17,571
2,862
1,006
24,801
245
10
255
2004
13,486
19,481
8,310
4,321
45,598
6,837
52,435
2,121
3,670
58,226
2003
838
3,877
922
21,101
1,401
937
29,076
126
9
135
2003
12,142
19,757
7,375
3,201
42,475
6,201
48,676
1,856
6,563
57,095
2002
303
2,308
1,033
19,328
1,084
734
24,790
52
-
52
2002
10,095
17,878
10,056
1,044
39,073
7,638
46,711
1,723
3,774
52,208
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 expanding its retail franchise, enhancing its product
offering and providing competitive rates. The Bancorp’s goal is to
continue to grow the core deposit component of its funding
profile. At December 31, 2006, core deposits represented 61% of
the Bancorp’s asset funding base, compared to 57% at December
31, 2005.
Core deposits grew two percent compared to December 31,
2005, but the Bancorp continues to realize a mix shift as
customers move from lower-yield transaction accounts to higher-
yield time deposits. Overall, transaction deposits balances
remained stable compared to the prior year.
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 as well as certificates
$100,000 and over as a method to fund earning asset growth.
On an average basis, core deposits increased five percent
while continuing to realize a mix shift within core deposits
compared to 2005. The Bancorp realized strong double-digit
growth in savings, money market and other time deposits
mitigated by decreases in demand and interest checking deposits.
The Bancorp experienced double-digit average transaction deposit
increases in the Indianapolis, Tampa, Orlando, Lexington and
Louisville markets.
TABLE 23: AVERAGE DEPOSITS
As of December 31 ($ in millions)
Demand
Interest checking
Savings
Money market
Transaction deposits
Other time
Core deposits
Certificates - $100,000 and over
Foreign office
Total deposits
2006
$13,741
16,650
12,189
6,366
48,946
10,500
59,446
5,795
3,711
$68,952
2005
13,868
18,884
10,007
5,170
47,929
8,491
56,420
4,001
3,967
64,388
2004
12,327
19,434
7,941
3,473
43,175
6,208
49,383
2,403
4,449
56,235
2003
10,482
18,679
8,020
3,189
40,370
6,426
46,796
3,832
3,862
54,490
2002
8,953
16,239
9,465
1,162
35,819
8,855
44,674
2,237
2,018
48,929
Borrowings
During 2006, the Bancorp reduced its reliance on wholesale
borrowings. As a result of not reinvesting cash flows from the
securities portfolio throughout the year and the balance sheet
actions in the fourth quarter, the Bancorp reduced the amount of
total borrowings $8.0 billion, or 32%, compared to the prior year-
end. As of December 31, 2006 and 2005 total borrowings as a
percentage of interest-bearing liabilities were 22% and 29%,
respectively. The Bancorp continues to explore additional
alternatives regarding the level and cost of various other sources
of funding. Refer to the Liquidity Risk Management section for
discussion on the Bancorp’s liquidity management and Note 11 of
for a
the Notes
comprehensive listing of the components of long-term debt.
to Consolidated Financial Statements
TABLE 24: BORROWINGS
As of December 31 ($ in millions)
Federal funds purchased
Short-term bank notes
Other short-term borrowings
Long-term debt
Total borrowings
2006
$1,421
-
2,796
12,558
$16,775
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
Fifth Third Bancorp 37
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Designated risk managers have been assigned to the business
lines reporting directly to the Enterprise Risk Management division
and indirectly to senior executives within the division or affiliate.
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.
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 of the Board of
Directors has approved the formation of key management
governance committees that are responsible for evaluating risks
and controls.
include the Market Risk
Committee, the Credit Risk Committee, the Operational Risk
Committee and the Executive Asset Liability 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 before launching a new product or
initiative. Significant risk policies approved by the management
governance committees are also reviewed and approved by the
Risk and Compliance Committee of the Board of Directors.
These committees
RISK MANAGEMENT
is responsible for the
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 mitigation of those
risks that are inconsistent with the Bancorp’s risk profile. The
Enterprise Risk Management division, led by the Bancorp’s Chief
Risk Officer, ensures consistency in the Bancorp’s approach to
managing and monitoring risk within the structure of the
Bancorp’s affiliate operating model. The risks faced by the
Bancorp include, but are not limited to, credit, market, liquidity,
operational and regulatory compliance. 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:
•
•
•
•
•
•
•
•
Risk Policy - ensures consistency in the approach to risk
management as the Bancorp’s clearinghouse for credit,
market and operational risk policies, procedures and
guidelines;
Operational Risk Management - 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;
Insurance Risk Management - responsible for all property,
casualty and liability insurance policies including the claims
administration process for the Bancorp;
Capital Markets Risk Management - responsible for
establishing and monitoring proprietary trading limits,
monitoring liquidity and interest rate risk and utilizing
value at risk and earnings at risk models;
Credit Risk Review - responsible for evaluating the
sufficiency of underwriting, documentation and approval
processes for consumer and commercial credits, counter-
party credit risk, the accuracy of risk grades assigned to
commercial credit exposures, and appropriate accounting
for charge-offs, non-accrual status and specific reserves;
Compliance Risk Management - responsible for oversight
of compliance with all banking regulations;
for
Risk Strategies and Reporting
quantitative analytics and Board of Directors and senior
management reporting on credit, market and operational
risk metrics; and
Investment Advisors Risk Management - responsible for
trust compliance, fiduciary risk and trading risk in the
Investment Advisors line of business.
responsible
-
38
Fifth Third Bancorp
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 25: COMMERCIAL LOAN AND LEASE PORTFOLIO EXPOSURE (a)
Outstanding
2006
Exposure Nonaccrual
Outstanding
2005
Exposure
Nonaccrual
As of December 31 ($ in millions)
By industry:
Real estate
Construction
Manufacturing
Retail trade
Transportation and warehousing
Business services
Healthcare
Wholesale trade
Financial services and insurance
Individuals
Other services
Accommodation and food
Public administration
Agribusiness
Entertainment and recreation
Other
Communication and information
Utilities
Mining
Total
By loan size:
Less than $200,000
$200,000 to $1 million
$1 million to $5 million
$5 million to $10 million
$10 million to $25 million
Greater than $25 million
Total
By state:
Ohio
Michigan
Illinois
Florida
Indiana
Kentucky
Tennessee
Pennsylvania
Missouri
West Virginia
Out-of-footprint
$10,652
5,490
5,198
3,655
2,097
1,862
1,860
1,827
1,509
1,364
959
860
792
609
602
578
567
370
288
$41,139
4 %
16
32
17
21
10
100 %
25 %
22
10
10
9
6
3
1
1
-
13
13,196
8,963
11,443
6,515
2,432
3,640
3,208
3,642
4,855
1,785
1,373
1,323
930
782
841
1,269
1,073
1,187
637
69,094
3
12
27
16
24
18
100
50
69
22
27
4
16
9
11
8
13
14
10
-
8
2
4
1
-
3
271
13
34
48
5
-
-
100
9,503
4,911
4,457
3,602
1,701
1,886
1,664
1,879
1,111
1,840
945
997
830
569
527
1,041
544
301
219
38,527
5
19
34
18
18
6
100
11,689
8,094
9,975
5,962
1,993
3,351
2,844
3,540
3,069
2,371
1,260
1,396
1,004
752
749
1,596
1,119
1,001
419
62,184
4
15
28
20
19
14
100
32
49
47
18
6
13
10
9
1
12
9
9
-
2
3
3
4
-
-
227
14
34
33
8
-
11
100
28
19
10
9
9
6
3
2
1
-
13
100
36
19
8
9
15
8
1
-
-
-
4
100
26
22
10
10
10
6
3
1
1
-
11
100
29
21
10
9
10
6
2
1
1
-
11
100
30
21
8
4
25
6
3
-
-
1
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.
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
conservative
collection
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 and authority delegation process
centrally. The Credit Risk Review function, within the Enterprise
Risk Management division, provides objective assessments of the
quality of underwriting and documentation, the accuracy of risk
grades and the charge-off and reserve 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 these assessments to promptly
identify potential problem loans or leases within the portfolio,
maintain an adequate reserve 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 risk grading system currently utilized for reserve analysis
purposes encompasses ten categories. The Bancorp also maintains
a dual risk rating system that provides for thirteen probability of
default grade categories and an additional six grade categories for
estimating actual losses given an event of default. The probability
of default and loss given default evaluations 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 reserve analysis purposes. The
dual risk rating system is expected to be consistent with Basel II
expectations and allows for more precision in the analysis of
Scoring systems and delinquency
commercial credit risk.
monitoring are used to assess the credit risk in the Bancorp’s
homogenous consumer loan portfolios.
documentation
underwriting,
and
Fifth Third Bancorp 39
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 26: SUMMARY OF NONPERFORMING ASSETS AND DELINQUENT LOANS
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
Nonperforming assets as a percent of total loans, leases and other assets,
2006
$133
84
54
38
43
352
-
103
$455
$40
23
16
68
63
$210
2005
145
51
31
30
37
294
-
67
361
21
14
10
53
57
155
2004
110
51
13
24
30
228
1
74
303
22
13
13
43
51
142
2003
129
42
19
25
27
242
8
69
319
15
12
13
51
54
145
2002
159
41
14
18
15
247
-
26
273
29
18
9
60
46
162
including other real estate owned
.59
Allowance for loan and lease losses as a percent of nonperforming assets (b)
251
(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, 2006, 2005 and 2004, these advances were $14 million, $13
million and $23 million, respectively. Information prior to December 31, 2004 was not available.
.61 %
170
.51
235
.52
206
.61
219
(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
25 provides breakouts of the commercial loan and lease portfolio,
including held for sale, by major industry classification, by loan size
and by state, illustrating the diversity and granularity of the
Bancorp’s portfolio.
strategy
The commercial portfolio
is characterized by 87% of
outstanding balances and exposures concentrated within the
Bancorp’s primary market areas of Ohio, Kentucky, Indiana,
Michigan, Illinois, Florida, Tennessee, West Virginia, Missouri and
Pennsylvania. Exclusive of a national large-ticket leasing business,
the commercial portfolio is characterized by 94% of outstanding
balances and 91% of exposures concentrated within these ten
the
states.
commercial portfolio are characterized by 97% of outstanding
balances and 96% of exposures concentrated within these ten
states.
The mortgage and construction segments of
Analysis of Nonperforming Assets
Nonperforming assets include: (i) nonaccrual loans and leases for
which ultimate collectibility of the full amount of the principal
and/or 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 of the full principal and/or interest under the contractual
terms of the loan are not expected. Additionally, loans are placed
on nonaccrual status 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 and previously accrued but unpaid interest is
reversed. 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.
Total nonperforming assets were $455 million at December
31, 2006, an increase of $94 million compared to $361 million at
December 31, 2005. Nonperforming assets remain a small
percentage of total loans, leases and other assets, including other
real estate owned at .61% as of December 31, 2006, compared to
40
Fifth Third Bancorp
.52% as of December 31, 2005.
Commercial nonaccrual credits as a percent of commercial
loans increased from .59% in 2005 to .66% in 2006 primarily due
to increases in the Indianapolis and Cleveland markets offset by a
decrease in the Cincinnati market. Consumer nonaccrual loans as a
percent of loans increased slightly from .20% in 2005 to .24% in
2006. Overall, nonaccrual loans continue to represent a small
portion of the portfolio at just .47% as of December 31, 2006,
compared to .41% as of December 31, 2005.
Total loans and leases 90 days past due have increased from
$155 million as of December 31, 2005 to $210 million as of
December 31, 2006. The $55 million increase from the prior year
was evenly distributed between commercial and consumer loans
and leases.
At December 31, 2006, there were $24 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 2006 and 2005,
interest income of $10 million and $8 million, respectively, was
recorded on nonaccrual and renegotiated loans and leases. For the
years ended 2006 and 2005, additional interest income of $85
million and $53 million, respectively, would have been recorded if
the nonaccrual and renegotiated loans and leases had been current
in accordance with the original terms.
Analysis of Net Loan Charge-offs
Net charge-offs as a percent of average loans and leases were 44 bp
for 2006, compared to 45 bp for 2005. The ratio of commercial
loan net charge-offs to average commercial loans outstanding
increased to 53 bp in 2006 compared to 41 bp in 2005 due to
increases in net charge-offs in the Indianapolis and Southern
Indiana markets, partially offset by a decrease in the Cincinnati
market. The net charge-off ratio for commercial mortgage loans
increased 15 bp due to
in the
Indianapolis, Chicago and Cleveland markets. The net charge-off
ratio for commercial lease financing decreased 109 bp in 2006.
The comparison to prior year is impacted by approximately $27
million in charge-offs related to bankrupt commercial airline
carriers during 2005. Consumer lease financing net losses charged
off decreased to $5 million as a result of decreased net charge-offs
in nearly all affiliate markets and lower averages balances. Overall,
the level of net charge-offs remains a small percentage of the total
loan and lease portfolio. The Bancorp expects net charge-offs to
be in the low to mid 50 bp range in 2007. Table 27 provides a
summary of credit loss experience and net charge-offs as a
increased net charge-offs
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 27: SUMMARY OF CREDIT LOSS EXPERIENCE
For the years ended December 31 ($ in millions)
Losses charged off:
Commercial loans
Commercial mortgage loans
Commercial lease financing
Construction loans
Residential mortgage loans
Consumer loans
Consumer lease financing
Total losses
Recoveries of losses previously charged off:
Commercial loans
Commercial mortgage loans
Commercial lease financing
Construction loans
Residential mortgage loans
Consumer loans
Consumer lease financing
2006
$(131)
(27)
(4)
(8)
(22)
(203)
(13)
(408)
24
3
5
-
-
52
8
92
Total recoveries
Net losses charged off:
Commercial loans
Commercial mortgage loans
Commercial lease financing
Construction loans
Residential mortgage loans
Consumer loans
Consumer lease financing
Total net losses charged off
Net charge-offs as a percent of average loans and leases (excluding held for sale):
(107)
(24)
1
(8)
(22)
(151)
(5)
$(316)
Commercial loans
Commercial mortgage loans
Commercial lease financing
Construction loans
Residential mortgage loans
Consumer loans
Consumer lease financing
Total net losses charged off
.53 %
.25
(.03)
.11
.28
.67
.37
.44
2005
(99)
(13)
(38)
(5)
(18)
(181)
(19)
(373)
24
4
1
1
-
39
5
74
(75)
(9)
(37)
(4)
(18)
(142)
(14)
(299)
.41
.10
1.06
.07
.25
.68
.78
.45
2004
(95)
(14)
(8)
(7)
(15)
(156)
(26)
(321)
14
5
1
-
-
41
8
69
(81)
(9)
(7)
(7)
(15)
(115)
(18)
(252)
.54
.12
.21
.15
.27
.63
.81
.45
2003
(152)
(9)
(24)
(3)
(24)
(136)
(32)
(380)
16
2
2
1
-
40
7
68
(136)
(7)
(22)
(2)
(24)
(96)
(25)
(312)
1.00
.10
.72
.09
.57
.58
.98
.63
2002
(81)
(18)
(11)
(6)
(10)
(115)
(32)
(273)
20
5
2
3
-
46
10
86
(61)
(13)
(9)
(3)
(10)
(69)
(22)
(187)
.52
.23
.35
.12
.23
.49
1.04
.43
percentage of average loans and leases outstanding by loan
category.
Allowance for Credit Losses
The allowance for credit losses is comprised of the allowance for
loan and lease losses and the reserve for unfunded commitments.
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. Several factors are taken into
consideration in the determination of the overall allowance for loan
and lease losses, including the unallocated component. These
factors include, but are not limited to, the overall risk profile of the
loan and lease portfolios, net charge-off experience, the extent of
impaired loans and leases, the level of nonaccrual loans and leases,
the level of 90 days past due loans and leases and the overall
percentage level of the allowance for loan and lease losses. The
trends, credit
Bancorp also considers overall asset quality
administration
risk
identification practices, credit policy and underwriting practices,
overall portfolio growth, portfolio concentrations and current
and portfolio management practices,
national and local economic conditions that might impact the
portfolio.
In 2006, the Bancorp has not substantively changed any
material 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 adequacy of this reserve is
similar to the Bancorp’s methodology for determining the
allowance for loan and lease losses. The provision for unfunded
commitments is included in other noninterest expense on the
Consolidated Statements of Income. Table 28 shows the changes
in the allowance for credit losses during 2006.
Certain inherent but undetected losses are probable within the
loan and lease portfolio. An unallocated component to the
allowance for loan and lease losses is maintained to recognize this
imprecision in estimating and measuring loss. The Bancorp’s
current methodology for determining this measure is based on
historical loss rates, current credit grades, specific allocation on
TABLE 28: CHANGES IN ALLOWANCE FOR CREDIT LOSSES
For the years ended December 31 ($ in millions)
Balance, beginning of year
Net losses charged off
Provision for loan and lease losses
Net change in reserve for unfunded commitments
Balance, end of year
Components of allowance for credit losses (a):
2006
$814
(316)
343
6
$847
2005
785
(299)
330
(2)
814
2004
770
(252)
268
(1)
785
2003
683
(312)
399
-
770
2002
624
(187)
246
-
683
Allowance for loan and lease losses
Reserve for unfunded commitments
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 period presentation.
Fifth Third Bancorp 41
$771
76
$847
744
70
814
713
72
785
697
73
770
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 29: ATTRIBUTION OF ALLOWANCE FOR LOAN AND LEASE LOSSES TO PORTFOLIO LOANS AND LEASES
As of December 31 ($ in millions)
Allowance attributed to:
Commercial loans
Commercial mortgage loans
Construction loans
Residential mortgage loans
Consumer loans
Lease financing
Unallocated
2004
2006
2005
2003
210
73
43
44
160
47
136
713
234
77
34
29
146
64
113
697
$252
95
52
48
247
29
48
$771
201
78
47
37
183
56
142
744
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:
$20,725
10,405
6,847
8,151
23,311
4,914
$74,353
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
2002(a)
159
117
41
43
141
132
50
683
12,743
5,885
3,327
3,495
15,116
5,362
45,928
Commercial loans
Commercial mortgage loans
Construction loans
Residential mortgage loans
Consumer loans
Lease financing
Unallocated (as a percent of total portfolio loans and leases)
1.24
1.98
1.24
1.24
.93
2.46
.11
Total portfolio loans and leases
1.49
(a) The allowance for loan and lease losses in 2002 includes funded and unfunded commitments. At December 31, 2004, the reserve for unfunded commitments was reclassified from the allowance
.91
.77
.59
1.06
.59
.06
1.04 %
1.31
.96
.90
.63
.85
.86
.23
1.19
1.05
.85
.67
.51
.83
1.06
.20
1.06
1.65
1.12
.94
.66
.84
1.12
.22
1.33
1.21 %
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.
impaired commercial credits and other qualitative adjustments.
Approximately 85% of the required reserves come from the
baseline historical loss rates, specific reserve estimates and current
credit grades; while 15% comes from qualitative adjustments. As a
result, the required reserves tend to slightly lag the deterioration in
the portfolio due to the heavy reliance on realized historical losses
and the credit grade rating process. Consequently, a larger
unallocated reserve is required towards the end of the stronger part
of the credit cycle. As the credit cycle deteriorates and the actual
loss rates and downgrades increase, the Bancorp’s methodology
will result in a lower unallocated reserve as the incurred losses get
reflected into the main components of the methodology that drive
the majority of the required reserve calculations. Unallocated
reserves as a percent of total portfolio loans and leases for the year
ended December 31, 2006 were .06% compared to .20% for the
year ended December 31, 2005.
The allowance for loan and lease losses at December 31, 2006
decreased to 1.04% of the total portfolio loans and leases
compared to 1.06% at December 31, 2005. 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 29 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 30 shows the Bancorp’s
originations of these products in 2006 and 2005. The Bancorp
does not currently originate mortgage loans that permit principal
payment deferral or payments that are less than the accruing
interest. Table 31 provides the amount of these loans as a percent
of the residential mortgage loans in the Bancorp’s portfolio and the
delinquency rates of these loan products as of December 31, 2006
and 2005, 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, 2006 and 2005 were $1.2 billion and 1.74% and $1.2
billion and 1.24%, respectively.
The Bancorp manages credit risk in the mortgage portfolio
through conservative underwriting and documentation standards
and geographic and product diversification. The Bancorp may also
package and sell loans in the portfolio without recourse or may
purchase mortgage insurance for the loans sold in order to mitigate
credit risk.
42
Fifth Third Bancorp
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 30: RESIDENTIAL MORTGAGE ORIGINATIONS
For the years ended December 31 ($ in millions)
Greater than 80% LTV with no mortgage insurance
Interest-only
Greater than 80% LTV and interest-only
80/20 loans
2006
$679
1,283
180
431
TABLE 31: RESIDENTIAL MORTGAGE OUTSTANDINGS
Percent of total
7%
14
2
5
2005
$1,245
1,240
408
445
Percent of total
13 %
13
4
5
As of December 31 ($ in millions)
Greater than 80% LTV with no mortgage insurance
Interest-only
Greater than 80% LTV and interest-only
80/20 loans
2006
Percent
of total
23 %
15
7
-
Delinquency
Ratio
3.79%
.14
1.15
.72
Balance
$1,893
1,227
560
28
Balance
$1,773
899
361
28
2005
Percent
of total
25%
13
5
-
Delinquency
Ratio
3.11%
.41
.07
-
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 or financial position 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:
•
•
•
Assets and liabilities may mature or reprice at different
times;
Short-term and long-term market interest rates may
change by different amounts; or
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.
As a result of the ongoing analysis of the Bancorp’s interest
rate risk profile, management recommended and the Bancorp’s
Board of Directors approved a decision on November 20, 2006 to
reduce the size of the available-for-sale securities portfolio. This
action was undertaken in order to, among other reasons, improve
the composition of the Bancorp’s balance sheet with a lower
concentration of fixed-rate assets and better position the Bancorp
for an uncertain economic and
interest rate environment.
Management continues to review the Bancorp’s balance sheet
composition and to model the interest rate risk, and possible
actions to reduce this risk, given numerous future interest rate
scenarios.
interest
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
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 of the future volume and pricing
of each of the product lines offered by the Bancorp as well as
other pertinent assumptions on the balance sheet. 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 Executive Asset Liability 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 has a Market Risk Management
function as part of the Enterprise Risk Management division that
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 12-
month and 24-month horizons assuming a 200 bp parallel ramped
increase or decrease in market interest rates. In accordance with
the current policy, the rate movements are assumed to occur over
one year and are sustained thereafter. The following table shows
the Bancorp’s estimated earnings sensitivity profile and the ALCO
policy limits on the asset and liability positions as of December
31, 2006:
TABLE 32: ESTIMATED EARNINGS SENSITIVITY PROFILE
Change in Net Interest
Income (FTE)
12
Months
(.29)%
.01
.07
.41
13 to 24
Months
.45
.20
(.43)
(2.27)
Change in
Interest
Rates (bp)
+200
+100
-100
-200
ALCO Policy Limits
12
Months
(5.00)
-
-
(5.00)
13 to 24
Months
(7.00)
-
-
(7.00)
Economic Value of Equity
The Bancorp also employs economic value of equity (“EVE”) as a
measurement tool in managing interest rate sensitivity. Whereas
net interest income simulation highlights exposures over a
relatively short time horizon, the EVE analysis incorporates all
cash flows over the estimated remaining life of all balance sheet
and derivative positions. The EVE of the balance sheet, at a point
in time, is defined as the discounted present value of asset and
derivative cash flows less the discounted value of liability cash
flows. The sensitivity of EVE to changes in the level of interest
rates is a measure of longer-term interest rate risk. In contrast to
the net interest income simulation, which assumes interest rates
will change over a period of time, EVE uses instantaneous
changes in rates. EVE 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 EVE
analysis. Particularly
important are the assumptions driving
prepayments and the expected changes in balances and pricing of
the transaction deposit portfolios. The following table shows the
Bancorp’s EVE sensitivity profile as of December 31, 2006:
TABLE 33: ESTIMATED EVE SENSITIVITY PROFILE
Change in EVE
Change in
Interest Rates (bp)
+200
-200
2006
(3.98)%
2.52
ALCO Policy Limits
(20.0)
(20.0)
Fifth Third Bancorp 43
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
At December 31, 2006, the Bancorp has reduced its
sensitivity, relative to December 31, 2005, to the impact of an
instantaneous rate movement as a result of the balance sheet
actions taken during the fourth quarter of 2006. 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 EVE measures the discounted present value of cash
flows over the estimated lives of instruments, the change in EVE
does not directly correlate to the degree that earnings would be
impacted over a shorter time horizon (i.e., the current fiscal year).
Further, EVE 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 EVE analyses do not necessarily
include certain actions that management may undertake to manage
this risk in response to anticipated changes in interest rates.
Use of Derivatives to Manage Interest Rate Risk
An integral component of the Bancorp’s interest rate risk
management strategy is its use of derivative instruments to
minimize significant unplanned fluctuations in earnings and cash
flows caused by changes in market interest rates. 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.
As part of its overall risk management strategy relative to its
mortgage banking activity, the Bancorp enters into forward
contracts accounted
to
economically hedge interest rate lock commitments that are also
considered free-standing derivatives.
free-standing derivatives
for as
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 market volatility. Credit risks arise
from the possible inability of counterparties to meet the terms of
their contracts, which the Bancorp minimizes through approvals,
limits and monitoring procedures. The notional amount and fair
values of these derivatives as of December 31, 2006 are included
in Note 8 of the Notes to Consolidated Financial Statements.
Portfolio Loans and Leases and Interest Rate Risk
Although the Bancorp’s portfolio loans and leases contain both
fixed and floating/adjustable rate products, the rates of interest
earned by the Bancorp on the outstanding balances are generally
established for a period of time. The interest rate sensitivity of
loans and leases is directly related to the length of time the rate
earned is established. Table 34 shows a summary of the expected
principal cash flows of the Bancorp’s portfolio loans and leases as
of December 31, 2006. Additionally, Table 35 shows a summary
of expected principal cash flows occurring after one year as of
December 31, 2006.
Mortgage Servicing Rights and Interest Rate Risk
The net carrying amount of the MSR portfolio was $519 million
as of December 31, 2006 compared to $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 increase in interest rates and the resulting impact of
changing prepayment speeds led to recoveries of $19 million and
in 2006 and 2005,
$33 million of temporary
respectively. Servicing rights are deemed temporarily impaired
when a borrower’s loan rate is distinctly higher than prevailing
market rates. See Note 7 of the Notes to Consolidated Financial
Statements for further discussion on servicing rights.
impairment
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,
2006 was approximately $196 million compared to approximately
$130 million at December 31, 2005. The Bancorp also enters into
foreign exchange contracts for the benefit of commercial
customers involved in international trade to hedge their exposure
to foreign currency fluctuations. The Bancorp has several internal
controls in place to ensure excessive risk is not being taken in
include an
to customers.
providing
independent determination of currency volatility and credit
equivalent exposure on these contracts, counterparty credit
approvals and country limits.
this service
These
TABLE 34: PORTFOLIO LOAN AND LEASE PRINCIPAL CASH FLOWS
As of December 31, 2006 ($ in millions)
Commercial loans
Commercial mortgage loans
Commercial construction loans
Commercial lease financing
Residential mortgage and construction loans
Consumer loans
Consumer lease financing
Total
Less than 1 year
$11,953
3,841
4,206
1,054
2,576
6,405
415
$30,450
1-5 years
7,539
5,048
1,680
1,878
4,045
12,717
651
33,558
Greater than 5
years
1,233
1,516
282
909
2,209
4,189
7
10,345
Total
20,725
10,405
6,168
3,841
8,830
23,311
1,073
74,353
TABLE 35: PORTFOLIO LOAN AND LEASE PRINCIPAL CASH FLOWS OCCURRING AFTER ONE YEAR
Interest Rate
As of December 31, 2006 ($ in millions)
Commercial loans
Commercial mortgage loans
Commercial construction loans
Commercial lease financing
Residential mortgage and construction loans
Consumer loans
Consumer lease financing
Total
44
Fifth Third Bancorp
Fixed
$2,508
2,237
351
2,787
3,293
7,894
658
$19,728
Floating or Adjustable
6,264
4,327
1,611
-
2,961
9,012
-
24,175
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 36: MATURITY DISTRIBUTION OF CERTIFICATES - $100,000 AND OVER
As of December 31, 2006 ($ in millions)
Three months or less
Over three months through six months
Over six months through one year
Over one year
Total
$2,673
1,544
1,032
1,379
$6,628
TABLE 37: AGENCY RATINGS
As of December 31, 2006
Fifth Third Bancorp:
Commercial paper
Senior debt
Subordinated debt
Fifth Third Bank and Fifth Third Bank (Michigan):
Short-term deposit
Long-term deposit
Senior debt
Subordinated debt
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 estimated
weighted-average life of the available-for-sale portfolio was 4.3
years at December 31, 2006, based on current prepayment
expectations. Of the $11.1 billion (fair value basis) of securities in
the available-for-sale portfolio at December 31, 2006, $3.0 billion
in principal and interest is expected to be received in the next 12
months, and an additional $1.6 billion is expected to be received
in the next 13 to 24 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-term, fixed-rate single-family residential
mortgage loans underwritten according to FHLMC or Federal
National Mortgage Association (“FNMA”) guidelines are sold for
cash upon origination. 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 capable of being securitized,
sold or transferred off-balance sheet. For the years ended
December 31, 2006 and 2005, a total of $9.2 billion and $9.5
billion, respectively, were sold, securitized or transferred off-
balance sheet.
Additionally, the Bancorp has a shelf registration in place
with the Securities and Exchange Commission (“SEC”) permitting
ready access to the public debt markets and qualifies as a “well-
known seasoned issuer” under SEC rules. As of December 31,
2006, $750 million of debt or other securities were available for
issuance under this shelf registration. The Bancorp also has $15.8
billion of funding available for issuance through private offerings
of debt securities pursuant to its bank note program. These
sources, in addition to the Bancorp’s 9.32% average equity capital
base, provide a stable funding base.
Core 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
67% of its average total assets during 2006 compared to 64%
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
Moody’s
Standard and Poor’s
Fitch
Prime-1
Aa3
A1
Prime-1
Aa2
Aa2
Aa3
A-1
A+
A
A-1+
AA-
AA-
A+
F1+
AA-
A+
F1+
AA
AA-
A+
to fund asset growth. The maturity distribution for domestic
certificates of deposit of $100,000 and over as of December 31,
2006 is shown in Table 36. Management does not rely on any one
source of liquidity and manages availability in response to
changing balance sheet needs.
As of December 31, 2006, the Moody’s senior debt rating for
the Bancorp was Aa3, a rating surpassed by only four other U.S.
bank holding companies. Table 37 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.
CAPITAL MANAGEMENT
The Bancorp maintains a relatively high level of capital as a
margin of safety for its depositors and shareholders. At
December 31, 2006, shareholders’ equity was $10.0 billion
compared to $9.4 billion at December 31, 2005, an increase of six
percent. The Bancorp is reviewing its capital structure and
expects the tangible equity ratio to be approximately 7.0% at the
end of 2007. The Bancorp issued $750 million of Tier II-
qualifying subordinated debt during 2006. The issuance added
approximately 73 bp to the total risk-based capital ratio. The
Bancorp expects this ratio to remain at approximately 11.0% in
2007. See Note 26 of the Notes to Consolidated Financial
Statements for additional information regarding regulatory capital
ratios.
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 2006,
the Bancorp’s annual dividend increased to $1.58 from $1.46 in
2005.
Stock Repurchase Program
On January 10, 2005, the Bancorp repurchased 35.5 million shares
of
its common stock, approximately six percent of total
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 $43.55 for actual shares
acquired by the counterparty during the purchase period, plus
interest.
This share
transaction was considered
two separate
transactions, (i) the acquisition of treasury shares on the
acquisition date and (ii) a forward contract indexed to the
Bancorp’s stock. The treasury shares were accounted for at cost
Fifth Third Bancorp 45
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 38: CAPITAL RATIOS
As of December 31 ($ in millions)
Average equity as a percent of average assets
Tangible equity as a percent of tangible assets
Tier I capital
Total risk-based capital
Risk-weighted assets
Regulatory capital ratios:
Tier I capital
Total risk-based capital
Tier I leverage
2006
2005
9.32 % 9.06
6.87
7.79
$8,625
11,385
102,823
8.39 %
11.07
8.44
8,209
10,240
98,293
8.35
10.42
8.08
2004
9.34
8.35
8,522
10,176
82,633
10.31
12.31
8.89
2003
10.01
8.56
8,168
9,992
74,477
10.97
13.42
9.11
2002
11.08
9.54
7,656
8,844
65,444
11.70
13.51
9.73
TABLE 39: SHARE REPURCHASES
2004
For the years ended December 31
14,137,512
Shares authorized for repurchase at January 1
40,000,000
Additional authorizations
(18,452,400)
Shares repurchases (a)
35,685,112
Shares authorized for repurchase at December 31
Average price paid per share
53.48
(a) Excludes 357,612, 134,435 and 40,850 shares repurchased during 2006, 2005 and 2004, respectively, in connection with various employee compensation plans. These repurchases
35,685,112
20,000,000
(37,838,159)
17,846,953
$43.19
17,846,953
-
(2,039,908)
15,807,045
$39.72
2006
2005
are not included against the maximum number of shares that may yet be repurchased under the Board of Directors’ authorization.
for
equity
stock qualified
as a contra equity transaction. The forward contract indexed to
the Bancorp’s
classification.
Additionally, for diluted earnings per share purposes the Bancorp
assumed the transaction would be net settled in shares as the
Bancorp had the choice of settling in cash or shares and the
Bancorp did not have a stated policy or the ability to demonstrate
a past practice of cash settlement. These incremental shares were
subsequently excluded
from quarterly earnings per share
calculations, as the effect of inclusion would have been anti-
dilutive.
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. At December 31, 2006, the Bancorp
had 15.8 million shares remaining under this authorization.
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 39.
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 are
generally carried at the lower of cost or fair value.
The Bancorp has no material contracts for which a lack of
marketplace quotations requires the estimation of fair value. The
Bancorp’s derivative product policy and investment policies
provide a framework within which the Bancorp and its affiliates
may use certain authorized financial derivatives as a market risk
management tool in meeting the Bancorp’s ALCO capital
planning directives and to hedge changes in fair value of its largely
fixed-rate mortgage servicing rights portfolio. The Bancorp also
provides qualifying commercial customers access to the derivative
market, including foreign exchange, interest rate and commodity
contracts. 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 matching
terms that are generally settled daily. These policies are reviewed
and approved annually by the Risk and Compliance Committee of
46
Fifth Third Bancorp
the Board of Directors.
the customer
investment grade commercial
Through December 31, 2006 and 2005, the Bancorp had
transferred, subject to credit recourse, certain primarily floating-
loans to an
rate, short-term
unconsolidated qualified special purpose entity (“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
relationships. The
outstanding balance of such loans at December 31, 2006 and 2005
was approximately $3.4 billion and $2.8 billion, respectively.
These loans may be transferred back to the Bancorp upon the
occurrence of certain specified events. 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 $3.4 billion and $2.8 billion, respectively, at December
31, 2006 and 2005. In addition, the Bancorp’s agreement to
provide liquidity support to the QSPE was $3.8 billion as of year
end 2006 compared to $3.4 billion as of year end 2005. At
December 31, 2006 and 2005, the Bancorp’s loss reserve related
to the liquidity support and credit enhancement provided to the
QSPE was $16 million and $10 million, respectively.
ineligible
The Bancorp had the following cash flows with these
unconsolidated QSPEs during the years ended December 31,
2006 and 2005:
TABLE 40: CASH FLOWS WITH UNCONSOLIDATED QSPEs
For the years ended December 31 ($ in millions)
Proceeds from transfers, including new securitizations
Proceeds from collections reinvested in revolving-
2006
$1,618
2005
1,680
period securitizations
Fees received
97
35
132
32
The Bancorp utilizes securitization
trusts 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
the
Bancorp’s
retention of
subordinated
interest-only strips,
residual interests, credit recourse and, in some cases, a cash
reserve account. At December 31, 2006, the Bancorp had
retained servicing assets totaling $524 million, subordinated
securitization policy permits
tranches, servicing rights,
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
tranche security interests totaling $15 million and residual interests
totaling $21 million. 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, 2006 and 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. In the event of nonperformance, the Bancorp has rights
to the underlying collateral value attached to the loan. The
Bancorp maintained an estimated credit
loss reserve of
approximately $18 million and $21 million relating to these
residential mortgage loans sold at December 31, 2006 and 2005,
respectively. To determine the credit loss reserve, the Bancorp
used an approach that is consistent with its overall approach in
estimating credit losses for various categories of residential
mortgage loans held in its loan portfolio.
Contractual Obligations and Commitments
The Bancorp has certain obligations and commitments to make
future payments under contracts. At December 31, 2006, the
aggregate contractual obligations and commitments were:
TABLE 41: CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS
As of December 31, 2006 ($ in millions)
Contractually obligated payments due by period:
Total deposits (a)
Long-term debt (b)
Short-term borrowings (c)
Noncancelable leases (d)
Capital expenditures (e)
Partnership investment commitments (f)
Purchase obligations (g)
Total contractually obligated payments due by period
Other commitments by expiration period:
Less than
1 year
1-3 years
3-5 years
Greater than
5 years
$66,423
2,029
4,217
72
126
260
15
$73,142
1,225
3,890
-
134
-
-
9
5,258
26
794
-
112
-
-
-
932
1,706
5,845
-
377
-
-
-
7,928
Total
69,380
12,558
4,217
695
126
260
24
87,260
Letters of credit (h)
Commitments to extend credit (h)
Total other commitments by expiration period
(a)
$2,877
23,962
$26,839
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.
In the banking industry, interest-bearing obligations are principally used to fund interest-earning assets. As such, interest charges on contractual obligations were excluded from
reported amounts, as the potential cash outflows would have corresponding cash inflows from interest-earning assets. See Note 11 of the Notes to Consolidated Financial Statements
for additional information on these debt instruments.
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 Consolidated Financial Statements.
3,024
18,123
21,147
8,163
42,085
50,248
1,773
-
1,773
(b)
(c)
489
-
489
Includes commitments to various general contractors for work related to banking center construction.
Includes low-income housing, historic tax and venture capital partnership investments.
(d) See Note 4 of the Notes to Consolidated Financial Statements for additional information on these noncancelable leases.
(e)
(f)
(g) Represents agreements to purchase goods or services.
(h) See Note 12 of the Notes to Consolidated Financial Statements for additional information on these commitments.
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 over financial reporting, designed to
provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with accounting principles generally accepted in the United States of America. 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 over financial reporting can provide only reasonable assurance with
respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control over financial reporting may
vary over time.
The Bancorp’s Management assessed the effectiveness of the Bancorp’s internal control over financial reporting as of December 31, 2006 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, 2006. Based on this assessment,
Management believes that the Bancorp maintained effective internal control over financial reporting as of December 31, 2006.
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, 2006 and Bancorp Management’s
assessment of the internal control over financial reporting. This report appears on the following page.
George A. Schaefer, Jr.
Chairman and Chief Executive Officer
February 15, 2007
Christopher G. Marshall
Executive Vice President and Chief Financial Officer
February 15, 2007
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, 2006, 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, 2006, 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, 2006, 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, 2006 of the Bancorp and our report dated February 15, 2007 expressed an unqualified
opinion on those financial statements.
Cincinnati, Ohio
February 15, 2007
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, 2006
and 2005, 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, 2006. 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, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended
December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.
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, 2006, 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 15, 2007 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 15, 2007
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
Corporate banking revenue
Other noninterest income
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
Other noninterest expense
Total noninterest expense
Income Before Income Taxes and Cumulative Effect
Applicable income taxes
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 cumulative effect of change in accounting principle, net
Earnings Per Share
Earnings per diluted share from continuing operations
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
2006
2005
2004
$5,000 3,918 2,847
904 1,032 1,217
30 39 45
934 1,071 1,262
21 6 5
5,955 4,995 4,114
398 314 174
363 176 58
261 140 39
433 263 162
278 129 48
177 126 58
1,910 1,148 539
208 138 77
- 6 15
194 138 78
770 600 393
3,082 2,030 1,102
2,873 2,965 3,012
343 330 268
2,530 2,635 2,744
857 748 631
517 522 515
155 174 178
367 358 363
318 299 228
300 360 587
(364) 39 (37)
3 - -
2,153 2,500 2,465
443
1,174 1,133 1,018
292 283 261
122 105 84
245 221 185
1,223 1,185 1,424
3,056 2,927 2,972
1,627 2,208 2,237
712
659
1,184 1,549 1,525
4 -
-
$1,188 1,549 1,525
$1,188 1,548 1,524
$2.13 2.79 2.72
0.01 - -
$2.14 2.79 2.72
$2.12 2.77 2.68
0.01 - -
$2.13 2.77 2.68
50
Fifth Third Bancorp
CONSOLIDATED BALANCE SHEETS
2006
2005
3,078
21,924
389
117
158
1,304
$2,737
11,053
356
187
809
1,150
19,174
7,037
9,188
4,852
7,152
22,084
1,751
(1,313)
69,925
(744)
69,181
1,726
143
2,169
208
441
4,387
105,225
20,725
6,847
10,405
4,984
8,151
23,311
1,176
(1,246)
74,353
(771)
73,582
1,940
202
2,193
166
524
5,770
$100,669
As of December 31 ($ in millions, except share data)
Assets
Cash and due from banks
Available-for-sale and other securities (amortized cost: 2006-$11,236 and 2005-$22,533)
Held-to-maturity securities (fair value: 2006-$356 and 2005-$389)
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
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
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)
1,827
Capital surplus
8,007
Retained earnings
(413)
Accumulated other comprehensive income
(1,279)
Treasury stock
10,022 9,446
Total Shareholders' Equity
Total Liabilities and Shareholders' Equity
105,225
(a) Stated value $2.22 per share; authorized 1,300,000,000; outstanding at 2006 - 556,252,674 (excludes 27,174,430 treasury shares) and 2005 - 555,623,430 (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
90,647 95,779
$14,331
15,993
13,181
6,584
10,987
6,628
1,676
69,380
1,421
2,796
2,283
2,209
12,558
1,295
9
1,812
8,317
(179)
(1,232)
$100,669
27,803,674 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
1,295
9
11
(11)
1,295
9
$1,295
9
Accumulated
Other
Retained Comprehensive Treasury
Stock
Income
Earnings
6,481
1,525
(735)
(1)
(1)
7,269
1,549
(810)
(1)
8,007
1,188
(880)
(1)
1
(962)
(120)
(49)
(169)
(244)
(987)
33
222
281
(1)
(1,414)
(1,746)
43
206
1,413
219
(413)
(1,279)
288
(54)
(82)
45
84
2
8,317
(179)
(1,232)
Capital
Surplus
1,964
87
(33)
(133)
11
36
2
1,934
97
65
(43)
(121)
11
6
85
(208)
1
1,827
76
(6)
(45)
(49)
8
(1)
2
1,812
Total
8,667
1,525
(49)
1,476
(735)
(1)
(987)
87
-
89
11
317
-
8,924
1,549
(244)
1,305
(810)
(1)
(1,649)
65
-
85
11
6
1,509
-
1
9,446
1,188
288
1,368
(54)
(880)
(1)
(82)
77
(6)
-
35
8
(1)
4
10,022
($ in millions, except per share data)
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
Net income
Other comprehensive income
Comprehensive income
Cumulative effect of change in accounting for pension and
other postretirement obligations
Cash dividends declared:
Common stock at $1.58 per share
Preferred stock
Shares acquired for treasury
Stock-based compensation expense
Impact of cumulative effect of change in accounting principle
Restricted stock grants
Stock-based awards exercised, including treasury shares issued
Loans repaid related to the exercise of stock-based awards, net
Change in corporate tax benefit related to stock-based
compensation
Other
Balance at December 31, 2006
See Notes to Consolidated Financial Statements
52
Fifth Third Bancorp
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31 ($ in millions)
Operating Activities
Net Income
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan and lease losses
Cumulative effect of change in accounting principle, net of tax
Depreciation, amortization and accretion
Stock-based compensation expense
Benefit 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 in other assets
(Decrease) increase 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
(Increase) decrease in other short-term investments
Increase in loans and leases
(Increase) decrease in operating lease equipment
Purchases of bank premises and equipment
Proceeds from disposal of bank premises and equipment
Cash received on divestitures
Net cash (paid) acquired in business combination
Net Cash Provided by (Used In) Investing Activities
Financing Activities
Increase in core deposits
Increase (decrease) in certificates - $100,000 and over, including foreign office
(Decrease) increase in federal funds purchased
(Decrease) increase in short-term bank notes
Decrease 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 (Used In) Provided by Financing Activities
(Decrease) 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
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 and note issued
Stock options
Common stock issued
Securitizations:
Capitalized servicing rights
Residual interest
Available-for-sale securities retained
See Notes to Consolidated Financial Statements
2006
$1,188
343
(4)
399
77
(21)
(44)
(3)
408
9,352
(131)
(7,172)
(70)
-
(1,440)
(31)
642
3,493
12,568
3,033
(4,676)
38
(5)
(651)
(6,644)
(77)
(443)
60
-
(5)
3,198
1,467
479
(3,902)
-
(1,462)
3,731
(6,441)
(867)
43
(82)
2
(7,032)
(341)
3,078
$2,737
$3,051
489
1,901
6
17
(18)
-
-
-
-
-
2005
2004
1,549
1,525
330
-
405
65
(16)
(46)
-
7
9,697
(162)
(7,084)
(40)
-
(922)
42
355
4,180
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)
12
2,581
517
2,561
3,078
1,952
676
3,399
5,149
1,297
(5,179)
(63)
(1,446)
-
-
-
268
-
459
87
(13)
(58)
-
95
6,824
(112)
(4,788)
259
(91)
(861)
(35)
(73)
3,486
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)
9
444
202
2,359
2,561
1,096
708
605
921
282
(916)
(36)
(281)
9
21
21
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 banking centers located throughout Ohio,
Kentucky, Indiana, Michigan, Illinois, Florida, Tennessee, West
Virginia, Pennsylvania and Missouri.
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 residential mortgage loans 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 is accounted for on the cost
recovery 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 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.
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. Additionally, the carrying value of loans held for sale
designated as the hedged item in a fair value hedge transaction are
adjusted for changes in their fair value over the term of the
hedging relationship. 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 carrying 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 loss experience and such factors
that, 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.
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. Intercompany transactions and balances have been
eliminated. Certain prior period data has been reclassified to
conform to current period presentation. Such reclassifications
have no effect on previously reported consolidated financial
positions or results of operation.
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. Securities are
classified as available-for-sale when, in management’s judgment,
they may be sold in response to, or in anticipation of, changes in
market conditions. The Bancorp’s management has evaluated the
securities in an unrealized loss position in the available-for-sale
portfolio and maintains the intent and ability to hold these
securities to the earlier of the recovery of the losses or maturity.
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
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 management’s intent and ability
to hold the security to recovery. 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.
income
in
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
is
discontinued when there is a clear indication that 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
income for commercial
interest
loans
54 54
Fifth Third Bancorp
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 Standards (“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 a 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 for allowance analysis purposes encompasses ten
categories. The Bancorp also maintains a dual risk rating system
that provides for thirteen 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
Rather, standard credit scoring systems and
risk graded.
risks.
delinquency monitoring are used
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.
to assess credit
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.
The Bancorp’s current methodology for determining the
allowance for loan and lease losses is based on historical loss rates,
current credit grades, specific allocation on impaired commercial
credits and other qualitative adjustments.
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. An unallocated allowance is maintained to recognize
the imprecision in estimating and measuring loss when evaluating
allowances for individual loans or pools of loans.
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, Pennsylvania and Missouri. 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
probable losses related to unfunded credit facilities and is included
in other liabilities in the Consolidated Balance Sheets. The
determination of the adequacy of the reserve is based upon an
evaluation of
including an
the unfunded credit facilities,
assessment of historical commitment utilization experience, credit
risk grading and credit grade migration. Net adjustments to the
reserve for unfunded commitments are
in other
noninterest expense.
included
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
income in 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 comprehensive income or in noninterest
income in the 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.
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
in the economic assumptions used,
the potential volatility
particularly the prepayment speeds. The Bancorp monitors this
risk and adjusts its valuation allowance as necessary to adequately
Fifth Third Bancorp 55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the Bancorp obtains an
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,
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.
independent
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
income tax purposes.
is used for
Amortization of leasehold improvements is computed using the
straight-line method over the lives of the related leases or useful
lives of the related assets, whichever is shorter. In accordance with
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 primary-
asset approach whenever events or changes in circumstances
improvements are
dictate. Maintenance, repairs and minor
charged to noninterest expense as incurred.
those
instruments at fair value
Derivative Financial Instruments
The Bancorp accounts for its derivatives under SFAS No. 133,
“Accounting for Derivative Instruments and Hedging Activities,”
as amended. This Statement requires recognition of all derivatives
as either assets or liabilities in the balance sheet and requires
measurement of
through
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
in accumulated other
that
comprehensive 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.
is effective, are
recorded
it
Prior to entering into 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,
56 56
Fifth Third Bancorp
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 Sheets. 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 laws. Deferred tax assets are recognized to the extent they
exist and are subject to a valuation allowance based on
management’s judgment that realization is more-likely-than-not.
Accrued taxes represent the net estimated amount due to
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 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 Revenue
Service is currently challenging the Bancorp’s tax treatment of
certain leasing transactions. For additional information, see Note
21.
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.
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/or 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 Financial Accounting Standards Board
(“FASB”) issued SFAS No. 148, “Accounting for Stock-Based
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 granted to employees after January 1, 1995.
Stock-based compensation expense is included in salaries, wages
and incentives expense in the Consolidated Statements of Income.
In December 2004, the FASB issued SFAS No. 123 (Revised
requires
2004), “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 vesting period. This Statement was effective for financial
statements as of the beginning of the first interim or annual
reporting period of the first fiscal year beginning after September
15, 2005. On January 1, 2006, the Bancorp elected to adopt this
Statement using the modified retrospective application. Adoption
the Bancorp’s
of
Consolidated Financial Statements: i) the recognition of a benefit
for the cumulative effect of change in accounting principle of
approximately $4 million (net of $2 million of tax) during the first
quarter of 2006 due to the recognition of an estimate of forfeiture
experience to be realized for all unvested stock-based awards
outstanding; ii) the reclassification in the Consolidated Statements
of Cash Flows for the years ended December 31, 2005 and 2004
of $6 million and $9 million, respectively, of net cash provided
related to the excess corporate tax benefit received on stock-based
compensation, previously recorded in the operating activities
section, to the financing activities section and iii) the recognition
of approximately $9 million of incremental salaries, wages and
incentives expense in the second quarter of 2006 related to the
issuance in April 2006 of stock-based awards to retirement-eligible
employees. The adoption of this Statement did not have an impact
on basic or diluted earnings per share. For further information on
stock-based compensation see Note 18.
this Statement had
impacts on
three
issued Statement of Position
In December 2003, the Accounting Standards Executive
Committee of the American Institute of Certified Public
Accountants
(“SOP”) 03-3,
“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 (i.e. impaired loans) 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.
Its Application
Impairment and
In March 2004, the Emerging Issues Task Force (“EITF”)
reached a consensus on Issue 03-1, “The Meaning of Other-Than-
Temporary
to Certain
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
Its Application
Impairment and
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 was 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.
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 in 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 in accounting principle, unless it 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 was effective for accounting
changes and error corrections made in fiscal years beginning after
December 15, 2005. The adoption of this Statement did not have
a material effect on the Bancorp’s Consolidated Financial
Statements.
In February 2006, the FASB
issued SFAS No. 155,
“Accounting for Certain Hybrid Financial Instruments, an
amendment of FASB Statements No. 133 and 140.” This
Statement amends FASB Statements No. 133 and No. 140 as well
as resolves issues addressed in Statement No. 133 Implementation
Issue No. D1, “Application of Statement No. 133 to Beneficial
Interests in Securitized Financial Assets.” Specifically, this
Statement: i) permits fair value remeasurement for any hybrid
financial instrument that contains an embedded derivative that
otherwise would require bifurcation; ii) clarifies which interest-
only strips and principal-only strips are not subject to the
requirements of Statement No. 133; iii) establishes a requirement
to evaluate interests in securitized financial assets to identify
interests that are free-standing derivatives or that are hybrid
financial
instruments that contain an embedded derivative
requiring bifurcation; iv) clarifies that concentrations of credit risk
in the form of subordination are not embedded derivatives; and v)
amends Statement No. 140 to eliminate the prohibition on a
qualifying SPE from holding a derivative financial instrument that
pertains to a beneficial interest other than another derivative
financial instrument. This Statement is effective for all financial
instruments acquired or issued after the beginning of the first
fiscal year that begins after September 15, 2006. The adoption of
this Statement on January 1, 2007 did not have a material effect
on the Bancorp’s Consolidated Financial Statements.
the FASB
In March 2006,
issued SFAS No. 156,
“Accounting for Servicing of Financial Assets, an amendment of
FASB Statement No. 140.” This Statement amends FASB
Statement No. 140 and requires 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 Statement permits the Bancorp to choose either to
report servicing assets and liabilities at fair value or at amortized
Fifth Third Bancorp 57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
This Statement is effective as of the beginning of the first fiscal
year that begins after September 15, 2006. Upon adoption of this
Statement on January 1, 2007, the Bancorp elected to continue to
report all classes of servicing assets and liabilities at amortized cost
subsequent to initial recognition at fair value.
In July 2006, the FASB issued FSP FAS 13-2, “Accounting
for a Change or Projected Change in the Timing of Cash Flows
Relating to Income Taxes Generated by a Leveraged Lease
Transaction.” This FSP addresses the 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 FSP amends SFAS No. 13, “Accounting
for Leases,” and applies to all transactions classified as leveraged
leases. The timing of cash flows relating to income taxes generated
by a leveraged lease is an important assumption that affects the
periodic income recognized by the lessor. Under this FSP, the
projected timing of income tax cash flows generated by a
leveraged lease transaction is required to be reviewed annually or
more frequently if events or circumstances indicate that a change
in timing has occurred or is projected to occur. 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, the cumulative effect of the change in the net
investment balance resulting from the recalculation will be
recognized as an adjustment to the beginning balance of retained
earnings. On an ongoing basis following the adoption, a change in
the net investment balance resulting from a recalculation will 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 the remaining terms of the affected leases.
Additionally, upon adoption, only tax positions that meet the
more-likely-than-not recognition threshold should be reflected in
the financial statements and all recognized tax positions in a
leveraged lease must be measured in accordance with FASB
Interpretation No. 48, “Accounting for Uncertainty in Income
Taxes - An Interpretation of FASB Statement No. 109,” issued in
July 2006.
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, including penalties, 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
could involve a projected change in the timing of these leveraged
lease cash flows.
58 58
Fifth Third Bancorp
This FSP
is effective for fiscal years beginning after
December 15, 2006. Upon adoption of this FSP on January 1,
2007, the Bancorp recognized an after-tax adjustment to
beginning retained earnings of $96 million representing the
cumulative effect of applying the provisions of this FSP.
income taxes recognized
In July 2006, the FASB issued Interpretation (“FIN”) No. 48,
“Accounting for Uncertainty in Income Taxes - An Interpretation
of FASB Statement No. 109.” This Interpretation clarifies the
accounting for uncertainty
in
in
accordance with FASB Statement No. 109, “Accounting for
Income Taxes.” This Interpretation also prescribes a recognition
threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected
to be taken in a tax return. This Interpretation also provides
guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. The
evaluation of a tax position in accordance with this Interpretation
is a two-step process. The first step is a recognition process to
determine whether it is more-likely-than-not that a tax position
will be sustained upon examination, including resolution of any
related appeals or litigation processes, based on the technical
merits of the position. The second step is a measurement process
whereby a tax position that meets the more-likely-than-not
recognition threshold is assessed to determine the amount of
benefit to be recognized in the financial statements. This
Interpretation
is effective for fiscal years beginning after
December 15, 2006 and the cumulative effect of applying the
provisions of this Interpretation will be recognized as an
adjustment to the beginning balance of retained earnings.
Adoption of this Interpretation on January 1, 2007 did not have a
material effect on
the Bancorp’s Consolidated Financial
Statements.
In September 2006, the FASB issued SFAS No. 157, “Fair
Value Measurements.”
This Statement defines fair value,
establishes a framework for measuring fair value and expands
disclosures about fair value measurements. This Statement
emphasizes that fair value is a market-based measurement and
should be determined based on assumptions that a market
participant would use when pricing an asset or liability. This
Statement clarifies that market participant assumptions should
include assumptions about risk as well as the effect of a restriction
on the sale or use of an asset. Additionally, this Statement
establishes a fair value hierarchy that provides the highest priority
to quoted prices in active markets and the lowest priority to
unobservable data. This Statement is effective for fiscal years
beginning after November 15, 2007, and interim periods within
those fiscal years. The Bancorp is currently in the process of
its
evaluating the
Consolidated Financial Statements.
impact of adopting this Statement on
In September 2006, the FASB issued SFAS No. 158,
“Employer’s Accounting for Defined Benefit Pension and Other
Postretirement Plans – An Amendment of FASB Statements No.
87, 88, 106, and 132(R).” This Statement amends the current
accounting for pensions and postretirement benefits by requiring
an entity to recognize the overfunded or underfunded status of a
defined benefit postretirement plan as an asset or liability in its
statement of financial position and to recognize changes in that
funded status in the year in which the changes occur through
comprehensive income. This Statement also requires recognition,
as a component of other comprehensive income (net of tax), of
the actuarial gains and losses and the prior service costs and
credits that arise during the period, but are not recognized as
components of net periodic benefit cost pursuant to SFAS No. 87
and No. 106. Additionally, this Statement requires an entity to
measure defined benefit plan assets and obligations as of the date
of the employer’s fiscal year-end statement of financial position.
The Bancorp adopted this Statement on December 31, 2006. The
effect of this Statement was to recognize $59 million, after-tax, of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
net actuarial losses and prior service cost as a reduction to
accumulated other comprehensive income.
In September 2006, the SEC issued Staff Accounting Bulletin
(“SAB”) 108, “Financial Statements – Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements.” This SAB provides guidance
on the consideration of prior year misstatements in determining
whether the current year’s financial statements are materially
misstated. In providing this guidance, the SEC staff references
both the “iron curtain” and “rollover” approaches to quantifying a
current year misstatement for purposes of determining materiality.
The iron curtain approach focuses on how the current year’s
balance sheet would be affected in correcting misstatements
without considering the year in which the misstatement originated.
the amount of
rollover approach
the
focuses on
The
misstatements that originated in the current year’s income
statement. The SEC staff indicates that registrants should
quantify the impact of correcting all misstatements, including both
the carryover and reversing effects of prior year misstatements, on
the current year financial statements. This SAB is effective for
fiscal years ending after November 15, 2006. Registrants may
either restate their financials for any material misstatements arising
from the application of this SAB or recognize a cumulative effect
of applying SAB 108 within the current year opening balance in
retained earnings. The adoption of this SAB did not have a
material
the Bancorp’s Consolidated Financial
Statements.
impact on
2. SECURITIES
The following table provides a breakdown of the securities portfolio as of December 31:
($ 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:
Amortized
Cost
Unrealized
Gains
Unrealized
Losses
Fair Value
Amortized
Cost
Unrealized
Gains
Unrealized
Losses
Fair Value
2006
2005
$1,396
100
603
7,999
172
966
$11,236
-
-
11
10
1
3
25
-
(5)
-
(193)
(2)
(8)
(208)
1,396
95
614
7,816
171
961
11,053
506
2,034
657
16,127
2,119
1,090
22,533
-
-
19
12
3
1
35
(21)
(69)
-
(502)
(45)
(7)
(644)
485
1,965
676
15,637
2,077
1,084
21,924
Obligations of states and
political subdivisions
Other debt securities
-
-
Total
-
(a) Other securities consist of FHLB and Federal Reserve Bank restricted stock holdings of $527 million and $187 million at December 31, 2006, respectively, and $567 million and $185 million
$345
11
$356
345
11
356
378
11
389
378
11
389
-
-
-
-
-
-
-
-
-
at December 31, 2005, respectively, that are carried at cost, FHLMC preferred stock holdings, certain mutual fund holdings and equity security holdings.
During the fourth quarter of 2006, the Bancorp evaluated its
overall balance sheet composition and took certain actions with
respect to its available-for-sale securities portfolio. The Bancorp’s
objective was to reduce the size of its available-for-sale securities
portfolio to a size that is more consistent with its liquidity,
collateral and
interest rate risk management requirements,
improve the asset/liability profile of the Bancorp and better
position the Bancorp for an uncertain economic and interest rate
environment. On November 20, 2006, the Bancorp’s Board of
Directors approved the following actions with respect to the
Bancorp’s available-for-sale securities portfolio: (i) sales of $11.3
billion in available-for-sale securities and (ii) reinvestment of
approximately $2.8 billion in available-for-sale securities that are
more efficient when used as collateral. The sale of available-for-
sale securities resulted in pretax losses of $398 million, or $255
million after-tax.
In determining the securities to sell, the Bancorp assessed (i)
the relative value of the classes of securities in its available-for-sale
portfolio; (ii) the Bancorp’s customer acceptance of using certain
classes of securities as forms of collateral; and (iii) the exposure in
the portfolio to certain sectors with a changing credit risk profile.
As a result of this assessment, the Bancorp sold the following
available-for-sale securities in the fourth quarter of 2006:
($ in millions)
15-year fixed-rate agency mortgage-backed securities
Adjustable-rate agency mortgage-backed securities
U.S. Treasury notes
Available-for-sale securities sold due to relative performance
Agency collateralized mortgage obligations
Whole loan collateralized mortgage obligations
Whole loan adjustable rate mortgages
Available-for-sale securities sold due to collateral inefficiency
Agency debentures
Other security classes
Total
Available-for-Sale
Securities Sold
$4,074
1,724
500
6,298
2,135
1,095
795
4,025
798
194
$11,315
Fifth Third Bancorp 59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Bancorp sold nearly all of its 15-year fixed-rate and
adjustable-rate agency mortgage-backed securities and all of its
U.S. Treasury notes to reduce its interest rate spread exposure in
these asset classes. The Bancorp sold nearly all of its whole loan
collateralized mortgage obligations and adjustable-rate mortgages
and the majority of its agency collateralized mortgage obligations
as these classes of securities are not widely accepted by the
Bancorp’s customers as forms of collateral. The Bancorp sold all
of its FNMA agency debentures to reduce its credit exposure as a
result of recent market events.
The Bancorp purchased approximately $1.4 billion in 30-year
fixed-rate agency mortgage-backed securities and $1.4 billion of
one-month and three-month U.S. Treasury bills for collateral
purposes.
During the third quarter of 2006, the Bancorp sold $726
million of FHLMC callable debt, which represented nearly all of
its position in these securities, in order to manage its liquidity and
reduce its credit exposure as a result of recent market events.
The Bancorp believes it met its objective to reduce the size
of its available-for-sale securities portfolio to a size that is more
consistent with its liquidity, collateral and interest rate risk
management requirements, improve the asset/liability profile of
the Bancorp and better position the Bancorp for an uncertain
economic and interest rate environment as a result of these
actions. The Bancorp assesses its remaining securities relative to
the same portfolio objective, its market outlook and its desired
asset class allocations. Given this assessment, the Bancorp
maintains its intent and ability to hold the remaining available-for-
sale securities to the earlier of the recovery of the unrealized losses
or maturity.
The amortized cost and approximate fair value of securities
at December 31, 2006, by contractual maturity, are shown in the
following table. Actual maturities may differ from contractual
maturities when there exists a right to call or prepay obligations
with or without call or prepayment penalties.
($ in millions)
Debt securities:
Under 1 year
1-5 years
5-10 years
Over 10 years
Other securities
Total
Available-for-Sale & Other
Amortized
Cost
Fair Value
Held-to-Maturity
Amortized
Cost
Fair Value
$1,431
257
588
7,994
966
$11,236
1,433
259
589
7,811
961
11,053
2
21
302
31
-
356
2
21
302
31
-
356
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, 2006 and 2005:
Less than 12 months
12 months or more
Total
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
$747
-
3
853
10
8
$1,621
$-
654
7,523
1,800
64
$10,041
-
-
-
(3)
-
(2)
(5)
-
(21)
(205)
(39)
(7)
(272)
1
95
4
5,383
119
41
5,643
477
1,252
7,646
178
-
9,553
-
(5)
-
(190)
(2)
(6)
(203)
(21)
(48)
(297)
(6)
-
(372)
748
95
7
6,236
129
49
7,264
477
1,906
15,169
1,978
64
19,594
-
(5)
-
(193)
(2)
(8)
(208)
(21)
(69)
(502)
(45)
(7)
(644)
At December 31, 2006 and 2005, securities with a fair value of
$7.7 billion and $16.6 billion, respectively, were pledged to secure
borrowings, public deposits, trust funds and for other purposes as
required or permitted by law.
Unrealized gains and losses on trading securities held at
the
December 31, 2006 and 2005 were not material
Consolidated Financial Statements.
to
($ in millions)
2006
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
2005
U.S. Treasury and Government agencies
U.S. Government sponsored agencies
Agency mortgage-backed securities
Other bonds, notes and debentures
Other securities
Total
sponsored agencies and
At December 31, 2006, 95% of the unrealized losses in the
available-for-sale securities portfolio were comprised of securities
issued by the U.S. Treasury and Government agencies, U.S.
Government
states and political
subdivisions as well as agency mortgage-backed securities. The
Bancorp believes the price movements in these securities are
dependent upon movements
At
December 31, 2006, one percent of unrealized losses in the
available-for-sale securities portfolio were represented by non-rated
securities.
interest rates.
in market
60 60
Fifth Third Bancorp
3. LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES
A summary of the total loans and leases as of December 31:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ in millions)
Loans held for sale:
Commercial loans
Commercial leases
Residential mortgage
Home equity
Other consumer loans
Total loans held for sale
Portfolio loans and leases (a):
Commercial:
Commercial loans
Commercial mortgage
Commercial construction
Commercial leases
Total commercial
Consumer:
Residential mortgage
Residential construction
Credit card
Home equity
Other consumer loans
Consumer leases
2006
Unearned
Income
-
-
-
-
-
-
-
-
-
(1,143)
(1,143)
Gross
$ -
-
1,075
1
74
$1,150
$20,725
10,405
6,168
4,984
42,282
Net
-
-
1,075
1
74
1,150
20,725
10,405
6,168
3,841
41,139
8,151
679
1,110
12,364
9,837
1,176
33,317
$75,599
-
-
-
-
-
(103)
(103)
(1,246)
8,151
679
1,110
12,364
9,837
1,073
33,214
74,353
Total consumer
Total portfolio loans and leases
(a) At December 31, 2006 and 2005, deposit overdrafts of $43 million and $56 million, respectively, were included in portfolio loans.
The following is a summary of the gross investment in lease financing at December 31:
($ in millions)
Direct financing leases
Leveraged leases
Total
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
Initial direct cost, net of amortization
Gross investment in lease financing
Unearned income
Net investment in lease financing
Gross
125
3
1,144
-
32
1,304
19,174
9,188
6,342
4,852
39,556
7,152
695
866
12,000
9,218
1,751
31,682
71,238
2005
Unearned
Income
-
-
-
-
-
-
-
-
-
(1,157)
(1,157)
-
-
-
-
-
(156)
(156)
(1,313)
2006
$3,640
2,520
$6,160
2006
$4,479
1,652
29
6,160
(1,246)
$4,914
Net
125
3
1,144
-
32
1,304
19,174
9,188
6,342
3,695
38,399
7,152
695
866
12,000
9,218
1,595
31,526
69,925
2005
4,141
2,462
6,603
2005
4,580
1,983
40
6,603
(1,313)
5,290
At December 31, 2006, the minimum future lease payments receivable for each of the years 2007 through 2011 were $1.1 billion, $.9
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
Balance at December 31
2006
$744
(408)
92
(316)
343
$771
2005
713
(373)
74
(299)
330
744
2004
697
(321)
69
(252)
268
713
As of December 31, 2006, impaired loans, under SFAS No.
114, with a valuation allowance totaled $193 million and impaired
loans without a valuation allowance totaled $100 million. The
total valuation allowance on the impaired loans at December 31,
2006 was $59 million. As of December 31, 2005, impaired loans
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
was $54 million.
Average impaired loans, net of valuation allowances, were
$209 million in 2006, $169 million in 2005 and $140 million in
2004. Cash basis interest income recognized on those loans
during each of the years was immaterial.
At December 31, 2006 and 2005, total nonperforming assets
were $455 million and $361 million, respectively, and total loans
and leases 90 days past due were $210 million and $155 million,
respectively.
Fifth Third Bancorp 61
4. BANK PREMISES AND EQUIPMENT
A summary of bank premises and equipment at December 31:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ in millions)
Land and improvements
Buildings
Equipment
Leasehold improvements
Construction in progress
Accumulated depreciation and amortization
Total
Estimated Useful Life
5 to 50 yrs.
3 to 20 yrs.
3 to 30 yrs.
2006
$487
1,218
1,121
270
137
(1,293)
$1,940
2005
373
1,125
960
204
195
(1,131)
1,726
Depreciation and amortization expense related to bank
premises and equipment was $187 million in 2006, $161 million in
2005 and $130 million in 2004.
Occupancy expense for cancelable and noncancelable leases
was $78 million for 2006, $68 million for 2005 and $57 million for
2004. Occupancy expense has been reduced by rental income
from leased premises of $12 million in 2006, 2005 and 2004.
The Bancorp’s subsidiaries have entered into a number of
lease agreements for
noncancelable lease agreements with respect to bank premises and
equipment. The minimum annual rental commitments under
noncancelable
land and buildings at
December 31, 2006, exclusive of income taxes and other charges,
are $72 million in 2007, $69 million in 2008, $64 million in 2009,
$59 million in 2010, $53 million in 2011 and $377 million in 2012
and subsequent years.
5. GOODWILL
Changes in the net carrying amount of goodwill by reporting segment for the years ended December 31, 2006 and 2005 were as follows:
($ in millions)
Balance as of December 31, 2004
Acquisition activity
Balance as of December 31, 2005
Acquisition activity
Reclassification
Balance as of December 31, 2006
Commercial
Banking
$373
498
871
-
-
$871
Branch
Banking
254
544
798
(1)
-
797
Consumer
Lending
58
124
182
-
-
182
Investment
Advisors
103
24
127
-
11
138
Processing
Solutions
191
-
191
14
-
205
Total
979
1,190
2,169
13
11
2,193
The Bancorp completed
its most recent annual goodwill
impairment test as of September 30, 2006 and determined that no
impairment exists. In the table above, acquisition activity includes
acquisitions in the respective period plus purchase accounting
adjustments related to previous acquisitions. During 2006, the
Bancorp acquired a credit card processing company. The
acquisition resulted in the recognition of $14 million of goodwill
and did not have a material impact on the financial results of the
Bancorp. Additionally, during 2006, $11 million of goodwill was
reclassified from other intangible assets.
6. INTANGIBLE ASSETS
Intangible assets consist of core deposits, servicing rights, customer
lists and non-competition agreements. Intangibles, excluding
servicing rights, are amortized on either a straight-line or an
accelerated basis over their estimated useful lives and have an
estimated weighted-average life at December 31, 2006 of 3.3 years.
($ in millions)
As of December 31, 2006:
Mortgage servicing rights
Other consumer and commercial servicing rights
Core deposits
Other
Total intangible assets
As of December 31, 2005:
Mortgage servicing rights
Other consumer and commercial servicing rights
Core deposits
Other
Total intangible assets
The Bancorp reviews intangible assets for possible impairment
whenever events or changes in circumstances indicate that carrying
amounts may not be recoverable. The details of the Bancorp’s
intangible assets are shown in the following table.
Gross Carrying
Amount
Accumulated
Amortization
Valuation
Allowance
Net Carrying
Amount
$1,210
23
417
43
$1,693
$1,075
22
432
29
$1,558
(664)
(18)
(276)
(18)
(976)
(596)
(14)
(244)
(9)
(863)
(27)
-
-
-
(27)
(46)
-
-
-
(46)
519
5
141
25
690
433
8
188
20
649
As of December 31, 2006, all of the Bancorp’s intangible
assets were being amortized. Amortization expense recognized on
intangible assets, including servicing rights, for 2006 and 2005 was
Estimated
$116 million and $125 million,
respectively.
amortization expense, including servicing rights, is $105 million in
2007, $92 million in 2008, $78 million in 2009, $66 million in 2010
and $11 million in 2011.
62 62
Fifth Third Bancorp
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. SERVICING RIGHTS
Changes in capitalized servicing rights for the years ended
December 31:
($ in millions)
Balance at January 1
Amount capitalized
Amortization
Servicing valuation recovery
Balance at December 31
2006
$441
136
(72)
19
$524
2005
352
135
(79)
33
441
The estimated fair value of capitalized servicing rights was
$532 million and $466 million at December 31, 2006 and 2005,
respectively. The Bancorp serviced $28.7 billion and $25.7 billion
of residential mortgage loans and $.5 billion and $.9 billion of
consumer loans for other investors at December 31, 2006 and
2005, respectively.
Changes in the servicing rights valuation allowance for the
years ended December 31:
($ in millions)
Balance at January 1
Servicing valuation recovery
Permanent impairment write-off
Balance at December 31
2006
$(46)
19
-
$(27)
2005
(79)
33
-
(46)
The volatility of longer-term interest rates during 2006 and
2005 and the resulting impact of changing prepayment speeds led
to the recovery of $19 million and $33 million, respectively, in
temporary impairment on the mortgage servicing rights (“MSR”)
8. DERIVATIVES
The Bancorp maintains an overall risk management strategy that
incorporates the use of derivative instruments to reduce certain
risks related to interest rate, prepayment and foreign currency
volatility.
The Bancorp’s
interest rate risk management strategy
involves modifying the repricing characteristics of certain financial
instruments 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 interest 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
are financial instruments granting the owner the right, but not the
obligation, to enter into or cancel a swap.
Prepayment volatility arises mostly from changes in fair value
of the largely fixed-rate MSR portfolio, mortgage loans and
mortgage-backed securities. The Bancorp may enter into various
free-standing derivatives (principal-only swaps, swaptions, floors,
to economically hedge
options and
prepayment volatility. Principal-only swaps are total return swaps
based on changes in the value of the underlying mortgage
principal-only trust.
interest rate swaps)
Foreign currency volatility occurs as the Bancorp enters into
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.
The Bancorp also enters into derivative contracts (including
foreign exchange contracts, commodity contracts and interest rate
swaps, floors and caps) for the benefit of commercial customers.
portfolio. Temporary impairment or impairment recovery, effected
through a change in the MSR valuation reserve, are captured as a
component of mortgage banking net revenue in the Consolidated
Statements of Income.
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 free-
standing derivatives (principal-only swaps, swaptions and interest
rate swaps) and various available-for-sale securities (primarily
principal-only strips).
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 Bancorp recognized a net loss of $9 million and $23
million in 2006 and 2005, respectively, related to changes in fair
value and settlement of free-standing derivatives purchased to
economically hedge the MSR portfolio. See Note 8 in the
Consolidated Financial Statements for further information on the
derivatives, including the notional amount and fair value, used to
hedge the MSR portfolio. A gain of $3 million was recognized in
2006 on the sale of securities used to hedge the MSR portfolio. As
of December 31, 2006 and 2005, the available-for-sale securities
portfolio included $176 million and $197 million, respectively, in
instruments related to the non-qualified hedging strategy.
The Bancorp may economically hedge significant exposures
related to these free-standing derivatives by entering
into
offsetting
reputable
third-party contracts with approved,
counterparties with substantially matching terms and currencies.
Credit risk arises from the possible inability of counterparties to
meet the terms of their contracts. The Bancorp’s exposure is
limited 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, counterparty
collateral and monitoring procedures.
Fair Value Hedges
The Bancorp may enter 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, 2006 and 2005, certain interest rate swaps
met the criteria required to qualify for the shortcut method of
accounting. Based on this shortcut method of accounting
treatment, no ineffectiveness is assumed. For interest rate swaps
that do not meet the shortcut requirements, an assessment of
hedge effectiveness was performed and such swaps were
accounted for using the “long-haul” method. The long-haul
method requires periodic assessment of hedge effectiveness and
measurement of ineffectiveness. The ineffectiveness results to the
extent the changes in the fair value of derivative recorded does
not offset changes in fair value of the debt due to changes in the
hedged risk, in the Consolidated Statements of Income. For
interest rate swaps accounted for as a fair value hedge using the
long-haul method, ineffectiveness is the difference between the
changes in the fair value of the interest rate swap and changes in
fair value of the long-term debt attributable to the risk being
hedged. For interest rate swaps that do not qualify for the
shortcut method of accounting, the ineffectiveness is reported
within interest expense in the Consolidated Statements of Income.
For the years ended December 31, 2006 and 2005, changes in the
interest rate swaps attributed to hedge
fair value of any
ineffectiveness were insignificant to the Bancorp’s Consolidated
Fifth Third Bancorp 63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Statements of Income.
During 2006 and 2005, the Bancorp terminated interest rate
swaps designated as fair value hedges and in accordance with
SFAS No. 133, an amount equal to the cumulative fair value
adjustment to the hedged items at the date of termination is
amortized as an adjustment to interest expense over the remaining
term of the long-term debt. For the years ended December 31,
2006 and 2005, $14 million in net deferred losses, net of tax, and
$3 million in net deferred gains, net of tax, on the terminated fair
value hedges were amortized into interest expense, respectively.
($ in millions)
Included in other assets:
Interest rate swaps related to debt
Forward contracts related to mortgage loans held for sale
Total included in other assets
Included in other liabilities:
Interest rate swaps related to debt
Forward contracts related to mortgage loans held for sale
Total included in other liabilities
Cash Flow Hedges
The Bancorp may enter 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.
The Bancorp has no outstanding cash flow hedges as of
December 31, 2006 or 2005. In prior periods, the Bancorp
terminated certain derivatives qualifying as cash flow hedges. The
deferred gains or losses of those terminated instruments, net of
tax, are included in accumulated other comprehensive income and
are being amortized over the designated hedging periods, which
range up to 4 months. As of December 31, 2006 and 2005, less
than $1 million and $13 million, respectively, in net deferred
losses, net of tax, related to terminated cash flow hedges were
recorded in accumulated other comprehensive income. For the
years ended December 31, 2006 and 2005, $12 million and $14
million, respectively, in net deferred losses, net of tax, on the
terminated cash flow hedges were amortized into net interest
income. As of December 31, 2006, less than $1 million in net
deferred losses, net of tax, on terminated cash flow hedges
included
income are
expected to be reclassified into net interest income during the next
12 months.
in accumulated other comprehensive
These
instruments
Free-Standing Derivative Instruments
The majority of the free-standing derivative instruments the
Bancorp enters into are for the benefit of 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.
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, commodity contracts to hedge
such items as natural gas and various other derivative contracts.
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 hedges
interest rate exposure on
commercial customer transactions by executing offsetting swap
agreements with primary dealers. Revaluation gains and losses on
its
64
Fifth Third Bancorp
The Bancorp also enters into forward contracts to hedge its
residential mortgage loans held for sale. The hedged mortgage
loans held for sale are grouped into portfolios of loans that share
the same risk exposure. For the year ended December 31, 2006,
the Bancorp recognized a net loss of $5 million related to the
ineffectiveness of the hedging relationships. Those forward
contracts that do not meet the criteria for fair value hedge
accounting are accounted for as free-standing derivatives.
The following table reflects the notional amount and market
value of all fair value hedges included in the Consolidated Balance
Sheets as of December 31:
2006
Notional
Amount
Fair Value
2005
Notional
Amount
Fair Value
$ -
653
$2,575
419
$ -
4
$4
$95
2
$97
500
61
3,095
739
21
-
21
103
3
106
foreign exchange, commodity and other commercial customer
derivative contracts are recorded as a component of corporate
banking revenue.
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. The Bancorp
does not designate
the foreign
instruments against
denominated
loans, and therefore, does not obtain hedge
accounting treatment. Revaluation gains and losses on such
foreign currency derivative contracts are recorded within other
noninterest income in the Consolidated Statements of Income as
are revaluation gains and losses on foreign denominated loans.
these
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 changes in
fair value of its largely fixed-rate MSR portfolio. 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. The Bancorp enters into forward
contracts to economically hedge the change in fair value of certain
residential mortgage loans held for sale due to changes in interest
rates. Interest rate lock commitments issued on residential
mortgage loan commitments that will be held for resale are also
considered free-standing derivative instruments and the interest
rate exposure on these commitments is economically hedged
primarily with forward contracts. Revaluation gains and losses
from free-standing derivatives related to mortgage banking activity
are recorded as a component of mortgage banking net revenue.
Additionally, the Bancorp occasionally may enter into free-
standing derivative instruments (options, swaptions and interest
rate swaps) in order to minimize significant fluctuations in
interest rate volatility.
earnings and cash flows caused by
Revaluation gains and losses on 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:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2004
($ in millions)
45
Foreign exchange contracts
(3)
Forward contracts related to interest rate lock commitments and mortgage loans held for sale
4
Interest rate lock commitments
(10)
Derivative instruments related to MSR portfolio
Derivative instruments related to interest rate risk
7
The following table reflects the market value of all free-standing derivatives included in the Consolidated Balance Sheets as of December 31:
2005
52
(2)
1
(23)
3
2006
$56
7
(2)
(9)
(20)
($ in millions)
Included in other assets:
Foreign exchange contracts for customers
Interest rate contracts for customers
Commodity contracts for customers
Foreign exchange contracts
Derivative instruments related to MSR portfolio
Interest rate lock commitments
Forward contracts related to interest rate lock commitments
Derivative instruments related to interest rate risk
Total included in other assets
Included in other liabilities:
Foreign exchange contracts for customers
Interest rate contracts for customers
Commodity contracts for customers
Derivative instruments related to MSR portfolio
Interest rate lock commitments
Forward contracts related to interest rate lock commitments
Derivative instruments related to interest rate risk
Total included in other liabilities
2006
Notional
Amount
Fair Value
2005
Notional
Amount
Fair Value
$5,064
8,174
68
68
2,335
389
243
213
$4,783
8,398
62
583
750
103
7
$164
110
4
1
14
2
1
9
$305
$149
110
4
5
3
1
-
$272
3,771
5,964
-
-
560
315
71
-
3,654
5,924
-
586
165
416
-
118
48
-
-
4
1
-
-
171
104
48
-
10
-
1
-
163
The following table summarizes the Bancorp’s derivative instrument positions (excluding $27.6 billion in notional amount from the customer
accommodation program) at December 31, 2006:
($ in millions)
Interest rate swaps related to debt:
Receive fixed/pay floating
Mortgage lending commitments:
Forward contracts on mortgage loans held for sale and interest
rate lock commitments
Mortgage servicing rights portfolio:
Principal-only swaps
Interest rate swaps – Receive fixed/pay floating
Interest rate swaps – Receive floating/pay fixed
Interest rate swaptions – Receive fixed
Interest rate swaptions – Pay fixed
Foreign currency:
Forward contracts
Swaps
Interest rate futures/forwards
Total
Notional
Amount
$2,775
1,418
48
785
460
1,225
400
15
53
20
$7,199
Weighted-Average
Remaining Maturity
(in months)
Average Receive
Rate
Average Pay
Rate
107
4.85 %
5.43 %
1
2
62
86
5
3
2
2
2
5.12
5.36
4.86
4.23
5.37
4.95
5.28
Fifth Third Bancorp 65
9. OTHER ASSETS
The following table provides the components of other assets included in the Consolidated Balance Sheets as of December 31:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ in millions)
Bank owned life insurance
Accounts receivable and drafts-in-process
Partnership investments
Accrued interest receivable
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
2006
$1,949
1,446
698
533
309
119
90
626
$5,770
2005
$1,865
1,073
388
511
192
188
54
116
$4,387
banks. Other short-term borrowings include securities sold under
repurchase agreements, FHLB advances and other borrowings with
original maturities of one year or less. A summary of short-term
borrowings and weighted-average rates follows:
2006
2005
2004
Amount
Rate
Amount
Rate
Amount
Rate
$1,421
-
2,796
$4,148
-
4,522
$5,434
-
6,287
5.26%
-
4.04
5.02%
-
4.28
$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
$8,037
1,275
8,233
2.00%
2.30
1.71
1.30%
1.46
1.17
66
Fifth Third Bancorp
11. LONG-TERM DEBT
A summary of long-term borrowings at December 31:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ in millions)
Parent Company
Senior:
Extendable notes
Subordinated:
Fixed-rate notes (b)
Fixed-rate notes (b)
Floating-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)
Junior subordinated:
Floating-rate debentures (a)
Floating-rate debentures (a)
Mandatorily redeemable securities (a)
Federal Home Loan Bank advances
Securities sold under repurchase agreements
Other
Total
(a) Qualify as Tier I capital for regulatory capital purposes.
(b) Qualify as Tier II capital for regulatory capital purposes.
The senior extendable notes are obligations of the Bancorp. These
notes currently pay interest at one-month LIBOR and, in 2007, can
be extended for twelve months to pay interest at one-month
LIBOR plus 1 bp. In 2008, the notes can be extended an
additional twelve months paying an interest rate of one-month
LIBOR plus 2 bp. The final maturity of these notes is 2009.
The subordinated fixed-rate notes due in 2017 and 2018 are
the obligation of the Bancorp. The Bancorp entered into interest
rate swaps to convert the fixed-rate notes to floating-rate. The rate
paid on these swaps was 5.37% at December 31, 2006.
The subordinated floating-rate notes due
in 2016 are
obligations of the Bancorp. The notes pay interest at three-month
LIBOR plus 42 bp.
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 Bancorp entered into a swap to convert the fixed-rate
debt into floating. The interest rate paid on the swap was 5.86% at
December 31, 2006. The trust preferred securities have been called
in the first quarter of 2007.
the 8.136%
issued
The three-month LIBOR plus 80 bp junior subordinated
debentures due in 2027 were issued to Old Kent Capital Trust 1
(“OKCT1”).
The Bancorp has fully and unconditionally
guaranteed all of OKCT1’s obligations under trust preferred
securities issued by OKCT1. The trust preferred securities were
redeemed in the first quarter of 2007.
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 are as follows: $375
million in 2007, $500 million in 2008, $109 million in 2009, $800
Maturity
Interest Rate
2006
2005
2007 - 2009
5.33%
$1,748
1,749
2017
2018
2016
2027
5.45%
4.50%
5.79%
8.136%
2007 - 2019
2013
2008 - 2014
2.70% - 5.20%
5.48%
5.40% - 5.45%
2015
4.75%
2027
2033 - 2034
2031
2007 - 2037
2007 - 2032
6.17%
8.15% - 8.27%
Varies
0% - 8.34%
Varies
492
459
250
217
2,006
500
1,200
492
103
67
647
4,258
-
119
$12,558
-
463
-
219
2,030
1,150
1,199
497
103
67
596
4,790
2,300
64
15,227
million in 2010 and $275 million in 2019. The Bancorp entered
into swaps to convert $1.1 billion of the fixed-rate debt into
floating. At December 31, 2006, the rates paid on these swaps
ranged from 5.37% to 5.41%.
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, 2006,
the rate paid on the swaps ranged from 5.34% to 5.60%.
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.
At December 31, 2006, 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 $8.7 billion. The advances mature as follows: $1.6 billion
in 2007, $13 million in 2008, $1.5 billion in 2009, $1 million in 2010
and $1.1 billion in 2011 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 $4.2 billion was outstanding at
December 31, 2006 with $15.8 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, 2006.
The Bancorp pays down long-term debt in accordance with
contractual terms over maturity periods summarized in the above
table. Contractually obligated payments for long-term debt are due
over the following periods: $2.0 billion in less than one year; $3.9
billion in one to three years; $.8 billion in three to five years; and
$5.9 billion in greater than five years.
Fifth Third Bancorp 67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
financial
instruments primarily
loans, principal-only swaps,
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
include
customers. These
commitments to extend credit, standby and commercial letters of
credit, foreign exchange contracts, commitments to sell residential
mortgage
rate swap
agreements, interest rate floors, interest rate caps, commodities
contracts, 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, 2006, all 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.
interest
Creditworthiness for all instruments is evaluated on a case-
involves
instruments
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
the risk of dealing with
derivative
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)
Customer derivatives in a gain position
Forward contracts to sell mortgage loans
Noncancelable lease obligations
Purchase obligations
Contract or
Notional
Amount
2006
$42,085
2005
35,724
8,163
3,911
1,418
695
24
7,300
2,410
1,285
609
34
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
13. LEGAL AND REGULATORY PROCEEDINGS
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, including penalties, 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,
68
Fifth Third Bancorp
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, 2006 and 2005, the Bancorp
had a reserve for probable credit losses totaling $75 million and
$69 million, respectively, included in other liabilities.
replacement value of
limited
the
to
is
At December 31, 2006,
Standby and commercial letters of credit are conditional
commitments issued to guarantee the performance of a customer
to a third party. At December 31, 2006, approximately $2.9
billion of standby letters of credit expire within one year, $4.8
billion expire between one to five years and $.5 billion expire
thereafter.
letters of credit of
approximately $32 million were issued to commercial customers
for a duration of one year or less to facilitate trade payments in
domestic and foreign currency transactions. At December 31,
2006 and 2005, the reserve related to these standby letters of
credit was less than $1 million. Approximately 69% of the total
standby letters of credit were secured as of December 31, 2006
and 2005. In the event of nonperformance by the customers, the
Bancorp has rights to the underlying collateral, which can include
commercial real estate, physical plant and property, inventory,
receivables, cash and marketable securities.
to accommodate customers,
As discussed in Note 8, the Bancorp’s policy is to enter into
derivative contracts
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. A liability arises when a
customer does not perform according to the derivative contract
while the Bancorp must perform the offsetting agreement.
Customer derivatives in a gain position with a corresponding
offset are included in the table. The fair value of these contracts at
December 31, 2006 and 2005 were $45 million and $31 million,
respectively.
lease
agreements. The minimum
The Bancorp’s subsidiaries have entered into a number of
noncancelable
rental
commitments under noncancelable lease agreements are shown in
the table. The Bancorp has also entered into a limited number of
agreements for work related to banking center construction and to
purchase goods or services.
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.
lease
transactions, excluding
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
cash flows. Recently issued FSP FAS 13-2, which is effective as of
January 1, 2007, mandates that a change or projected change in the
timing of lessor cash flows related to income taxes generated by
leveraged
interest and penalty
assessments, will require a lessor to recalculate the rate of return
and allocation of income to positive investment years from
inception of the lease. Upon adoption of FSP FAS 13-2 on
January 1, 2007, the Bancorp recorded a $96 million after-tax
charge to retained earnings related to its portfolio of leveraged
leases. The amount of this reduction will be recognized as income
over the remaining term of the affected leases. In January 2007, the
Bancorp made a $356 million deposit with the IRS to mitigate the
risk associated with tax years after 1997 and, in particular, the
leveraged lease transactions noted above. The deposit enables the
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Bancorp to stop the accrual of interest at a current rate of 8-10%
on any tax deficiency to the extent of the deposit if the Bancorp is
not ultimately successful in its suit.
On April 26, 2006 the Bancorp was added as a defendant in a
consolidated antitrust class action lawsuit originally filed against
Visa®, MasterCard® and several other major financial institutions
in the United States District Court for the Eastern District of New
York. The plaintiffs, merchants operating commercial businesses
throughout the U.S. and trade associations, claim that the
interchange fees charged by card-issuing banks are unreasonable
and seek injunctive relief and unspecified damages. As this
litigation is still in its early stages, it is not possible for management
to assess the probability of a material adverse outcome or the range
of possible damages to the Bancorp, if any.
As an outgrowth of the recent SEC consent order involving
BISYS Fund Services, Inc. (“BISYS”), which has provided certain
administrative services to the Fifth Third Funds, Fifth Third Asset
Management, Inc. (“FTAM”), an indirect wholly-owned subsidiary
of the Bancorp, has received an informal request for information
from the SEC regarding its past dealings with BISYS. FTAM is
responding to the SEC’s requests and intends to cooperate with the
SEC in this review. The impact to the Bancorp of the final
disposition of this inquiry cannot be assessed at this time.
Several putative class action complaints have been filed against
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.
At December 31, 2006 and 2005, the Bancorp had issued $8.1
billion and $7.3 billion, respectively, of financial and performance
standby letters of credit to guarantee the performance of various
customers to third parties. The maximum amount of credit risk in
the event of nonperformance by these parties is equivalent to the
contract amount and
totals $8.1 billion and $7.3 billion,
respectively. Upon issuance, the Bancorp recognizes a liability
equal to the amount of fees received from the customer for these
standby letter of credit commitments. At December 31, 2006 and
2005, the reserve related to these standby letters of credit was less
than $1 million. Approximately 69% of the total standby letters of
credit were secured as of December 31, 2006 and 2005. In the
event of nonperformance by the customers, the Bancorp has rights
to the underlying collateral, which can include commercial real
estate, physical plant and property, inventory, receivables, cash and
marketable securities.
investment grade commercial
Through December 31, 2006 and 2005, the Bancorp had
transferred, subject to credit recourse, certain primarily floating-
rate, short-term
loans to an
unconsolidated qualified special purpose entity (“QSPE”) that is
wholly owned by an independent third-party. The outstanding
balance of such loans at December 31, 2006 and 2005 was
approximately $3.4 billion and $2.8 billion, respectively. These
loans may be transferred back to the Bancorp upon the occurrence
of certain specified events. 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. The maximum amount of credit risk in the
event of nonperformance by
is
approximately equivalent to the total outstanding balance of $3.4
billion and $2.8 billion, respectively, at December 31, 2006 and
2005. In addition, the Bancorp’s agreement to provide liquidity
support to the QSPE was $3.8 billion as of year end 2006
compared to $3.4 billion as of year end 2005. At December 31,
2006 and 2005, the Bancorp’s loss reserve related to the liquidity
support and credit enhancement provided to the QSPE was $16
million and $10 million, respectively, recorded in other liabilities on
the Consolidated Balance Sheets.
the underlying borrowers
the Bancorp in various federal courts and one state court. The
Bancorp has filed to remove the state court action to federal court.
The complaints relate to an alleged intrusion of The TJX
Companies, Inc.’s (“TJX”) computer system and the potential theft
of their customers’ non-public personal information and alleged
violations of the Graham-Leach-Bliley Act.
Some of the
complaints were filed by consumers and seek unquantified
damages on behalf of putative classes of persons who transacted
business at any one of TJX’s stores during the period of May 2006
through December 2006. Another was filed by a bank and seeks
unquantified damages on behalf of other similarly situated entities
that suffered
intrusion.
Management believes there are substantial defenses to these claims
and intends to defend them vigorously. The impact of the final
disposition of these lawsuits cannot be assessed at this time.
the alleged
in relation
losses
to
The Bancorp and its subsidiaries are not parties to any other
material litigation. However, there are other litigation matters
which arise 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 or cash flows.
At December 31, 2006 and 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.
In the event of nonperformance, the Bancorp has rights to the
underlying collateral value attached to the loan. The Bancorp
maintained an estimated credit loss reserve of approximately $18
million and $21 million relating to these residential mortgage loans
sold at December 31, 2006 and 2005, respectively, recorded in
other liabilities on the Consolidated Balance Sheets. To determine
the credit loss reserve, the Bancorp used an approach that is
consistent with its overall approach in estimating credit losses for
various categories of residential mortgage loans held in its loan
portfolio.
As of December 31, 2006 and 2005, the Bancorp had fully
and unconditionally guaranteed $376 million of certain long-term
borrowing obligations issued by four wholly-owned issuing trust
entities.
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. If the Bancorp is unable to collect these amounts from
the merchant, it will bear the loss for refunded amounts. The
likelihood of
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 years ended December 31, 2006 and 2005, the Bancorp
processed approximately $120 million and $100 million,
respectively, 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
credit loss reserve at December 31, 2006 and 2005.
incurring a contingent
Fifth Third Securities, Inc (“FTS”), a subsidiary of the
Bancorp, guarantees the collection of all margin account balances
Fifth Third Bancorp 69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
15. RELATED PARTY TRANSACTIONS
At December 31, 2006 and 2005, certain directors, executive
officers, principal holders of Bancorp common stock, associates of
such persons, and affiliated companies of such persons were
indebted,
lend, to the
Bancorp’s banking subsidiaries in the aggregate amount, net of
participations, of $271 million and $307 million, respectively. As
of December 31, 2006 and 2005, the outstanding balance on loans
to related parties, net of participations and undrawn commitments,
was $76 million and $81 million, respectively.
including undrawn commitments to
Commitments to lend to related parties as of December 31,
2006 and 2005, net of participations, were comprised of $260
million and $296 million, respectively, to directors and $11 million
at December 31, 2006 and 2005 to executive officers. The
commitments are in the form of loans and guarantees for various
business and personal interests. This indebtedness was incurred in
the ordinary course of business on substantially the same terms,
including interest rates and collateral, as those prevailing at the time
16. OTHER COMPREHENSIVE INCOME
The Bancorp has elected to present the disclosures required by
SFAS No. 130, “Reporting of Comprehensive Income,” in the
Consolidated Statements of Changes in Shareholders’ Equity and
in the table below. The Bancorp adopted SFAS No. 158,
“Employers’ Accounting for Defined Benefit Pension and Other
Postretirement Plans - An Amendment of FASB Statements No.
87, 88, 106, and 132(R).” This statement requires companies to
December 31, 2006 was $51 million compared to $55 million as of
December 31, 2005. In the event of any customer default, FTS has
rights to the underlying collateral provided. Given the existence of
the underlying collateral provided and negligible historical credit
losses, FTS does not maintain a loss reserve.
of comparable
This
indebtedness does not involve more than the normal risk of
repayment or present other unfavorable features.
transactions with unrelated parties.
None of the Bancorp’s affiliates, officers, directors or
employees has an interest in or receives any remuneration from any
special purpose entities or qualified special purpose entities with
which the Bancorp transacts business.
The Bancorp maintains a written policy and procedures
covering related party transactions. These procedures cover
transactions such as employee-stock purchase loans, personal lines
of credit, residential secured loans, overdrafts, letters of credit and
increases in indebtedness. Such transactions are subject to the
Bancorp’s normal underwriting and approval procedures. Prior to
the loan closing, Compliance Risk Management must approve and
determine whether the transaction requires approval from or a post
notification be sent to the Bancorp’s Board of Directors.
recognize the unamortized actuarial net gains or losses and
unamortized prior service costs as components of accumulated
other comprehensive income.
Disclosure of the reclassification adjustments, related tax
effects allocated to other comprehensive income and accumulated
other comprehensive income as of and for the years ended
December 31 were as follows:
($ in millions)
2006
Gains (losses) on available-for-sale securities
Reclassification adjustment for net losses recognized in net income
Reclassification adjustment for cash flow hedge derivative net losses
recognized in net income
Total other comprehensive income
Cumulative effect of change in accounting for pension and other
postretirement obligations
Total accumulated other comprehensive income
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 net 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 net gains recognized in net income
Change in minimum pension liability
Total
Current Period Activity
Pretax
Tax Effect
$61
364
20
$445
$(455)
(39)
9
21
90
$(374)
$(74)
37
(39)
(1)
(1)
$(78)
(20)
(129)
(8)
(157)
158
13
(3)
(7)
(31)
130
27
(13)
15
-
-
29
Net
41
235
12
288
(297)
(26)
6
14
59
(244)
(47)
24
(24)
(1)
(1)
(49)
Accumulated Balance
Pretax Tax Effect
Net
$(183)
(2)
(185)
(92)
$(277)
64
1
65
33
98
(608)
213
(22)
(8)
(638)
(114)
(52)
(98)
(264)
9
3
225
42
19
34
95
(119)
(1)
(120)
(59)
(179)
(395)
(13)
(5)
(413)
(72)
(33)
(64)
(169)
70
Fifth Third Bancorp
17. COMMON STOCK AND TREASURY STOCK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of the share activity within common stock issued and treasury stock for the years ended December 31:
($ and shares in millions)
Shares at December 31, 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
Shares acquired for treasury
Stock-based awards exercised, including treasury shares issued
Restricted stock grants
Shares at December 31, 2006
During 2004, the Bancorp repurchased approximately 18 million
shares of its common stock, approximately three percent of total
outstanding shares, for $987 million.
transaction with a counterparty for
On January 10, 2005, the Bancorp executed an overnight
share repurchase
the
acquisition of 35.5 million shares of its common stock at a
purchase price of $45.95 per share, or $1.6 billion. Pursuant to the
agreement with the counterparty, the counterparty purchased 35.5
million shares in the open market over a period of time that was
completed during the third quarter of 2005. In accordance with
EITF Issue 99-7 “Accounting for an Accelerated Share
Repurchase Program,” the share transaction was considered two
separate transactions, (i) the acquisition of treasury shares on the
acquisition date and (ii) a forward contract indexed to the
Bancorp’s stock. The treasury shares were accounted for at cost as
a contra equity transaction. The forward contract associated with
the overnight share repurchase transaction was accounted for in
accordance with EITF 00-19, “Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a
Company’s Own Stock,” as an equity instrument. At the end of
the purchase period, the Bancorp received a cash payment of $97
million for the purchase price adjustment based on the volume
weighted average purchase price of $43.55. The payment received
in connection with the price adjustment was recorded as an
Common Stock
Value
$1,295
-
-
-
-
-
1,295
-
-
-
11
(11)
1,295
-
-
-
$1,295
Shares
583
-
-
-
-
-
583
-
-
-
5
(5)
583
-
-
-
583
Treasury Stock
Value
$962
987
(222)
(33)
(281)
1
1,414
1,746
(206)
(43)
(1,413)
(219)
1,279
82
(84)
(45)
$1,232
Shares
17
19
(4)
(1)
(5)
-
26
38
(4)
(1)
(26)
(5)
28
2
(2)
(1)
27
addition to capital surplus. Additionally, for diluted earnings per
share purposes, the Bancorp assumed the transaction would be
net settled in shares as the Bancorp had the choice of settling in
cash or shares and the Bancorp did not have a stated policy or the
ability to demonstrate a past practice of cash settlement. These
incremental shares were subsequently excluded from quarterly
earnings per share calculations, as the effect of inclusion would
have been anti-dilutive.
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.
During 2006, the Bancorp repurchased approximately 2
million shares of its common stock, less than one percent of total
outstanding shares, for $82 million. At December 31, 2006,
for
approximately 15.8 million shares
repurchase.
remain authorized
Fifth Third Bancorp 71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
18. STOCK-BASED COMPENSATION
The Bancorp has historically emphasized employee stock
ownership. Based on total stock-based awards outstanding and
shares
Incentive
Compensation Plan, the Bancorp’s total overhang is approximately
nine percent. The following table provides detail of the number of
future grants under
remaining
the
for
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,
2006:
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
Stock 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,
24,456
2,380
(d)
(e)
$49.08
(c)
(c)
(e)
1,613(f)
13,748(h)
(b)
(b)
(b)
(b)
26,836
$49.08
performance shares and performance units and stock awards. As of December 31, 2006, 11.9 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 293 thousand shares, dependent on
relative performance.
(e) At December 31, 2006, approximately 13.1 million SARs were outstanding at a weighted-average grant price of $43.43. 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, including an additional 1,500,000 shares approved by
shareholders on March 28, 2006.
(g) Excludes 2.4 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 $32.63 per share.
(h) Includes .3 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 and provides for nonqualified and
incentive stock options, stock appreciation rights, restricted stock
and restricted stock units, performance shares and performance
units and stock awards. Stock options and SARs are issued at fair
market value based on the closing price on 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 either after four years or ratably after three, four and
five years of continued employment and include dividend and
voting rights.
As discussed in Note 1, effective January 1, 2006, the Bancorp
adopted SFAS No. 123(R) using the modified retrospective
application basis in accounting for stock-based compensation
plans.
Under SFAS No. 123(R), the Bancorp recognizes
compensation expense for the grant-date fair value of stock-based
compensation issued over its requisite service period. Awards with
a graded vesting are expensed on a straight-line basis. The grant-
date fair value of stock options is measured using the Black-
Scholes option-pricing model.
The Bancorp uses the following assumptions, which are
evaluated and revised as necessary, in estimating the grant-date fair
value of each option grant for the year ended:
Expected option life (in years)
Expected volatility
Expected dividend yield
Risk-free interest rate
2006
6
23%
4.1%
4.9%
2005
6
26%
3.5%
4.3%
2004
6
28%
2.3%
3.9%
The expected option life is derived from historical exercise
patterns and represents the amount of time that options granted
are expected to be outstanding. The expected volatility is based on
a combination of historical and implied volatilities of the Bancorp’s
stock. The interest rate for periods within the contractual life of
the option is based on the U.S. Treasury yield curve in effect at the
time of grant.
Stock-based compensation expense was $76 million, $65
million and $87 million for the years ended December 31, 2006,
2005 and 2004, respectively. The total related income tax benefit
recognized was $23 million, $16 million and $18 million for the
years ended December 31, 2006, 2005 and 2004, respectively. The
following tables include a summary of stock-based compensation
transactions for the previous three fiscal years:
2006
2005
2004
Weighted-
Average
Option Price
Stock Options (shares in thousands)
Outstanding at January 1
$46.49
Granted (a)
-
Exercised
21.70
Forfeited or expired
53.24
Outstanding at December 31
$47.58
$47.43
Exercisable at December 31
(a) 2005 stock options granted include 2,514 options assumed as part of the First National acquisition completed on January 1, 2006. 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 stock options were granted under
a Franklin Financial plan assumed by the Bancorp.
Weighted-
Average
Option Price
$45.31
22.90
21.16
54.30
$46.49
$46.01
Weighted-
Average
Option Price
$44.40
19.81
25.41
58.07
$45.31
$43.57
Shares
40,727
1,105
(4,248)
(1,422)
36,162
30,912
Shares
36,162
2,515
(4,830)
(2,301)
31,546
29,364
Shares
31,546
-
(1,931)
(2,715)
26,900
25,978
72
Fifth Third Bancorp
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
There were no stock options granted during 2006. The
weighted-average grant-date fair value of options granted for the
years ended 2005 and 2004 was $20.54 and $36.57 per share,
respectively.
The total intrinsic value of options exercised was $32 million,
$103 million and $121 million
in 2006, 2005 and 2004,
respectively. Cash received from options exercised was $35
million, $90 million and $105 million in 2006, 2005 and 2004,
respectively. The actual tax benefit realized from the exercised
options was $9 million, $28 million and $21 million in 2006, 2005
and 2004, respectively. The total grant-date fair value of stock
options that vested during 2006, 2005 and 2004 was $25 million,
$78 million and $104 million, respectively.
At December 31, 2006, there was $7 million of compensation
expense related to non-vested stock options not yet recognized.
The expense is expected to be recognized over a remaining
weighted-average period of approximately 2.1 years.
Stock Appreciation Rights (shares in thousands)
Outstanding at January 1
Granted
Exercised
Forfeited or expired
Outstanding at December 31
Exercisable at December 31
Shares
7,541
6,949
-
(1,437)
13,053
989
2006
2005
2004
Weighted-
Average
Grant Price
$47.51
39.18
-
44.31
$43.43
$42.99
Shares
3,529
4,892
-
(880)
7,541
4
Weighted-
Average
Grant Price
$54.37
42.82
-
48.88
$47.51
$54.37
Weighted-
Average
Grant Price
$-
54.37
-
54.40
$54.37
$54.40
Shares
-
3,716
-
(187)
3,529
1
The weighted-average grant-date fair value of SARs granted
was $7.35, $9.31 and $14.11 per share for the years ended 2006,
2005 and 2004, respectively. The total grant-date fair value of
SARs that vested during 2006, 2005 and 2004 was $10 million,
$.05 million and $.01 million, respectively.
At December 31, 2006,
there was $52 million of
compensation expense related to non-vested SARs not yet
recognized. The expense is expected to be recognized over a
remaining weighted-average period of approximately 1.7 years.
Restricted Stock (shares in thousands)
Nonvested at January 1
Granted
Vested
Forfeited
Nonvested at December 31
2006
2005
2004
Weighted-
Average
Grant-Date
Fair Value
$46.16
38.93
44.91
40.76
$40.28
Shares
1,482
1,265
(24)
(343)
2,380
Shares
596
1,086
(29)
(171)
1,482
Weighted-
Average
Grant-Date
Fair Value
$54.01
42.31
50.62
48.19
$46.16
Weighted-
Average
Grant-Date
Fair Value
$58.11
53.86
59.16
54.26
$54.01
Shares
48
607
(18)
(41)
596
The total grant-date fair value of restricted stock that vested
during 2006, 2005 and 2004 was $1.1 million, $1.2 million and $1.1
million, respectively. At December 31, 2006, there was $43 million
of compensation expense related to nonvested restricted stock not
yet recognized. The expense is expected to be recognized over a
remaining weighted-average period of approximately 2.5 years.
The Bancorp has no specific policy to repurchase common
shares to mitigate the dilutive impact of options; however, the
Bancorp has historically made adequate discretionary purchases
based on cash availability, market trends and other factors, to
satisfy stock option exercise activity.
At December 31, 2006, there were 9.7 million incentive
options, 17.2 million non-qualified options, 13.1 million SARs and
2.4 million restricted stock awards outstanding, .3 million shares
reserved for performance unit awards and 11.9 million shares
available for grant. As of December 31, 2006, the aggregate
intrinsic value of both outstanding options and exercisable options
was $64 million. Stock options, SARs and restricted stock
outstanding represent eight percent of the Bancorp’s issued shares
at December 31, 2006.
Outstanding Stock Options
Exercisable Stock Options
Exercise Price
per Share
Number of
Options at Year
End (000’s)
Under $10.00
$10.01-$25.00
$25.01-$40.00
$40.01-$55.00
Over $55.01
All options
47
1,922
4,414
15,614
4,903
26,900
Weighted-
Average
Exercise Price
$7.98
21.45
35.92
48.29
66.46
$47.58
Weighted-
Average
Remaining
Contractual Life
(in years)
3.31
1.48
1.87
4.00
5.28
3.70
Number of
Options at Year
End (000’s)
47
1,922
4,414
14,770
4,825
25,978
Weighted-
Average
Exercise Price
$7.98
21.45
35.92
48.11
66.60
$47.43
Weighted-
Average
Remaining
Contractual Life
(in years)
3.31
1.48
1.87
3.87
5.27
3.61
thousand
In addition, approximately 111
shares of
performance-based awards were granted during 2006. 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 a weighted-average
grant-date fair value of $39.14 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,
2006, 2005 and 2004, respectively, there were 317,483, 333,472 and
236,115 shares purchased by participants and the Bancorp
recognized compensation expense of $2 million for each of the
years ended 2006, 2005 and 2004.
Fifth Third Bancorp 73
19. OTHER NONINTEREST INCOME AND OTHER NONINTEREST EXPENSE
The major components of other noninterest income and other noninterest expense for the years ended December 31:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ in millions)
Other noninterest income:
Cardholder fees
Consumer loan and lease fees
Operating lease income
Bank owned life insurance income
Insurance income
Gain on sale of third-party sourced merchant processing contracts
Other
Total
Other noninterest expense:
Marketing and communications
Postal and courier
Bankcard
Loan and lease
Travel
Information technology and operations
Operating lease
Debt and other financing agreement termination
Other
Total
20. SALES AND TRANSFERS OF LOANS
The Bancorp sold fixed and adjustable rate residential mortgage
loans and student loans during 2006 and 2005. 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 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
2006
2005
2004
$49
47
26
86
28
-
64
$300
$124
49
317
93
52
112
18
49
409
$1,223
46
50
55
91
27
-
91
360
126
50
271
89
54
114
40
-
441
1,185
39
57
156
61
28
157
89
587
99
49
224
82
41
87
114
325
403
1,424
on the sold financial assets. In 2006 and 2005, the Bancorp
recognized pretax gains of $81 million and $123 million,
respectively, on the sales of residential mortgage loans, home
equity lines of credit and student loans. Total proceeds from the
loan sales in 2006 and 2005 were $9.4 billion and $9.7 billion,
respectively.
Initial carrying values of retained interests recognized during
2006 and 2005 were as follows:
($ in millions)
Mortgage servicing assets
Other consumer and commercial servicing assets
Consumer residual interests
2006
$135
1
-
2005
134
1
5
Key economic assumptions used in measuring the Bancorp’s
servicing rights and residual interests during 2006 and 2005 were as
follows:
2006
2005
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 lines of credit:
Servicing assets
Residual interest
Fixed
Adjustable
Adjustable
Adjustable
6.8
2.7
1.8
1.6
13.7%
38.6
37.5
37.5
10.4%
11.7
11.7
11.7
N/A
N/A
N/A
.35%
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%
Based on historical credit experience, expected credit losses for servicing rights have been deemed immaterial. At December 31, 2006,
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:
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
7.4
3.7
1.2
1.5
0.3
0.7
10.9 %
26.5
$20
3
$39
6
10.3 %
10.9
$18
1
$35
2
- %
-
40.0
40.0
1.55
1.55
-
1
-
-
1
2
-
-
11.7
11.7
12
12
-
-
-
-
-
-
-
-
-
.35
-
1.25
$-
-
-
-
-
-
$-
-
-
-
-
-
Rate
Fixed
Adjustable
Adjustable
Adjustable
($ 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
74
Fifth Third Bancorp
Fair
Value
$483
45
3
15
1
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
These sensitivities are hypothetical and should be used with
caution. As the figures indicate, changes in fair value based on a
10% variation in assumptions typically cannot be extrapolated
because the relationship of the change in assumption to the change
in fair value may not be linear. Also, in the previous table, the
effect of a variation in a particular assumption on the fair value of
the retained interest is calculated without changing any other
assumption; in reality, changes in one factor may result in changes
in another (for example, increases in market interest rates may
result in lower prepayments and increased credit losses), which
($ 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
might magnify or counteract the sensitivities.
retains certain
investment grade securities
In addition to the retained interests listed previously, the
Bancorp
from
securitizations. The fair value of these retained securities was $15
million and $30 million at December 31, 2006 and 2005,
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:
Balance
2006
$20,725
10,405
3,841
6,847
9,263
23,905
1,073
76,059
2005
19,299
9,188
3,698
7,037
8,353
22,987
1,595
72,157
Balance of Loans 90 Days or
More Past Due
2006
$38
17
2
18
57
79
2
$213
2005
20
8
1
11
49
65
3
157
Net Credit
Losses
2006
$107
24
(1)
8
22
154
5
$319
2005
75
9
37
4
19
147
14
305
Total portfolio loans and leases
(a) Excluding securitized assets that the Bancorp continues to service but with which it has no other continuing involvement.
556
1,150
$74,353
928
1,304
69,925
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 .80% and .70% as of December 31, 2006
and 2005, respectively. For the automotive loans securitized in
2004, the static pool credit losses were 1.09% and 1.00% as of
December 31, 2006 and 2005, respectively.
floating-rate,
recourse, certain primarily
During 2006 and 2005, 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. The
Bancorp retains servicing and receives monthly servicing fees. At
December 31, 2006 and 2005, the outstanding balance of loans
transferred was $3.4 billion and $2.8 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 the
fair value of this right was deemed immaterial due to the short-
term servicing period of the assets transferred and the small spread
provided by the transferred loans. As of December 31, 2006, the
$3.4 billion balance of outstanding loans had a weighted-average
remaining maturity of 2.7 years.
($ in millions)
Proceeds from transfers, including new securitizations
Proceeds from collections reinvested in revolving-period securitizations
Fees received
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
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
investors and the
they contracted. The
return for which
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, 2006, the remaining balance of sold
automotive loans was $146 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 2006, pursuant to the terms of the sales and servicing
agreement, $39 million in fixed-rate home equity line of credit
balances were put back to the Bancorp. As of December 31, 2006,
the remaining balance of sold home equity lines of credit was $374
million.
The Bancorp had
following
unconsolidated QSPEs during 2006 and 2005:
the
cash
flows with
2006
$1,618
97
35
2005
1,680
132
32
Fifth Third Bancorp 75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
21. INCOME TAXES
The Bancorp and its subsidiaries file a consolidated Federal income tax return. The following is a summary of applicable income taxes
included in the Consolidated Statements of Income at December 31:
($ 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
2006
2005
2004
$457
7
464
(24)
3
(21)
$443
654
21
675
(7)
(9)
(16)
659
691
34
725
(12)
(1)
(13)
712
Deferred income taxes are included as a component of accrued taxes, interest and expenses in the Consolidated Balance Sheets and are
comprised of the following temporary differences at December 31:
($ 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
Mortgage servicing rights
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
Dividends on subsidiary preferred stock
Other, net
Effective tax rate
2006
35.0%
.4
(2.8)
(3.9)
(2.2)
.7
27.2%
2005
35.0
.4
(2.3)
(2.3)
(1.7)
.8
29.9
Retained earnings at December 31, 2006 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.
76
Fifth Third Bancorp
2006
2005
$270
160
98
112
117
757
1,750
189
70
124
173
2,306
$1,549
260
149
225
129
127
890
1,786
203
61
99
186
2,335
1,445
2004
35.0
1.0
(2.0)
(1.7)
(1.7)
1.2
31.8
22. RETIREMENT AND BENEFIT PLANS
The following tables summarize the defined benefit retirement plans as of and for the years ended December 31:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Plans With an Overfunded Status
($ in millions)
Fair value of plan assets at January 1
Actual return on assets
Contributions
Settlement
Benefits paid
Plan merger
Fair value of plan assets at December 31
Projected benefit obligation at January 1
Service cost
Interest cost
Settlement
Actuarial loss
Benefits paid
Plan merger
Projected benefit obligation at December 31
Overfunded projected benefit obligation recognized
in the Consolidated Balance Sheets as an asset (a)
2006
$238
26
15
(20)
(7)
-
$252
$220
1
12
(20)
7
(7)
-
$213
$39
2005
196
11
50
(17)
(6)
4
238
216
1
12
(16)
8
(6)
5
220
Plans With an Underfunded Status
($ in millions)
Fair value of plan assets at January 1
Actual return on assets
Contributions
Settlement
Benefits paid
Plan merger
Fair value of plan assets at December 31
Projected benefit obligation at January 1
Service cost
Interest cost
Settlement
Actuarial loss
Benefits paid
Plan merger
Projected benefit obligation at December 31
Unfunded projected benefit obligation recognized in
the Consolidated Balance Sheets as a liability (a)
2006
$ -
-
3
-
(3)
-
$ -
$38
1
-
-
1
(3)
-
$37
($37)
2005
5
-
13
(11)
(3)
(4)
-
38
2
(10)
10
6
(3)
(5)
38
(a) SFAS No. 158 was implemented prospectively at December 31, 2006. As a result, the Bancorp recognized the overfunded and unfunded projected benefit obligation of its pension plans as an
asset and liability, respectively, in the Consolidated Balance Sheet as of December 31, 2006.
Amounts recognized in accumulated other comprehensive income
consist of:
($ in millions)
Net actuarial loss
Net prior service cost
Total
2006
$89
3
$92
The Bancorp implemented SFAS No. 158, “Employers’
Accounting
and Other
for Defined Benefit Pension
Postretirement Plans – an amendment of FASB Statements No.
87, 88 106, and 132(R)” at December 31, 2006. SFAS No. 158
requires the funded status of pension plans to be recorded in the
balance sheet as an asset for plans with an overfunded status and a
liability for plans with an underfunded status. The Bancorp
recognized the overfunded and underfunded status of its pension
plans as an asset and liability, respectively, in the Consolidated
Balance Sheet as of December 31, 2006.
The Bancorp’s qualified defined benefit plan is currently
overfunded. This plan’s benefits were frozen in 1998, except for
grandfathered employees. The Bancorp’s retirement plans with an
underfunded status are nonqualified, supplemental retirement
plans, which are funded on an as needed basis. A majority of
these plans were obtained in acquisitions from prior years.
The following table summarizes the incremental effect of
in the
applying SFAS No. 158 on
Consolidated Balance Sheet as of December 31, 2006:
individual
items
line
($ in millions)
Financial statement line item:
Prepaid benefit cost
Deferred tax asset
Total assets
Accrued benefit liability
Total liabilities
Accumulated other
comprehensive income
Total shareholders’ equity
Before
Application
of SFAS
No. 158
Adjustment
After
Application
of SFAS
No. 158
$124
3
127
38
38
(5)
(5)
(85)
30
(55)
(1)
(1)
(54)
(54)
39
33
72
37
37
(59)
(59)
1
15
(18)
(2)
9
1
10
16
2006
$89
3
92
9
1
$102
The following tables summarize net periodic pension cost and
other changes in plan assets and benefit obligations recognized in
other comprehensive income for the years ended December 31:
2006
2005
2004
($ 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 net prior service cost
Settlement
Net periodic pension cost
$1
13
(19)
-
9
1
8
$13
1
14
(18)
-
8
-
9
14
($ in millions)
Other changes in plan assets and benefit obligations
recognized in other comprehensive income:
Net actuarial loss
Prior service cost
Total recognized in other comprehensive income
Amortization of actuarial loss
Amortization of prior service cost
Total recognized in net periodic pension cost and
other comprehensive income
The estimated net actuarial loss and prior service cost for the
defined benefit pension plans that will be amortized from
accumulated other comprehensive income into net periodic
pension cost during 2007 are $7 million and $1 million,
respectively.
The plan assumptions are evaluated annually and are updated
as necessary. The discount rate assumption reflects the yield on 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, 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.
Fifth Third Bancorp 77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the plan assumptions for the
years ended December 31:
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
2006
2005
2004
5.80 %
5.00
8.48
5.375
5.00
8.45
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
Lowering both the expected rate of return on the plan and
the discount rate by 0.25% would have increased the 2006
pension expense by approximately $1 million.
Plan assets consist primarily of common trust and mutual
funds (equities and fixed income) and Bancorp common stock. As
of December 31, 2006 and 2005, $156 million and $178 million,
respectively, of plan assets were managed by Fifth Third Bank, a
subsidiary of the Bancorp, through common trust and mutual
funds and included $15 million, respectively, of Bancorp common
stock. The following table provides the Bancorp’s weighted-
average asset allocations by asset category for 2006 and 2005:
Weighted-average asset allocation
Equity securities
Bancorp common stock
Total equity securities
Total fixed income securities
Cash
Total
2006
69%
6
75
22
3
100%
2005
69
6
75
23
2
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.
Plan assets are not expected to be returned to the Bancorp during
2007.
The accumulated benefit obligation for all defined benefit
plans was $249 million and $254 million at December 31, 2006
and December 31, 2005, respectively. At December 31, 2006 and
2005, amounts relating to the Bancorp’s defined benefit plans with
an accumulated benefit obligation exceeding assets were as
follows:
($ in millions)
Projected benefit obligation
Accumulated benefit obligation
Fair value of plan assets
2006
$37
38
-
2005
38
38
-
Based on the actuarial assumptions, the Bancorp does not
expect to contribute to the Plan in 2007. Estimated pension
benefit payments, which reflect expected future service, are $20
million in 2007, $20 million in 2008, $19 million in 2009, $20
million in 2010 and $18 million in 2011. The total estimated
payments for the years 2012 through 2016 is $83 million.
The Bancorp’s profit sharing plan expense was $60 million
for 2006, $62 million for 2005 and $69 million for 2004.
Expenses recognized during the years ended December 31, 2006,
2005 and 2004 for matching contributions to the Bancorp’s
defined contribution savings plans were $35 million, $33 million
and $28 million, respectively.
23. EARNINGS PER SHARE
Reconciliation of earnings per share to earnings per diluted share for the years ended December 31:
(in millions, except per share data)
EPS
Income before cumulative effect
Net income available to common
shareholders before cumulative effect (a)
Cumulative effect of change in accounting
principle, net of tax
Net income available to common
shareholders (a)
Diluted EPS
Net income available to common
shareholders before cumulative effect
Effect of dilutive securities:
Stock based awards
Convertible preferred stock (b)
Income plus assumed conversions before
cumulative effect
Cumulative effect of change in accounting
principle, net of tax
Net income available to common
2006
2005
Income
$1,184
Average
Shares
Per Share
Amount
Income
$1,549
Average
Shares
Per Share
Amount
Income
$1,525
2004
Average
Shares
Per
Share
Amount
1,184
555
$2.13
1,548
554
$2.79
1,524
561
$2.72
4
.01
-
-
-
-
$1,188
555
$2.14
$1,548
554
$2.79
$1,524
561
$2.72
$1,184
555
$1,548
2
-
554
4
-
$1,524
561
7
-
1,184
557
$2.12
1,549
558
$2.77
1,525
568
$2.68
4
.01
-
-
-
-
shareholders plus assumed conversions
$1,188
557
$2.13
$1,548
558
$2.77
$1,525
568
$2.68
(a) Dividends on preferred stock are $.740 million for the years ended December 31, 2006, 2005 and 2004.
(b) The additive effect to income from dividends on convertible preferred stock is $.580 million and the average share dilutive effect from convertible preferred stock is .308 million shares for the years
ended December 31, 2006, 2005 and 2004.
During the first quarter of 2006, the Bancorp recognized a
benefit for the cumulative effect of change in accounting principle
of $4 million, net of $2 million of tax, related to the adoption of
SFAS 123(R). The benefit recognized relates to the Bancorp’s
estimate of forfeiture experience to be realized for all unvested
stock-based awards outstanding.
Options to purchase 33.1 million, 28.1 million and 16.2
million shares outstanding at December 31, 2006, 2005 and 2004,
respectively, were not included in the computation of net income
per diluted share because the exercise price of these options were
greater than the average market price of the common shares and,
therefore, the effect would be antidilutive.
78
Fifth Third Bancorp
24. FAIR VALUE OF FINANCIAL INSTRUMENTS
Carrying amounts and estimated fair values for financial instruments as of December 31:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ 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
Other short-term borrowings
Long-term debt
Derivative liabilities
Short positions
Other financial instruments:
Commitments to extend credit
Letters of credit
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
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 and other short-term borrowings.
trading and other
Available-for-sale, held-to-maturity,
securities, including short positions: Fair values were based on
prices obtained from an independent nationally recognized pricing
service.
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.
Portfolio loans and leases, net: Fair values were estimated by
discounting the future cash flows using the current rates at which
25. BUSINESS COMBINATIONS
On January 1, 2005, the Bancorp acquired in a merger 100% of the
outstanding stock of First National Bankshares, Inc. (“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 allowed the Bancorp to
increase 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
2006
2005
Carrying
Amount Fair Value
Carrying
Amount
Fair Value
$2,737
11,053
356
187
809
1,150
73,582
309
1,949
69,380
1,421
2,796
12,558
369
29
75
23
2,737
11,053
356
187
809
1,152
73,660
309
1,949
69,371
1,421
2,796
12,762
369
29
75
23
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
similar loans would be made to borrowers with similar credit
ratings and for the same remaining maturities.
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, 2006 and 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.
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, or a discounted cash flow
calculation using prevailing market rates for borrowings of similar
terms.
Commitments
to extend credit: Fair values of
commitments were based on estimated probable credit losses.
loan
Letters of credit: Fair values of letters of credit were based on
unamortized fees on the letters of credit.
included the fair value of stock-based awards issued in exchange
for stock-based 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 Bancorp’s Consolidated 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.
Fifth Third Bancorp 79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 10 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
goodwill and is not being amortized. 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 included the
fair value of stock-based awards issued in exchange for stock-based
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 Bancorp’s Consolidated 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 and is not
being amortized. 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 included in the results of operations
subsequent to the date of acquisition were not material to the
Bancorp’s financial condition and operating results for the periods
presented.
26. CERTAIN REGULATORY REQUIREMENTS AND CAPITAL RATIOS
The principal source of income and funds for the Bancorp (parent
company) are dividends from its subsidiaries. During 2006, the
amount of dividends the bank subsidiaries could pay to the
Bancorp without prior approval of regulatory agencies was limited
to their 2006 eligible net profits, as defined, and the adjusted
retained 2005 and 2004 net income of those subsidiaries.
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% or more, a Tier I capital ratio of 6% or more, a
Tier I leverage ratio of 5% 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, 2006 and 2005.
As of December 31, 2006, 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.
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 2006 and 2005, the
subsidiary banks were required to maintain average cash reserve
balances of $289 million and $211 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 available-for-sale securities and
unrecognized pension actuarial gains and losses and prior service
cost, 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
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.
80
Fifth Third Bancorp
Capital and risk-based capital and leverage ratios for the Bancorp and its significant subsidiary banks at December 31:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ 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.
2006
2005
Amount
Ratio
Amount
Ratio
$11,385
6,573
5,814
216
11.07 %
12.82
11.41
11.78
$10,240
6,237
5,352
177
10.42 %
12.61
10.98
12.05
8,625
5,336
5,341
203
8,625
5,336
5,341
203
8.39
10.41
10.48
11.07
8.44
9.53
11.30
12.52
8,209
4,973
4,922
167
8,209
4,973
4,922
167
8.35
10.05
10.10
11.33
8.08
8.77
10.75
12.24
2006
27. PARENT COMPANY FINANCIAL STATEMENTS
($ 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
$605
46
2
653
1,270
32
1
1,303
682
32
1
715
120
22
142
77
23
100
15
9
24
2004
2005
Change in Undistributed Earnings of
Subsidiaries
Applicable income taxes
Income Before Change in Undistributed
Earnings of Subsidiaries
Increase in undistributed earnings of
511
(35)
1,203
(25)
546
1,228
691
1
690
subsidiaries
Net Income
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
642
$1,188
321
1,549
835
1,525
2006
2005
$909
636
11,735
137
37
$13,454
$7
259
3,166
3,432
10,022
$13,454
666
529
10,753
137
36
12,121
2
242
2,431
2,675
9,446
$12,121
Condensed Statements of Cash Flows (Parent Company Only)
For the years ended December 31
2005
Operating Activities
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision (benefit) for deferred income
$1,188
1,549
2006
2004
1,525
taxes
Increase in other assets
Increase (decrease) in accrued expenses
and other liabilities
Increase in undistributed earnings of
subsidiaries
Other, net
Net Cash Provided by Operating
Activities
Investing Activities
Capital contribution to subsidiaries
(Increase) decrease in loans to subsidiaries
Net Cash (Used in) Provided by
Investing Activities
Financing Activities
Increase (decrease) in other short-term
borrowings
Repayment of long-term debt
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
1
(1)
17
(1)
(4)
(29)
(1)
(24)
(84)
(642)
(14)
(321)
1
(835)
-
549
1,195
581
(25)
(107)
-
1,811
-
(759)
(132)
1,811
(759)
5
(13)
748
(867)
43
(82)
(8)
(174)
243
666
$909
(26)
-
-
(794)
96
(1,649)
-
(2,373)
633
33
666
24
-
1,749
(704)
89
(987)
-
171
(7)
40
33
Fifth Third Bancorp 81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
retail
through
28. SEGMENTS
The Bancorp’s principal activities include Commercial Banking,
Branch Banking, Consumer Lending, Investment Advisors and
Processing Solutions. During the first quarter of 2006, the
Bancorp began reporting its Retail line of business as two business
segments, Branch Banking and Consumer Lending. All prior year
information has been updated to reflect this presentation.
Commercial Banking offers banking, cash management and
financial services
large and middle-market businesses,
to
Branch Banking
government and professional customers.
provides a full range of deposit and loans and lease products to
individuals and small businesses
locations.
Consumer Lending includes the Bancorp’s mortgage, home equity
and other indirect lending activities. Investment Advisors
provides a full range of investment alternatives for individuals,
companies and not-for-profit organizations. Processing Solutions
provides electronic funds transfer, debit, credit and merchant
transaction processing, operates the Jeanie® ATM network and
to affiliated and
provides other data processing services
unaffiliated customers. The Other/Eliminations column includes
the unallocated portion of the investment portfolio, certain non-
deposit funding, unassigned equity and certain support activities
and other items not attributed to the business segments.
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. During the fourth quarter of
2006, the Bancorp changed the application of the provision for
loan and lease losses to the segments to include only actual net
charge-offs.
The Bancorp manages interest rate risk centrally at the
corporate level by employing a funds transfer pricing (“FTP”)
methodology. This methodology insulates the business segments
from interest rate volatility, 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. During 2006,
the Bancorp made certain changes to the average duration of
indeterminate-lived deposits and corresponding changes to the
FTP crediting rates assigned to those deposits. This change more
closely aligns the crediting rates to the expected economic benefit
while continuing to insulate the segments from interest rate
volatility. Prior year results are restated and presented on a
comparable basis. 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 headquarter 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. Results of operations and
average assets by segment for each of the three years ended
December 31 are:
Commercial
Banking
Branch
Banking
Consumer
Lending
Investment
Advisors
Processing
Solutions
Other/
Eliminations
Total
($ in millions)
2006
Net interest income (a)
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
Corporate banking revenue
Other noninterest income
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
Other noninterest expense
Total noninterest expense
Income before income taxes and
cumulative effect
Applicable income taxes (a)
Income before cumulative effect
Cumulative effect of change in accounting
principle, net of tax
Net income
Average assets
(a) Includes taxable-equivalent adjustments of $26 million.
82
Fifth Third Bancorp
$1,254
105
1,149
13
147
-
3
304
48
-
-
515
196
44
2
14
505
761
903
252
651
1,290
101
1,189
195
358
5
87
12
106
-
-
763
353
98
32
121
468
1,072
880
310
570
380
94
286
-
-
148
-
-
78
-
3
229
68
33
1
8
193
303
212
75
137
125
3
122
1
7
2
367
2
7
-
-
386
143
29
1
10
200
383
125
44
81
33
10
23
694
5
-
-
1
4
78
-
782
58
13
10
3
443
527
278
98
180
(183)
30
(213)
(46)
-
-
(90)
(1)
57
(442)
-
(522)
356
75
76
89
(586)
10
(745)
(310)
(435)
2,899
343
2,556
857
517
155
367
318
300
(364)
3
2,153
1,174
292
122
245
1,223
3,056
1,653
469
1,184
$651
$36,037
570
42,852
137
21,883
81
5,519
180
1,235
4
(431)
(2,288)
4
1,188
105,238
($ in millions)
2005
Net interest income (a)
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
Corporate banking revenue
Other noninterest income
Securities gains (losses), net
Total noninterest income
Noninterest expense:
Salaries, wages and incentives
Employee benefits
Equipment expense
Net occupancy expense
Other noninterest expense
Total noninterest expense
Income before income taxes
Applicable income taxes (a)
Net income
Average assets
(a) Includes taxable-equivalent adjustments of $31 million.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Commercial
Banking
Branch
Banking
Consumer
Lending
Investment
Advisors
Processing
Solutions
Other/
Eliminations
Total
$1,190
97
1,093
13
153
-
3
287
38
-
494
194
45
1
12
465
717
870
256
$614
$32,247
1,251
91
1,160
164
359
5
86
13
89
-
716
355
101
28
109
437
1,030
846
298
548
40,291
397
90
307
-
-
165
-
-
125
-
290
66
32
1
7
244
350
247
87
160
20,238
131
4
127
1
7
2
360
2
4
-
376
141
29
1
8
206
385
118
42
76
4,569
28
18
10
612
5
-
-
1
15
-
633
44
9
3
3
403
462
181
64
117
1,140
(1)
30
(31)
(42)
(2)
2
(91)
(4)
89
39
(9)
333
67
71
82
(570)
(17)
(23)
(57)
34
4,391
2,996
330
2,666
748
522
174
358
299
360
39
2,500
1,133
283
105
221
1,185
2,927
2,239
690
1,549
102,876
Commercial
Banking
Branch
Banking
Consumer
Lending
Investment
Advisors
Processing
Solutions
Other/
Eliminations
Acquisitions
(b)
Total
$1,104
82
1,022
9
155
5
5
217
18
-
409
1,247
70
1,177
132
365
5
86
11
83
-
682
421
84
337
-
-
167
-
-
227
-
394
129
2
127
-
7
1
367
5
6
-
386
29
10
19
524
4
-
-
1
168
-
697
298
26
272
(34)
3
-
(95)
(6)
109
(37)
(60)
(180)
(6)
(174)
-
(19)
-
-
-
(24)
-
(43)
3,048
268
2,780
631
515
178
363
228
587
(37)
2,465
($ in millions)
2004
Net interest income (a)
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
Corporate banking revenue
Other noninterest income
Securities gains (losses), net
Total noninterest income
Noninterest expense:
Salaries, wages and incentives
Employee benefits
Equipment expense
Net occupancy expense
Other noninterest expense
159
37
1
10
403
610
821
258
$563
$28,377
310
88
29
99
393
919
940
320
620
38,987
75
27
2
6
301
411
320
109
211
18,831
122
26
1
8
211
368
145
49
96
3,881
42
8
4
3
350
407
309
105
204
998
408
76
48
85
(188)
429
(217)
(60)
(157)
9,498
(98)
(1)
(1)
(26)
(46)
(172)
(45)
(33)
(12)
(5,676)
1,018
261
84
185
1,424
2,972
2,273
748
1,525
94,896
Total noninterest expense
Income before income taxes
Applicable income taxes (a)
Net income
Average assets
(a) Includes taxable-equivalent adjustments of $36 million.
(b) 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 the
divested First National insurance business) have been included in the segments and are eliminated in the Acquisitions column.
Fifth Third Bancorp 83
ANNUAL REPORT ON FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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, 2006
Only those sections of this 2006 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,
2006. No other information contained in this 2006 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.
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(b) of the Act:
Common Stock Without Par Value
Name of exchange on which registered:
The NASDAQ Stock Market LLC
Indicate by checkmark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes: (cid:95) 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: (cid:95)
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: (cid:95) No: (cid:133)(cid:3)
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 registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K. (cid:133)
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: (cid:95)
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: (cid:95)
There were 556,314,458 shares of the Bancorp’s Common
Stock, without par value, outstanding as of January 31, 2007.
The Aggregate Market Value of the Voting Stock held by non-
affiliates of the Bancorp was $17,609,835,370 as of June 30,
2006.
report
incorporates
DOCUMENTS INCORPORATED BY REFERENCE
the
into a single document
This
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 2007 Annual Meeting of Shareholders is incorporated by
reference into Part III of this report.
84
Fifth Third Bancorp
10-K Cross Reference Index
PART I
Item 1.
Business
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.
Item 3.
Item 4.
Properties
Legal Proceedings
Submission of Matters to a Vote of Security Holders
Executive Officers of the Bancorp
19-20, 85-88
29
31-33, 82-83
26
25-27
36-37, 59-60
35, 61
39-44
37,45
18
37, 65
22-24
none
88
68-69
none
88-89
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
Item 8.
Item 9.
Market Risk
Financial Statements and Supplementary Data
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, Executive Officers and Corporate
Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and
89-90
18
18-47
38-47
50-83
none
90-91
none
91
91
Management and Related Stockholder Matters
72-73, 91
Item 13. Certain Relationships and Related Transactions, and
Director Independence
Item 14. Principal Accounting Fees and Services
PART IV
Item 15. Exhibits, Financial Statement Schedules
SIGNATURES
91
91
91-93
94
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
ANNUAL REPORT ON FORM 10-K
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, proxy statements, 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.
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.
The Bancorp’s subsidiaries provide a wide range of
financial products and services to 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 lease. Each of the
banking subsidiaries has deposit insurance provided by the
Federal Deposit Insurance Corporation (“FDIC”) through the
Deposit Insurance Fund. 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 25
of the Notes to Consolidated Financial Statements.
Regulation and Supervision
In addition to the generally applicable state and federal laws
governing businesses and employers, the Bancorp and its
subsidiary banks are subject to extensive regulation by federal
to financial
laws and regulations applicable
and state
institutions and their parent companies. Virtually all aspects of
the business of the Bancorp and its subsidiary banks are subject
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 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
to order
subsidiaries of bank holding companies, and
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 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 declared by the FRB, in cooperation
with the Treasury 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”
the Federal Community Reinvestment Act
rating under
Fifth Third Bancorp 85
ANNUAL REPORT ON FORM 10-K
(“CRA”). In 2000, the Bancorp elected and qualified for FHC
status under the GLBA.
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 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
Office of the Comptroller of the Currency (“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, 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
86
Fifth Third Bancorp
collateral for certain loans, and the amount of interest that may
be charged on loans.
In 2006, the Federal Deposit Insurance Reform Act of
2005 was signed into law (“FDIRA”). Pursuant to the FDIRA,
the Bank Insurance Fund and Savings Association Insurance
Fund were merged to create the Deposit Insurance Fund. On
January 1, 2007, final rules under the FDIRA became effective
which set a base assessment schedule for 2007 for Deposit
Insurance Fund premiums. Under the final rules, for banks with
over $10 billion in assets the premium assessment will be
determined by factors including the institution’s CAMELS
component ratings, and, if available, long-term debt issuer
ratings. The final rules also provide that the FDIC will apply
assessment credits to offset 100% of a bank’s entire premium
charge in 2007 and up to 90% of a bank’s premium charge in
2008, 2009 and 2010 until the credit is exhausted. The Bancorp
expects its assessment credits to be exhausted in 2008. Given
current CAMEL ratings and deposit balances as of December
31, 2006, the Bancorp expects to incur FDIC insurance
assessments of less than $1 million in 2007, $8 million in 2008
and $34 million in 2009.
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 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,
low- and moderate-income
neighborhoods. Fifth Third Bank and Fifth Third Bank
(Michigan) received an “Outstanding” CRA rating and Fifth
Third Bank, N.A. received a “Satisfactory” rating. 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
including
ANNUAL REPORT ON FORM 10-K
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.
The minimum risk-based capital requirements adopted by
the federal banking agencies follow the Capital Accord of the
Basel Committee on Banking Supervision. In 2004, the Basel
Committee published its new capital guidelines (“Basel II”)
governing the capital adequacy of large, internationally active
banking organizations. Studies of the impact of Basel II on the
large banks that will operate under the new rules indicated that
such banks could benefit from a material reduction in minimum
risk based capital requirements. In response to the potential
inequities between the Basel II banks and other banks, in
December 2006, the federal banking agencies issued a notice of
proposed changes to the risk based capital rules for banks in the
U.S. which will not be subject to Basel II, known as Basel IA.
In Basel IA, the banking agencies are proposing to expand the
number of risk-weight categories, allow the use of external
ratings to risk-weight certain exposures, expand the range of
recognized collateral and eligible guarantors, use loan-to-value
ratios to risk-weight residential mortgages, increase the credit
conversion factor for certain commitments with an original
maturity of one year or less, assess a charge for early
amortizations in securitizations of revolving exposures, and
remove the 50 percent limit on the risk weight for certain
derivative transactions. Until such time as final rules are
adopted, the Bancorp is unable to predict whether and when it
will be subject to new capital requirements.
The FRB, 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 thereof, to create, 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 statute requires explanations
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,
to
consumers on policies and procedures regarding the disclosure
of such nonpublic personal information, and, except as
otherwise
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.
law, prohibits disclosing
required by
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
laundering,
respect
to, among other matters, anti-money
transaction
compliance, suspicious activity and currency
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
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 Patriot Act.
federal banking agencies)
to evaluate
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 thereunder prescribe the
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 must meet ICA
requirements for segregation of assets, identification of assets
and client approval. Future legislative and regulatory changes in
laws and regulations governing custody of
the existing
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.
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 recordkeeping 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
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
Fifth Third Bancorp 87
ANNUAL REPORT ON FORM 10-K
industry may be significantly affected by new laws and
regulations.
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, July 2, 2007. On
December 13, 2006, the FRB and SEC jointly proposed new
Regulation R, that will govern bank securities broker activities.
As currently proposed, we will have until January 1, 2009 to
comply by either registering as a broker-dealer or “pushing out”
brokerage activities
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.
to affiliated broker-dealers.
to
increase
including
(ii) auditor
responsibility measures,
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;
independence
provisions that restrict non-audit services that accountants may
their audit clients; (iii) additional corporate
provide
governance and
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
the oversight of, and
restatement; (v) an
to, audit
enhancement of certain
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)
insiders,
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;
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.
in
requirements
that management assess
requirements
relating
(xi)
Additional information regarding regulatory matters is
included in Note 26 of the Notes to Consolidated Financial
Statements.
88
Fifth Third Bancorp
ITEM 2. PROPERTIES
The Bancorp’s executive offices and the main office of Fifth
Third Bank are located on Fountain Square Plaza 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, 2006, the Bancorp, through its banking
and non-banking subsidiaries, operated 1,150 banking centers,
of which 781 were owned, 280 were leased and 89 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
from mortgages and major
encumbrances.
free
EXECUTIVE OFFICERS OF THE BANCORP
Officers are appointed annually by the Board of Directors at the
the Annual
meeting of Directors
Meeting of Shareholders. The names, ages and positions of the
Executive Officers of the Bancorp as of February 20, 2007 are
listed below along with their business experience during the
past 5 years:
immediately following
George A. Schaefer, Jr., 61. Chairman of the Bancorp since
June 2006 and Chief Executive Officer of the Bancorp and Fifth
Third Bank since 1990.
Kevin T. Kabat, 50. President of the Bancorp since June 2006.
Previously, Mr. Kabat was Executive Vice President of the
Bancorp since December 2003. Prior to that he 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.
Greg D. Carmichael, 45. Executive Vice President and Chief
Operating Officer of the Bancorp since June 2006. Prior to that
he was the 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, 40. 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, 43. 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.
Malcolm D. Griggs, 46. 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.
Bruce K. Lee, 46. 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
ANNUAL REPORT ON FORM 10-K
Executive Vice President and Chief Credit Officer of Capital
Holding, Inc. prior to its acquisition by Fifth Third Bancorp in
2001.
Christopher G. Marshall, 47. Executive Vice President and
Chief Financial Officer of the Bancorp since May 2006.
Previously, Mr. Marshall was a senior executive for Bank of
America and served in various management capacities since
2001 and prior to that he was Chief Operating Officer and CFO
for Global Business Services of Honeywell International and
CFO for AlliedSignal Technology Services Corporation.
Daniel T. Poston, 48. 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, 45. 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.
Mahesh Sankaran, 44. Senior Vice President and Treasurer
of the Bancorp since June 2006. Previously, Mr. Sankaran was
treasurer
Incorporated since
February 2005. Prior to that Mr. Sankaran was Treasurer for
Compass Bankshares, Inc.
for Huntington Bancshares
Robert A. Sullivan, 52. Senior 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.
Carlos Winston Wilkinson, 44. Executive Vice President of
the Bancorp since April 2006. Previously, Mr. Wilkinson was a
Retail Executive for Wachovia Mortgage Corporation.
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON
EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
The information required by this item is included in the
Corporate Information found on the inside of the back cover
and
the
subsidiaries can pay to the Bancorp discussed in Note 26 of the
Notes to the Consolidated Financial Statements. Additionally,
as of December 31, 2006, the Bancorp had approximately
57,411 shareholders of record.
the discussion of dividend
limitations
that
in
Issuer Purchases of Equity Securities
Average
Price
Paid Per
Share
$38.42
39.71
39.34
$39.70
Period
October 2006
November 2006
December 2006
Total
Shares
Purchased
(a)
12,593
2,074,538
19,098
2,106,229
Shares
Purchased
as Part of
Publicly
Announced
Plans or
Programs
-
2,039,908
-
2,039,908
Maximum
Shares that
May Be
Purchased
Under the
Plans or
Programs
(b)
17,846,953
15,807,045
15,807,045
15,807,045
(a) The Bancorp repurchased 12,593, 34,630 and 19,098 shares during
October, November and December of 2006 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 89
ANNUAL REPORT ON FORM 10-K
The following performance graphs do not constitute soliciting material and should not be deemed filed or incorporated by
reference into any other Company filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the
extent the Bancorp specifically incorporates the performance graphs by reference therein.
Total Return Analysis
The graphs below summarize the cumulative return experienced by the Bancorp's shareholders over the years 2002 through 2006, and
1997 through 2006, respectively, compared to the S&P 500 Stock, the S&P Banks and the NASDAQ Banks indices:
FIFTH THIRD BANCORP VS. MARKET INDICES
5 YEAR RETURN
x
e
d
n
I
n
r
u
t
e
R
l
a
t
o
T
100
80
60
40
20
0
(20)
(40)
2001
2002
2003
2004
2005
2006
Fifth Third (FITB)
S&P Banks (BIX)
Nasdaq Bank (CBNK)
S&P 500 (SPX)
10 YEAR RETURN
x
e
d
n
I
n
r
u
t
e
R
l
a
t
o
T
300
250
200
150
100
50
0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Fifth Third (FITB)
S&P Banks (BIX)
Nasdaq Bank (CBNK)
S&P 500 (SPX)
ITEM 9A. CONTROLS AND PROCEDURES
The Bancorp conducted 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 (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange
Act). Based on the foregoing, as of the end of the period
covered by this report, 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
90
Fifth Third Bancorp
the reports the Bancorp files and submits under the Exchange
Act is recorded, processed, summarized and reported as and
when required.
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. The Bancorp’s Management assessed the
effectiveness of the Bancorp’s internal control over financial
reporting as of December 31, 2006. Management’s assessment is
based on the criteria established in the Internal Control —
ANNUAL REPORT ON FORM 10-K
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, 2006. Based on this assessment, Management believes that
the Bancorp maintained effective internal control over financial
reporting as of December 31, 2006. 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, 2006 and Bancorp
Management’s assessment of the internal control over financial
reporting. This report appears on page 48 of the annual report.
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.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND
CORPORATE GOVERNANCE
The information required by this item relating to the Executive
Officers of the Registrant is included in PART I under
“EXECUTIVE OFFICERS OF THE BANCORP.”
The information required by this item concerning Directors
and the nomination process is incorporated herein by reference
under the caption “ELECTION OF DIRECTORS” of the
Bancorp’s Proxy Statement for the 2007 Annual Meeting of
Shareholders.
The information required by this item concerning the Audit
Committee and Code of Business Conduct and Ethics is
incorporated herein by
captions
“CORPORATE GOVERNANCE”
“BOARD OF
ITS COMMITTEES, MEETINGS AND
DIRECTORS,
FUNCTIONS” of the Bancorp’s Proxy Statement for the 2007
Annual Meeting of Shareholders.
reference under
and
the
The information required by this item concerning Section
16
is
(a) Beneficial Ownership Reporting Compliance
incorporated herein by reference under the caption “SECTION
16
REPORTING
COMPLIANCE” of the Bancorp’s Proxy Statement for the 2007
Annual Meeting of Shareholders.
OWNERSHIP
BENEFICIAL
(a)
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by
reference under the captions “COMPENSATION DISCUSSION
“COMPENSATION COMMITTEE
AND ANALYSIS,”
REPORT”
COMMITTEE
INTERLOCKS AND INSIDER PARTICIPATION” of the
Bancorp’s Proxy Statement for the 2007 Annual Meeting of
Shareholders.
“COMPENSATION
and
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 “COMPENSATION DISCUSSION
AND ANALYSIS” of the Bancorp’s Proxy Statement for the
2007 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, AND DIRECTOR INDEPENDENCE
The information required by this item is incorporated herein by
reference under the captions “CERTAIN TRANSACTIONS”,
“CORPORATE
“ELECTION
ITS
GOVERNANCE” and “BOARD OF DIRECTORS,
COMMITTEES, MEETINGS AND FUNCTIONS” of
the
Bancorp’s Proxy Statement for the 2007 Annual Meeting of
Shareholders.
DIRECTORS”,
OF
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 2007 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
54-83
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.
The following lists the Exhibits to the Annual Report on Form 10-K.
3(i)
3(ii)
4.1
4.2
4.3
4.4
4.5
4.6
4.7
Second Amended Articles of Incorporation of Fifth Third Bancorp,
as 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, 2006.
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.
4.8
Form of Fifth Third Bancorp, as successor to Old Kent Financial
Fifth Third Bancorp 91
ANNUAL REPORT ON FORM 10-K
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.
4.9
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
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.
4.12 Indenture, dated as of May 23, 2003, between Fifth Third Bancorp
and Wilmington Trust Company, as Trustee. Incorporated by
reference to Registrant’s Current Report on Form 8-K filed with the
Securities and Exchange Commission on May 22, 2003.
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.
4.14 First Supplemental Indenture, dated as of December 20, 2006,
between Fifth Third Bancorp and Wilmington Trust Company, as
Trustee.
4.15 Global security representing Fifth Third Bancorp’s $500,000,000
5.45% Subordinated Notes due 2017.
4.16 Global security representing Fifth Third Bancorp’s $250,000,000
Floating Rate Subordinated Notes due 2016.
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. *
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 December 8, 2006. *
92
Fifth Third Bancorp
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, 2006. *
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. *
10.25 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. *
10.26 Southern Community Bancorp Equity Incentive Plan. Incorporated
by reference to Southern Community Bancorp’s Registration
Statement on Form SB-2, Registration No. 333-35548. *
10.27 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.
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
ANNUAL REPORT ON FORM 10-K
the Exhibits to Registrant’s Quarterly Report on Form 10-Q for the
quarter ended September 30, 2005. *
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.
10.33 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. *
10.34 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.
10.35 Amendment to Stipulation dated May 10, 2005. Incorporated by
reference to Registrant’s Current Report on Form 8-K filed with the
Securities and Exchange Commission on November 18, 2005.
10.36 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.
10.38 Offer letter from Fifth Third Bancorp to Christopher G. Marshall
dated April 12, 2006. Incorporated by reference to Registrant’s
Quarterly Report on Form 10-Q for the quarter ended June 30,
2006.*
10.39 Form of Executive Agreements effective February 19, 2007, between
Fifth Third Bancorp and Kevin T. Kabat, Robert A. Sullivan, Greg
D. Carmichael, Christopher G. Marshall, Carlos Winston Wilkinson,
Bruce K. Lee and Charles D. Drucker.*
10.40 Form of Executive Agreements effective February 19, 2007, between
Fifth Third Bancorp and Paul L. Reynolds, Malcolm D. Griggs and
Daniel T. Poston.*
10.41 Form of Executive Agreement effective February 19, 2007, between
Fifth Third Bancorp and Mahesh Sankaran.*
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.
Code of Ethics. Incorporated by reference to Exhibit 14 of the
14
Registrant’s Current Report on Form 8-K filed with the Securities
and Exchange Commission on January 23, 2007.
21
23
Fifth Third Bancorp Subsidiaries, as of December 31, 2006.
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 93
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.
Chairman and CEO
Principal Executive Officer
February 20, 2007
Pursuant to requirements of the Securities Exchange Act of
1934, this report has been signed on February 20, 2007 by the
following persons on behalf of the Registrant and in the
capacities indicated.
OFFICERS:
George A. Schaefer, Jr.
Director, Chairman, and CEO
Principal Executive Officer
Christopher G. Marshall
Executive 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
Gary R. Heminger
Joan R. Herschede
Allen M. Hill
Robert L. Koch II
Mitchel D. Livingston, Ph.D.
Kenneth W. Lowe
Hendrik G. Meijer
James E. Rogers
John J. Schiff, Jr.
Dudley S. Taft
Thomas W. Traylor
94
Fifth Third Bancorp
AVERAGE ASSETS ($ IN MILLIONS)
CONSOLIDATED TEN YEAR COMPARISON
Year
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
Loans and
Leases
$73,493
67,737
57,042
52,414
45,539
44,888
42,690
38,652
36,014
33,850
Interest-Earning Assets
Interest-Bearing
Deposits in
Banks (a)
$126
105
195
215
184
132
82
103
135
186
Federal Funds
Sold (a)
$252
88
120
92
155
69
118
224
241
327
Securities
$20,910
24,806
30,282
28,640
23,246
19,737
18,630
16,901
16,090
15,425
Total
$94,781
92,736
87,639
81,361
69,124
64,826
61,520
55,880
52,480
49,788
Cash and Due
from Banks
$2,495
2,758
2,216
1,600
1,551
1,482
1,456
1,628
1,566
1,367
Other
Assets
$8,713
8,102
5,763
5,250
5,007
5,000
4,229
3,344
2,782
2,495
Total
Average
Assets
$105,238
102,876
94,896
87,481
75,037
70,683
66,611
60,292
56,306
53,161
AVERAGE DEPOSITS AND SHORT-TERM BORROWINGS ($ IN MILLIONS)
Deposits
Year
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
Demand
$13,741
13,868
12,327
10,482
8,953
7,394
6,257
6,079
5,627
4,932
Interest
Checking
$16,650
18,884
19,434
18,679
16,239
11,489
9,531
8,553
7,030
6,209
Savings
$12,189
10,007
7,941
8,020
9,465
4,928
5,799
6,206
6,332
4,548
Money
Market
$6,366
5,170
3,473
3,189
1,162
2,552
939
1,328
1,471
2,508
INCOME ($ IN MILLIONS, EXCEPT PER SHARE DATA)
Other
Time
$10,500
8,491
6,208
6,426
8,855
13,473
13,716
13,858
15,117
15,887
Certificates
- $100,000
and Over
$5,795
4,001
2,403
3,832
2,237
3,821
4,283
4,197
3,856
4,173
Foreign
Office
$3,711
3,967
4,449
3,862
2,018
1,992
3,896
952
270
441
Total
$68,952
64,388
56,235
54,490
48,929
45,649
44,421
41,173
39,703
38,698
Short-Term
Borrowings
$8,670
9,511
13,539
12,373
7,191
8,799
9,725
8,573
7,095
6,113
Total
$77,622
73,899
69,774
66,863
56,120
54,448
54,146
49,746
46,798
44,811
Year
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
Interest
Income
$5,955
4,995
4,114
3,991
4,129
4,709
4,947
4,199
4,052
3,933
Interest
Expense
$3,082
2,030
1,102
1,086
1,430
2,278
2,697
2,026
2,047
2,030
Noninterest
Income
$2,153
2,500
2,465
2,483
2,183
1,788
1,476
1,335
1,161
901
Noninterest
Expense
$3,056
2,927
2,972
2,551
2,337
2,453
2,027
1,987
1,826
1,486
Per Share (b)
Originally Reported
Net Income
Available to
Common
Shareholders Earnings
$1,184
1,548
1,524
1,664
1,530
1,001
1,054
871
759
756
$2.14
2.79
2.72
2.91
2.64
1.74
1.86
1.55
1.36
1.35
Diluted
Earnings
$2.13
2.77
2.68
2.87
2.59
1.70
1.83
1.53
1.34
1.33
Dividends
Declared Earnings
$1.58
1.46
1.31
1.13
.98
.83
.70
.582/3
.471/3
.379/10
$2.14
2.79
2.72
2.91
2.64
1.74
1.70
1.32
1.09
1.10
Diluted
Earnings
$2.13
2.77
2.68
2.87
2.59
1.70
1.68
1.29
1.06
1.08
Dividend
Payout
Ratio
74.2 %
52.7
48.9
39.4
37.8
48.8
41.7
45.5
44.6
35.2
MISCELLANEOUS AT DECEMBER 31 ($ IN MILLIONS, EXCEPT SHARE DATA)
Shareholders’ Equity
Year
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
Common Shares
Outstanding (b)
556,252,674
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
Common
Stock
$1,295
1,295
1,295
1,295
1,295
1,294
1,263
1,255
1,238
1,235
Preferred
Stock
$9
9
9
9
9
9
9
9
9
9
Capital
Surplus
$1,812
1,827
1,934
1,964
2,010
1,943
1,454
1,090
887
812
Retained
Earnings
$8,317
8,007
7,269
6,481
5,465
4,502
3,982
3,551
3,179
3,000
Accumulated
Other
Comprehensive
Income
$(179)
(413)
(169)
(120)
369
8
28
(302)
135
140
Treasury
Stock
$(1,232)
(1,279)
(1,414)
(962)
(544)
(4)
(1)
-
(58)
(184)
Book Value
Per
Share (b)
$18.02
17.00
16.00
15.29
14.98
13.31
11.83
9.91
9.67
9.00
Allowance
for Loan
and Lease
Losses
$771
744
713
697
683
624
609
573
532
509
Total
$10,022
9,446
8,924
8,667
8,604
7,752
6,735
5,603
5,390
5,005
(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 and 1997.
Fifth Third Bancorp 95
FIFTH THIRD BANCORP
BOARD COMMITTEES
Executive Committee
George A. Schaefer, Jr.,
Chairman
Allen M. Hill
James P. Hackett
Robert L. Koch II
Dudley S. Taft
Compensation Committee
Allen M. Hill, Chairman
Kenneth W. Lowe
Hendrik G. Meijer
James E. Rogers
Audit Committee
James P. Hackett, Chairman
Darryl F. Allen, Vice Chairman
John F. Barrett
Gary R. Heminger
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
FIFTH THIRD BANCORP
DIRECTORS
George A. Schaefer, Jr.
Chairman & 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.
Gary R. Heminger
Executive Vice President
Marathon Oil Corporation
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.
James E. Rogers
Chairman & CEO
Duke Energy 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.
96
Fifth Third Bancorp
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
Robert B. Morgan
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.
Chairman & CEO
Kevin T. Kabat
President
Greg D. Carmichael
Executive Vice President &
Chief Operating Officer
David J. DeBrunner
Senior Vice President & Controller
Charles D. Drucker
Executive Vice President
Malcolm D. Griggs
Executive Vice President &
Chief Risk Officer
Bruce K. Lee
Executive Vice President
Christopher G. Marshall
Executive Vice President &
Chief Financial Officer
Daniel T. Poston
Executive Vice President & Auditor
Paul L. Reynolds
Executive Vice President, Secretary &
General Counsel
Mahesh Sankaran
Senior Vice President & Treasurer
Robert A. Sullivan
Senior Executive Vice President
Carlos Winston Wilkinson
Executive Vice President
AFFILIATE CHAIRMEN
Charlie W. Brinkley, Jr.
Central Florida
John Condon
Ohio Valley
H. Lee Cooper
Southern Indiana
Gordon E. Inman
Tennessee
R. Daniel Sadlier
Western Ohio
Donald B. Shackelford
Central Ohio
John S. Szuch
Northwestern Ohio
AFFILIATE PRESIDENTS &
CEOs
Samuel G. Barnes
Central Kentucky
John Bultema
Central Florida
David A. Call
Ohio Valley
Todd F. Clossin
Northeastern Ohio
John N. Daniel
Southern Indiana
Mark Eckhoff
Northern Michigan
Robert M. Eversole
Central Ohio
Dan W. Hogan
Tennessee
Brian P. Keenan
Tampa Bay
Gregory L. Kosch
Eastern Michigan
Robert W. LaClair
Northwestern Ohio
Philip R. McHugh
Louisville
John E. Pelizzari
Central Indiana
Thomas R. Quinn, Jr.
South Florida
Timothy P. Rawe
Northern Kentucky
Robert A. Sullivan
Cincinnati
Michelle L. VanDyke
Western Michigan
Raymond J. Webb
Western Ohio
Terry E. Zink
Chicago
Fifth Third Bancorp CORPORATE INFORMATION
Corporate Office
Fifth Third Center
Cincinnati, OH 45263
(513) 579-5300
Website
www.53.com
Investor Relations
Jeff Richardson
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
Senior Vice President &
Investordirect.53.com
Director, Investor Relations
(513) 534-0983
Stock Trading
(513) 534-0629 (fax)
The common stock of Fifth Third Bancorp
Jim Eglseder
Assistant Vice President
(513) 534-8424
is traded in the over-the-counter market
and is listed under the symbol “FITB” on
the NASDAQ® Global Select Market System.
(513) 534-0629 (fax)
Press Releases
For copies of current press releases,
please visit our Website at www.53.com.
2006
Low
$37.75
$35.95
$35.86
$36.30
Dividends
Paid Per
Share
$0.40
$0.40
$0.40
$0.38
High
$42.50
$43.99
$44.67
$48.12
2005
Low
$35.04
$36.38
$40.24
$42.05
Dividends
Paid Per
Share
$0.38
$0.38
$0.35
$0.35
High
$41.57
$40.18
$41.02
$41.43
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
©Fifth Third Bank 2007
Member F.D.I.C. – Federal Reserve System
®Reg. U.S. Pat. & T.M. Office
www.53.com