Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
SCHEDULE 14A
PROXY STATEMENT PURSUANT TO SECTION 14(a) OF THE SECURITIES
EXCHANGE ACT OF 1934
(AMENDMENT NO. )
Filed by the Registrant x
Filed by a Party other than the Registrant ¨
Check the appropriate box:
| ¨ | Preliminary Proxy Statement |
| ¨ | CONFIDENTIAL, FOR USE OF THE COMMISSION ONLY (AS PERMITTED BY RULE 14a-6(e)(2)) |
| x | Definitive Proxy Statement |
| ¨ | Definitive Additional Materials |
| ¨ | Soliciting Material Pursuant to Section 240.14a-12 |
FIFTH THIRD BANCORP
(NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
(NAME OF PERSON(S) FILING PROXY STATEMENT, IF OTHER THAN THE REGISTRANT)
Payment of Filing Fee (Check the appropriate box):
| x | No fee required. |
| ¨ | Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11. |
| (1) | Title of each class of securities to which transaction applies: |
| (2) | Aggregate number of securities to which transaction applies: |
| (3) | Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the filing fee is calculated and state how it was determined): |
| (4) | Proposed maximum aggregate value of transaction: |
| (5) | Total fee paid: |
| ¨ | Fee paid previously with preliminary materials. |
| ¨ | Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing. |
| (1) | Amount Previously Paid: |
| (2) | Form, Schedule or Registration Statement No.: |
| (3) | Filing Party: |
| (4) | Date Filed: |
Table of Contents
38 FOUNTAIN SQUARE PLAZA
CINCINNATI, OHIO 45263
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
December 8, 2008
To the Shareholders of Fifth Third Bancorp:
You are cordially invited to attend the Special Meeting of the Shareholders of Fifth Third Bancorp to be held at The Bankers Club of Cincinnati, located at 511 Walnut Street, 30th Floor, Cincinnati, Ohio on Monday, December 29, 2008 at 9:00 a.m. for the purposes of considering and acting upon the following:
| (1) | The proposal described in the proxy statement to amend (i) Article Fourth of the Second Amended Articles of Incorporation, as amended (the “Articles”), to revise the terms of the authorized, unissued shares of Preferred Stock, without par value, available for issuance by Fifth Third Bancorp to allow for limited voting rights for a new series of Preferred Stock so that the new series of Preferred Stock will meet the requirements for participation in the Troubled Asset Relief Program Capital Purchase Program (“TARP CPP”) established by the United States Department of Treasury pursuant to the Emergency Economic Stabilization Act of 2008 (“EESA”), and (ii) Article III, Sections 13 and 14 of the Code of Regulations of Fifth Third Bancorp, as amended (“Code of Regulations”), to expressly provide that the standard for removing Directors as set forth in the Articles shall prevail over any standard for removing Directors as set forth in the Code of Regulations, and to expressly provide that any procedures for filling vacancies on the Board of Directors as set forth in the Articles, shall prevail over any procedures for filling vacancies on the Board of Directors as set forth in the Code of Regulations. In the event that both Proposals 1 and 3 are approved by shareholders, the Company will not implement the amendments contemplated by Proposal 1 (such amendments would be superseded by the amendments in Proposal 3). The proposed amendments are attached as Annex 1 to the proxy statement and are incorporated by reference therein. |
| (2) | The proposal described in the proxy statement to amend Article Fourth of the Second Amended Articles of Incorporation to revise the express terms of the issued and outstanding shares of the Series G Preferred Stock of Fifth Third Bancorp to allow the Series G Preferred Stock to have certain of the voting rights as may be granted by Fifth Third Bancorp if it authorizes and issues a new series of Preferred Stock pursuant to the TARP CPP established by the Department of Treasury pursuant to the EESA. The proposed amendment is attached as Annex 2 to the proxy statement and is incorporated by reference therein. |
| (3) | The proposal described in the proxy statement to amend (i) Article Fourth of the Articles to revise the terms of the authorized, unissued shares of Preferred Stock, without par value, available for issuance by Fifth Third Bancorp to provide greater flexibility in the terms of Preferred Stock that Fifth Third Bancorp may offer and sell in the future, including but not limited to shares of Preferred Stock that may be issued to the Department of Treasury upon participation in the TARP CPP, and to clarify the ability of Fifth Third Bancorp to issue shares of Preferred Stock without stockholder approval in accordance with the terms of Ohio law, and (ii) Article III, Sections 13 and 14 of the Code of Regulations to expressly provide that the standard for removing Directors as set forth in the Articles shall prevail over any standard for removing Directors as set forth in the Code of Regulations, and to expressly provide that any procedures for filling vacancies on the Board of Directors as set forth in the Articles, shall prevail over any procedures for filling vacancies on the Board of Directors as set forth in the Code of Regulations. In the event that both Proposals 1 and 3 are approved by shareholders, the |
Table of Contents
| Company will not implement the amendments contemplated by Proposal 1 (such amendments would be superseded by the amendments in Proposal 3). The proposed amendments are attached as Annex 3 to the proxy statement and are incorporated by reference therein. |
| (4) | The proposal described in the proxy statement to approve the adjournment of the Special Meeting, if necessary, to solicit additional proxies in the event that there are not sufficient votes at the time of the Special Meeting to adopt the proposed amendments to Article Fourth of our Articles and/or our Code of Regulations. |
| (5) | Transaction of such other business that may properly come before the Special Meeting or any adjournment thereof. |
Shareholders of record at the close of business on December 4, 2008 will be entitled to vote at the Special Meeting.
IMPORTANT NOTICE REGARDING THE AVAILABILITY OF PROXY MATERIALS FOR THE SPECIAL MEETING TO BE HELD ON DECEMBER 29, 2008: This proxy statement is available at www.viewmaterial.com/fitb.
All shareholders who find it convenient to do so are invited to attend the Special Meeting in person. In any event, please vote at your earliest convenience by signing and returning the proxy card you receive or by voting over the internet or by telephone.
If you plan to attend the Special Meeting:
Please note that space limitations make it necessary to limit attendance only to shareholders of the Company and the holders of shareholder proxies. Admission to the Special Meeting will be on a first-come, first-served basis and will require presentation of a valid driver’s license or other federal or state issued photo identification card. Shareholders of record should bring the admission ticket attached to their notice or proxy card in order to be admitted to the meeting. “Street name” shareholders will need to bring a copy of a brokerage statement reflecting stock ownership as of the record date in order to be admitted to the meeting. Registration and seating will begin at approximately 8:30 a.m. Communication and recording devices will not be permitted at the Special Meeting. A copy of the regulations for conduct at the Special Meeting is attached as Annex 4 to the proxy statement.
By Order of the Board of Directors
Paul L. Reynolds
Secretary
Table of Contents
| Page No. | ||
| 1 | ||
| Information About the Special Meeting and the Matters to be Voted Upon |
1 | |
| General Special Meeting Information Relating to Holders of Common Stock |
6 | |
| 8 | ||
| 11 | ||
| 20 | ||
| 23 | ||
| 26 | ||
| 28 | ||
| 30 | ||
| 31 | ||
| 31 | ||
| 31 | ||
| Annex 1 - 1 | ||
| Annex 2 - 1 | ||
| Annex 3 - 1 | ||
| Annex 4 - 1 | ||
| Exhibit I—Summary of Terms of TARP Capital Purchase Program Senior Preferred Stock and Warrants |
Exhibit I - 1 | |
| A-1 | ||
| A-2 | ||
| A-62 | ||
| B-1 | ||
| —Management’s Discussion and Analysis of Financial Condition and Results of Operations at December 31, 2007 and 2006 |
B-2 | |
| —Quantitative and Qualitative Disclosures about Market Risk |
B-39 | |
| —Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
None | |
| —Management’s Assessment as to the Effectiveness of Internal Control over Financial Reporting |
B-59 | |
| C-1 | ||
| C-2 | ||
| D-1 | ||
| D-2 | ||
| D-36 | ||
| D-55 | ||
Table of Contents
38 Fountain Square Plaza
Cincinnati, Ohio 45263
PROXY STATEMENT
The Board of Directors of Fifth Third Bancorp (the “Company”) is soliciting proxies for the Special Meeting of Shareholders to be held at The Bankers Club located at 511 Walnut Street, 30th Floor, Cincinnati, Ohio on Monday, December 29, 2008 at 9:00 a.m. (the “Special Meeting”). Each of the 577,437,040 shares of Common Stock and 44,300 shares of the 8.50% Non-Cumulative Perpetual Convertible Preferred Stock, Series G of Fifth Third Bancorp (the “Series G Preferred Stock”) outstanding as of the close of business on December 4, 2008 is entitled to one vote on all matters to be acted upon at the Special Meeting, and only shareholders of record on the books of the Company at the close of business on December 4, 2008 will be entitled to vote at the Special Meeting, either in person or by proxy. The shares represented by all properly executed proxies which are sent to the Company will be voted as designated and each not designated will be voted and counted as described in this proxy statement. Each person giving a proxy may revoke it by giving notice to the Company in writing or in open meeting at any time before it is voted.
The expense of soliciting proxies will be borne by the Company. Proxies will be solicited principally by mail, but may also be solicited by the Directors, officers, and other regular employees of the Company, who will receive no compensation therefor in addition to their regular compensation. Brokers and others who hold stock on behalf of others will be asked to send proxy material to the beneficial owners of the stock, and the Company will reimburse them for their expenses.
The Company has retained D.F. King & Co., Inc., a proxy solicitation firm, to assist the Company in soliciting proxies for a fee of $15,000, plus out of pocket expenses.
This proxy statement and the form of proxy are first being sent or made available to shareholders on or about December 8, 2008.
INFORMATION ABOUT THE SPECIAL MEETING AND THE MATTERS TO BE VOTED UPON
Why is the Company holding a Special Meeting?
The Company is considering raising capital through the sale of Preferred Stock to the U.S. Department of the Treasury (the “Department of Treasury”) pursuant to the Department of Treasury’s Troubled Asset Relief Program Capital Purchase Program (the “TARP CPP”), which was created under the Emergency Economic Stabilization Act of 2008 (“EESA”). The Special Meeting is being held to approve proposed amendments to the Company’s Second Amended Articles of Incorporation, as amended (the “Articles”), and to the Company’s Code of Regulations, as amended (“Code of Regulations”), to enable the Company to participate in the TARP CPP.
What is the TARP CPP?
On October 14, 2008, the Department of Treasury announced the creation of the TARP CPP to encourage U.S. financial institutions to build capital to increase the flow of financing to businesses and consumers in the U.S. and to support the U.S. economy. The TARP CPP is designed to attract broad participation by healthy financial institutions and to do so in a way that attracts private capital to them as well as with a goal of increasing confidence in U.S. banks and increasing the confidence of such banks to lend their capital. Pursuant to the TARP, up to $700 billion can be provided to the Department of Treasury to buy mortgages and other assets from financial institutions, to guarantee assets of financial institutions, and to invest and take equity positions in financial institutions. Under the TARP CPP, the Department of Treasury will purchase up to $250 billion of senior preferred shares from qualifying financial institutions that meet the TARP CPP’s eligibility requirements and that applied to participate in the TARP CPP by November 14, 2008.
Table of Contents
Why would the Company consider participating in the TARP CPP?
The challenges experienced by financial institutions due to the recent economic downturn and turbulence in the financial markets make it prudent for financial institutions not only to preserve their existing capital but to supplement such capital as a protection against the uncertain duration and severity of the challenges arising from the current economic situation. Under the TARP CPP, the Department of Treasury has authorized the purchase of up to $250 billion of preferred securities on standardized terms from qualifying financial institutions.
In June, 2008, the Company announced a capital plan that would increase its capital and capital ratio targets in anticipation of a difficult second half of 2008 and a difficult 2009. The Company’s capital plan included a reduction in the current dividend on the shares of Common Stock, raising approximately $1.0 billion in capital through a public offering of Depositary Shares in Series G Preferred Stock, and the sale of non-core assets to generate additional capital of approximately $1.0 billion. The dividend reduction and the sale of Depositary Shares were accomplished in June, 2008 and the Company began to explore the potential for asset sales. Upon the establishment of the TARP CPP by the Department of Treasury, the Company reevaluated its capital plan. Following preliminary approval for the Company’s participation in the TARP CPP, the Company determined that the available investment by the Department of Treasury in Preferred Stock of the Company should be pursued and that a sale of non-core assets would no longer be a part of the Company’s near-term capital planning.
If the Company participates in the TARP CPP, how much capital could the Company raise?
Under the TARP CPP, eligible financial institutions can generally apply to issue and sell preferred stock to the Department of Treasury in aggregate amounts equal to between 1% and 3% of the institution’s risk-weighted assets. The Company submitted its application for participation in the TARP CPP on October 24, 2008 and received notice of its preliminary approval from the Department of Treasury on October 28, 2008. By letter dated November 12, 2008, the Department of Treasury informed the Company to proceed with preparing the standard agreements required by the Department of Treasury. Based on the preliminary approval and the November 12, 2008 letter, if the Company participates in the TARP CPP, the Company will issue and the Department of Treasury will purchase approximately $3.46 billion in Preferred Stock which represents approximately 3% of the Company’s risk-weighted assets as of June 30, 2008. In addition, the Company will be required to issue warrants to the Department of Treasury to purchase shares of the Company’s Common Stock having an aggregate value equal to 15% of the purchase price of the Preferred Stock purchased by the Department of Treasury, an amount equal to approximately $519.66 million. The exercise price of the warrants is expected to be approximately $11.716, which is the average closing price of a share of the Company’s Common Stock for the 20 trading days ending prior to October 27, 2008 (the date on which the Department of Treasury preliminarily approved the Company for participation in the TARP CPP), subject to customary anti-dilution adjustments. Exercise of these warrants would result in the issuance of approximately 44.36 million common shares, which would represent approximately 7.68% of the Company’s outstanding shares of Common Stock as of December 4, 2008.
What does the Company plan to do with the proceeds of the TARP CPP?
The Company anticipates that, upon receipt of the approximately $3.46 billion of proceeds from the TARP CPP, it would initially use the proceeds to pay down short-term borrowings.
It is important to note that the Preferred Stock investment yields both cash proceeds and increased capital. The cash proceeds will supplement the Company’s cash and other sources of liquidity, including deposits, to provide for the general operating needs of the Company. These needs are expected to include making loans to qualified borrowers; purchasing securities backed by loans; repaying liabilities in the ordinary course of business; and financing other ordinary activities of the Company.
The capital represented by the shares of Preferred Stock anticipated to be sold to the Department of Treasury would be expected to be prudently leveraged to further enhance earnings opportunities, primarily through lending and other indirect forms of lending such as purchases of securities backed by loans. To the extent that the capital
2
Table of Contents
is not immediately deployed to a level of leverage equivalent to that of the Company’s current balance sheet, due to timing or other factors, that capital would serve to enhance the Company’s existing capital levels.
Why does the Company need to amend the Articles and Code of Regulations to participate in the TARP CPP?
In order for the Company to participate in the TARP CPP, the Company must be able to issue and sell Preferred Stock to the Department of Treasury upon certain standard terms required by the Department of Treasury, including certain limited class voting rights and certain rights relating to the removal of particular directors and the filling of certain director vacancies.
Although the Company’s Preferred Stock currently available for issuance may be issued upon action by the Board of Directors without further shareholder approval, the Company’s Articles prohibit the issuance of shares of Preferred Stock with voting rights, except for voting rights as otherwise required by law. Consequently, in order for the Company to participate in the TARP CPP, the Articles must be amended to permit the Board of Directors to include the standard limited voting rights required by the Department of Treasury in the terms of the Preferred Stock that the Company would sell to the Department of Treasury. In particular, the Department of Treasury’s standard terms require, among other things, that (i) the shares of Preferred Stock purchased by it, voting as a single class with other parity shares having similar voting rights, be entitled to elect two persons to the Company’s Board of Directors in the event the Company fails to pay dividends on such Preferred Stock for six quarterly periods, whether or not consecutive, and (ii) such Directors may be removed at any time, with or without cause, and any vacancy created thereby may be filled, only by the affirmative vote of the holders of a majority of such shares, voting together as a class, to the extent the voting rights of such holders described above are then exercisable.
Additionally, the Company’s Code of Regulations do not allow for the removal of a director without cause or the filling of a director vacancy by the affirmative vote of certain holders of Preferred Stock. The Code of Regulations needs to be amended to eliminate any inconsistencies between the Articles and the Code of Regulations if the amendment to the Articles described herein is approved.
The Company is not seeking the approval of shareholders to authorize the issuance of a particular security. Under Proposal 1, the Company is only seeking shareholder approval to amend the Articles in order to satisfy the standard terms required under the TARP CPP and to amend the Code of Regulations to eliminate any inconsistencies between the Articles and Code of Regulations if such proposed amendment to the Articles is approved.
What will be the terms of the Preferred Stock issued to the Department of Treasury if the Company participates in the TARP CPP?
In addition to the limited class voting rights and changes with respect to the removal of directors, and the filling of director vacancies described in the previous question, Preferred Stock issued by the Company to the Department of Treasury under the TARP CPP (a) will be senior to Common Stock with respect to dividend rights and upon liquidation, (b) will rank equally with the Company’s existing outstanding shares of Series G Preferred Stock with respect to dividends and upon liquidation, and (c) will not be subject to any contractual restrictions on transfer. Cumulative dividends will be payable on such Preferred Stock at a rate of 5% per annum until the fifth anniversary of the issuance of the Preferred Stock and at a rate of 9% per annum thereafter.
The Preferred Stock may not be redeemed for a period of three years from the date of issuance, except with the proceeds from the sale of Tier 1 qualifying perpetual Preferred Stock or Common Stock for cash. All redemptions of the Preferred Stock shall be at its issue price plus any accrued and unpaid dividends. Any redemption of the Preferred Stock also is subject to the approval of the Board of Governors of the Federal Reserve System. See Exhibit I hereto for a complete summary of the standard terms of preferred stock currently required by the Department of Treasury.
3
Table of Contents
What will happen if the proposed amendments to the Company’s Articles and Code of Regulations are not adopted?
If the Company’s shareholders do not approve either of the proposed amendments to the Articles and Code of Regulations set forth in Proposals 1 and 3, the Company believes that it may not be able to participate in the TARP CPP under the Department of Treasury’s current standard terms. A failure to qualify for the TARP CPP will potentially eliminate a possible low-cost source of additional capital that would allow the Company to strengthen its capital position, increase its ability to extend credit to qualified borrowers, support its existing operations, improve its ability to leverage future strategic operations to grow, add value for Company shareholders and enhance its competitive position.
If the proposed Amendments to the Articles and Code of Regulations are approved, is the Company’s participation in the TARP CPP guaranteed?
There can be no assurance that the Company will ultimately participate in the TARP CPP or that the Company will issue any Preferred Stock to the Department of Treasury, even if shareholders approve the proposed amendments. Until final documents have been executed by the Company and the Department of Treasury, either party could decide not to continue with the issuance and the sale of the Preferred Stock and warrants.
When and where is the Special Meeting?
The Special Meeting of shareholders of the Company will be held at The Bankers Club, 511 Walnut Street, 30th Floor, Cincinnati, Ohio on Monday, December 29, 2008 at 9:00 a.m. Eastern Time.
What matters will be voted upon at the Special Meeting?
Shareholders will be voting on the following matters:
1. To amend (i) Article Fourth of the Articles to revise the terms of the authorized, unissued shares of Preferred Stock, without par value, available for issuance by Fifth Third Bancorp to allow for limited voting rights for a new series of Preferred Stock, so that the new series of Preferred Stock will meet the requirements for participation in the TARP CPP established by the Department of Treasury pursuant to the EESA, and (ii) Article III, Sections 13 and 14 of the Code of Regulations to expressly provide that the standard for removing Directors as set forth in the Articles shall prevail over any standard for removing Directors as set forth in the Code of Regulations, and to expressly provide that any procedures for filling vacancies on the Board of Directors as set forth in the Articles shall prevail over any procedures for filling vacancies on the Board of Directors as set forth in the Code of Regulations. In the event that both Proposals 1 and 3 are approved by shareholders, the Company will not implement the amendments contemplated by Proposal 1 (such amendments would be superseded by the amendments in Proposal 3). These proposed amendments are attached as Annex 1 to this proxy statement. (“Proposal 1”)
2. To amend Article Fourth of the Articles to revise the express terms of the issued and outstanding shares of the Series G Preferred Stock of Fifth Third Bancorp to allow the Series G Preferred Stock to have certain of the voting rights as may be granted by Fifth Third Bancorp if it authorizes and issues a new series of Preferred Stock pursuant to the TARP CPP established by the Department of Treasury pursuant to the EESA. This proposed amendment is attached as Annex 2 to this proxy statement. (“Proposal 2”)
3. To amend (i) Article Fourth of the Articles to revise the terms of the authorized, unissued shares of Preferred Stock, without par value, available for issuance by Fifth Third Bancorp to provide greater flexibility in the terms of Preferred Stock that Fifth Third Bancorp may offer and sell in the future, including but not limited to shares of Preferred Stock that may be issued to the Department of Treasury upon participation in the TARP CPP, and to clarify the ability of Fifth Third Bancorp to issue shares of Preferred Stock without stockholder approval in accordance with the terms of Ohio law and (ii) Article III, Sections 13 and 14 of the Code of Regulations to expressly provide that the standard for removing Directors as set forth in the Articles shall prevail over any
4
Table of Contents
standard for removing Directors as set forth in the Code of Regulations, and to expressly provide that any procedures for filling vacancies on the Board of Directors as set forth in the Articles shall prevail over any procedures for filling vacancies on the Board of Directors as set forth in the Code of Regulations. In the event that both Proposals 1 and 3 are approved by shareholders, the Company will not implement the amendments contemplated by Proposal 1 (such amendments would be superseded by the amendments in Proposal 3). These proposed amendments are attached as Annex 3 to this proxy statement. (“Proposal 3”).
4. To approve the adjournment of the Special Meeting, if necessary, to solicit additional proxies in the event that there are not sufficient votes at the time of the Special Meeting to adopt the proposed amendments to Article Fourth of our Articles and Article III of our Code of Regulations. (“Proposal 4”).
Why is the Company seeking shareholder approval to adjourn the Special Meeting in Proposal 4?
Approval of the proposed amendments to the Articles and Code of Regulations require the affirmative vote of the holders of two-thirds of the Common Stock outstanding and the affirmative vote of the holders of two-thirds of each series of Preferred Stock outstanding. In the event there are not sufficient votes at the time of the Special Meeting to adopt any of the proposed amendments, the Board of Directors is seeking shareholder approval to adjourn the Special Meeting to a later date in order to permit additional proxy solicitation. Pursuant to the Company’s Code of Regulations and Ohio law, shareholders may authorize the holder of proxies solicited by the Board of Directors to vote in favor of adjourning the Special Meeting.
How many votes are needed to approve the Proposals?
The vote required to approve each of the proposals that are scheduled to be presented at the Special Meeting is as follows:
| Proposal |
Vote Required | |
| Proposals 1, 2 and 3 | The three proposals to amend the Company’s Articles each require the affirmative vote of the holders of two-thirds of the outstanding shares of Common Stock and two-thirds of the outstanding shares of Series G Preferred Stock, each voting as a separate class. Abstentions and broker non-votes will have the same effect as votes against the proposal. While the proposed amendments to the Company’s Code of Regulations contained in Proposals 1 and 3 on a stand-alone basis would only require the affirmative vote of the holders of a majority of shares of Common Stock outstanding, such amendments will be deemed approved only upon the affirmative two thirds vote of the Common Stock and Series G Preferred Stock as described above in this paragraph. | |
| Proposal 4 | The proposal to adjourn the Special Meeting requires the affirmative vote of the holders of a majority of the shares of Common Stock and Series G Preferred Stock present in person or represented by proxy at the Special Meeting, whether or not a quorum is present. Abstentions and shares not voted by shareholders of record present in person and entitled to vote will have the same effect as votes against the proposal. Broker non-votes will have no effect on the outcome of the proposal. | |
5
Table of Contents
What constitutes a quorum for the Special Meeting?
Under the Code of Regulations, a majority of the votes eligible to be cast on every matter to be voted upon at the Special Meeting must be present in person or by proxy to establish a quorum at the Special Meeting. Abstentions and broker non-votes are counted as being present for purposes of determining the presence of a quorum.
Who could help answer my questions about proxy materials, the Special Meeting or the procedures for voting my shares?
Shareholders who have questions about proxy materials, need additional copies or require assistance with the procedures for voting shares may call our proxy solicitor as follows:
D.F. King & Co., Inc.
48 Wall Street
New York NY 10005
1-800-207-3158 (toll free) or
1-212-269-5550 (call collect)
GENERAL SPECIAL MEETING INFORMATION RELATING TO
HOLDERS OF COMMON STOCK
Who can vote?
December 4, 2008 has been fixed as the record date for the determination of shares entitled to notice of and to vote at the Special Meeting. You are entitled to vote if you are a holder of record of shares of the Company’s Common Stock as of the close of business on December 4, 2008. Each eligible shareholder is entitled to one vote per share of Common Stock.
How do I vote my shares of Common Stock?
You may vote your shares of Common Stock on matters that are properly presented at the Special Meeting in four ways:
| • | By completing the accompanying form of proxy and returning it in the envelope provided; |
| • | By submitting your vote telephonically; |
| • | By submitting your vote electronically via the Internet; or |
| • | By attending the Special Meeting and casting your vote in person. |
For the Special Meeting, the Company is offering holders of record of Common Stock the opportunity to vote their shares electronically through the Internet or by telephone. Instead of submitting your vote for shares of Common Stock by mail on the enclosed proxy card, you may vote by telephone or via the Internet by following the procedures described on your proxy card. In order to vote via telephone or the Internet, please have the enclosed proxy card in hand, and call the number or go to the website listed on the proxy card and follow the instructions. The telephone and Internet voting procedures are designed to authenticate shareholders’ identities, to allow shareholders to give their voting instructions, and to confirm that shareholders’ instructions have been properly recorded.
Shareholders voting through the Internet should understand that they may bear certain costs associated with Internet access, such as usage charges from their Internet service providers.
6
Table of Contents
Can the proxy materials be accessed electronically?
The Company has sent the proxy materials for the Special Meeting to shareholders on or about December 8, 2008 by first-class U.S. mail. Additionally, the Company’s proxy statement for the Special Meeting sent to holders of record of the Company’s shares of Common Stock is available at www.viewmaterial.com/fitb.
How do I vote if my shares of Common Stock are held in “Street Name”?
If you hold your shares of Common Stock in “street name” with a broker, a financial institution or another holder of record, then that entity is considered the shareholder of record for voting purposes and should give you instructions for voting your shares of Common Stock. As a beneficial owner of Common Stock, you have the right to direct the record holder on how to vote the shares held on your behalf. If you hold your shares of Common Stock in “street name,” you may be eligible to appoint your proxy electronically via the Internet or telephonically and may incur costs associated with such electronic access or telephone usage.
If you hold your shares of Common Stock in “street name” and wish to attend the Special Meeting and vote in person, you must bring an account statement or letter from your broker, financial institution or other holder of record authorizing you to vote on behalf of such record holder. The account statement or letter must show that you were the direct or indirect beneficial owner of shares of Common Stock as of the close of business on December 4, 2008, the record date for voting at the Special Meeting.
How will my shares of Common Stock be voted?
Shares of Common Stock represented by properly executed proxies will be voted at the Special Meeting, and if a shareholder has specified how the shares of Common Stock represented thereby are to be voted, they will be voted in accordance with such specification. It is intended that shares of Common Stock represented by a proxy card that has been properly signed and returned but on which no specification has been made, will be voted FOR all of Proposals 1, 2, 3 and 4.
How do I change or revoke my proxy representing my shares of Common Stock?
A proxy may be revoked at any time before a vote is taken or the authority granted is otherwise exercised. Revocation may be accomplished by: (1) the execution of a later dated proxy; (2) the execution of a later casted telephone or Internet vote with regard to the same shares; (3) by giving notice in writing to Paul L. Reynolds, Secretary, Fifth Third Bancorp, 38 Fountain Square, Cincinnati, Ohio 45263; or (4) by notifying the Secretary in person at the Special Meeting. Any shareholder who attends the Special Meeting and revokes his/her proxy may vote in person. However, your attendance at the Special Meeting alone will not revoke your proxy. The last-dated proxy you submit (by any means) will supersede any previously submitted proxy. If you hold your shares of Common Stock in “street name” and instructed your broker, financial institution or other holder of record to vote your shares of Common Stock and you would like to revoke or change your vote, then you must follow the instructions provided by your record holder.
If I vote my shares of Common Stock in advance, can I still attend the Special Meeting?
Yes. You are encouraged to vote promptly by telephone, Internet or by returning your signed proxy card by mail, so that your shares of Common Stock will be represented at the Special Meeting. However, voting your shares of Common Stock by proxy does not affect your right to attend the Special Meeting in person.
7
Table of Contents
GENERAL SPECIAL MEETING INFORMATION RELATING TO HOLDERS OF
SERIES G PREFERRED STOCK AND DEPOSITARY SHARES REPRESENTING INTERESTS THEREIN
Why am I receiving this proxy statement?
The close of business on Thursday, December 4, 2008, has been fixed as the record date by the Company for shares of Series G Preferred Stock and by Wilmington Trust Company, as the depository, for the determination of Depositary Shares representing interests in shares of Series G Preferred Stock (the “Depositary Shares”) entitled to notice of and to vote at the Special Meeting. As of the close of business on December 4, 2008, Wilmington Trust Company was the sole holder of all of the outstanding shares of Series G Preferred Stock, and The Depository Trust Company was the sole holder of record of all of the outstanding Depositary Shares, held in its nominee name as Cede & Co.
You are receiving a proxy statement because you beneficially owned Depositary Shares in “street name” as of the close of business on December 4, 2008. That entitles you to provide instructions to your broker, bank, trustee or other nominee as to how your Depositary Shares (and in turn, the Series G Preferred Stock) will be voted at the Special Meeting. Your broker, bank, trustee or other nominee (or their respective intermediary) will provide voting results from the beneficial holders to the tabulator for the Depositary Shares who will in turn provide a summary of votes cast by the beneficial holders to Wilmington Trust Company who will then vote the Series G Preferred Stock accordingly. This proxy statement describes the matters on which we would like you to provide instructions to your broker, bank, trustee or other nominee and provides information on those matters so that you can make an informed decision.
The notice of Special Meeting, proxy statement and voting instruction card are being mailed to holders of Depositary Shares on or about December 8, 2008. Since your Depositary Shares are held in “street name,” please refer to the information forwarded by your bank, broker, trustee or other nominee to see the options available to you for instructing your broker, bank, trustee or other nominee how to vote Depositary Shares beneficially owned by you.
What is a voting instruction card?
Your broker, banker, trustee or other nominee will provide materials and instructions for voting Depositary Shares owned beneficially by you. You may receive a voting instruction card to be completed and returned to your broker, banker, trustee or other nominee. Alternatively, you may receive other instructions for how to indicate to your broker, banker, trustee or other nominee how you would like Depositary Shares owned beneficially by you to be voted.
When you complete and return such voting instruction card and/or comply with such other instructions to indicate how you would like Depositary Shares owned beneficially by you to be voted, you are indirectly giving the depository the authority to vote the Series G Preferred Stock represented by your Depositary Shares in the manner you indicate on your voting instruction card.
Why did I receive more than one voting instruction card for my Depositary Shares?
You will receive multiple voting instruction cards or other instructions for how to indicate to your broker, banker, trustee or other nominee how you would like Depositary Shares owned beneficially by you to be voted, if you hold your Depositary Shares in different ways (e.g., joint tenancy, trusts or custodial accounts) or in multiple accounts.
If your Depositary Shares are held by a broker, banker, trustee or other nominee (i.e., in “street name”), you will receive your voting instruction card or other voting information from such person, and you will return your voting instruction card or cards to your broker, banker, trustee or other nominee.
You should indicate your vote on and sign each voting instruction card that you receive.
8
Table of Contents
What is the difference between a “Shareholder of Record” and a “Street Name” holder of Depositary Shares?
These terms describe how Depositary Shares are held. All Depositary Shares are registered in the name of Cede & Co. with Wilmington Trust Company, the depository, and Cede & Co. is the sole “shareholder of record.” Because your Depositary Shares are held in the name of a brokerage, bank, trust or other nominee as a custodian, you are a “street name” holder.
How do I vote my Depositary Shares?
Because you hold your Depositary Shares in “street name,” your broker/bank/trustee/nominee will provide you with materials and instructions for voting your Depositary Shares. Your nominee may be participating in a program that allows you to submit a proxy by telephone or via Internet. If so, the voting form your nominee sends you will provide instructions for submitting your vote by telephone or via the Internet. The last-dated vote you submit (by any means) will supersede any previously submitted vote. Also, if you vote by telephone or via the Internet, you may revoke your vote by following the instructions provided by your nominee.
Please consult the instructions provided by your nominee for information about the deadline for submitting a vote by telephone or via the Internet.
How are my Depositary Shares counted in the shareholder vote for the Series G Preferred Stock?
Each share of Series G Preferred Stock is entitled to one vote and, accordingly, each Depositary Share that you own is entitled to 1/250th of a vote. To the extent your instructions to your nominee request the voting of your fractional interest of a share of Series G Preferred Stock, Wilmington Trust Company, the depository, in turn shall aggregate such interest with all other fractional interests resulting from requests with the same voting instructions and shall vote the number of whole votes resulting from such aggregation in accordance with the instructions received in such requests.
Can I vote my Depositary Shares in person at the Special Meeting?
Only Wilmington Trust Company, the depository and sole record holder of the Series G Preferred Stock, may vote at the Special Meeting.
What vote is required for the Series G Preferred Stock to approve each proposal?
The vote of the Series G Preferred Stock required to approve each of the proposals that are scheduled to be presented at the Special Meeting, and on which the Series G Preferred Stock is entitled to vote, is as follows:
Proposal 1, Proposal 2 and Proposal 3 require the affirmative vote of the holders of two-thirds of the outstanding shares of the Series G Preferred Stock (and, therefore, the holders of two-thirds of the Depositary Shares); and
Proposal 4 requires the affirmative vote of a majority of the Series G Preferred Stock (and therefore, the Depositary Shares) and of the Common Stock present in person or represented by proxy at the Special Meeting, whether or not a quorum is present. The Series G Preferred Stock and the Common Stock will vote together as a single class on Proposal 4, but will vote as separate classes on Proposal 1, Proposal 2 and Proposal 3.
How would the Series G Preferred Stock representing my Depositary Shares be voted if I do not direct my broker, bank, trust or other nominee how they should be voted?
If you sign and return your voting instruction card to your broker/banker/trustee/nominee without indicating how you want your Depositary Shares to be voted, or otherwise fail to provide voting instructions to your broker/
9
Table of Contents
banker/trustee/nominee, neither your nominee nor Wilmington Trust Company will be able to vote the Series G Preferred Stock represented by your Depositary Shares with respect to any of the Proposals. Therefore, you are urged to sign and complete the voting instruction card or otherwise provide voting instructions to your broker/banker/trustee/nominee in the manner specified by your broker/banker/trustee/nominee.
What if I do not return my voting instruction card?
Because you hold your Depositary Shares in “street name,” if you do not give your bank, broker, trustee or other nominee specific voting instructions for your Depositary Shares, your nominee (through its intermediary) cannot direct the depository to vote the Series G Preferred Stock represented by your Depositary Shares on any of the Proposals. Your failure to provide such instructions will be treated as a vote against Proposals 1, 2 and 3.
How are abstentions and broker non-votes treated?
If you do not give your nominee specific voting instructions and your nominee does not vote, the votes will be “broker non-votes.” “Broker non-votes” will be treated as “No” votes on Proposals 1, 2 and 3 for which you do not provide instructions. Similarly, abstentions as to any such Proposal will have the same effect as a vote against such Proposal.
Who will count the votes of the Depositary Shares?
The depository will count the votes of the holders of the Depositary Shares and will vote the shares of Series G Preferred Stock at the Special Meeting in accordance with such votes.
10
Table of Contents
TO AMEND ARTICLE FOURTH, SECTION (A)2)(d)1. OF
THE SECOND AMENDED ARTICLES OF INCORPORATION, AS AMENDED
AND
TO AMEND ARTICLE III, SECTIONS 13 AND 14 OF
THE CODE OF REGULATIONS, AS AMENDED
OF FIFTH THIRD BANCORP
(Item 1 on Proxy Card)
The Board of Directors recommends approval of the amendments of Article Fourth, Section (A)2)(d)1. of the Articles and of Article III, Sections 13 and 14 of the Code of Regulations, in the manner shown in Annex 1 hereto.
What are these Amendments intended to accomplish?
The proposed Amendment to Article Fourth, Section (A)2)(d)1. of the Articles would revise the express terms of the authorized and unissued shares of Preferred Stock to allow the Board to provide limited voting rights in order to comply with the standard terms required for shares of preferred stock that may be issued in connection with the TARP CPP authorized by EESA and implemented by the Department of Treasury (the “Designated Preferred Stock”). The limited class voting rights currently required by the Department of Treasury to be included in the Designated Preferred Stock eligible to be purchased as a condition to participation in the TARP CPP are: (1) to allow such shares of Designated Preferred Stock to vote as a class with any other preferred stock having similar voting rights for the election and removal of two directors of the Company (the “Preferred Directors”) in the event the Company fails to pay dividends on such shares of preferred stock purchased by the Department of Treasury for six quarterly dividend periods, whether or not consecutive; and (2) to allow such shares of Designated Preferred Stock to vote as a class on certain significant corporate actions, namely the authorization of any senior stock, any amendment to the terms of the Designated Preferred Stock purchased by the Department of Treasury, and certain share exchanges, reclassifications, mergers and consolidations.
The proposed amendment to Article III, Section 13 of the Code of Regulations would expressly provide that any standard for removing Directors as may be contained in the Articles will govern if there is any conflict with the standards for removing Directors as set forth in the Code of Regulations. Similarly, the proposed amendment to Article III, Section 14 of the Code of Regulations would expressly provide that any procedures for filling vacancies on the Board of Directors as may be contained in the Articles will apply if there is any conflict with the procedures for filling vacancies on the Board as set forth in the Code of Regulations.
Why are these Amendments needed?
Although the Company’s Preferred Stock currently available for issuance may be issued upon action by the Board of Directors without further shareholder approval, Article Fourth, Section (A)2)(d)1. of the Articles currently provides that any and all shares of the Company’s Preferred Stock will have no voting rights, except as otherwise required by law. As described above, the Department of Treasury requires in its standard terms that any shares of Designated Preferred Stock purchased by it pursuant to the TARP CPP must have certain limited class voting rights that go beyond the voting rights required by Ohio law. Therefore, unless Proposal 3 is approved or the Company’s shareholders approve this proposed amendment to the Articles, the Board of Directors will not be able to include these limited class voting rights in the terms of Preferred Stock that the Company would issue to the Department of Treasury in order to participate in the TARP CPP. The inability to do so could result in the Company not being able to participate in the TARP CPP notwithstanding that the Department of Treasury has already preliminarily approved a capital investment in the Company of approximately $3.46 billion through the sale of Designated Preferred Stock.
The proposed amendments to the Code of Regulations will eliminate any inconsistencies between the Articles and the Code of Regulations, if the foregoing amendment to the Articles is approved as described in this Proposal 1.
11
Table of Contents
Why does the Company want to participate in the TARP CPP?
The recent challenges experienced as a result of turbulence in the financial markets make it important for financial institutions not only to preserve existing capital but also to supplement such capital as a protection against further economic difficulties. In June, 2008, the Company announced a capital plan that would increase its capital and capital ratios targets in anticipation of a difficult second half of 2008 and a difficult 2009. The Company’s capital plan included a reduction in the current dividend for shares of Common Stock, the raising of approximately $1.0 billion in capital through a public offering of Depositary Shares in Series G Preferred Stock, and the sale of non-core assets to generate additional capital of approximately $1.0 billion. The dividend reduction and sale of Depositary Shares were accomplished in June, 2008 and the Company began to explore the potential for asset sales.
Upon the establishment of the TARP CPP by the Department of Treasury, which provides a low cost capital-raising opportunity to generate capital in a cost effective manner, the Company reevaluated its capital plan. Following preliminary approval for the Company’s participation in the TARP CPP, the Company determined that the available investment amount of approximately $3.46 billion by the Department of Treasury in Preferred Stock of the Company should be pursued and that a sale of non-core assets would no longer be part of the Company’s near-term capital planning. Even though the Company is above “well-capitalized” regulatory levels, participation in the TARP CPP would provide the Company with a unique opportunity to strengthen its capital position during these uncertain times. The Company’s Board of Directors and management believe that participation in the TARP CPP will increase the Company’s ability to extend credit to qualified borrowers, support the Company’s existing operations, improve the Company’s ability to leverage future strategic opportunities to grow, add value for the Company’s shareholders, and enhance the Company’s competitive position.
What would be the key terms of shares of Designated Preferred Stock that the Company might sell to the Department of Treasury?
Liquidation Preferences, Dividends, and Redemption Rights. Should the Company and its Board of Directors determine to proceed with participation in the TARP CPP, the Board of Directors would authorize the Company to issue and sell to the Department of Treasury shares of Designated Preferred Stock. Such Designated Preferred Stock would have dividend and liquidation preferences senior to the Company’s Common Stock and equal to the Company’s Series G Preferred Stock. All shares of Designated Preferred Stock would pay cumulative dividends at a rate of 5% per annum for the first five years and 9% per annum after year five, payable quarterly in arrears. Shares of Designated Preferred Stock would be redeemable after three years at its issue price, plus accrued and unpaid dividends. Prior to the third anniversary of the Department of Treasury’s investment, shares of Designated Preferred Stock could only be redeemed using the proceeds of an offering of other qualifying perpetual preferred securities of the Company or shares of Common Stock, which offering would provide the Company with proceeds of at least 25% of the issue price of the shares of Designated Preferred Stock. Any such redemption must be approved by the Company’s primary federal bank regulator, currently the Board of Governors of the Federal Reserve System. The Department of Treasury would be permitted to transfer the Designated Preferred Stock to a third party at any time.
Voting Rights as to the Election of Preferred Directors. The standard terms required by the Department of Treasury for Designated Preferred Stock include that whenever, at any time or times, dividends payable on the shares of Designated Preferred Stock have not been paid for an aggregate of six quarterly dividend periods or more, whether or not consecutive, the authorized number of directors of the Company shall automatically be increased by two and the holders of the Designated Preferred Stock shall have the right, with holders of shares of any one or more other classes or series of the Company’s Preferred Stock that have like voting rights with the Designated Preferred Stock with respect to such matter, voting together as a class, to elect two directors (hereinafter the “Preferred Directors” and each a “Preferred Director”) to fill such newly created directorships at the Company. Such Preferred Directors are to be in addition to the Directors elected by the holders of the Company’s Common Stock. Holders of Designated Preferred Stock and any voting parity Preferred Stock will not be entitled to vote on Directors elected by the holders of the Common Stock, and vice versa.
12
Table of Contents
Additional Limited Class Voting Rights. The standard terms required by the Department of Treasury for Designated Preferred Stock also include that, for so long as such shares remain outstanding, in addition to any other vote or consent of shareholders required by law or by the Articles, the vote or consent of the holders of at least two thirds of the shares of the Designated Preferred Stock at the time outstanding, voting as a separate class, given in person or by proxy, either in writing without a meeting or by vote at any meeting called for the purpose, shall be necessary for effecting or validating:
| • | Authorization of Senior Stock. Any amendment or alteration of the Articles to authorize or create or increase the authorized amount of, or any issuance of, any shares of, or any securities convertible into or exchangeable or exercisable for shares of, any class or series of capital stock of the Company ranking senior to Designated Preferred Stock with respect to either or both the payment of dividends and/or the distribution of assets on any liquidation, dissolution or winding up of the Company; |
| • | Amendment of Designated Preferred Stock. Any amendment, alteration or repeal of any provision of the Articles so as to adversely affect the rights, preferences, privileges or voting powers of Designated Preferred Stock; or |
| • | Share Exchanges, Reclassifications, Mergers and Consolidations. Any consummation of a binding share exchange or reclassification involving Designated Preferred Stock, or of a merger or consolidation of the Company with another corporation or other entity, unless in each case (x) the shares of Designated Preferred Stock remain outstanding or, in the case of any such merger or consolidation with respect to which the Company is not the surviving or resulting entity, are converted into or exchanged for preference securities of the surviving or resulting entity or its ultimate parent, and (y) such shares remaining outstanding or such preference securities, as the case may be, have such rights, preferences, privileges and voting powers, and limitations and restrictions thereof, taken as a whole, as are not materially less favorable to the holders thereof than the rights, preferences, privileges and voting powers, and limitations and restrictions thereof, of Designated Preferred Stock immediately prior to such consummation, taken as a whole; |
provided, however, that for all the above purposes, any increase in the amount of the authorized Preferred Stock, including any increase in the authorized amount of Designated Preferred Stock necessary to satisfy preemptive or similar rights granted by the Company to other persons prior to the date that the Department of Treasury and the Company would enter into a definitive securities purchase agreement, or the creation and issuance, or an increase in the authorized or issued amount, whether pursuant to preemptive or similar rights or otherwise, of any other series of Preferred Stock, or any securities convertible into or exchangeable or exercisable for any other series of Preferred Stock, ranking equally with and/or junior to Designated Preferred Stock with respect to the payment of dividends (whether such dividends are cumulative or non-cumulative) and the distribution of assets upon liquidation, dissolution or winding up of the Company will not be deemed to adversely affect the rights, preferences, privileges or voting powers, and shall not require the affirmative vote or consent of, the holders of outstanding shares of the Designated Preferred Stock.
If this proposed amendment to the Articles is approved by shareholders, each share of Designated Preferred Stock issued to the Department of Treasury pursuant to the TARP CPP would have one vote per share, consistent with the Ohio Revised Code and the Company’s Code of Regulations.
What other terms and conditions must the Company agree to in order to participate in the TARP CPP?
Issuance of Warrants to Purchase Common Stock. In conjunction with the sale of the Designated Preferred Stock, the Department of Treasury will receive warrants to purchase common shares with an aggregate market price equal to 15% of the investment in the Designated Preferred Stock. The exercise price of the warrants, and the market price for determining the number of shares of Common Stock subject to the warrants, is expected to be approximately $11.716 per share, which is the average closing price of a share of the Company’s Common Stock for the 20 trading days ending prior to October 27, 2008 (the date on which the Department of Treasury preliminarily approved the Company for participation in the TARP CPP), subject to customary anti-dilution
13
Table of Contents
adjustments. The warrants will have a term of 10 years. The Department of Treasury will agree not to exercise voting power with respect to any shares of Common Stock that it acquires upon exercise of the warrants. The Company will have to take the steps necessary to register, pursuant to the Securities Act of 1933, as amended, the shares of Designated Preferred Stock issued by the Company and the related warrants and underlying Common Stock purchasable upon exercise.
Restrictions on Dividends and Stock Repurchases. As long as the shares of Designated Preferred Stock remain outstanding, the Company would be permitted to declare and pay dividends on its Common Stock and Series G Preferred Stock unless the Company fails to pay the required cumulative dividends on the Designated Preferred Stock. Unless the Designated Preferred Stock has been transferred or redeemed in whole, the Department of Treasury’s consent will be required until the third anniversary of the Department of Treasury’s investment to declare or pay any dividends or make any distributions on the shares of Common Stock (other than for (i) regular quarterly cash dividends of not more than the amount of the last quarterly cash dividend per share declared or, if lower, publicly announced an intention to declare, on shares of Common Stock prior to October 14, 2008, (ii) dividends payable solely in shares of Common Stock, and (iii) dividends or distributions of rights or junior stock in connection with a stockholders’ rights plan), and any repurchases other than repurchases of the Designated Preferred Stock or repurchases in connection with the Company’s benefit plans in the ordinary course of business and consistent with past practice.
Limitations on Executive Compensation. If the Company participates in the TARP CPP, the Company would also be required to adopt and adhere to the standards for executive compensation and corporate governance established under Section 111 of the EESA, for the period during which the Department of Treasury holds equity issued under the TARP CPP. These standards would generally apply to the Company’s chief executive officer, chief financial officer and the next three most highly compensated executive officers. In particular, the Company would be required to meet certain governance and executive compensation standards, including: (i) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (ii) requiring a clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (iii) prohibiting certain severance payments to an executive officer, generally referred to as “golden parachute” payments, above specified limits; and (iv) agreeing not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive. The affected officers of the Company have executed waivers in which they have agreed to any modifications to their existing compensation arrangements that may be necessary to meet these requirements.
A complete summary of the expected terms of the securities that the Department of Treasury would purchase from qualifying financial institutions is set forth in Exhibit I, attached hereto. The final terms of the Company’s participation in the TARP CPP, including the specific terms of the Designated Preferred Stock and warrants, would be set forth in definitive agreements to be executed by the Department of Treasury and the Company. The standard forms of these agreements as required by the Department of Treasury are available on the Department of Treasury’s website at www.treas.gov/initiatives/eesa/application-documents.
If the Company completes the proposed sale of Preferred Stock to the Department of Treasury, what effects will such sale have on the Company’s financial statements?
The following unaudited pro forma financial information of Fifth Third Bancorp for the fiscal year ended December 31, 2007 and the nine months ended September 30, 2008 show the effects of issuing $3.46 billion of Designated Preferred Stock to the Department of Treasury pursuant to the TARP CPP. The pro forma financial data presented below may change materially based on the actual proceeds received, the timing and utilization of proceeds, as well as certain other factors including any subsequent changes in the price of the Company’s Common Stock, dividends and the discount rate to determine the fair value of the Designated Preferred Stock and warrants. Accordingly, the Company can provide no assurance that the pro forma assumptions included in the following unaudited pro forma financial information will ever be achieved. The Company is providing the
14
Table of Contents
following pro forma financial information solely for the purpose of providing shareholders with information that may be useful for considering and evaluating the Proposals contained in this proxy statement.
The following unaudited pro forma financial information should be read in conjunction with the consolidated financial statements and the notes thereto, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Quantitative and Qualitative Disclosures about Market Risk,” from the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007 and Quarterly Report on Form 10-Q for the period ended September 30, 2008. Such historical information is included as Appendices A, B, C and D to this proxy statement.
PRO FORMA CONDENSED CONSOLIDATED
SUMMARIES OF INCOME (unaudited)
| Historical 12 Months Ended |
Pro Forma(1) 12 Months Ended | |||||
| (In millions, except per share data) | Dec 31, 2007 |
Dec 31, 2007 | ||||
| Total interest income |
$ | 6,027 | $ | 6,027 | ||
| Total interest expense(2) |
3,018 | 2,983 | ||||
| Net interest income |
3,009 | 3,044 | ||||
| Provision for loan and lease losses |
628 | 628 | ||||
| Net interest income after provision for loan and lease losses |
2,381 | 2,416 | ||||
| Total noninterest income |
2,467 | 2,467 | ||||
| Total noninterest expense |
3,311 | 3,311 | ||||
| Applicable income taxes(3) |
461 | 473 | ||||
| Net income |
1,076 | 1,099 | ||||
| Dividends on preferred stock(4) |
1 | 199 | ||||
| Net income available to common shareholders |
$ | 1,075 | $ | 900 | ||
| PER COMMON SHARE DATA |
||||||
| Earnings per share, basic |
$ | 2.00 | $ | 1.67 | ||
| Earnings per share, diluted |
1.99 | 1.58 | ||||
| Cash dividends declared |
1.70 | 1.70 | ||||
| Average number of shares outstanding (in thousands) |
537,670 | 537,670 | ||||
| Average number of shares outstanding, diluted(5) |
540,118 | 570,379 | ||||
| (1) | The income statement effect is given assuming the cash proceeds were received at the beginning of the period. |
| (2) | The cash proceeds are assumed to initially be used to pay down short-term borrowings at the current target federal funds rate of 1.00%. Subsequent redeployment of the funds is anticipated, but the timing of such redeployment is uncertain. |
| (3) | Income taxes on incremental income due to the pay down of short-term borrowings are assumed to be 35%. |
| (4) | Projected dividends on the preferred stock expected to be issued to the Department of Treasury include a 5% annual cash dividend plus accretion of the difference between the carrying value and the par value of the preferred stock. The difference between the carrying value and the par value of the preferred stock will be accreted using the constant effective yield method over 5 years. In the pro forma financial statements for the year ended December 31, 2007, the Company accreted $25 million of this difference as dividends on preferred stock. |
| (5) | Treasury stock method was used for purposes of evaluating the effect of the warrants on diluted shares outstanding. |
15
Table of Contents
PRO FORMA CONDENSED CONSOLIDATED
SUMMARIES OF INCOME (unaudited)
| Historical 9 Months Ended |
Pro Forma(1) 9 Months Ended |
||||||
| (In millions, except per share data) |
Sept 30, 2008 |
Sept 30, 2008 |
|||||
| Total interest income |
$ | 4,202 | $ | 4,202 | |||
| Total interest expense(2) |
1,581 | 1,555 | |||||
| Net interest income |
2,621 | 2,647 | |||||
| Provision for loan and lease losses |
2,203 | 2,203 | |||||
| Net interest income after provision for loan and lease losses |
418 | 444 | |||||
| Total noninterest income |
2,304 | 2,304 | |||||
| Total noninterest expense |
2,543 | 2,543 | |||||
| Applicable income taxes(3) |
150 | 159 | |||||
| Net income |
29 | 46 | |||||
| Dividends on preferred stock(4) |
26 | 174 | |||||
| Net income (loss) available to common shareholders |
$ | 3 | $ | (128 | ) | ||
| PER COMMON SHARE DATA |
|||||||
| Earnings per share, basic |
$ | 0.01 | $ | (0.23 | ) | ||
| Earnings per share, diluted |
0.01 | (0.23 | ) | ||||
| Cash dividends declared |
0.74 | 0.74 | |||||
| Average number of shares outstanding (in thousands) |
546,835 | 546,835 | |||||
| Average number of shares outstanding, diluted(5) |
548,749 | 546,835 | |||||
| (1) | The income statement effect is given assuming the cash proceeds were received at the beginning of the period. |
| (2) | The cash proceeds are assumed to initially be used to pay down short-term borrowings at the current target federal funds rate of 1.00%. Subsequent redeployment of the funds is anticipated, but the timing of such redeployment is uncertain. |
| (3) | Income taxes on incremental income due to the pay down of short-term borrowings are assumed to be 35%. |
| (4) | Projected dividends on the preferred stock expected to be issued to the Department of Treasury include a 5% annual cash dividend plus accretion of the difference between the carrying value and the par value of the preferred stock. The difference between the carrying value and the par value of the preferred stock will be accreted using the constant effective yield method over 5 years. In the pro forma financial statements for the nine months ended September 30, 2008, the Company accreted $18 million of this difference as dividends on preferred stock. |
| (5) | Treasury stock method was used for purposes of evaluating the effect of the warrants on diluted shares outstanding. |
16
Table of Contents
PRO FORMA CONDENSED CONSOLIDATED
BALANCE SHEETS (unaudited)
| Historical as of |
Pro Forma(1) as of |
|||||||
| (In millions) |
Sept 30, 2008 |
Sept 30, 2008 |
||||||
| ASSETS |
||||||||
| Cash and due from banks |
$ | 2,774 | $ | 2,774 | ||||
| Securities |
14,452 | 14,452 | ||||||
| Other short-term investments |
229 | 229 | ||||||
| Loans held for sale |
1,000 | 1,000 | ||||||
| Total portfolio loans and leases |
85,498 | 85,498 | ||||||
| Allowance for loans and lease losses |
(2,058 | ) | (2,058 | ) | ||||
| Other assets |
14,399 | 14,399 | ||||||
| Total assets |
$ | 116,294 | $ | 116,294 | ||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY |
||||||||
| Total deposits |
$ | 77,460 | $ | 77,460 | ||||
| Federal funds purchased |
2,521 | 2,521 | ||||||
| Other short-term borrowings(2) |
8,791 | 5,327 | ||||||
| Accrued taxes, interest and expenses |
1,757 | 1,757 | ||||||
| Other liabilities |
2,122 | 2,122 | ||||||
| Long-term debt |
12,947 | 12,947 | ||||||
| Total liabilities |
105,598 | 102,134 | ||||||
| Common stock |
1,295 | 1,295 | ||||||
| Preferred stock(3) |
1,082 | 4,408 | ||||||
| Capital surplus |
597 | 597 | ||||||
| Warrants(3) |
— | 138 | ||||||
| Retained earnings |
8,013 | 8,013 | ||||||
| Accumulated other comprehensive income |
(60 | ) | (60 | ) | ||||
| Treasury stock |
(231 | ) | (231 | ) | ||||
| Total shareholders’ equity |
10,696 | 14,160 | ||||||
| Total liabilities and shareholders’ equity |
$ | 116,294 | $ | 116,294 | ||||
| REGULATORY CAPITAL RATIOS |
||||||||
| Tier 1 capital |
8.57 | % | 11.62 | % | ||||
| Total risk-based capital |
12.30 | 15.35 | ||||||
| Tier 1 leverage |
8.77 | 11.90 | ||||||
| (1) | The balance sheet effect is given assuming the cash proceeds were received at the balance sheet date. |
| (2) | The cash proceeds are assumed to initially be used to pay down other short-term borrowings. Subsequent redeployment of the funds is anticipated, but the timing of such redeployment is uncertain. |
| (3) | The carrying values of the preferred stock and the warrants expected to be issued to the Department of Treasury are based on their estimated relative fair values. The fair value of the preferred stock was estimated using a 12.5% discount rate and a 5 year expected life. The fair value of the warrants was estimated using a Black-Scholes valuation. The Black-Scholes valuation requires assumptions regarding the Bancorp’s common stock price, dividend yield, stock price volatility, and a risk-free rate. The assumptions used for these estimated fair values may be different from the assumptions used at the time of the receipt of the cash proceeds from the Department of the Treasury due to changing economic, market and other conditions and factors set forth in the Section titled “Forward-Looking Statements.” |
17
Table of Contents
Could these Amendments have adverse effects to the holders of the Company’s Common Stock and/or Series G Preferred Stock?
The Company does not believe that the amendments proposed in this Proposal 1 will have adverse consequences to the holders of the Company’s Common Stock or Series G Preferred Stock. If these amendments are approved and implemented and the Designated Preferred Stock is issued, the holders of the shares of Designated Preferred Stock could elect two Preferred Directors under certain circumstances. Such Preferred Directors would be in addition to the Directors elected by the holders of Common Stock, and will be a minority of Directors comprising the Company’s Board of Directors. Holders of shares of Designated Preferred Stock will not be entitled to vote on any other Directors of the Company, which Directors will continue to be subject solely to election by the holders of Common Stock. Accordingly, the voting rights of the holders of Common Stock will not be reduced or diminished as a result of the adoption of these amendments. Holders of Series G Preferred Stock currently have no right to vote in any election of Directors and, therefore, the rights of the holders of Series G Preferred Stock are unaffected by these proposed amendments other than as described in Proposal 2.
The Company believes that the other limited class voting rights set forth in the Department of Treasury’s standard terms for Designated Preferred Stock would be available to the holders of such shares under existing provisions of the Ohio Revised Code, even if not set forth in the express terms of such Preferred Stock. Therefore, the Company does not believe that the inclusion of these rights in shares of Designated Preferred Stock that the Company may issue to the Department of Treasury will have any adverse consequence to the holders of either Common Stock or Series G Preferred Stock.
Additionally, it is the opinion of the Board of Directors that the limited class voting rights desired to be included in the terms of any shares of Designated Preferred Stock issued and sold by the Company pursuant to the TARP CPP will not have any potential anti-takeover effect on the Company. However, potential adverse effects of issuing Designated Preferred Stock might include, among other things, restricting dividends on the Common Stock or Series G Preferred Stock, reducing the market price of the Common Stock or Series G Preferred Stock, or impairing the liquidation rights of the Common Stock or Series G Preferred Stock.
What would be the likely effect of a failure to approve these Amendments?
On October 24, 2008 the Company filed an application with the Department of Treasury with respect to the TARP CPP and on October 28, 2008 the Company was notified by the Department of Treasury that it had received preliminary approval for the sale and issuance of up to approximately $3.46 billion of Designated Preferred Stock to the Department of Treasury. By letter dated November 12, 2008, the Department of Treasury informed the Company to proceed with preparing the standard agreements required by the Department of Treasury. Notwithstanding the foregoing, at this time there are no binding agreements or commitments with respect to the issuance of Designated Preferred Stock to the Department of Treasury and the Company’s participation in the TARP CPP is not guaranteed. However, the Company believes that, if it is able to issue shares of its Preferred Stock containing the standard terms required by the Department of Treasury, the Department of Treasury will complete its investment in the Company.
In the event that the shareholders of the Company fail to approve the amendments set forth in this Proposal 1 (and/or the amendment described in Proposal 3 below), the Company will be unable to satisfy the standard terms required by the Department of Treasury for participation in the TARP CPP. The inability to do so may result in the Company not being able to qualify for equity investment by the Department of Treasury pursuant to the TARP CPP. The recent significant economic downturn and turbulence in the financial markets make it prudent for financial institutions not only to preserve existing capital, but to consider augmenting capital as a protection against the uncertain duration and severity of the challenges arising from current economic and financial conditions. The Company’s application to participate in the TARP CPP represents the Company’s desire and strategy to protect and improve the Company’s capital and liquidity during these challenging times. A failure to qualify for the TARP CPP could eliminate a potential source of capital to improve the Company’s capital position. In the opinion of the Company’s management and Board of Directors, it would be in the best interest of the Company to augment its capital to the extent possible through participation in the TARP CPP.
18
Table of Contents
If these Amendments are approved by the Company’s shareholders, when would the Company implement these Amendments?
If these proposed amendments are approved at the Special Meeting, the Company’s implementation of these amendments will be contingent upon the purchase by the Department of Treasury in connection with the TARP CPP of shares of the Company’s Preferred Stock that would meet the Department of Treasury’s required terms for Designated Preferred Stock. In the event that both Proposals 1 and 3 are approved by shareholders, the Company will not implement the amendments contemplated by Proposal 1 (such amendments would be superseded by the amendments in Proposal 3).
What is the required vote for approval by the Company’s shareholders of these Amendments?
The resolutions attached to this proxy statement as Annex 1 will be submitted for adoption at the Special Meeting. The affirmative vote of (i) the holders of shares of the Common Stock of the Company entitling them to exercise two-thirds of the voting power of such shares and (ii) the affirmative vote of the holders of the Series G Preferred Stock of the Company entitling them to exercise two-thirds of the voting power of such shares, is necessary to adopt the proposed amendment to the Company’s Articles. Proxies representing shares of Common Stock will be voted in favor of the resolutions unless otherwise instructed by you. Abstentions and shares not voted by brokers and other entities holding shares on behalf of the beneficial owners will have the same effect as votes cast against the proposed amendment to the Company’s Articles. While the proposed amendments to the Company’s Code of Regulations on a stand-alone basis would only require the affirmative vote of the holders of a majority of shares of Common Stock outstanding, such amendments will only be deemed approved upon the affirmative two thirds vote of the Common Stock and Series G Preferred Stock as described above in this paragraph.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE “FOR” APPROVAL OF THIS PROPOSAL TO AMEND THE COMPANY’S ARTICLES TO ALLOW THE DESIGNATED PREFERRED STOCK TO HAVE LIMITED CLASS VOTING RIGHTS AND TO AMEND THE COMPANY’S CODE OF REGULATIONS TO ELIMINATE ANY INCONSISTENCIES WITH THE ARTICLES, IF AMENDED AS DESCRIBED IN THIS PROPOSAL.
19
Table of Contents
TO AMEND ARTICLE FOURTH, SECTION (A)2)(c)6. OF
SECOND AMENDED ARTICLES OF INCORPORATION, AS AMENDED
OF FIFTH THIRD BANCORP
(Item 2 on Proxy Card)
The Board of Directors recommends approval of the amendment of Section (A)2)(c)6. of Article Fourth of the Articles in the manner shown in Annex 2 hereto.
What is this Amendment intended to accomplish?
The proposed amendment to Article Fourth, Section (A)2)(c)6. of the Articles would revise the express terms of the issued and outstanding shares of the Company’s Series G Preferred Stock to provide the holders of such shares the right to participate in the election and removal of Preferred Directors with the holders of Designated Preferred Stock, voting together as a single class, if the Company is able to include such limited class voting rights in the terms of shares of Designated Preferred Stock that may be sold to the Department of Treasury pursuant to the TARP CPP. As described in more detail under “Proposal 1,” the standard terms required by the Department of Treasury provide that whenever, at any time or times, dividends payable on shares of Designated Preferred Stock have not been paid for an aggregate of six quarterly dividend periods or more, whether or not consecutive, the authorized number of directors of the Company shall automatically be increased by two and the holders of the Designated Preferred Stock would have the right, with holders of shares of other Preferred Stock of the Company having similar voting rights voting together as a class, to elect to and remove from the Company’s Board of Directors, two Preferred Directors.
Why is this Amendment needed?
Currently, the holders of shares of Series G Preferred Stock have no voting rights, except for those voting rights required by Ohio law. Under Ohio law, even if shares are otherwise designated as non-voting shares, the holders of such shares are entitled to vote as a separate class on certain changes in the terms of the shares of such class, including changes in the express terms or additions to the terms in any manner substantially prejudicial to the holders of the shares of such class. Ohio law also requires that any merger or consolidation of a corporation with or into any other entity in which the corporation is not the surviving corporation shall be approved by the holders of each class of outstanding stock, if such class of stock would be changed in such merger or consolidation in a manner that would have required the approval of such class if the change were effected by an amendment to the corporation’s articles of incorporation.
Therefore, the holders of shares of Series G Preferred Stock currently have no right to vote for the election of any directors of the Company. However, the terms of the Series G Preferred Stock do provide the holders of such shares the right to nominate two advisory directors (the “Advisory Directors”) to attend meetings of the Company’s Board of Directors if dividends payable on the Series G Preferred Stock shall have not been declared and paid for at least six quarterly dividend periods or their equivalent, whether or not consecutive. Although the right to elect two directors upon the occurrence of such non-payments of dividends was a typical feature of preferred stock issuances being completed at the time the Company created, issued and sold shares of Series G Preferred Stock in June, 2008, the Company was unable to provide the holders of the Series G Preferred Stock with such a right because the Company’s Articles prohibit the holders of Preferred Stock from having such voting rights. An amendment to the Company’s Articles could not have been accomplished in a timely manner in conjunction with the offering of the Series G Preferred Stock. Accordingly, the Company was only able to provide the holders of the Series G Preferred Stock the right to nominate Advisory Directors as a substitute for the right to elect actual directors.
20
Table of Contents
If Proposal 1 or Proposal 3 is approved, the Company therefore believes that it would be appropriate and fair to also amend the Company’s Articles to allow the holders of the Series G Preferred Stock to participate with the holders of Designated Preferred Stock, if issued and sold by the Company, in electing and removing Preferred Directors. In order to be consistent with prevailing market terms for similar securities, the Board of Directors likely would have included such limited class voting right in the terms of the Series G Preferred Stock at the time of the June, 2008 offering, if the Articles would have allowed such a term at that time.
In addition, because the standard terms of the Designated Preferred Stock desired to be purchased by the Department of Treasury under the TARP CPP specifically contemplates and allows other shares of preferred stock having similar rights to participate in such limited class voting rights in the election of Preferred Directors, the Company believes it is in the best interests of the holders of Series G Preferred Stock and the holders of Common Stock to include the holders of Series G Preferred Stock within the class of shareholders able to vote on such matters. Expanding the number of shareholders who have the right to participate in any such vote will help ensure that the Preferred Directors will represent the interests of all shareholders.
The shares of Series G Preferred Stock were issued with a liquidation preference of $25,000 per share. The Company intends to propose that should Designated Preferred Stock be issued, such shares would likewise be issued with a liquidation preference of $25,000 per share. Because each share of Series G Preferred Stock and Designated Preferred Stock would be entitled to one vote in the limited circumstances described above, consistent with the provisions of Ohio law and the Company’s Code of Regulations, the voting power of the Series G Preferred Stock and Designated Preferred Stock would be proportionate to the investment made by such holders in acquiring shares of these series of Preferred Stock.
Could this Amendment have adverse effects to the holders of the Company’s Common Stock and Series G Preferred Stock?
The Company does not believe that providing such a right to the holders of the Series G Preferred Stock would have an adverse effect on the holders of the Company’s Common Stock. If Proposal 1 (and/or Proposal 3) is adopted and the Company ultimately issues and sells Designated Preferred Stock to the Department of Treasury pursuant to the TARP CPP, the holders of Common Stock would have already agreed to the possibility of two directors being added to the Company’s Board of Directors and to the election of such persons without the vote of the Common Stock. This proposed amendment would not result in any additional increase in the size of the Company’s Board of Directors, as the holders of Designated Preferred Stock and Series G Preferred Stock, acting together as a single class, would still be able to elect a total of only two directors.
The Company believes that the holders of shares of Series G Preferred Stock can only benefit from this proposed amendment, as it expands the rights of such shares and in no way eliminates or diminishes any rights of the Series G Preferred Stock. The right of the Series G Preferred Stock to appoint two Advisory Directors would remain intact. While the Company further believes that the vote of the holders of shares of Series G Preferred Stock on this amendment is not required under Ohio law as it does not appear in any way to be substantially prejudicial to the rights of such holders, the Company nonetheless is allowing the holders of Series G Preferred Stock to vote on this amendment.
What would be the likely effect of a failure to approve this Amendment?
The failure to approve this proposed amendment will have no effect on the ability of the Company to participate in the TARP CPP, and no effect on the terms of any Designated Preferred Stock that the Company may issue in connection with a sale of such shares to the Department of Treasury. If either or both of Proposals 1 and 3 are approved, but Proposal 2 is not approved, at the Special Meeting, the Company intends to proceed with its participation in the TARP CPP.
21
Table of Contents
If this Amendment is approved by the Company’s shareholders, when would the Company implement this Amendment?
If this proposed amendment is approved, the Company’s implementation of this amendment will be contingent upon shareholder approval of one or both of Proposals 1 and 3 and the closing of the Company’s sale to the Department of Treasury of shares of Designated Preferred Stock in connection with the Company’s participation in TARP CPP. If this proposed amendment is approved and neither Proposal 1 nor Proposal 3 is approved, or if the closing of the Company’s sale to the Department of Treasury of Designated Preferred Stock does not occur, then the Company will not implement this amendment to the Articles and such approval by shareholders will be considered null and void.
What is the required vote for approval by the Company’s shareholders of this Amendment?
The resolutions attached to this proxy statement as Annex 2 will be submitted for adoption at the Special Meeting. The affirmative vote of (i) the holders of shares of the Common Stock of the Company entitling them to exercise two-thirds of the voting power of such shares and (ii) the affirmative vote of the holders of the Series G Preferred Stock of the Company entitling them to exercise two-thirds of the voting power of such shares, is necessary to adopt the proposed amendment to the Company’s Articles. Proxies representing shares of Common Stock will be voted in favor of the resolutions unless otherwise instructed by you. Abstentions and shares not voted by brokers and other entities holding shares on behalf of the beneficial owners will have the same effect as votes cast against the proposed amendment to the Articles.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE “FOR” APPROVAL OF THIS PROPOSAL TO AMEND THE COMPANY’S ARTICLES TO ALLOW THE SERIES G PREFERRED STOCK TO HAVE LIMITED CLASS VOTING RIGHTS, TOGETHER WITH THE DESIGNATED PREFERRED STOCK, IF ANY IS ISSUED, WITH REGARD TO THE ELECTION OF TWO PREFERRED DIRECTORS OF THE COMPANY.
22
Table of Contents
TO AMEND ARTICLE FOURTH, SECTION (A)2)(d) OF
SECOND AMENDED ARTICLES OF INCORPORATION, AS AMENDED
AND
TO AMEND ARTICLE III, SECTIONS 13 AND 14 OF
THE CODE OF REGULATIONS, AS AMENDED
OF FIFTH THIRD BANCORP
(Item 3 on Proxy Card)
The Board of Directors recommends approval of the amendments of Article Fourth, Section (A)2)(d) of the Company’s Articles, and of Article III, Sections 13 and 14 of the Code of Regulations, in the manner shown in Annex 3 hereto.
What are these Amendments intended to accomplish?
Article Fourth, Section (A)2) of the Company’s Articles currently provides that the Company may designate and issue up to 500,000 shares of Preferred Stock, without par value. Of those authorized shares of Preferred Stock, the Company has to date designated an aggregate of 55,250 shares of Preferred Stock as follows: 7,250 shares of Series D Perpetual Preferred Stock; 2,000 shares of Series E Perpetual Preferred Stock, and 46,000 shares of Series G Preferred Stock. All shares of Series D and E Perpetual Preferred Stock have been repurchased by the Company and have been returned to authorized and unissued status. Accordingly, 454,000 authorized shares of undesignated Preferred Stock are currently eligible for issuance from time to time as determined by the Company’s Board of Directors. No shareholder approval is needed in connection with any such issuances, except as otherwise required by law or applicable stock exchange rules, if the terms of any series of shares of Preferred Stock are in accordance with the allowed terms set forth in Article Fourth, Section (A)2)(d).
The proposed amendment to Article Fourth, Section (A)2)(d) of the Articles would apply to all future issuances by the Company of series of shares of its Preferred Stock such that, as expressly allowed by the Ohio Revised Code, the amended Articles would (1) provide the Board of Directors with the ability to tailor voting rights as deemed appropriate by the Board in connection with the specific securities then being offered, (2) provide that the express terms over which the Board may exercise discretion includes both dividends and distribution rights and that liquidation rights and preferences can be established, not just liquidation price, and (3) clarify that, consistent with the express provisions of Section 1701.06 of the Ohio Revised Code, the express terms of all shares of Preferred Stock within a series of Preferred Stock must be the same for all shares within that series. Note that Section 1701.06 of the Ohio Revised Code also would allow the Board of Directors to grant pre-emptive rights, to alter the express terms of issued Preferred Stock, and to add other unspecified rights and privileges to shares of Preferred Stock, but the Company is not seeking authority to include those items in future series of Preferred Stock as the Board of Directors determined that those rights were broader than necessary and carried a greater risk of having an adverse impact on existing shares of Common Stock and Preferred Stock.
The proposed amendment to Article III, Section 13 of the Code of Regulations would expressly provide that any standard for removing Directors as may be contained in the Articles will govern if there is any conflict with the standards for removing Directors as set forth in the Code of Regulations. Similarly, the proposed amendment to Article III, Section 14 of the Code of Regulations would expressly provide that any procedures for filling vacancies on the Board of Directors as may be contained in the Articles will apply if there is any conflict with the procedures for filling vacancies on the Board as set forth in the Code of Regulations.
Why are these Amendments needed?
The proposed amendment to Article Fourth, Section (A)2)(d) would provide the Company with additional flexibility in creating one or more future series of shares of Preferred Stock. As described in Proposal 1, the Company is currently hampered in its ability to create, issue and sell shares of Preferred Stock that contain terms
23
Table of Contents
that may be required by the marketplace. Due to the severe restrictions on voting rights contained in Article Fourth, Section (A)2)(d)1 of the current Articles, the Company’s ability to participate in the TARP CPP is jeopardized because the Company must first hold a special meeting of shareholders to amend the Articles to allow for the grant of limited class voting rights. There can be no assurance that the requisite shareholder approval will be approved, notwithstanding the determination by both the Company’s Board of Directors and management that participation in the TARP CPP is in the best interests of the Company and its shareholders and the preliminary determination by Department of Treasury that the Company is approved to participate in the TARP CPP and increase its capital position.
As described in Proposal 2, the severe restrictions on voting rights contained in the current Articles also impacted the Company’s offering of Series G Preferred Stock in June 2008, as the Company was not able to offer and sell such shares on terms that were customary and prevailing in the marketplace at that time. Fortunately, the Company was able to provide an alternative mechanism that was acceptable to the marketplace, but there can be no assurances that in future situations the Company may not be forced to forego capital raising opportunities or to sell securities on less favorable terms, if the terms of such securities are not in line with usual and customary provisions.
The proposed amendments to the Code of Regulations will eliminate any inconsistencies between the Articles and the Code of Regulations, if the foregoing amendment to the Articles is approved as described in this Proposal 3 and the Company subsequently issues one or more series of Preferred Stock having voting rights in the election of directors, including but not limited to the Company’s potential issuance of Designated Preferred Stock in connection with participation in the TARP CPP.
Could these Amendments have adverse effects to the holders of the Company’s Common Stock and/or Series G Preferred Stock?
The Company currently has the authority, upon action by its Board of Directors and without the need for shareholder approval to issue shares of Preferred Stock on terms established by the Board of Directors. The effect of these amendments modestly increases the number of terms over which the Board of Directors can exercise its discretion in creating new series of the Company’s Preferred Stock. Of these additional terms, all of which are currently allowed by Ohio law, only the ability to grant voting rights is likely to have any potential impact on the rights of the holders of Common Stock and/or the Series G Preferred Stock. The Company believes that the other proposed revisions are clarifying in nature and have no effect on the Company’s existing shareholders.
As to voting rights, unlike the proposed amendment to the Articles relating to limited class voting rights set forth in Proposal 1 specifically relating to shares of Preferred Stock that may be issued to the Department of Treasury in connection with the Company’s participation in the TARP CPP, which standard terms are known, this proposed amendment would also impact future issuances where the nature of voting rights that may be included are not yet known and cannot yet be determined.
As with all blank check preferred stock, if additional series of shares of Preferred Stock are issued by the Company, it may potentially have an anti-takeover effect by making it more difficult to obtain shareholder approval of various actions, such as a merger or removal of management. The changes in the terms of the authorized, unissued shares of Preferred Stock have not been proposed in connection with any anti-takeover related purpose and the Board of Directors and management have no knowledge of any current efforts by anyone to obtain control of the Company or to effect large accumulations of the Company’s Common Stock or Preferred Stock, other than the potential sale of Designated Preferred Stock to the Department of Treasury in connection with the Company’s desired participation in the TARP CPP.
Additionally, the issuance of additional shares of Preferred Stock may, among other things, have a dilutive effect on earnings per share and on the equity and voting power of existing shareholders. The terms of any Preferred Stock issuance which will be determined by the Company’s Board of Directors, will depend upon the reason for issuance and will be dependent largely on market conditions and other factors existing at the time.
24
Table of Contents
What would be the likely effect of a failure to approve these Amendments?
In order for the Company to be able to satisfy the standard terms required by the Department of Treasury for participation in the TARP CPP, the shareholders of the Company must approve the amendments set forth in this Proposal 3 or the amendments described in Proposal 1. The inability to do so may result in the Company not being able to qualify for equity investment by the Department of Treasury pursuant to the TARP CPP. The recent significant economic downturn and turbulence in the financial markets make it prudent for financial institutions not only to preserve existing capital, but to consider augmenting capital as a protection against the uncertain duration and severity of the challenges arising from current economic situations. The Company’s application to participate in the TARP CPP represents the Company’s desire and strategy to protect and improve the Company’s capital and liquidity during these challenging times. A failure to qualify for the TARP CPP could eliminate a potential source of capital to improve the Company’s capital position. In the opinion of the Company’s management and Board of Directors, it would be in the best interest of the Company to augment its capital to the extent possible through participation in the TARP CPP.
If Proposal 1 is approved, then the Company would be able to proceed with its desired participation in the TARP CPP regardless of whether this Proposal 3 is approved. However, the failure to approve this Proposal 3 could limit the Company in connection with future capital raising transactions or other strategic transactions if such transactions require the Company to issue Preferred Stock containing terms that the Board of Directors does not have authority to grant. In such cases, the Company may lose opportunities due to the time delay and uncertainty of needing to hold a special meeting of shareholders in order to proceed with such transactions.
If these Amendments are approved by the Company’s shareholders, when would the Company implement these Amendments?
If these proposed amendments are approved at the Special Meeting, the Company will immediately amend its Articles and Code of Regulations in accordance with this Proposal 3. The Company’s implementation of these amendments is not contingent upon any other event or circumstance. In addition, if this Proposal 3 is approved, the Company will not need to implement the amendments set forth in Proposal 1 because the amendments set forth in this Proposal 3 would be sufficient for the Company to proceed with the purchase by the Department of Treasury in connection with the TARP CPP of shares of the Company’s Preferred Stock that would meet the Department of Treasury’s required terms for Designated Preferred Stock. In the event that both Proposals 1 and 3 are approved by shareholders, then the Company will not implement the amendments set forth in Proposal 1 as such amendments would be superseded by the amendments in this Proposal 3.
What is the required vote for approval by the Company’s shareholders of these Amendments?
The resolutions attached to this proxy statement as Annex 3 will be submitted for adoption at the Special Meeting. The affirmative vote of (i) the holders of shares of the Common Stock of the Company entitling them to exercise two-thirds of the voting power of such shares and (ii) the affirmative vote of the holders of the Series G Preferred Stock of the Company entitling them to exercise two-thirds of the voting power of such shares, is necessary to adopt the proposed amendment to the Company’s Articles. Proxies representing shares of Common Stock will be voted in favor of the resolutions unless otherwise instructed by you. Abstentions and shares not voted by brokers and other entities holding shares on behalf of the beneficial owners will have the same effect as votes cast against the proposed amendment to the Company’s Articles. While the proposed amendments to the Company’s Code of Regulations on a stand-alone basis would only require the affirmative vote of a majority of shares of Common Stock outstanding, such amendments will only be deemed approved upon the affirmative two thirds vote of the Common Stock and Series G Preferred Stock as described above in this paragraph.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE “FOR” APPROVAL OF THIS PROPOSAL TO AMEND THE COMPANY’S ARTICLES TO PROVIDE ADDITIONAL FLEXIBILITY IN CREATING AND ISSUING FUTURE SERIES OF PREFERRED STOCK AND TO AMEND THE COMPANY’S CODE OF REGULATIONS TO ELIMINATE ANY INCONSISTENCIES WITH THE ARTICLES, IF AMENDED AS DESCRIBED IN THIS PROPOSAL.
25
Table of Contents
TO APPROVE THE ADJOURNMENT OF THE SPECIAL MEETING, IF NECESSARY
(Item 4 on Proxy Card)
Why is the Company seeking shareholder approval to adjourn the Special Meeting?
As described in more detail under “Proposal 1,” “Proposal 2” and “Proposal 3,” the Company is seeking approval of proposed amendments to the Articles and Code of Regulations. Such amendments require the affirmative vote of the holders of two-thirds of the Common Stock outstanding and the affirmative vote of the holders of two-thirds of the Series G Preferred Stock outstanding. In the event there are not sufficient votes at the time of the Special Meeting to adopt any of the proposed amendments, particularly in light of the accelerated time period in which the Company seeks approval of these Proposals, the Board of Directors will seek shareholder approval to adjourn the Special Meeting to a later date in order to permit additional proxy solicitation. Pursuant to the Company’s Code of Regulations, shareholders may authorize the holder of proxies solicited by the Board of Directors to vote in favor of adjourning the Special Meeting and no notice of an adjourned meeting need be given if the date, time and place of the adjourned meeting are fixed and announced at the Special Meeting.
In order to permit proxies that have been received by the Company at the time of the Special Meeting to be voted for an adjournment, if necessary, the Company submits this proposal to adjourn the Special Meeting to the holders of shares of Common Stock and Series G Preferred Stock as a separate matter for consideration. In this Proposal, the Company is asking the holders of any proxy of Common Stock and of Series G Preferred Stock solicited by the Board of Directors to vote in favor of adjourning the Special Meeting and any later adjournments.
If the Company’s holders of Common Stock and Series G Preferred Stock approve this adjournment proposal, the Company may adjourn the Special Meeting, and any adjourned session of the Special Meeting, to provide additional time to solicit additional proxies in favor of the amendments to the Articles and Code of Regulations, including the solicitation of proxies from shareholders that have previously voted against such proposals. Among other things, approval of the adjournment proposal could mean that, even if proxies representing a sufficient number of votes against the Proposal to amend the Articles and Code of Regulations have been received, the Company could adjourn the Special Meeting without a vote on the Proposals and seek to convince the holders of those shares of Common Stock and shares of Series G Preferred Stock to change their votes in favor of the adoption of the amendments.
What would be the likely effect of a failure to obtain shareholder approval to adjourn the Special Meeting?
In the event there are not sufficient votes at the time of the Special Meeting to adopt the proposed amendments to the Articles and Code of Regulations, and the shareholders do not approve an adjournment of the Special Meeting to a later date or dates, the Company and Board of Directors will not have additional time to solicit additional proxies in favor of the amendments to the Articles and Code of Regulations, including the solicitation of proxies from shareholders that have previously voted against such proposals. In such event, the proposed amendments to the Articles and Code of Regulations would not be approved and the Company would have to decide whether to call another special meeting and attempt to re-solicit all votes.
If the Company’s shareholders do not approve either of the proposed amendments to the Articles and Code of Regulations set forth in Proposals 1 and 3, the Company believes that it may not be able to participate in the TARP CPP under the Department of Treasury’s current standard terms. A failure to qualify for the TARP CPP will potentially eliminate a possible low-cost source of additional capital that would allow the Company to enhance its capital position and further support its existing operations and anticipated future growth.
26
Table of Contents
What would be the benefit if the adjournment of the Special Meeting is approved?
The Company’s Board of Directors believes that if the number of shares of Common Stock and/or shares of Series G Preferred Stock present or represented at the Special Meeting and voting in favor of the Proposals to adopt the amendments to the Articles and the Code is insufficient, it is in the best interests of the shareholders to enable the Board of Directors to continue to seek to obtain a sufficient number of additional votes to adopt the Proposals. Adoption of the Proposals will enable the Company to move forward with the consummation of the transaction under the TARP CPP. The Company submitted its application for participation in the TARP CPP on October 24, 2008 and received notice of its preliminary approval from the Department of Treasury on October 28, 2008. By letter dated November 12, 2008, the Department of Treasury informed the Company to proceed with preparing the standard agreements required by the Department of Treasury. If the Company participates in the TARP CPP, the Company will issue and the Department of Treasury will purchase approximately $3.46 billion in Preferred Stock. Therefore, approving adjournment of the Special Meeting to allow solicitation of additional proxies, if necessary, improves the ability of the Company to move forward with its participation in the TARP CPP.
What is the required vote for approval by the Company’s shareholders of the adjournment of the Special Meeting?
The affirmative vote of a majority of the votes entitled to be cast by the holders of the Company’s Common Stock and Series G Preferred Stock present or represented at the Special Meeting and entitled to vote thereon is required to approve an adjournment of the Special Meeting. Abstentions will have the same effect as a vote cast against Proposal 4. Shares not voted by brokers and other entities holding shares on behalf of beneficial owners, and shares for which authority to vote is withheld, will have no effect on the outcome. Proxies representing shares of Common Stock received by the Company and not revoked prior to or at the Special Meeting will be voted for this proposal unless otherwise instructed by the holders of such shares of Common Stock.
THE BOARD OF DIRECTORS RECOMMENDS THAT THE SHAREHOLDERS VOTE “FOR” THE APPROVAL OF THE ADJOURNMENT OF THE SPECIAL MEETING, IF NECESSARY, TO SOLICIT ADDITIONAL PROXIES, IN THE EVENT THERE ARE NOT SUFFICIENT VOTES AT THE TIME OF THE SPECIAL MEETING TO ADOPT THE PROPOSED AMENDMENTS TO THE ARTICLES.
27
Table of Contents
Under Section 13(d) of the Securities Exchange Act of 1934, a beneficial owner of a security is any person who directly or indirectly has or shares voting power or investment power over such security. Such beneficial owner under this definition need not enjoy the economic benefit of such securities. The Company is not aware of any shareholder who currently beneficially owns 5% or more of the Common Stock of the Company as of November 21, 2008. The only shareholder known to the Company to be deemed to be beneficial owners of 5% or more of the Series G Preferred Stock of the Company as of November 21, 2008 is as follows:
| Title of Class |
Name and Address of Beneficial Owner |
Amount and Nature |
Percent |
|||||
| Series G Preferred Stock |
Wilmington Trust Company 1100 North Market St. Wilmington, Delaware 19801 |
44,300 | 1 | 100 | % |
| 1 |
Wilmington Trust Company is the registered owner of 44,300 shares of 8.50% Non-Cumulative Perpetual Convertible Preferred Stock, Series G (“Series G Preferred Stock”) for the benefit of the holders of 11,075,000 Depositary shares, which Depositary shares represent 1/250th of an interest in a share of Series G Preferred Stock. |
The following table sets forth certain information regarding the beneficial ownership of the Common Stock of the Company of each current Named Executive Officer2, of each current Director and of all Directors and Executive Officers as a group as of November 21, 2008. None of the Company’s current Executive Officers or Directors own any Series G Preferred Stock or any Depositary Shares representing interests therein.
Named Executive Officers
| Title of Class |
Name of Officer |
Number of Shares4 |
Percent of Class | |||
| Common Stock |
Kevin T. Kabat3 | 658,442 | .1139% | |||
| Common Stock |
Robert A. Sullivan | 333,819 | .0578% | |||
| Common Stock |
Greg D. Carmichael | 109,999 | .0190% | |||
| Common Stock |
Charles D. Drucker | 67,475 | .0117% | |||
| Common Stock |
Daniel T. Poston | 108,089 | .0187% | |||
| Common Stock |
Ross J. Kari | 0 | 0% |
Directors
| Title of Class |
Name of Director |
Number of Shares5 |
Percent of Class | |||
| Common Stock |
Darryl E. Allen | 25,277 | .0044% | |||
| Common Stock |
John F. Barrett | 82,110 | .0142% | |||
| Common Stock |
Ulysses L. Bridgeman | 6,667 | .0012% | |||
| Common Stock |
James P. Hackett | 26,130 | .0045% | |||
| Common Stock |
Gary R. Heminger | 8,359 | .0014% | |||
| Common Stock |
Allen M. Hill | 74,524 | .0129% | |||
| Common Stock |
Robert L. Koch II | 67,861 | .0118% | |||
| Common Stock |
Dr. Mitchel D. Livingston | 24,773 | .0043% | |||
| Common Stock |
Hendrik G. Meijer | 45,066 | .0078% | |||
| Common Stock |
James E. Rogers | 32,737 | .0057% | |||
| Common Stock |
John J. Schiff, Jr. | 481,162 | .0833% | |||
| Common Stock |
Dudley S. Taft | 94,608 | .0164% | |||
| Common Stock |
Thomas W. Traylor | 278,192 | .0482% | |||
| All Executive Officers and Directors as a Group (24 persons): |
3,274,455 | .5654% | ||||
28
Table of Contents
| 2 | The Named Executive Officers of the Company for the year ended December 31, 2007 included George A. Schaefer, Jr., Chairman of the Board and a Director, and Christopher G. Marshall, Chief Financial Officer. Mr. Schaefer retired from all positions with the Company effective June 17, 2008 and Mr. Marshall resigned as of April 30, 2008. Accordingly, neither of them is included in the above table. Daniel T. Poston served as Chief Financial Officer of the Company from April 30, 2008 through November 17, 2008. Ross J. Kari assumed the role of Chief Financial Officer of the Company effective November 17, 2008. Both Mr. Poston and Mr. Kari are included in the above table as they will be Named Executive Officers for the year ending December 31, 2008. |
| 3 | Mr. Kabat is both an Officer and Director. |
| 4 | The amounts shown represent the total shares owned outright by such individuals together with shares which are issuable upon the exercise of currently exercisable (or exercisable within 60 days), but unexercised, stock options and stock appreciation rights and shares held in the name of spouses, minor children, certain relatives, trusts, estates and certain affiliated companies as to which beneficial ownership may be disclaimed. These individuals have the right to acquire the shares indicated after their names, upon the exercise of currently exercisable (or exercisable within 60 days) stock options and stock appreciation rights, respectively: Mr. Kabat, 476,360 and 48,964; Mr. Sullivan, 179,358 and 48,964; Mr. Carmichael, 20,000 and 48,964; Mr. Drucker, 0 and 29,237 and Mr. Poston, 65,000 and 26,918. |
| 5 | The amounts shown represent the total shares owned outright by such individuals together with shares which are issuable upon the exercise of currently exercisable (or exercisable within 60 days), but unexercised, stock options and stock appreciation rights. Specifically, the following individuals have the right to acquire the shares indicated after their names, upon the exercise of stock options and stock appreciation rights, respectively: Mr. Allen, 10,000 and 2,500; Mr. Barrett, 10,000 and 2,500; Mr. Bridgeman, 1,750 and 250; Mr. Hackett, 7,000 and 2,500; Mr. Heminger, 500 and 250; Mr. Hill, 10,000 and 2,500; Mr. Kabat, 476,360 and 48,964; Mr. Koch, 11,700 and 2,500; Dr. Livingston, 10,000 and 2,500; Mr. Meijer, 7,000 and 2,500; Mr. Rogers, 10,000 and 2,500; Mr. Schiff, 5,000 and 2,500; Mr. Taft, 10,000 and 2,500; and Mr. Traylor, 11,700 and 2,500. The aggregate number of shares issuable upon the exercise of currently exercisable (or exercisable within 60 days), but unexercised, stock options and stock appreciation rights held by the Executive Officers who are not also Directors or nominees is 1,020,394. |
29
Table of Contents
This proxy statement contains statements about the Company that we believe are “forward-looking statements” 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. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business of the Company. They usually can be identified by the use of forward-looking language such as “will likely result,” “may,” “are expected to,” “is anticipated,” “estimate,” “forecast,” “projected,” “intends to,” or may include other similar words or phrases such as “believes,” “plans,” “trend,” “objective,” “continue,” “remain,” or similar expressions, or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” or similar verbs. You should not place undue reliance on these statements, as they are subject to risks and uncertainties, including but not limited to those described in the risk factors set forth in the Company’s most recent Annual Report on Form 10-K for the year ended December 31, 2007, filed with the SEC. When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements we may make. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to the Company.
There are a number of important factors that could cause the Company’s 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 and weakening in the economy, specifically, the real estate market, either national or in the states in which the Company, one or more acquired entities and/or the combined company do business, are less favorable than expected; (2) deteriorating credit quality; (3) political developments, wars or other hostilities may disrupt or increase volatility in securities markets or other economic conditions; (4) changes in the interest rate environment reduce interest margins; (5) prepayment speeds, loan origination and sale volumes, charge-offs and loan loss provisions; (6) our ability to maintain required capital levels and adequate sources of funding and liquidity; (7) changes and trends in capital markets; (8) competitive pressures among depository institutions increase significantly; (9) effects of critical accounting policies and judgments; (10) changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board or other regulatory agencies; (11) legislative or regulatory changes or actions, or significant litigation, adversely affect the Company, one or more acquired entities and/or the combined company or the businesses in which the Company, one or more acquired entities and/or the combined company are engaged; (12) ability to maintain favorable ratings from rating agencies; (13) fluctuation of Fifth Third Bancorp’s stock price; (14) ability to attract and retain key personnel; (15) ability to receive dividends from its subsidiaries; (16) the potentially dilutive effect of future acquisitions on current shareholders’ ownership of Fifth Third Bancorp; (17) effects of accounting or financial results of one or more acquired entities; (18) difficulties in combining the operations of acquired entities; (19) inability to generate the gains on sale and related increase in shareholders’ equity that the Company anticipates from the sale of certain non-core businesses; (20) loss of income from the sale of certain non-core businesses could have an adverse effect on the Company’s earnings and future growth; (21) ability to secure confidential information through the use of computer systems and telecommunications networks; (22) the impact of reputational risk created by these developments on such matters as business generation and retention, funding and liquidity; and (23) the Department of Treasury providing satisfactory definitive documentation for its purchase from the Company of shares of Designated Preferred Stock pursuant to the TARP CPP and agreement on final terms and conditions.
You should refer to the Company’s periodic and current reports filed with the SEC for further information on other factors which could cause actual results to be significantly different from those expressed or implied by these forward-looking statements. Copies of those filings are available at no cost on the SEC’s website at www.sec.gov or on the Company’s website at www.53.com. The Company undertakes no obligation to release revisions to these forward-looking statements or reflect events or circumstances after the date of this proxy statement.
30
Table of Contents
In order for shareholder proposals for the 2009 Annual Meeting of Shareholders to be eligible for inclusion in the Company’s proxy statement, they must have been received by the Company at its principal office in Cincinnati, Ohio, prior to November 6, 2008. Accordingly, no additional shareholder proposals will be accepted for inclusion in the Company’s proxy statement in connection with the 2009 Annual Meeting.
Any shareholder who intends to propose any other matter to be acted upon at the 2009 Annual Meeting of Shareholders (but not include such proposal in the Company’s proxy statement) must inform the Company no later than January 20, 2009. If notice is not provided by that date, the persons named in the Company’s proxy for the 2009 Annual Meeting will be allowed to exercise their discretionary authority to vote upon any such proposal without the matter having been discussed in the proxy statement for the 2009 Annual Meeting.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP is the Company’s independent registered accounting firm, and served as such for the years ended December 31, 2007 and 2006 and for the nine months ended September 30, 2008. Representatives from Deloitte & Touche LLP will be present at the Special Meeting to make such comments as they desire and to respond to questions from shareholders of the Company.
The Board of Directors does not know of any other business to be presented to the Special Meeting and does not intend to bring other matters before the Special Meeting. However, if any other matters properly come before the Special Meeting, it is intended that the persons named in the proxy will vote thereon according to their best judgment and interest of the Company. No other shareholder has informed the Company of any intention to propose any other matter to be acted upon at the Special Meeting. Accordingly, the persons named in the accompanying proxy are allowed to exercise their discretionary authority to vote upon any such proposal without the matter having been discussed in this proxy statement.
December 8, 2008
By order of the Board of Directors
Paul L. Reynolds
Secretary
31
Table of Contents
New or amended language is indicated by underlining and deleted language is indicated by strike-outs.
PROPOSED AMENDMENT TO SECTION (A)2)(d)1. OF ARTICLE FOURTH
OF THE SECOND AMENDED ARTICLES OF INCORPORATION, AS AMENDED,
OF FIFTH THIRD BANCORP AND PROPOSED AMENDMENT TO ARTICLE III, SECTIONS 13 AND 14 OF THE CODE OF REGULATIONS, AS AMENDED, OF FIFTH THIRD BANCORP
RESOLVED, That Section (A)2)(d)1. of Article Fourth of the Second Amended Articles of Incorporation, as amended, of Fifth Third Bancorp be, and it hereby is, amended in its entirety to read as follows:
| (d) | With respect to all other shares of Preferred Stock of the corporation: |
1. Each share of Preferred Stock shall entitle the holder thereof to no voting rights, except as otherwise required by law or except as otherwise provided by the Board of Directors in order to comply with the terms required for shares of Preferred Stock issued in connection with any capital purchase program(s) authorized by the Emergency Economic Stabilization Act of 2008 (“EESA”) and implemented by the United States Department of the Treasury.
RESOLVED, That Article III, Section 13 of the Code of Regulations, as amended, of Fifth Third Bancorp be, and it hereby is, amended in its entirety to read as follows:
Section 13. Removal of Directors. Except as otherwise provided by the Articles of Incorporation, no director shall be removed, without cause, during his term of office. Any director may be removed, for cause, at any time, by action of the holders of record of majority of the outstanding shares of stock entitled to vote thereon at a meeting of the holders of such shares, and the vacancy in the Board of Directors caused by any such removal may be filled by action of such stockholders at such meeting or at any subsequent meeting.
RESOLVED, That Article III, Section 14 of the Code of Regulations, as amended, of Fifth Third Bancorp be, and it hereby is, amended in its entirety to read as follows:
Section 14. Filling of Vacancies Not Caused by Removal. Except as otherwise provided by law or except as otherwise provided by the Articles of Incorporation, in case of any increase in the number of directors, or of any vacancy created by death, resignation or otherwise, the additional director or directors may be elected, or, as the case may be, the vacancy or vacancies may be filled either (a) by the Board of Directors at any meeting by affirmative vote of a majority of the remaining directors though the remaining directors be less than the quorum provided for by this Article III, or (b) by the holders of Common Stock of the Corporation entitled to vote thereon, either at an annual meeting of stockholders or at a special meeting of such holders called for the purpose. The directors so chosen shall hold office until the next annual meeting of stockholders and until their successors are elected and qualify.
RESOLVED, FURTHER, That the proper officers of Fifth Third Bancorp be and hereby are authorized and directed to take all actions, execute all instruments, and make all payments which are necessary or desirable, in their discretion, to make effective the foregoing amendment to the Second Amended Articles of Incorporation, as amended, of Fifth Third Bancorp including, without limitation, filing a certificate of such amendment with the Secretary of State of Ohio and to make effective the foregoing amendment to Article III, Sections 13 and 14 of the Code of Regulations, as amended, of Fifth Third Bancorp.
Annex 1-1
Table of Contents
New or amended language is indicated by underlining and deleted language is indicated by strike-outs.
PROPOSED AMENDMENT TO SECTION (A)2)(c)6. OF ARTICLE FOURTH
OF THE SECOND AMENDED ARTICLES OF INCORPORATION, AS AMENDED,
OF FIFTH THIRD BANCORP
RESOLVED, That Section (A)2)(c)6. of Article Fourth of the Second Amended Articles of Incorporation, as amended, of Fifth Third Bancorp be, and it hereby is, amended in its entirety to read as follows:
| 6. | Voting Rights. |
Except as required by Ohio law, and except for the circumstances provided for in Section 8(ii), holders of the Series G Preferred Stock will not have any voting rights and will not be entitled to elect any directors; provided, however, in the event the Company issues shares of Preferred Stock in connection with any capital purchase program(s) authorized by the Emergency Economic Stabilization Act of 2008 (“EESA”) and implemented by the United States Department of the Treasury, the holders of the Series G Preferred Stock voting together as a class with the holders of such Preferred Stock, shall have the right to elect two directors of the Company and to vote to remove such directors, upon the occurrence of events that would permit the holders of such Preferred Stock to elect or remove such directors. In situations in which Ohio law requires mandatory voting rights for a class of shares, the corporation will treat each series of the corporation’s preferred stock, including the Series G Preferred Stock, as a separate class for voting purposes.
RESOLVED, FURTHER, That the proper officers of Fifth Third Bancorp be and hereby are authorized and directed to take all actions, execute all instruments, and make all payments which are necessary or desirable, in their discretion, to make effective the foregoing amendment to the Second Amended Articles of Incorporation, as amended, of Fifth Third Bancorp including, without limitation, filing a certificate of such amendment with the Secretary of State of Ohio.
Annex 2-1
Table of Contents
New or amended language is indicated by underlining and deleted language is indicated by strike-outs.
PROPOSED AMENDMENT TO SECTION (A)2)(d) OF ARTICLE FOURTH
OF THE SECOND AMENDED ARTICLES OF INCORPORATION, AS AMENDED,
OF FIFTH THIRD BANCORP AND PROPOSED AMENDMENT TO ARTICLE III, SECTIONS 13 AND 14 OF THE CODE OF REGULATIONS, AS AMENDED, OF FIFTH THIRD BANCORP
RESOLVED, That Section (A)2)(d) of Article Fourth of the Second Amended Articles of Incorporation, as amended, of Fifth Third Bancorp be, and it hereby is, amended in its entirety to read as follows:
| (d) | With respect to all other shares of Preferred Stock of the corporation: |
| 1. | Each share of the Preferred Stock shall entitle the holder thereof to no voting rights, except as otherwise required by law and except as otherwise provided by the Board of Directors. |
| 2. | The dividend rights of the Preferred Stock shall be non-cumulative, except as otherwise provided by the Board of Directors. |
| 3. | The Board of Directors shall have the right to adopt amendments to these Articles of Incorporation in respect of any unissued or treasury shares of the Preferred Stock and thereby
fix or change the express terms of any such Preferred Stock as follows: the division of such shares into series and the designation and authorized number of shares of each series; whether shares shall have voting rights or not, and the
terms of any shares that are voting; dividend or distribution rights; the dividend rate; whether dividend rights shall be cumulative or non-cumulative; the dates of payment of dividends and the dates from which they are cumulative; liquidation
rights, preferences and price; redemption rights and price; sinking fund requirements, conversion rights and restrictions on the issuance of such shares or any series thereof; provided, however, except for the foregoing variations which the
Board of Directors are authorized to fix or change, all of the express terms of |
Upon the adoption of any amendment pursuant to the foregoing authority, a certificate signed by the president or a vice president and by a secretary or an assistant secretary, containing a copy of the resolution adopting the amendment and a statement of the manner and basis or its adoption, shall be accompanied by the fees then required by law, before the corporation shall have the rights to issue any of such shares.
RESOLVED, That Article III, Section 13 of the Code of Regulations, as amended, of Fifth Third Bancorp be, and it hereby is, amended in its entirety to read as follows:
Section 13. Removal of Directors. Except as otherwise provided by the Articles of Incorporation, no director shall be removed, without cause, during his term of office. Any director may be removed, for cause, at any time, by action of the holders of record of majority of the outstanding shares of stock entitled to vote thereon at a meeting of the holders of such shares, and the vacancy in the Board of Directors caused by any such removal may be filled by action of such stockholders at such meeting or at any subsequent meeting.
RESOLVED, That Article III, Section 14 of the Code of Regulations, as amended, of Fifth Third Bancorp be, and it hereby is, amended in its entirety to read as follows:
Section 14. Filling of Vacancies Not Caused by Removal. Except as otherwise provided by law or except as otherwise provided by the Articles of Incorporation, in case of any increase in the number of directors, or of any vacancy created by death, resignation or otherwise, the additional director or directors may be elected, or, as the case may be, the vacancy or vacancies may be filled either (a) by the Board of Directors at any meeting by affirmative vote of a majority of the remaining directors
Annex 3-1
Table of Contents
though the remaining directors be less than the quorum provided for by this Article III, or (b) by the holders of Common Stock of the Corporation entitled to vote thereon, either at an annual meeting of stockholders or at a special meeting of such holders called for the purpose. The directors so chosen shall hold office until the next annual meeting of stockholders and until their successors are elected and qualify.
RESOLVED, FURTHER, That the proper officers of Fifth Third Bancorp be and hereby are authorized and directed to take all actions, execute all instruments, and make all payments which are necessary or desirable, in their discretion, to make effective the foregoing amendment to the Second Amended Articles of Incorporation, as amended, of Fifth Third Bancorp including, without limitation, filing a certificate of such amendment with the Secretary of State of Ohio and to make effective the foregoing amendment to Article III, Sections 13 and 14 of the Code of Regulations, as amended, of Fifth Third Bancorp.
Annex 3-2
Table of Contents
REGULATIONS FOR CONDUCT AT THE DECEMBER 29, 2008 SPECIAL MEETING OF SHAREHOLDERS OF FIFTH THIRD BANCORP
We welcome you to the 2008 Special Meeting of Shareholders of Fifth Third Bancorp. In order to provide a fair and informative Meeting, we ask you to honor the following regulations for the Meeting. The business of the Meeting will be taken up as set forth in the Agenda attached to these Regulations. Special Meetings of Shareholders are business meetings, and they can be effective only if conducted in an orderly, business-like manner. Strict rules of parliamentary procedure will not be followed. The Chairman of the Meeting will control the meeting and make any required procedural rulings. Please follow the instructions of the Chairman. Thank you for your cooperation.
1. VOTING. Every shareholder having the right to vote shall be entitled to vote in person or by proxy at the Meeting. If you have already voted by proxy, there is no need to vote by ballot, unless you wish to change your vote. Except as otherwise stated in the proxy materials for this Meeting or as required by Ohio law, each matter brought before this Meeting for a vote shall require the affirmative vote of a majority of the votes entitled to be cast by the holders of the Company’s Common Stock and Series G Preferred Stock at this Meeting and entitled to vote on such matter.
2. QUESTIONS/STATEMENTS BY SHAREHOLDERS — ONE MINUTE LIMIT. To ask a question or make a statement at the Meeting relating to Proposal 1, Proposal 2, Proposal 3 or Proposal 4, you must be either a shareholder of record as of December 4, 2008 or a person named in a proxy given by such a shareholder. No other persons will be permitted to speak at the Meeting. There will be one period for questions and statements by shareholders as set forth on the Agenda attached to these Regulations.
In order that we may give as many shareholders as possible the opportunity to speak, remarks and questions will be limited to one minute per shareholder. You must restrict yourself to one comment or question at a time so that others may have an opportunity to be heard. Each shareholder may have only one turn to speak until all shareholders who wish to speak have had the opportunity to do so; additional turns may be allowed as time permits.
If you wish to speak, please raise your hand and wait until you are recognized. Please do not address the Meeting until recognized by the Chairman. When you are recognized, please state your name, place of residence, and whether you are a Fifth Third shareholder or a holder of a shareholder proxy, and, in the latter case, identify the shareholder on whose behalf you are speaking. All questions should be directed to the Chairman, who may call on other persons to respond or further direct questions when appropriate.
If you have a matter of individual concern which is not an appropriate subject for general discussion, please defer discussion until after the Meeting at which time officers of the Company will be available. The Chairman will stop discussions which are repetitive, derogatory, over the time limit, irrelevant to the business of the Company or the items on the Agenda for the Meeting, related to pending or threatened litigation, regulatory proceedings or similar actions or otherwise inappropriate. Derogatory references to personalities, comments that are in bad taste, the airing of personal grievances, the injection of irrelevant controversy, personal attacks, refusal to follow these Regulations or interference with any speaker will not be permitted and will be a basis for silencing or removal from the Meeting.
3. MISCELLANEOUS. No recording devices, cellular telephones, photographic equipment or bullhorns will be permitted into the Meeting. No written materials may be distributed by any person at or in physical proximity to the Meeting. The Chairman of the Meeting shall have the power to silence or have removed any person in order to ensure the orderly conduct of the Meeting.
Annex 4-1
Table of Contents
4. ADMINISTRATION AND INTERPRETATION. The Chairman of the Meeting has sole authority to preside over the Meeting and make any and all determinations with respect to the conduct of the Meeting, including, without limitation, the administration and interpretation of these regulations and procedures. The Chairman also has sole authority to create such additional regulations and procedures and to waive full or partial compliance with any regulation or procedure as the Chairman reasonably determines. Any action taken by the Chairman at the Meeting will be final, conclusive and binding on all persons. The Secretary of the Company shall act as secretary of the Meeting.
THANK YOU FOR YOUR COOPERATION AND ENJOY THE MEETING.
Annex 4-2
Table of Contents
Special Meeting of Shareholders
DECEMBER 29, 2008
AGENDA
Call to Order
| Consideration of Proposal #1 |
Proposed Amendment to Articles of Incorporation to revise the terms of the authorized, unissued shares of Preferred Stock, without par value, available for issuance by Fifth Third Bancorp to allow for limited voting rights for a new series of Preferred Stock and proposed Amendments to Code of Regulations to revise the express terms related to the removal of Directors and the filling of Director vacancies. |
| Consideration of Proposal #2 |
Proposed Amendment to Articles of Incorporation to revise the express terms of the issued and outstanding shares of the Series G Preferred Stock. |
| Consideration of Proposal #3 |
Proposed Amendment to Articles of Incorporation to revise the terms of the authorized, unissued shares of Preferred Stock, without par value, available for issuance by Fifth Third Bancorp to provide greater flexibility in the terms of Preferred Stock that Fifth Third Bancorp may offer and sell in the future and proposed Amendments to Code of Regulations to revise the express terms related to the removal of Directors and the filling of Director vacancies. |
| Consideration of Proposal #4 |
Adjournment of the Special Meeting, if necessary, to solicit additional proxies in the event that there are not sufficient votes at the time of the Special Meeting to adopt the proposed amendments to Article Fourth of the Amended Articles of Incorporation. |
Vote on Proposals 1 through 4
Question and Answer Session
Announcement of results and/or determination to adjourn the Special Meeting to a new date, time and place.
Adjournment
Annex 4-3
Table of Contents
TARP Capital Purchase Program
Senior Preferred Stock and Warrants
Summary of Senior Preferred Terms
| Issuer: |
Qualifying Financial Institution (“QFI”) means (i) any U.S. bank or U.S. savings association not controlled by a Bank Holding Company (“BHC”) or Savings and Loan Holding Company (“SLHC”); (ii) any U.S. BHC, or any U.S. SLHC which engages only in activities permitted for financial holdings companies under Section 4(k) of the Bank Holding Company Act, and any U.S. bank or U.S. savings association controlled by such a qualifying U.S. BHC or U.S. SLHC; and (iii) any U.S. BHC or U.S. SLHC whose U.S. depository institution subsidiaries are the subject of an application under Section 4( c )(8) of the Bank Holding Company Act; except that QFI shall not mean any BHC, SLHC, bank or savings association that is controlled by a foreign bank or company. For purposes of this program, “U.S. bank”, “U.S. savings association”, “U.S. BHC” and “U.S. SLHC” means a bank, savings association, BHC or SLHC organized under the laws of the United States or any State of the United States, the District of Columbia, any territory or possession of the United States, Puerto Rico, Northern Mariana Islands, Guam, American Samoa, or the Virgin Islands. The United States Department of the Treasury will determine eligibility and allocation for QFIs after consultation with the appropriate Federal banking agency. |
| Initial Holder: |
United States Department of the Treasury (the “UST”). |
| Size: |
QFIs may sell preferred stock to the UST subject to the limits and terms described below. |
Each QFI may issue an amount of Senior Preferred equal to not less than 1% of its risk-weighted assets and not more than the lesser of (i) $25 billion and (ii) 3% of its risk-weighted assets.
| Security: |
Senior Preferred, liquidation preference $1,000 per share. (Depending upon the QFI’s available authorized preferred shares, the UST may agree to purchase Senior Preferred with a higher liquidation preference per share, in which case the UST may require the QFI to appoint a depositary to hold the Senior Preferred and issue depositary receipts.) |
| Ranking: |
Senior to common stock and pari passu with existing preferred shares other than preferred shares which by their terms rank junior to any existing preferred shares. |
| Regulatory Capital Status: |
Tier 1. |
| Term: |
Perpetual life. |
Exhibit I-1
Table of Contents
| Dividend: |
The Senior Preferred will pay cumulative dividends at a rate of 5% per annum until the fifth anniversary of the date of this investment and thereafter at a rate of 9% per annum. For Senior Preferred issued by banks which are not subsidiaries of holding companies, the Senior Preferred will pay non-cumulative dividends at a rate of 5% per annum until the fifth anniversary of the date of this investment and thereafter at a rate of 9% per annum. Dividends will be payable quarterly in arrears on February 15, May 15, August 15 and November 15 of each year (consistent with the Company’s Second Amended Articles of Incorporation, as amended, the Senior Preferred, if issued by the Company to the UST, would provide for dividend payment dates of March 31, June 30, September 30 and December 31). |
| Redemption: |
Senior Preferred may not be redeemed for a period of three years from the date of this investment, except with the proceeds from a Qualified Equity Offering (as defined below) which results in aggregate gross proceeds to the QFI of not less than 25% of the issue price of the Senior Preferred. After the third anniversary of the date of this investment, the Senior Preferred may be redeemed, in whole or in part, at any time and from time to time, at the option of the QFI. All redemptions of the Senior Preferred shall be at 100% of its issue price, plus (i) in the case of cumulative Senior Preferred, any accrued and unpaid dividends and (ii) in the case of non-cumulative Senior Preferred, accrued and unpaid dividends for the then current dividend period (regardless of whether any dividends are actually declared for such dividend period), and shall be subject to the approval of the QFI’s primary federal bank regulator. |
“Qualified Equity Offering” shall mean the sale by the QFI after the date of this investment of Tier 1 qualifying perpetual preferred stock or common stock for cash.
Following the redemption in whole of the Senior Preferred held by the UST, the QFI shall have the right to repurchase any other equity security of the QFI held by the UST at fair market value.
| Restrictions on Dividends: |
For as long as any Senior Preferred is outstanding, no dividends may be declared or paid on junior preferred shares, preferred shares ranking pari passu with the Senior Preferred, or common shares (other than in the case of pari passu preferred shares, dividends on a pro rata basis with the Senior Preferred), nor may the QFI repurchase or redeem any junior preferred shares, preferred shares ranking pari passu with the Senior Preferred or common shares, unless (i) in the case of cumulative Senior Preferred all accrued and unpaid dividends for all past dividend periods on the Senior Preferred are fully paid or (ii) in the case of non-cumulative Senior Preferred the full dividend for the latest completed dividend period has been declared and paid in full. |
| Common dividends: |
The UST’s consent shall be required for any increase in common dividends per share until the third anniversary of the date of this investment unless prior to such third anniversary the Senior Preferred is redeemed in whole or the UST has transferred all of the Senior Preferred to third parties. |
Exhibit I-2
Table of Contents
| Repurchases: |
The UST’s consent shall be required for any share repurchases (other than (i) repurchases of the Senior Preferred and (ii) repurchases of junior preferred shares or common shares in connection with any benefit plan in the ordinary course of business consistent with past practice) until the third anniversary of the date of this investment unless prior to such third anniversary the Senior Preferred is redeemed in whole or the UST has transferred all of the Senior Preferred to third parties. In addition, there shall be no share repurchases of junior preferred shares, preferred shares ranking pari passu with the Senior Preferred, or common shares if prohibited as described above under “Restrictions on Dividends”. |
| Voting rights: |
The Senior Preferred shall be non-voting, other than class voting rights on (i) any authorization or issuance of shares ranking senior to the Senior Preferred, (ii) any amendment to the rights of Senior Preferred, or (iii) any merger, exchange or similar transaction which would adversely affect the rights of the Senior Preferred. |
If dividends on the Senior Preferred are not paid in full for six dividend periods, whether or not consecutive, the Senior Preferred will have the right to elect 2 directors. The right to elect directors will end when full dividends have been paid for four consecutive dividend periods.
| Transferability: |
The Senior Preferred will not be subject to any contractual restrictions on transfer. The QFI will file a shelf registration statement covering the Senior Preferred as promptly as practicable after the date of this investment and, if necessary, shall take all action required to cause such shelf registration statement to be declared effective as soon as possible. The QFI will also grant to the UST piggyback registration rights for the Senior Preferred and will take such other steps as may be reasonably requested to facilitate the transfer of the Senior Preferred including, if requested by the UST, using reasonable efforts to list the Senior Preferred on a national securities exchange. If requested by the UST, the QFI will appoint a depositary to hold the Senior Preferred and issue depositary receipts. |
| Executive Compensation: |
As a condition to the closing of this investment, the QFI and its senior executive officers covered by the EESA shall modify or terminate all benefit plans, arrangements and agreements (including golden parachute agreements) to the extent necessary to be in compliance with, and following the closing and for so long as UST holds any equity or debt securities of the QFI, the QFI shall agree to be bound by, the executive compensation and corporate governance requirements of Section 111 of the EESA and any guidance or regulations issued by the Secretary of the Department of Treasury on or prior to the date of this investment to carry out the provisions of such subsection. As an additional condition to closing, the QFI and its senior executive officers covered by the EESA shall grant to the UST a waiver releasing the UST from any claims that the QFI and such senior executive officers may otherwise have as a result of the issuance of any regulations which modify the terms of benefits plans, |
Exhibit I-3
Table of Contents
| arrangements and agreements to eliminate any provisions that would not be in compliance with the executive compensation and corporate governance requirements of Section 111 of the EESA and any guidance or regulations issued by the Secretary of the Department of Treasury on or prior to the date of this investment to carry out the provisions of such subsection. |
Summary of Warrant Terms
| Warrant: |
The UST will receive warrants to purchase a number of shares of common stock of the QFI having an aggregate market price equal to 15% of the Senior Preferred amount on the date of investment, subject to reduction as set forth below under “Reduction”. The initial exercise price for the warrants, and the market price for determining the number of shares of common stock subject to the warrants, shall be the market price for the common stock on the date of the Senior Preferred investment (calculated on a 20-trading day trailing average), subject to customary anti-dilution adjustments. The exercise price shall be reduced by 15% of the original exercise price on each six-month anniversary of the issue date of the warrants if the consent of the QFI stockholders described below has not been received, subject to a maximum reduction of 45% of the original exercise price. |
| Term: |
10 years |
| Exercisability: |
Immediately exercisable, in whole or in part |
| Transferability: |
The warrants will not be subject to any contractual restrictions on transfer; provided that the UST may only transfer or exercise an aggregate of one-half of the warrants prior to the earlier of (i) the date on which the QFI has received aggregate gross proceeds of not less than 100% of the issue price of the Senior Preferred from one or more Qualified Equity Offerings and (ii) December 31, 2009. The QFI will file a shelf registration statement covering the warrants and the common stock underlying the warrants as promptly as practicable after the date of this investment and, if necessary, shall take all action required to cause such shelf registration statement to be declared effective as soon as possible. The QFI will also grant to the UST piggyback registration rights for the warrants and the Common Stock underlying the warrants and will take such other steps as may be reasonably requested to facilitate the transfer of the warrants and the Common Stock underlying the warrants. The QFI will apply for the listing on the national exchange on which the QFI’s common stock is traded of the common stock underlying the warrants and will take such other steps as may be reasonably requested to facilitate the transfer of the warrants or the common stock. |
| Voting: |
The UST will agree not to exercise voting power with respect to any shares of common stock of the QFI issued to it upon exercise of the warrants. |
Exhibit I-4
Table of Contents
| Reduction: |
In the event that the QFI has received aggregate gross proceeds of not less than 100% of the issue price of the Senior Preferred from one or more Qualified Equity Offerings on or prior to December 31, 2009, the number of shares of common stock underlying the warrants then held by the UST shall be reduced by a number of shares equal to the product of (i) the number of shares originally underlying the warrants (taking into account all adjustments) and (ii) 0.5. |
| Consent: |
In the event that the QFI does not have sufficient available authorized shares of Common Stock to reserve for issuance upon exercise of the warrants and/or stockholder approval is required for such issuance under applicable stock exchange rules, the QFI will call a meeting of its stockholders as soon as practicable after the date of this investment to increase the number of authorized shares of Common Stock and/or comply with such exchange rules, and to take any other measures deemed by the UST to be necessary to allow the exercise of warrants into Common Stock. |
| Substitution: |
In the event the QFI is no longer listed or traded on a national securities exchange or securities association, or the consent of the QFI stockholders described above has not been received within 18 months after the issuance date of the warrants, the warrants will be exchangeable, at the option of the UST, for senior term debt or another economic instrument or security of the QFI such that the UST is appropriately compensated for the value of the warrant, as determined by the UST. |
Exhibit I-5
Table of Contents
Audited Consolidated Financial Statements (including Notes thereto) at December 31, 2007 and 2006, and for each of the years in the three year period ended December 31, 2007, as included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007.
A-1
Table of Contents
CONSOLIDATED STATEMENTS OF INCOME
| For the years ended December 31 ($ in millions, except per share data) | 2007 | 2006 | 2005 | |||||
| Interest Income |
||||||||
| Interest and fees on loans and leases |
$ | 5,418 | 5,000 | 3,918 | ||||
| Interest on securities |
590 | 934 | 1,071 | |||||
| Interest on other short-term investments |
19 | 21 | 6 | |||||
| Total interest income |
6,027 | 5,955 | 4,995 | |||||
| Interest Expense |
||||||||
| Interest on deposits |
2,007 | 1,910 | 1,148 | |||||
| Interest on other short-term borrowings |
324 | 402 | 282 | |||||
| Interest on long-term debt |
687 | 770 | 600 | |||||
| Total interest expense |
3,018 | 3,082 | 2,030 | |||||
| Net Interest Income |
3,009 | 2,873 | 2,965 | |||||
| Provision for loan and lease losses |
628 | 343 | 330 | |||||
| Net Interest Income After Provision for Loan and Lease Losses |
2,381 | 2,530 | 2,635 | |||||
| Noninterest Income |
||||||||
| Electronic payment processing revenue |
826 | 717 | 622 | |||||
| Service charges on deposits |
579 | 517 | 522 | |||||
| Investment advisory revenue |
382 | 367 | 358 | |||||
| Corporate banking revenue |
367 | 318 | 299 | |||||
| Mortgage banking net revenue |
133 | 155 | 174 | |||||
| Other noninterest income |
153 | 299 | 360 | |||||
| Securities gains (losses), net |
21 | (364 | ) | 39 | ||||
| Securities gains—non-qualifying hedges on mortgage servicing rights |
6 | 3 | — | |||||
| Total noninterest income |
2,467 | 2,012 | 2,374 | |||||
| Noninterest Expense |
||||||||
| Salaries, wages and incentives |
1,239 | 1,174 | 1,133 | |||||
| Employee benefits |
278 | 292 | 283 | |||||
| Net occupancy expense |
269 | 245 | 221 | |||||
| Payment processing expense |
244 | 184 | 145 | |||||
| Technology and communications |
169 | 141 | 142 | |||||
| Equipment expense |
123 | 116 | 105 | |||||
| Other noninterest expense |
989 | 763 | 772 | |||||
| Total noninterest expense |
3,311 | 2,915 | 2,801 | |||||
| Income Before Income Taxes and Cumulative Effect |
1,537 | 1,627 | 2,208 | |||||
| Applicable income taxes |
461 | 443 | 659 | |||||
| Income Before Cumulative Effect |
1,076 | 1,184 | 1,549 | |||||
| Cumulative effect of change in accounting principle, net of tax (a) |
— | 4 | — | |||||
| Net Income | $ | 1,076 | 1,188 | 1,549 | ||||
| Net Income Available to Common Shareholders (b) | $ | 1,075 | 1,188 | 1,548 | ||||
| Earnings Per Share | $ | 2.00 | 2.14 | 2.79 | ||||
| Earnings Per Diluted Share | $ | 1.99 | 2.13 | 2.77 | ||||
| (a) | Reflects a benefit of $4 million (net of $2 million of tax) for the adoption of SFAS No. 123(R) as of January 1, 2006. |
| (b) | Dividends on preferred stock are $.740 million for all years presented. |
See Notes to Consolidated Financial Statements
A-2
Table of Contents
CONSOLIDATED BALANCE SHEETS
| As of December 31 ($ in millions, except share data) | 2007 | 2006 | |||||
| Assets |
|||||||
| Cash and due from banks |
$ | 2,687 | 2,737 | ||||
| Available-for-sale and other securities (a) |
10,677 | 11,053 | |||||
| Held-to-maturity securities (b) |
355 | 356 | |||||
| Trading securities |
171 | 187 | |||||
| Other short-term investments |
593 | 809 | |||||
| Loans held for sale |
4,329 | 1,150 | |||||
| Portfolio loans and leases: |
|||||||
| Commercial loans |
24,813 | 20,831 | |||||
| Commercial mortgage loans |
11,862 | 10,405 | |||||
| Commercial construction loans |
5,561 | 6,168 | |||||
| Commercial leases |
3,737 | 3,841 | |||||
| Residential mortgage loans |
10,540 | 8,830 | |||||
| Home equity |
11,874 | 12,153 | |||||
| Automobile loans |
9,201 | 10,028 | |||||
| Credit card |
1,591 | 1,004 | |||||
| Other consumer loans and leases |
1,074 | 1,093 | |||||
| Portfolio loans and leases |
80,253 | 74,353 | |||||
| Allowance for loan and lease losses |
(937 | ) | (771 | ) | |||
| Portfolio loans and leases, net |
79,316 | 73,582 | |||||
| Bank premises and equipment |
2,223 | 1,940 | |||||
| Operating lease equipment |
353 | 202 | |||||
| Goodwill |
2,470 | 2,193 | |||||
| Intangible assets |
147 | 166 | |||||
| Servicing rights |
618 | 524 | |||||
| Other assets |
7,023 | 5,770 | |||||
| Total Assets |
$ | 110,962 | 100,669 | ||||
| Liabilities |
|||||||
| Deposits: |
|||||||
| Demand |
$ | 14,404 | 14,331 | ||||
| Interest checking |
15,254 | 15,993 | |||||
| Savings |
15,635 | 13,181 | |||||
| Money market |
6,521 | 6,584 | |||||
| Other time |
11,440 | 10,987 | |||||
| Certificates—$100,000 and over |
6,738 | 6,628 | |||||
| Foreign office |
5,453 | 1,676 | |||||
| Total deposits |
75,445 | 69,380 | |||||
| Federal funds purchased |
4,427 | 1,421 | |||||
| Other short-term borrowings |
4,747 | 2,796 | |||||
| Accrued taxes, interest and expenses |
2,427 | 2,283 | |||||
| Other liabilities |
1,898 | 2,209 | |||||
| Long-term debt |
12,857 | 12,558 | |||||
| Total Liabilities |
101,801 | 90,647 | |||||
| Shareholders’ Equity |
|||||||
| Common stock (c) |
1,295 | 1,295 | |||||
| Preferred stock (d) |
9 | 9 | |||||
| Capital surplus |
1,779 | 1,812 | |||||
| Retained earnings |
8,413 | 8,317 | |||||
| Accumulated other comprehensive income |
(126 | ) | (179 | ) | |||
| Treasury stock |
(2,209 | ) | (1,232 | ) | |||
| Total Shareholders’ Equity |
9,161 | 10,022 | |||||
| Total Liabilities and Shareholders’ Equity | $ | 110,962 | 100,669 | ||||
A-3
Table of Contents
| (a) | Amortized cost: December 31, 2007—$10,821 and December 31, 2006—$11,236 |
| (b) | Market values: December 31, 2007—$355 and December 31, 2006—$356 |
| (c) | Common shares: Stated value $2.22 per share; authorized 1,300,000,000; outstanding at December 31, 2007—532,671,925 (excludes 51,516,339 treasury shares) and December 31, 2006—556,252,674 (excludes 27,174,430 treasury shares). |
| (d) | 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 $1,000 per share were authorized, issued and outstanding. |
See Notes to Consolidated Financial Statements
A-4
Table of Contents
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
| ($ in millions, except per share data) | Common Stock |
Preferred Stock |
Capital Surplus |
Retained Earnings |
Accumulated Other Comprehensive Income |
Treasury Stock |
Total | ||||||||||||||
| Balance at December 31, 2004 |
$ | 1,295 | 9 | 1,934 | 7,269 | (169 | ) | (1,414 | ) | 8,924 | |||||||||||
| Net income |
1,549 | 1,549 | |||||||||||||||||||
| Other comprehensive income |
(244 | ) | (244 | ) | |||||||||||||||||
| Comprehensive income |
1,305 | ||||||||||||||||||||
| Cash dividends declared: |
|||||||||||||||||||||
| Common stock at $1.46 per share |
(810 | ) | (810 | ) | |||||||||||||||||
| Preferred stock |
(1 | ) | (1 | ) | |||||||||||||||||
| Shares acquired for treasury |
97 | (1,746 | ) | (1,649 | ) | ||||||||||||||||
| Stock-based compensation expense |
65 | 65 | |||||||||||||||||||
| Restricted stock grants |
(43 | ) | 43 | — | |||||||||||||||||
| Stock-based awards exercised, including treasury shares issued |
(121 | ) | 206 | 85 | |||||||||||||||||
| Loans repaid related to the exercise of stock-based awards, net |
11 | 11 | |||||||||||||||||||
| Change in corporate tax benefit related to stock-based compensation |
6 | 6 | |||||||||||||||||||
| Shares issued in business combinations |
11 | 85 | 1,413 | 1,509 | |||||||||||||||||
| Retirement of shares |
(11 | ) | (208 | ) | 219 | — | |||||||||||||||
| Other |
1 | 1 | |||||||||||||||||||
| Balance at December 31, 2005 |
1,295 | 9 | 1,827 | 8,007 | (413 | ) | (1,279 | ) | 9,446 | ||||||||||||
| Net income |
1,188 | 1,188 | |||||||||||||||||||
| Other comprehensive income |
288 | 288 | |||||||||||||||||||
| Comprehensive income |
1,368 | ||||||||||||||||||||
| Cumulative effect of change in accounting for pension and other postretirement obligations |
(54 | ) | (54 | ) | |||||||||||||||||
| Cash dividends declared: |
|||||||||||||||||||||
| Common stock at $1.58 per share |
(880 | ) | (880 | ) | |||||||||||||||||
| Preferred stock |
(1 | ) | (1 | ) | |||||||||||||||||
| Shares acquired for treasury |
(82 | ) | (82 | ) | |||||||||||||||||
| Stock-based compensation expense |
76 | 1 | 77 | ||||||||||||||||||
| Impact of cumulative effect of change in accounting principle |
(6 | ) | (6 | ) | |||||||||||||||||
| Restricted stock grants |
(45 | ) | 45 | — | |||||||||||||||||
| Stock-based awards exercised, including treasury shares issued |
(49 | ) | 84 | 35 | |||||||||||||||||
| Loans repaid related to the exercise of stock-based awards, net |
8 | 8 | |||||||||||||||||||
| Change in corporate tax benefit related to stock-based compensation |
(1 | ) | (1 | ) | |||||||||||||||||
| Other |
2 | 2 | 4 | ||||||||||||||||||
| Balance at December 31, 2006 |
1,295 | 9 | 1,812 | 8,317 | (179 | ) | (1,232 | ) | 10,022 | ||||||||||||
| Net income |
1,076 | 1,076 | |||||||||||||||||||
| Other comprehensive income |
53 | 53 | |||||||||||||||||||
| Comprehensive income |
1,129 | ||||||||||||||||||||
| Cash dividends declared: |
|||||||||||||||||||||
| Common stock at $1.70 per share |
(914 | ) | (914 | ) | |||||||||||||||||
| Preferred stock |
(1 | ) | (1 | ) | |||||||||||||||||
| Shares acquired for treasury |
(1,084 | ) | (1,084 | ) | |||||||||||||||||
| Stock-based compensation expense |
60 | 1 | 61 | ||||||||||||||||||
| Impact of cumulative effect of change in accounting principle |
(98 | ) | (98 | ) | |||||||||||||||||
| Restricted stock grants |
(59 | ) | 59 | — | |||||||||||||||||
| Stock-based awards exercised, including treasury shares issued |
(39 | ) | 86 | 47 | |||||||||||||||||
| Loans repaid related to the exercise of stock-based awards, net |
2 | 2 | |||||||||||||||||||
| Change in corporate tax benefit related to stock-based compensation |
2 | 2 | |||||||||||||||||||
| Employee stock ownership through benefit plans |
38 | (38 | ) | — | |||||||||||||||||
| Impact of diversification of nonqualified deferred compensation plan |
(8 | ) | (8 | ) | |||||||||||||||||
| Other |
1 | 2 | 3 | ||||||||||||||||||
| Balance at December 31, 2007 | $ | 1,295 | 9 | 1,779 | 8,413 | (126 | ) | (2,209 | ) | 9,161 | |||||||||||
See Notes to Consolidated Financial Statements
A-5
Table of Contents
CONSOLIDATED STATEMENTS OF CASH FLOWS
| For the years ended December 31 ($ in millions) | 2007 | 2006 | 2005 | |||||||
| Operating Activities |
||||||||||
| Net Income |
$ | 1,076 | 1,188 | 1,549 | ||||||
| Adjustments to reconcile net income to net cash (used in) provided by operating activities: |
||||||||||
| Provision for loan and lease losses |
628 | 343 | 330 | |||||||
| Cumulative effect of change in accounting principle, net of tax |
— | (4 | ) | — | ||||||
| Depreciation, amortization and accretion |
367 | 399 | 405 | |||||||
| Stock-based compensation expense |
61 | 77 | 65 | |||||||
| Benefit for deferred income taxes |
(178 | ) | (21 | ) | (16 | ) | ||||
| Realized securities gains |
(16 | ) | (44 | ) | (46 | ) | ||||
| Realized securities gains—non-qualifying hedges on mortgage servicing rights |
(6 | ) | (3 | ) | — | |||||
| Realized securities losses |
2 | 408 | 7 | |||||||
| Net gains on sales of loans |
(95 | ) | (131 | ) | (162 | ) | ||||
| Loans originated for sale, net of repayments |
(13,125 | ) | (8,671 | ) | (8,683 | ) | ||||
| Proceeds from sales of loans held for sale |
11,027 | 8,812 | 7,881 | |||||||
| Decrease (increase) in trading securities |
16 | (70 | ) | (40 | ) | |||||
| Decrease (increase) in other assets |
108 | (1,440 | ) | (922 | ) | |||||
| Increase (decrease) in accrued taxes, interest and expenses |
194 | (31 | ) | 58 | ||||||
| Excess tax benefit related to stock-based compensation |
(4 | ) | — | (16 | ) | |||||
| (Decrease) increase in other liabilities |
(741 | ) | 642 | 355 | ||||||
| Net Cash (Used In) Provided by Operating Activities |
(686 | ) | 1,454 | 765 | ||||||
| Investing Activities |
||||||||||
| Proceeds from sales of available-for-sale securities |
2,071 | 12,568 | 5,912 | |||||||
| Proceeds from calls, paydowns and maturities of available-for-sale securities |
13,468 | 3,033 | 5,271 | |||||||
| Purchases of available-for-sale securities |
(15,541 | ) | (4,676 | ) | (7,785 | ) | ||||
| Proceeds from calls, paydowns and maturities of held-to-maturity securities |
11 | 38 | 48 | |||||||
| Purchases of held-to-maturity securities |
(11 | ) | (5 | ) | (181 | ) | ||||
| Decrease (increase) in other short-term investments |
219 | (651 | ) | 402 | ||||||
| Net increase in loans and leases |
(6,181 | ) | (5,145 | ) | (8,297 | ) | ||||
| Proceeds from sales of loans |
745 | 540 | 1,816 | |||||||
| (Increase) decrease in operating lease equipment |
(172 | ) | (77 | ) | 124 | |||||
| Purchases of bank premises and equipment |
(459 | ) | (443 | ) | (437 | ) | ||||
| Proceeds from disposal of bank premises and equipment |
46 | 60 | 56 | |||||||
| Net cash (paid) acquired in business combination |
(230 | ) | (5 | ) | 242 | |||||
| Net Cash (Used In) Provided by Investing Activities |
(6,034 | ) | 5,237 | (2,829 | ) | |||||
| Financing Activities |
||||||||||
| Increase in core deposits |
2,225 | 1,467 | 3,874 | |||||||
| Increase in certificates—$100,000 and over, including other foreign office |
2,101 | 479 | 1,491 | |||||||
| Increase (decrease) in federal funds purchased |
3,006 | (3,902 | ) | 130 | ||||||
| Decrease in short-term bank notes |
— | — | (775 | ) | ||||||
| Increase (decrease) in other short-term borrowings |
1,951 | (1,462 | ) | (687 | ) | |||||
| Proceeds from issuance of long-term debt |
4,801 | 3,731 | 4,665 | |||||||
| Repayment of long-term debt |
(5,494 | ) | (6,441 | ) | (3,782 | ) | ||||
| Payment of cash dividends |
(898 | ) | (867 | ) | (794 | ) | ||||
| Exercise of stock-based awards, net |
49 | 43 | 96 | |||||||
| Purchases of treasury stock |
(1,084 | ) | (82 | ) | (1,649 | ) | ||||
| Excess tax benefit related to stock-based compensation |
4 | — | 16 | |||||||
| Other |
9 | 2 | (4 | ) | ||||||
| Net Cash Provided by (Used In) Financing Activities |
6,670 | (7,032 | ) | 2,581 | ||||||
| (Decrease) Increase in Cash and Due from Banks |
(50 | ) | (341 | ) | 517 | |||||
| Cash and Due from Banks at Beginning of Year |
2,737 | 3,078 | 2,561 | |||||||
| Cash and Due from Banks at End of Year |
$ | 2,687 | 2,737 | 3,078 | ||||||
| Cash Payments |
||||||||||
| Interest |
$ | 2,996 | 3,051 | 1,952 | ||||||
| Income taxes |
535 | 489 | 676 | |||||||
| Supplemental Cash Flow Information |
||||||||||
| Transfer from portfolio loans to loans held for sale, net |
1,200 | (138 | ) | (16 | ) | |||||
| Business Acquisitions: |
||||||||||
| Fair value of tangible assets acquired (noncash) |
2,446 | 6 | 5,149 | |||||||
| Goodwill and identifiable intangible assets acquired |
297 | 17 | 1,297 | |||||||
| Liabilities assumed and note issued |
(2,513 | ) | (18 | ) | (5,179 | ) | ||||
| Stock options |
— | — | (63 | ) | ||||||
| Common stock issued |
— | — | (1,446 | ) | ||||||
See Notes to Consolidated Financial Statements
A-6
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
A-7
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A-8
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A-9
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A-10
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A-11
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A-12
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A-13
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A-14
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A-15
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. BUSINESS COMBINATIONS
A-16
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A-17
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. SECURITIES
The following table provides a breakdown of the securities portfolio as of December 31:
| 2007 | 2006 | ||||||||||||||||||
| ($ in millions) | Amortized Cost |
Unrealized Gains |
Unrealized Losses |
Fair Value | Amortized Cost |
Unrealized Gains |
Unrealized Losses |
Fair Value | |||||||||||
| Available-for-sale and other: |
|||||||||||||||||||
| U.S. Treasury and Government agencies |
$ | 3 | — | — | 3 | 1,396 | — | — | 1,396 | ||||||||||
| U.S. Government sponsored agencies |
160 | 1 | (1 | ) | 160 | 100 | — | (5 | ) | 95 | |||||||||
| Obligations of states and political subdivisions |
490 | 6 | — | 496 | 603 | 11 | — | 614 | |||||||||||
| Agency mortgage-backed securities |
8,738 | 24 | (153 | ) | 8,609 | 7,999 | 10 | (193 | ) | 7,816 | |||||||||
| Other bonds, notes and debentures |
385 | 1 | (10 | ) | 376 | 172 | 1 | (2 | ) | 171 | |||||||||
| Other securities (a) |
1,045 | 7 | (19 | ) | 1,033 | 966 | 3 | (8 | ) | 961 | |||||||||
| Total | $ | 10,821 | 39 | (183 | ) | 10,677 | 11,236 | 25 | (208 | ) | 11,053 | ||||||||
| Held-to-maturity: |
|||||||||||||||||||
| Obligations of states and political subdivisions |
$ | 351 | — | — | 351 | 345 | — | — | 345 | ||||||||||
| Other debt securities |
4 | — | — | 4 | 11 | — | — | 11 | |||||||||||
| Total | $ | 355 | — | — | 355 | 356 | — | — | 356 | ||||||||||
| (a) | Other securities consist of FHLB and Federal Reserve Bank restricted stock holdings of $523 million and $199 million at December 31, 2007, respectively, and $527 million and $187 million at December 31, 2006, respectively, that are carried at cost, FHLMC preferred stock holdings, certain mutual fund holdings and equity security holdings. |
| Available-for-Sale & Other |
Held-to-Maturity | ||||||||
| ($ in millions) | Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value | |||||
| Debt securities: |
|||||||||
| Under 1 year |
$ | 120 | 120 | 3 | 3 | ||||
| 1-5 years |
323 | 326 | 63 | 63 | |||||
| 5-10 years |
591 | 591 | 259 | 259 | |||||
| Over 10 years |
8,742 | 8,607 | 30 | 30 | |||||
| Other securities |
1,045 | 1,033 | — | — | |||||
| Total | $ | 10,821 | 10,677 | 355 | 355 | ||||
A-18
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table provides the fair value and gross unrealized loss, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, as of December 31, 2007 and 2006:
| Less than 12 months | 12 months or more | Total | ||||||||||||||
| ($ in millions) | Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses |
||||||||||
| 2007 |
||||||||||||||||
| U.S. Treasury and Government agencies |
$ | 1 | — | 1 | — | 2 | — | |||||||||
| U.S. Government sponsored agencies |
99 | (1 | ) | — | — | 99 | (1 | ) | ||||||||
| Obligations of states and political subdivisions |
6 | — | 1 | — | 7 | — | ||||||||||
| Agency mortgage-backed securities |
2,279 | (25 | ) | 3,730 | (128 | ) | 6,009 | (153 | ) | |||||||
| Other bonds, notes and debentures |
279 | (9 | ) | 6 | (1 | ) | 285 | (10 | ) | |||||||
| Other securities |
57 | (7 | ) | 27 | (12 | ) | 84 | (19 | ) | |||||||
| Total | $ | 2,721 | (42 | ) | 3,765 | (141 | ) | 6,486 | (183 | ) | ||||||
| 2006 |
||||||||||||||||
| U.S. Treasury and Government agencies |
$ | 747 | — | 1 | — | 748 | — | |||||||||
| U.S. Government sponsored agencies |
— | — | 95 | (5 | ) | 95 | (5 | ) | ||||||||
| Obligations of states and political subdivisions |
3 | — | 4 | — | 7 | — | ||||||||||
| Agency mortgage-backed securities |
853 | (3 | ) | 5,383 | (190 | ) | 6,236 | (193 | ) | |||||||
| Other bonds, notes and debentures |
10 | — | 119 | (2 | ) | 129 | (2 | ) | ||||||||
| Other securities |
8 | (2 | ) | 41 | (6 | ) | 49 | (8 | ) | |||||||
| Total | $ | 1,621 | (5 | ) | 5,643 | (203 | ) | 7,264 | (208 | ) | ||||||
A-19
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES
A summary of the total loans and leases classified by primary purpose as of December 31:
| ($ in millions) | 2007 | 2006 | |||
| Loans and leases held for sale: |
|||||
| Commercial loans |
$ | 1,266 | — | ||
| Commercial mortgage loans |
105 | — | |||
| Residential mortgage loans |
893 | 1,075 | |||
| Home equity |
— | 1 | |||
| Automobile loans |
1,982 | — | |||
| Other consumer loans and leases |
83 | 74 | |||
| Total loans and leases held for sale | $ | 4,329 | 1,150 | ||
| Portfolio loans and leases (a): |
|||||
| Commercial loans |
$ | 24,813 | 20,831 | ||
| Commercial mortgage loans |
11,862 | 10,405 | |||
| Commercial construction loans |
5,561 | 6,168 | |||
| Commercial leases |
3,737 | 3,841 | |||
| Total commercial loans and leases |
45,973 | 41,245 | |||
| Residential mortgage loans |
10,540 | 8,830 | |||
| Home equity |
11,874 | 12,153 | |||
| Automobile loans |
9,201 | 10,028 | |||
| Credit card |
1,591 | 1,004 | |||
| Other consumer loans and leases |
1,074 | 1,093 | |||
| Total consumer loans and leases |
34,280 | 33,108 | |||
| Total portfolio loans and leases |
$ | 80,253 | 74,353 | ||
| (a) | At December 31, 2007 and 2006, deposit overdrafts of $78 million and $43 million, respectively, were included in portfolio loans. |
Total portfolio loans and leases were recorded net of unearned income, unamortized premiums and discounts, deferred loan fees and costs, and fair value adjustments associated with acquired loans of $1.3 billion and $876 million as of December 31, 2007 and 2006, respectively. The following is a summary of the gross investment in lease financing at December 31:
| ($ in millions) | 2007 | 2006 | |||
| Direct financing leases |
$ | 3,407 | 3,640 | ||
| Leveraged leases |
2,452 | 2,520 | |||
| Total | $ | 5,859 | 6,160 | ||
The components of the investment in lease financing at December 31:
| ($ in millions) | 2007 | 2006 | |||||
| Rentals receivable, net of principal and interest on nonrecourse debt |
$ | 4,438 | 4,479 | ||||
| Estimated residual value of leased assets |
1,397 | 1,652 | |||||
| Initial direct cost, net of amortization |
24 | 29 | |||||
| Gross investment in lease financing |
5,859 | 6,160 | |||||
| Unearned income |
(1,325 | ) | (1,245 | ) | |||
| Net investment in lease financing | $ | 4,534 | 4,915 | ||||
A-20
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2007, the minimum future lease payments receivable for each of the years 2008 through 2012 were $1.1 billion, $1.0 billion, $.9 billion, $.6 billion and $.5 billion, respectively.
Transactions in the allowance for loan and lease losses for the years ended December 31:
| ($ in millions) | 2007 | 2006 | 2005 | |||||||
| Balance at January 1 |
$ | 771 | 744 | 713 | ||||||
| Losses charged off |
(544 | ) | (408 | ) | (373 | ) | ||||
| Recoveries of losses previously charged off |
82 | 92 | 74 | |||||||
| Provision for loan and lease losses |
628 | 343 | 330 | |||||||
| Balance at December 31 | $ | 937 | 771 | 744 | ||||||
5. LOANS ACQUIRED IN A TRANSFER
A-21
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. BANK PREMISES AND EQUIPMENT
A summary of bank premises and equipment at December 31:
| ($ in millions) | Estimated Useful Life | 2007 | 2006 | ||||||
| Land and improvements |
$ | 620 | 487 | ||||||
| Buildings |
10 to 50 yrs. | 1,383 | 1,218 | ||||||
| Equipment |
3 to 20 yrs. | 1,210 | 1,121 | ||||||
| Leasehold improvements |
3 to 40 yrs. | 320 | 270 | ||||||
| Construction in progress |
113 | 137 | |||||||
| Accumulated depreciation and amortization |
(1,423 | ) | (1,293 | ) | |||||
| Total | $ | 2,223 | 1,940 | ||||||
A-22
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. GOODWILL
Changes in the net carrying amount of goodwill by reporting segment for the years ended December 31, 2007 and 2006 were as follows:
| ($ in millions) | Commercial Banking |
Branch Banking |
Consumer Lending |
Investment Advisors |
Processing Solutions |
Total | ||||||||
| Balance as of December 31, 2005 |
$ | 871 | 798 | 182 | 127 | 191 | 2,169 | |||||||
| Acquisition activity |
— | (1 | ) | — | — | 14 | 13 | |||||||
| Reclassification |
— | — | — | 11 | — | 11 | ||||||||
| Balance as of December 31, 2006 |
871 | 797 | 182 | 138 | 205 | 2,193 | ||||||||
| Acquisition activity |
124 | 153 | — | — | — | 277 | ||||||||
| Balance as of December 31, 2007 | $ | 995 | 950 | 182 | 138 | 205 | 2,470 | |||||||
8. INTANGIBLE ASSETS
| ($ in millions) | Gross Carrying Amount |
Accumulated Amortization |
Valuation Allowance |
Net Carrying Amount | |||||||
| As of December 31, 2007: |
|||||||||||
| Mortgage servicing rights |
$ | 1,417 | (755 | ) | (49 | ) | 613 | ||||
| Other consumer and commercial servicing rights |
24 | (19 | ) | — | 5 | ||||||
| Core deposits |
430 | (302 | ) | — | 128 | ||||||
| Other |
44 | (25 | ) | — | 19 | ||||||
| Total intangible assets | $ | 1,915 | (1,101 | ) | (49 | ) | 765 | ||||
| As of December 31, 2006: |
|||||||||||
| Mortgage servicing rights |
$ | 1,210 | (664 | ) | (27 | ) | 519 | ||||
| Other consumer and commercial servicing rights |
23 | (18 | ) | — | 5 | ||||||
| Core deposits |
417 | (276 | ) | — | 141 | ||||||
| Other |
43 | (18 | ) | — | 25 | ||||||
| Total intangible assets | $ | 1,693 | (976 | ) | (27 | ) | 690 | ||||
A-23
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. SALES OF RECEIVABLES AND SERVICING RIGHTS
| Rate |
2007 | 2006 | ||||||||||||||||||||
| Weighted- (in years) |
Prepayment Speed Assumption |
Discount Rate |
Weighted- Average Default Rate |
Weighted- (in years) |
Prepayment Speed Assumption |
Discount Rate |
Weighted- Rate | |||||||||||||||
| Residential mortgage loans: |
||||||||||||||||||||||
| Servicing assets |
Fixed | 6.4 | 12.9 | % | 9.6 | % | N/A | 6.8 | 13.7 | % | 10.4 | % | N/A | |||||||||
| Servicing assets |
Adjustable | 3.4 | 29.4 | 12.9 | N/A | 2.7 | 38.6 | 11.7 | N/A | |||||||||||||
| Prepayment Speed Assumption |
Residual Servicing Cash Flows |
Weighted- Average Default | ||||||||||||||||||||||||||||||||
| |
Impact of Adverse Change on Fair Value |
|
Impact of Adverse Change on Fair Value |
|
Impact of Adverse Change on Fair Value | |||||||||||||||||||||||||||||
| ($ in millions) | Rate | Fair Value |
Weighted- Average Life (in years) |
Rate | 10% | 20% | Discount Rate |
10% | 20% | Rate | 10% | 20% | ||||||||||||||||||||||
| Residential mortgage loans: |
||||||||||||||||||||||||||||||||||
| Servicing assets |
Fixed | $ | 565 | 5.9 | 12.1 | % | $ | 26 | $ | 49 | 9.7 | % | $ | 20 | $ | 39 | — | % | $ | — | $ | — | ||||||||||||
| Servicing assets |
Adjustable | 50 | 3.1 | 26.5 | 3 | 7 | 12.4 | 2 | 3 | — | — | — | ||||||||||||||||||||||
A-24
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table reflects changes in the servicing asset related to residential mortgage loans for the years ended December 31:
| ($ in millions) | 2007 | 2006 | |||||
| Carrying amount as of the beginning of period |
$ | 546 | 479 | ||||
| Servicing obligations that result from transfer of residential mortgage loans |
207 | 135 | |||||
| Amortization |
(91 | ) | (68 | ) | |||
| Carrying amount before valuation allowance | $ | 662 | 546 | ||||
| Valuation allowance for servicing assets: |
|||||||
| Beginning balance |
(27 | ) | (46 | ) | |||
| Servicing valuation impairment recovery |
(22 | ) | 19 | ||||
| Ending balance | (49 | ) | (27 | ) | |||
| Carrying amount as of the end of the period | $ | 613 | 519 | ||||
A-25
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair value of the servicing asset is based on the present value of expected future cash flows. The following table displays the beginning and ending fair value for the years ended December 31, 2007 and 2006:
| ($ in millions) | 2007 | 2006 | |||
| Fixed rate residential mortgage loans: |
|||||
| Fair value at beginning of period |
$ | 483 | 413 | ||
| Fair value at end of period |
565 | 483 | |||
| Adjustable rate residential mortgage loans: |
|||||
| Fair value at beginning of period |
45 | 45 | |||
| Fair value at end of period |
50 | 45 | |||
| Balance | Balance of Loans 90 Days or More Past Due |
Net Credit Losses |
||||||||||||
| ($ in millions) | 2007 | 2006 | 2007 | 2006 | 2007 | 2006 | ||||||||
| Commercial loans |
$ | 29,052 | 24,217 | 43 | 38 | 109 | 107 | |||||||
| Commercial mortgage |
11,967 | 10,405 | 73 | 17 | 44 | 24 | ||||||||
| Commercial construction loans |
5,561 | 6,168 | 67 | 6 | 29 | 8 | ||||||||
| Commercial leases |
3,737 | 3,841 | 5 | 2 | — | (1 | ) | |||||||
| Residential mortgage loans |
11,454 | 9,942 | 187 | 69 | 43 | 22 | ||||||||
| Home equity loans |
12,162 | 12,527 | 74 | 56 | 99 | 58 | ||||||||
| Automobile loans |
11,183 | 10,174 | 13 | 8 | 86 | 58 | ||||||||
| Other consumer loans and leases |
2,749 | 2,171 | 32 | 17 | 54 | 43 | ||||||||
| Total loans and leases managed and securitized (a) | $ | 87,865 | 79,445 | 494 | 213 | 464 | 319 | |||||||
| Less: |
||||||||||||||
| Loans securitized |
$ | 310 | 556 | |||||||||||
| Loans in unconsolidated QSPE |
2,973 | 3,386 | ||||||||||||
| Loans held for sale |
4,329 | 1,150 | ||||||||||||
| Total portfolio loans and leases | $ | 80,253 | 74,353 | |||||||||||
| (a) | Excluding securitized assets that the Bancorp continues to service but with which it has no other continuing involvement. |
A-26
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. DERIVATIVES
A-27
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| 2007 | 2006 | |||||||||
| ($ in millions) | Notional Amount |
Fair Value | Notional Amount |
Fair Value | ||||||
| Included in other assets: |
||||||||||
| Interest rate swaps related to debt |
$ | 3,000 | $ | 67 | — | — | ||||
| Forward contracts related to mortgage loans held for sale |
183 | 1 | 653 | 4 | ||||||
| Total included in other assets | $ | 68 | 4 | |||||||
| Included in other liabilities: |
||||||||||
| Interest rate swaps related to debt |
$ | 775 | $ | 21 | 2,575 | 95 | ||||
| Forward contracts related to mortgage loans held for sale |
511 | 4 | 419 | 2 | ||||||
| Total included in other liabilities | $ | 25 | 97 | |||||||
A-28
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| 2007 | 2006 | |||||||||
| ($ in millions) | Notional Amount |
Fair Value | Notional Amount |
Fair Value | ||||||
| Included in other assets: |
||||||||||
| Interest rate floors related to commercial loans |
$ | 1,500 | $ | 107 | — | — | ||||
| Interest rate caps related to debt |
1,750 | 11 | — | — | ||||||
| Total included in other assets | $ | 118 | — | |||||||
| Included in other liabilities: |
||||||||||
| Interest rate swaps related to consumer loans |
$ | 1,000 | $ | 11 | — | — | ||||
| Total included in other liabilities | $ | 11 | — | |||||||
A-29
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| ($ in millions) | 2007 | 2006 | 2005 | |||||||
| Foreign exchange contracts |
$ | 60 | 53 | 52 | ||||||
| Commodity contracts for customers |
2 | — | — | |||||||
| Interest rate lock commitments |
3 | (2 | ) | 1 | ||||||
| Derivative instruments related to held for sale mortgages |
(14 | ) | 7 | (2 | ) | |||||
| Derivative instruments related to MSR portfolio |
23 | (9 | ) | (23 | ) | |||||
| Derivative instruments related to foreign currency risk |
(19 | ) | 3 | — | ||||||
| Derivative instruments related to interest rate risk | (1 | ) | (20 | ) | 3 | |||||
A-30
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table reflects the fair value of all free-standing derivatives included in the Consolidated Balance Sheets as of December 31:
| 2007 | 2006 | |||||||||
| ($ in millions) | Notional Amount |
Fair Value | Notional Amount |
Fair Value | ||||||
| Included in other assets: |
||||||||||
| Foreign exchange contracts for customers |
$ | 7,132 | $ | 255 | 5,064 | 164 | ||||
| Interest rate contracts for customers |
12,265 | 391 | 8,174 | 110 | ||||||
| Commodity contracts for customers |
167 | 28 | 68 | 4 | ||||||
| Derivative instruments related to equity-linked CD |
50 | 5 | — | — | ||||||
| Interest rate lock commitments |
656 | 3 | 389 | 2 | ||||||
| Derivative instruments related to held for sale mortgages |
229 | 1 | 243 | 1 | ||||||
| Derivative instruments related to MSR portfolio |
3,062 | 70 | 2,335 | 14 | ||||||
| Derivative instruments related to foreign currency risk |
— | — | 68 | 1 | ||||||
| Derivative instruments related to interest rate risk |
1 | — | 213 | 9 | ||||||
| Total included in other assets | $ | 753 | 305 | |||||||
| Included in other liabilities: |
||||||||||
| Foreign exchange contracts for customers |
$ | 6,642 | $ | 234 | 4,783 | 149 | ||||
| Interest rate contracts for customers |
12,430 | 391 | 8,398 | 110 | ||||||
| Commodity contracts for customers |
163 | 22 | 62 | 4 | ||||||
| Derivative instruments related to equity-linked CD |
50 | 5 | — | — | ||||||
| Interest rate lock commitments |
253 | 1 | 750 | 3 | ||||||
| Derivative instruments related to held for sale mortgages |
588 | 9 | 103 | 1 | ||||||
| Derivative instruments related to MSR portfolio |
1,280 | 16 | 583 | 5 | ||||||
| Derivative instruments related to foreign currency risk |
153 | 1 | — | — | ||||||
| Derivative instruments related to interest rate risk |
— | — | 7 | — | ||||||
| Total included in other liabilities | $ | 679 | 272 | |||||||
A-31
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the Bancorp’s derivative instrument positions (excluding $39.8 billion in notional amount from the customer accommodation program) at December 31, 2007:
| ($ in millions) | Notional Amount |
Weighted-Average (in months) |
Average Receive Rate |
Average Pay Rate |
|||||||
| Interest rate swaps related to debt: |
|||||||||||
| Receive fixed/pay floating |
$ | 3,775 | 247 | 5.44 | % | 5.35 | % | ||||
| Mortgage lending commitments: |
|||||||||||
| Forward contracts on residential mortgage loans held for sale |
1,415 | 1 | |||||||||
| Forward contracts on commercial mortgage loans held for sale |
96 | 98 | |||||||||
| Mortgage servicing rights portfolio: |
|||||||||||
| Interest rate swaps—Receive fixed/pay floating |
1,012 | 88 | 5.44 | 5.09 | |||||||
| Interest rate swaps—Receive floating/pay fixed |
1,280 | 47 | 4.95 | 4.72 | |||||||
| Interest rate swaptions—Pay fixed |
1,375 | 2 | 5.48 | ||||||||
| Interest rate swaptions—Receive fixed |
675 | 9 | 4.31 | ||||||||
| Aggregate balance sheet risk: |
|||||||||||
| Interest rate floors |
1,500 | 64 | |||||||||
| Interest rate caps |
1,750 | 42 | |||||||||
| Forward swaps related to consumer loans |
1,000 | 23 | |||||||||
| Foreign currency forward contracts |
153 | 2 | |||||||||
| Interest rate futures/forwards |
1 | 14 | |||||||||
| Total | $ | 14,032 | |||||||||
11. OTHER ASSETS
The following table provides the components of other assets included in the Consolidated Balance Sheets as of December 31:
| ($ in millions) | 2007 | 2006 | |||
| Accounts receivable and drafts-in-process |
$ | 1,892 | 1,446 | ||
| Bank owned life insurance |
1,832 | 1,949 | |||
| Partnership investments |
958 | 698 | |||
| Derivative instruments |
939 | 309 | |||
| Accrued interest receivable |
564 | 533 | |||
| Other real estate owned |
159 | 90 | |||
| Prepaid pension and other expenses |
116 | 119 | |||
| Other |
563 | 626 | |||
| Total | $ | 7,023 | 5,770 | ||
A-32
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. SHORT-TERM BORROWINGS
| 2007 | 2006 | 2005 | ||||||||||||||||
| ($ in millions) | Amount | Rate | Amount | Rate | Amount | Rate | ||||||||||||
| As of December 31: |
||||||||||||||||||
| Federal funds purchased |
$ | 4,427 | 3.29 | % | $ | 1,421 | 5.26 | % | $ | 5,323 | 3.93 | % | ||||||
| Other short-term borrowings |
4,747 | 3.90 | 2,796 | 4.04 | 4,246 | 2.94 | ||||||||||||
| Average for the years ended December 31: |
||||||||||||||||||
| Federal funds purchased |
$ | 3,646 | 5.04 | % | $ | 4,148 | 5.02 | % | $ | 4,225 | 3.26 | % | ||||||
| Short-term bank notes |
— | — | — | — | 248 | 2.60 | ||||||||||||
| Other short-term borrowings |
3,244 | 4.32 | 4,522 | 4.28 | 5,038 | 2.74 | ||||||||||||
| Maximum month-end balance: |
||||||||||||||||||
| Federal funds purchased |
$ | 5,130 | $ | 5,434 | $ | 6,378 | ||||||||||||
| Short-term bank notes |
— | — | 775 | |||||||||||||||
| Other short-term borrowings |
5,381 | 6,287 | 6,531 | |||||||||||||||
A-33
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. LONG-TERM DEBT
A summary of long-term borrowings at December 31:
| ($ in millions) | Maturity | Interest Rate | 2007 | 2006 | |||||
| Parent Company |
|||||||||
| Senior: |
|||||||||
| Extendable notes |
2008 -2009 | 4.91% | $ | 1,745 | 1,748 | ||||
| Subordinated (b): |
|||||||||
| Fixed-rate notes |
2017 | 5.45% | 510 | 492 | |||||
| Fixed-rate notes |
2018 | 4.50% | 485 | 459 | |||||
| Floating-rate notes |
2016 | 5.35% | 250 | 250 | |||||
| Junior subordinated: |
|||||||||
| Fixed-rate debentures (b) |
2027 | 8.14% | — | 217 | |||||
| Floating-rate notes (a) |
2067 | 7.25% | 876 | — | |||||
| Floating-rate notes (a) |
2067 | 6.50% | 750 | — | |||||
| Floating-rate notes (a) |
2067 | 7.25% | 601 | — | |||||
| Subsidiaries |
|||||||||
| Senior: |
|||||||||
| Fixed-rate bank notes |
2008 -2019 | 2.87%-5.20% | 1,640 | 2,006 | |||||
| Floating-rate bank notes |
2013 | 5.02% | 500 | 500 | |||||
| Extendable bank notes |
2009 -2014 | 4.66% -5.05% | 1,200 | 1,200 | |||||
| Subordinated (b): |
|||||||||
| Fixed-rate bank notes |
2015 | 4.75% | 513 | 492 | |||||
| Junior subordinated(a): |
|||||||||
| Floating-rate bank notes |
2032 -2033 | 8.09%-8.78% | 52 | — | |||||
| Floating-rate debentures |
2027 | — | 103 | ||||||
| Floating-rate debentures |
2033 -2034 | 7.73% -7.78% | 67 | 67 | |||||
| Mandatorily redeemable securities (a) |
2031 | — | 647 | ||||||
| Federal Home Loan Bank advances |
2008 -2037 | 0% - 8.34% | 3,571 | 4,258 | |||||
| Other |
2008 -2032 | Varies | 97 | 119 | |||||
| Total | $ | 12,857 | 12,558 | ||||||
| (a) | Qualify as Tier I capital for regulatory capital purposes. |
| (b) | Qualify as Tier II capital for regulatory capital purposes. |
A-34
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A-35
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. COMMITMENTS, CONTINGENT LIABILITIES AND GUARANTEES
A-36
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A-37
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. LEGAL AND REGULATORY PROCEEDINGS
A-38
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A-39
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. RELATED PARTY TRANSACTIONS
A-40
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17. ACCUMULATED OTHER COMPREHENSIVE INCOME
| Total Other Comprehensive Income |
Total Accumulated Other Comprehensive Income |
||||||||||||||||||
| ($ in millions) | Pretax Activity |
Tax Effect |
Net Activity |
Beginning Balance |
Net Activity |
Ending Balance |
|||||||||||||
| 2007 |
|||||||||||||||||||
| Gains on available-for-sale securities |
$ | 60 | (23 | ) | 37 | ||||||||||||||
| Reclassification adjustment for net gains recognized in net income |
(21 | ) | 9 | (12 | ) | ||||||||||||||
| Unrecognized gains (losses) on available-for-sale securities |
39 | (14 | ) | 25 | (119 | ) | 25 | (94 | ) | ||||||||||
| Gains on cash flow hedge derivatives |
42 | (15 | ) | 27 | |||||||||||||||
| Reclassification adjustment for net gains on cash flow hedge derivatives recognized in net income |
(1 | ) | — | (1 | ) | ||||||||||||||
| Unrecognized gains (losses) on cash flow hedge derivatives |
41 | (15 | ) | 26 | (1 | ) | 26 | 25 | |||||||||||
| Defined benefit plans: |
|||||||||||||||||||
| Net prior service cost |
— | — | — | ||||||||||||||||
| Net actuarial loss |
3 | (1 | ) | 2 | |||||||||||||||
| Total pension and other postretirement obligations |
3 | (1 | ) | 2 | (59 | ) | 2 | (57 | ) | ||||||||||
| Total | $ | 83 | (30 | ) | 53 | (179 | ) | 53 | (126 | ) | |||||||||
| 2006 |
|||||||||||||||||||
| Gains on available-for-sale securities |
$ | 61 | (20 | ) | 41 | ||||||||||||||
| Reclassification adjustment for net losses recognized in net income |
364 | (129 | ) | 235 | |||||||||||||||
| Unrecognized gains (losses) on available-for-sale securities |
425 | (149 | ) | 276 | (395 | ) | 276 | (119 | ) | ||||||||||
| Reclassification adjustment for cash flow hedge derivative net losses recognized in net income |
20 | (8 | ) | 12 | |||||||||||||||
| Unrecognized gains (losses) on cash flow hedge derivatives |
20 | (8 | ) | 12 | (13 | ) | 12 | (1 | ) | ||||||||||
| Minimum pension liability (a) |
(5 | ) | 5 | — | |||||||||||||||
| Cumulative effect of change in accounting for pension and other postretirement obligations (a) |
— | (59 | ) | (59 | ) | ||||||||||||||
| Total | $ | 445 | (157 | ) | 288 | (413 | ) | 234 | (179 | ) | |||||||||
| 2005 |
|||||||||||||||||||
| Losses on available-for-sale securities |
$ | (455 | ) | 158 | (297 | ) | |||||||||||||
| Reclassification adjustment for net gains recognized in net income |
(39 | ) | 13 | (26 | ) | ||||||||||||||
| Unrecognized losses on available-for-sale securities |
(494 | ) | 171 | (323 | ) | (72 | ) | (323 | ) | (395 | ) | ||||||||
| Gains on cash flow hedge derivatives |
9 | (3 | ) | 6 | |||||||||||||||
| Reclassification adjustment for net losses recognized in net income |
21 | (7 | ) | 14 | |||||||||||||||
| Unrecognized gains (losses) on cash flow hedge derivatives |
30 | (10 | ) | 20 | (33 | ) | 20 | (13 | ) | ||||||||||
| Minimum pension liability |
90 | (31 | ) | 59 | (64 | ) | 59 | (5 | ) | ||||||||||
| Total | $ | (374 | ) | 130 | (244 | ) | (169 | ) | (244 | ) | (413 | ) | |||||||
| (a) | Upon adoption of SFAS No. 158, the Bancorp measured its liability for its total pension and other postretirement obligations to be $59 million. |
A-41
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
18. COMMON STOCK AND TREASURY STOCK
The following is a summary of the share activity within common stock issued and treasury stock for the years ended December 31:
| Common Stock | Treasury Stock | |||||||||||||
| ($ and shares in millions) | Value | Shares | Value | Shares | ||||||||||
| Shares at December 31, 2004 |
$ | 1,295 | 583 | $ | 1,414 | 26 | ||||||||
| Shares acquired for treasury |
— | — | 1,746 | 38 | ||||||||||
| Stock-based awards exercised, including treasury shares issued |
— | — | (206 | ) | (4 | ) | ||||||||
| Restricted stock grants |
— | — | (43 | ) | (1 | ) | ||||||||
| Shares issued in business combinations |
11 | 5 | (1,413 | ) | (26 | ) | ||||||||
| Retirement of shares |
(11 | ) | (5 | ) | (219 | ) | (5 | ) | ||||||
| Shares at December 31, 2005 |
$ | 1,295 | 583 | $ | 1,279 | 28 | ||||||||
| Shares acquired for treasury |
— | — | 82 | 2 | ||||||||||
| Stock-based awards exercised, including treasury shares issued |
— | — | (84 | ) | (2 | ) | ||||||||
| Restricted stock grants |
— | — | (45 | ) | (1 | ) | ||||||||
| Shares at December 31, 2006 |
$ | 1,295 | 583 | $ | 1,232 | 27 | ||||||||
| Shares acquired for treasury |
— | — | 1,084 | 27 | ||||||||||
| Stock-based awards exercised, including treasury shares issued |
— | — | (86 | ) | (2 | ) | ||||||||
| Restricted stock grants |
— | — | (59 | ) | (1 | ) | ||||||||
| Employee stock ownership through benefit plans |
— | — | 38 | 1 | ||||||||||
| Shares at December 31, 2007 | $ | 1,295 | 583 | $ | 2,209 | 52 | ||||||||
A-42
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
19. STOCK-BASED COMPENSATION
| Plan Category (shares in thousands) | Number of Shares to Be Issued Upon Exercise |
Weighted-Average Exercise Price |
Shares Available for Future Issuance |
|||||||
| Equity compensation plans approved by shareholders: |
7,321 | (b) | ||||||||
| Stock options (a) |
21,530 | $ | 50.61 | (b) | ||||||
| Stock appreciation rights (“SARs”) |
(c | ) | (c | ) | (b) | |||||
| Restricted stock |
3,395 | (d | ) | (b) | ||||||
| Performance units |
(e | ) | (d | ) | (b) | |||||
| Performance-based restricted stock |
124 | (d | ) | (b) | ||||||
| Employee stock purchase plan |
1,280 | (f) | ||||||||
| Deferred stock compensation plans |
275 | |||||||||
| Total shares | 25,049 | 8,876 | ||||||||
| (a) | Excludes 2.1 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 $33.46 per share. |
| (b) | Under the Incentive Compensation Plan, 20.0 million shares of stock were authorized for issuance as incentive and nonqualified stock options, SARs, restricted stock and restricted stock units, and performance shares and restricted stock awards. |
| (c) | At December 31, 2007, approximately 17.5 million SARs were outstanding at a weighted-average grant price of $41.81. 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. |
| (d) | Not applicable. |
| (e) | The number of shares to be issued is dependent upon the Bancorp achieving certain predefined performance targets and ranges from zero shares to approximately 290 thousand shares. |
| (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. |
A-43
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| 2007 | 2006 | 2005 | ||||||||||||||||
| Stock Options (shares in thousands) | Shares | Weighted- Exercise |
Shares | Weighted- Exercise |
Shares | Weighted- Exercise | ||||||||||||
| Outstanding at January 1 |
26,900 | $ | 47.58 | 31,546 | $ | 46.49 | 36,162 | $ | 45.31 | |||||||||
| Granted (a) |
4 | 40.98 | — | — | 2,515 | 22.90 | ||||||||||||
| Exercised |
(2,068 | ) | 26.91 | (1,931 | ) | 21.70 | (4,830 | ) | 21.16 | |||||||||
| Forfeited or expired |
(1,191 | ) | 53.87 | (2,715 | ) | 53.24 | (2,301 | ) | 54.30 | |||||||||
| Outstanding at December 31 |
23,645 | $ | 49.07 | 26,900 | $ | 47.58 | 31,546 | $ | 46.49 | |||||||||
| Exercisable at December 31 | 23,628 | $ | 49.07 | 25,978 | $ | 47.43 | 29,364 | $ | 46.01 | |||||||||
| (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. |
A-44
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Stock Appreciation Rights (shares in thousands) | 2007 | 2006 | 2005 | |||||||||||||||
| Shares | Weighted- Grant |
Shares | Weighted- Grant Price |
Shares | Weighted- Grant Price | |||||||||||||
| Outstanding at January 1 |
13,053 | $ | 43.43 | 7,541 | $ | 47.51 | 3,529 | $ | 54.37 | |||||||||
| Granted |
6,613 | 38.45 | 6,949 | 39.18 | 4,892 | 42.82 | ||||||||||||
| Exercised |
(56 | ) | 39.36 | — | — | — | — | |||||||||||
| Forfeited or expired |
(2,084 | ) | 41.36 | (1,437 | ) | 44.31 | (880 | ) | 48.88 | |||||||||
| Outstanding at December 31 | 17,526 | $ | 41.81 | 13,053 | $ | 43.43 | 7,541 | $ | 47.51 | |||||||||
| Exercisable at December 31 | 2,972 | $ | 41.45 | 989 | $ | 42.99 | 4 | $ | 54.37 | |||||||||
| 2007 | 2006 | 2005 | ||||||||||||||||
| Restricted Stock (shares in thousands) | Shares | Weighted- Average Grant-Date Fair Value |
Shares | Weighted- Average Grant-Date Fair Value |
Shares | Weighted- Average Grant-Date Fair Value | ||||||||||||
| Nonvested at January 1 |
2,380 | $ | 40.28 | 1,482 | $ | 46.16 | 596 | $ | 54.01 | |||||||||
| Granted |
1,622 | 38.19 | 1,265 | 38.93 | 1,086 | 42.31 | ||||||||||||
| Vested |
(39 | ) | 48.28 | (24 | ) | 44.91 | (29 | ) | 50.62 | |||||||||
| Forfeited |
(444 | ) | 40.95 | (343 | ) | 40.76 | (171 | ) | 48.19 | |||||||||
| Nonvested at December 31 | 3,519 | $ | 40.80 | 2,380 | $ | 40.28 | 1,482 | $ | 46.16 | |||||||||
A-45
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes outstanding and exercisable stock options by exercise price at December 31, 2007:
| Outstanding Stock Options | Exercisable Stock Options | |||||||||||||
| Exercise Price per Share | Number of End (000’s) |
Weighted- Average Exercise Price |
Weighted- (in years) |
Number of Options at Year End (000’s) |
Weighted- Average Exercise Price |
Weighted- Average Remaining Contractual Life (in years) | ||||||||
| Under $10.00 |
28 | $ | 7.46 | 3.17 | 28 | $ | 7.46 | 3.17 | ||||||
| $10.01-$25.00 |
629 | 19.49 | 2.33 | 629 | 19.49 | 2.33 | ||||||||
| $25.01-$40.00 |
3,762 | 36.23 | 1.01 | 3,762 | 36.23 | 1.01 | ||||||||
| $40.01-$55.00 |
14,672 | 48.30 | 3.00 | 14,664 | 48.29 | 3.00 | ||||||||
| Over $55.00 |
4,554 | 66.52 | 4.29 | 4,545 | 66.54 | 4.29 | ||||||||
| All stock options | 23,645 | $ | 49.07 | 2.91 | 23,628 | $ | 49.07 | 2.91 | ||||||
A-46
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
20. OTHER NONINTEREST INCOME AND OTHER NONINTEREST EXPENSE
The major components of other noninterest income and other noninterest expense for the years ended December 31:
| ($ in millions) | 2007 | 2006 | 2005 | |||||
| Other noninterest income: |
||||||||
| Bank owned life insurance |
$ | (106 | ) | 86 | 91 | |||
| Cardholder fees |
56 | 49 | 46 | |||||
| Consumer loan and lease fees |
46 | 47 | 50 | |||||
| Insurance income |
32 | 28 | 27 | |||||
| Operating lease income |
32 | 26 | 55 | |||||
| Banking center fees |
29 | 22 | 21 | |||||
| Gain on loan sales |
25 | 17 | 24 | |||||
| Other |
39 | 24 | 46 | |||||
| Total | $ | 153 | 299 | 360 | ||||
| Other noninterest expense: |
||||||||
| Loan processing |
$ | 119 | 93 | 89 | ||||
| Marketing |
84 | 78 | 76 | |||||
| Affordable housing investments |
57 | 42 | 35 | |||||
| Travel |
54 | 52 | 54 | |||||
| Postal and courier |
52 | 49 | 50 | |||||
| Intangible amortization |
42 | 45 | 46 | |||||
| Professional services fees |
35 | 28 | 26 | |||||
| Supplies |
31 | 28 | 35 | |||||
| Franchise and other taxes |
23 | 30 | 37 | |||||
| Operating lease |
22 | 18 | 40 | |||||
| Visa litigation expense |
172 | — | — | |||||
| Debt and other financing agreement termination |
— | 49 | — | |||||
| Other |
298 | 251 | 284 | |||||
| Total | $ | 989 | 763 | 772 | ||||
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) | 2007 | 2006 | 2005 | ||||||||
| Current income tax expense: |
|||||||||||
| U.S. income taxes |
$ | 623 | 457 | 654 | |||||||
| State and local income taxes |
16 | 7 | 21 | ||||||||
| Total current tax expense |
639 | 464 | 675 | ||||||||
| Deferred income tax expense: |
|||||||||||
| U.S. income taxes |
(197 | ) | (24 | ) | (7 | ) | |||||
| State and local income taxes |
19 | 3 | (9 | ) | |||||||
| Total deferred tax expense |
(178 | ) | (21 | ) | (16 | ) | |||||
| Applicable income tax expense | $ | 461 | $ | 443 | 659 | ||||||
A-47
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A reconciliation between the statutory U.S. income tax rate and the Bancorp’s effective tax rate for the years ended December 31:
| 2007 | 2006 | 2005 | |||||||
| Statutory tax rate |
35.0 | % | 35.0 | 35.0 | |||||
| Increase (decrease) resulting from: |
|||||||||
| State taxes, net of federal benefit |
1.5 | .4 | .4 | ||||||
| Tax-exempt income |
1.4 | (2.8 | ) | (2.3 | ) | ||||
| Credits |
(5.0 | ) | (3.9 | ) | (2.3 | ) | |||
| Dividends on subsidiary preferred stock |
(2.5 | ) | (2.2 | ) | (1.7 | ) | |||
| Other, net |
(.4 | ) | .7 | .8 | |||||
| Effective tax rate | 30.0 | % | 27.2 | 29.9 |
A-48
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| ($ in millions) | 2007 | |||
| Unrecognized tax benefits at January 1 |
$ | 446 | ||
| Gross increases for tax positions taken during prior period |
— | |||
| Gross decreases for tax positions taken during prior period |
— | |||
| Gross increases for tax positions taken during current period |
47 | |||
| Settlements with taxing authorities |
(4 | ) | ||
| Lapse of applicable statute of limitations |
(20 | ) | ||
| Unrecognized tax benefits at December 31 | $ | 469 | ||
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) | 2007 | 2006 | |||
| Deferred tax assets: |
|||||
| Allowance for credit losses |
$ | 328 | 270 | ||
| Deferred compensation |
174 | 160 | |||
| Other comprehensive income |
68 | 98 | |||
| State net operating losses |
72 | 112 | |||
| Other |
221 | 117 | |||
| Total deferred tax assets |
863 | 757 | |||
| Deferred tax liabilities: |
|||||
| Lease financing |
1,344 | 1,750 | |||
| State deferred taxes |
149 | 189 | |||
| Bank premises and equipment |
75 | 70 | |||
| Mortgage servicing rights |
160 | 124 | |||
| Other |
154 | 173 | |||
| Total deferred tax liabilities |
1,882 | 2,306 | |||
| Total net deferred tax liability | $ | 1,019 | 1,549 | ||
A-49
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
22. RETIREMENT AND BENEFIT PLANS
A-50
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A-51
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
23. EARNINGS PER SHARE
The calculation of earnings per share and the reconciliation of earnings per share to earnings per diluted share for the years ended December 31:
| (in millions, except per share data) | 2007 | 2006 | 2005 | ||||||||||||||||||||||||
| Income | Average Shares |
Per Share Amount |
Income | Average Shares |
Per Share Amount |
Income | Average Shares |
Per Share Amount |
|||||||||||||||||||
| Earnings per share: |
|||||||||||||||||||||||||||
| Net income before cumulative effect |
$ | 1,076 | $ | 1,184 | $ | 1,549 | |||||||||||||||||||||
| Net income available to common shareholders before cumulative effect (a) |
1,075 | 538 | $ | 2.00 | 1,184 | 555 | $ | 2.13 | 1,548 | 554 | $ | 2.79 | |||||||||||||||
| Cumulative effect of change in accounting principle, net of tax |
— | — | — | 4 | — | .01 | — | — | — | ||||||||||||||||||
| Net income available to common shareholders (a) |
$ | 1,075 | 538 | $ | 2.00 | $ | 1,188 | 555 | $ | 2.14 | $ | 1,548 | 554 | $ | 2.79 | ||||||||||||
| Earnings per diluted share: |
|||||||||||||||||||||||||||
| Net income available to common shareholders before cumulative effect |
$ | 1,075 | 538 | $ | 2.00 | $ | 1,184 | 555 | $ | 2.13 | $ | 1,548 | 554 | $ | 2.79 | ||||||||||||
| Effect of dilutive securities: |
|||||||||||||||||||||||||||
| Stock based awards |
2 | (.01 | ) | 2 | (.01 | ) | 4 | (.02 | ) | ||||||||||||||||||
| Convertible preferred stock (b) |
— | — | — | — | — | — | — | — | — | ||||||||||||||||||
| Income plus assumed conversions before cumulative effect |
1,076 | 540 | $ | 1.99 | 1,184 | 557 | $ | 2.12 | 1,549 | 558 | $ | 2.77 | |||||||||||||||
| Cumulative effect of change in accounting principle, net of tax |
— | — | — | 4 | — | .01 | — | — | — | ||||||||||||||||||
| Net income available to common shareholders plus assumed conversions |
$ | 1,076 | 540 | $ | 1.99 | $ | 1,188 | 557 | $ | 2.13 | $ | 1,549 | 558 | $ | 2.77 | ||||||||||||
A-52
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| (a) | Dividends on preferred stock are $.740 million for all periods presented. |
| (b) | The additive effect to income from dividends on convertible preferred stock is $.580 million and the average share dilutive effect from convertible preferred stock is ..308 million shares for all periods presented. |
24. FAIR VALUE OF FINANCIAL INSTRUMENTS
Carrying amounts and estimated fair values for financial instruments as of December 31:
| 2007 | 2006 | ||||||||
| ($ in millions) | Carrying Amount |
Fair Value |
Carrying Amount |
Fair Value | |||||
| Financial assets: |
|||||||||
| Cash and due from banks |
$ | 2,687 | 2,687 | 2,737 | 2,737 | ||||
| Available-for-sale and other securities |
10,677 | 10,677 | 11,053 | 11,053 | |||||
| Held-to-maturity securities |
355 | 355 | 356 | 356 | |||||
| Trading securities |
171 | 171 | 187 | 187 | |||||
| Other short-term investments |
593 | 593 | 809 | 809 | |||||
| Loans held for sale |
4,329 | 4,371 | 1,150 | 1,152 | |||||
| Portfolio loans and leases, net |
79,316 | 79,600 | 73,582 | 73,660 | |||||
| Derivative assets |
939 | 939 | 309 | 309 | |||||
| Financial liabilities: |
|||||||||
| Deposits |
75,445 | 75,378 | 69,380 | 69,371 | |||||
| Federal funds purchased |
4,427 | 4,427 | 1,421 | 1,421 | |||||
| Other short-term borrowings |
4,747 | 4,747 | 2,796 | 2,796 | |||||
| Long-term debt |
12,857 | 13,298 | 12,558 | 12,762 | |||||
| Derivative liabilities |
715 | 715 | 369 | 369 | |||||
| Short positions |
35 | 35 | 29 | 29 | |||||
| Other financial instruments: |
|||||||||
| Commitments to extend credit |
94 | 94 | 75 | 75 | |||||
| Letters of credit |
26 | 26 | 23 | 23 | |||||
A-53
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
25. CERTAIN REGULATORY REQUIREMENTS AND CAPITAL RATIOS
A-54
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A-55
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Capital and risk-based capital and leverage ratios for the Bancorp and its significant subsidiary banks at December 31:
| 2007 | 2006 | |||||||||||
| ($ in millions) | Amount | Ratio | Amount | Ratio | ||||||||
| Total risk-based capital (to risk-weighted assets): |
||||||||||||
| Fifth Third Bancorp (Consolidated) |
$ | 11,733 | 10.16 | % | $ | 11,385 | 11.07 | % | ||||
| Fifth Third Bank (Ohio) |
6,058 | 10.39 | 6,573 | 12.82 | ||||||||
| Fifth Third Bank (Michigan) |
5,787 | 10.13 | 5,814 | 11.41 | ||||||||
| Fifth Third Bank, N.A. |
519 | 21.76 | 216 | 11.78 | ||||||||
| Tier I capital (to risk-weighted assets): |
||||||||||||
| Fifth Third Bancorp (Consolidated) |
8,924 | 7.72 | 8,625 | 8.39 | ||||||||
| Fifth Third Bank (Ohio) |
4,744 | 8.13 | 5,336 | 10.41 | ||||||||
| Fifth Third Bank (Michigan) |
5,191 | 9.09 | 5,341 | 10.48 | ||||||||
| Fifth Third Bank, N.A. |
503 | 21.07 | 203 | 11.07 | ||||||||
| Tier I leverage (to average assets): |
||||||||||||
| Fifth Third Bancorp (Consolidated) |
8,924 | 8.50 | 8,625 | 8.44 | ||||||||
| Fifth Third Bank (Ohio) |
4,744 | 8.11 | 5,336 | 9.53 | ||||||||
| Fifth Third Bank (Michigan) |
5,191 | 10.55 | 5,341 | 11.30 | ||||||||
| Fifth Third Bank, N.A. |
503 | 25.59 | 203 | 12.52 | ||||||||
A-56
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
26. PARENT COMPANY FINANCIAL STATEMENTS
($ in millions)
A-57
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
27. SEGMENTS
A-58
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| ($ in millions) | Commercial Banking |
Branch Banking |
Consumer Lending |
Investment Advisors |
Processing Solutions |
General Corporate |
Eliminations | Total | |||||||||||||
| 2007 |
|||||||||||||||||||||
| Net interest income (a) |
$ | 1,310 | 1,465 | 404 | 154 | (6 | ) | (294 | ) | — | 3,033 | ||||||||||
| Provision for loan and lease losses |
127 | 162 | 148 | 13 | 11 | 167 | — | 628 | |||||||||||||
| Net interest income after provision for loan and lease losses |
1,183 | 1,303 | 256 | 141 | (17 | ) | (461 | ) | — | 2,405 | |||||||||||
| Noninterest income: |
|||||||||||||||||||||
| Electronic payment processing |
(6 | ) | 174 | — | 1 | 699 | 1 | (43 | )(b) | 826 | |||||||||||
| Service charges on deposits |
154 | 421 | — | 7 | (1 | ) | (2 | ) | — | 579 | |||||||||||
| Investment advisory revenue |
3 | 90 | — | 386 | — | (5 | ) | (92 | )(c) | 382 | |||||||||||
| Corporate banking revenue |
341 | 13 | — | 10 | 3 | — | — | 367 | |||||||||||||
| Mortgage banking net revenue |
— | 7 | 122 | 2 | — | 2 | — | 133 | |||||||||||||
| Other noninterest income |
66 | 74 | 69 | 2 | 41 | (99 | ) | — | 153 | ||||||||||||
| Securities gains (losses), net |
— | — | 6 | — | — | 21 | — | 27 | |||||||||||||
| Total noninterest income |
558 | 779 | 197 | 408 | 742 | (82 | ) | (135 | ) | 2,467 | |||||||||||
| Noninterest expense: |
|||||||||||||||||||||
| Salaries, wages and incentives |
220 | 382 | 56 | 140 | 62 | 379 | — | 1,239 | |||||||||||||
| Employee benefits |
44 | 101 | 28 | 27 | 13 | 65 | — | 278 | |||||||||||||
| Payment processing expense |
— | 6 | — | — | 237 | 1 | — | 244 | |||||||||||||
| Net occupancy expense |
15 | 136 | 8 | 10 | 4 | 96 | — | 269 | |||||||||||||
| Technology and communications |
4 | 14 | 2 | 2 | 31 | 116 | — | 169 | |||||||||||||
| Equipment expense |
3 | 37 | 1 | 1 | 4 | 77 | — | 123 | |||||||||||||
| Other noninterest expense |
507 | 447 | 158 | 215 | 137 | (340 | ) | (135 | ) | 989 | |||||||||||
| Total noninterest expense |
793 | 1,123 | 253 | 395 | 488 | 394 | (135 | ) | 3,311 | ||||||||||||
| Income before income taxes |
948 | 959 | 200 | 154 | 237 | (937 | ) | — | 1,561 | ||||||||||||
| Applicable income taxes (a) |
246 | 338 | 70 | 54 | 84 | (307 | ) | — | 485 | ||||||||||||
| Net income |
$ | 702 | 621 | 130 | 100 | 153 | (630 | ) | — | 1,076 | |||||||||||
| Average assets | $ | 38,796 | 45,054 | 23,728 | 5,923 | 1,068 | (12,092 | ) | — | 102,477 | |||||||||||
| (a) | Includes taxable-equivalent adjustments of $24 million. |
| (b) | Electronic payment processing service revenues provided to the banking segments are eliminated in the Consolidated Statements of Income. |
| (c) | Revenue sharing agreements between Investment Advisors and Branch Banking are eliminated in the Consolidated Statements of Income. |
A-59
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| ($ in millions) | Commercial Banking |
Branch Banking |
Consumer Lending |
Investment Advisors |
Processing Solutions |
General Corporate |
Eliminations | Total | ||||||||||||||
| 2006 |
||||||||||||||||||||||
| Net interest income (a) |
$ | 1,317 | 1,300 | 409 | 139 | (3 | ) | (263 | ) | — | 2,899 | |||||||||||
| Provision for loan and lease losses |
99 | 108 | 94 | 4 | 9 | 29 | — | 343 | ||||||||||||||
| Net interest income after provision for loan and lease losses |
1,218 | 1,192 | 315 | 135 | (12 | ) | (292 | ) | — | 2,556 | ||||||||||||
| Noninterest income: |
||||||||||||||||||||||
| Electronic payment processing |
(5 | ) | 159 | — | 1 | 601 | (1 | ) | (38 | )(b) | 717 | |||||||||||
| Service charges on deposits |
146 | 365 | — | 7 | (1 | ) | — | — | 517 | |||||||||||||
| Investment advisory revenue |
3 | 87 | — | 367 | — | (3 | ) | (87 | )(c) | 367 | ||||||||||||
| Corporate banking revenue |
292 | 15 | — | 7 | 1 | 3 | — | 318 | ||||||||||||||
| Mortgage banking net revenue |
— | 5 | 148 | 2 | — | — | — | 155 | ||||||||||||||
| Other noninterest income |
40 | 80 | 78 | 2 | 35 | 64 | — | 299 | ||||||||||||||
| Securities gains (losses), net |
— | — | — | — | (1 | ) | (363 | ) | — | (364 | ) | |||||||||||
| Securities gains, net—non qualifying hedges on mortgage servicing rights |
— | — | 3 | — | — | — | — | 3 | ||||||||||||||
| Total noninterest income |
476 | 711 | 229 | 386 | 635 | (300 | ) | (125 | ) | 2,012 | ||||||||||||
| Noninterest expense: |
||||||||||||||||||||||
| Salaries, wages and incentives |
200 | 357 | 66 | 143 | 57 | 351 | — | 1,174 | ||||||||||||||
| Employee benefits |
44 | 100 | 32 | 29 | 13 | 74 | — | 292 | ||||||||||||||
| Payment processing expense |
— | 15 | — | — | 169 | — | — | 184 | ||||||||||||||
| Net occupancy expense |
14 | 121 | 8 | 10 | 3 | 89 | — | 245 | ||||||||||||||
| Technology and communications |
— | 13 | 2 | 2 | 32 | 92 | — | 141 | ||||||||||||||
| Equipment expense |
2 | 32 | 1 | 1 | 4 | 76 | — | 116 | ||||||||||||||
| Other noninterest expense |
467 | 397 | 158 | 196 | 132 | (462 | ) | (125 | ) | 763 | ||||||||||||
| Total noninterest expense |
727 | 1,035 | 267 | 381 | 410 | 220 | (125 | ) | 2,915 | |||||||||||||
| Income before income taxes and cumulative effect |
967 | 868 | 277 | 140 | 213 | (812 | ) | — | 1,653 | |||||||||||||
| Applicable income taxes (a) |
274 | 306 | 98 | 49 | 75 | (333 | ) | — | 469 | |||||||||||||
| Income before cumulative effect |
693 | 562 | 179 | 91 | 138 | (479 | ) | — | 1,184 | |||||||||||||
| Cumulative effect of change in accounting principle, net of tax |
— | — | — | — | — | 4 | — | 4 | ||||||||||||||
| Net income | $ | 693 | 562 | 179 | 91 | 138 | (475 | ) | — | 1,188 | ||||||||||||
| Average assets | $ | 35,134 | 43,428 | 22,154 | 5,500 | 586 | (1,563 | ) | — | 105,238 | ||||||||||||
| (a) | Includes taxable-equivalent adjustments of $26 million. |
| (b) | Electronic payment processing service revenues provided to the banking segments are eliminated in the Consolidated Statements of Income. |
| (c) | Revenue sharing agreements between Investment Advisors and Branch Banking are eliminated in the Consolidated Statements of Income. |
A-60
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| ($ in millions) | Commercial Banking |
Branch Banking |
Consumer Lending |
Investment Advisors |
Processing Solutions |
General Corporate |
Eliminations | Total | ||||||||||||
| 2005 |
||||||||||||||||||||
| Net interest income (a) |
$ | 1,177 | 1,210 | 424 | 122 | (9 | ) | 72 | — | 2,996 | ||||||||||
| Provision for loan and lease losses |
90 | 97 | 89 | 4 | 18 | 32 | — | 330 | ||||||||||||
| Net interest income after provision for loan and lease losses |
1,087 | 1,113 | 335 | 118 | (27 | ) | 40 | — | 2,666 | |||||||||||
| Noninterest income: |
||||||||||||||||||||
| Electronic payment processing |
— | 143 | — | 1 | 517 | (4 | ) | (35 | )(b) | 622 | ||||||||||
| Service charges on deposits |
149 | 368 | — | 7 | (1 | ) | (1 | ) | — | 522 | ||||||||||
| Investment advisory revenue |
3 | 86 | — | 360 | — | (5 | ) | (86 | )(c) | 358 | ||||||||||
| Corporate banking revenue |
276 | 19 | — | 2 | 1 | 1 | — | 299 | ||||||||||||
| Mortgage banking net revenue |
— | 5 | 165 | 2 | — | 2 | — | 174 | ||||||||||||
| Other noninterest income |
30 | 67 | 124 | 5 | 41 | 93 | — | 360 | ||||||||||||
| Securities gains (losses), net |
— | — | — | — | — | 39 | — | 39 | ||||||||||||
| Total noninterest income |
458 | 688 | 289 | 377 | 558 | 125 | (121 | ) | 2,374 | |||||||||||
| Noninterest expense: |
||||||||||||||||||||
| Salaries, wages and incentives |
201 | 362 | 59 | 140 | 44 | 327 | — | 1,133 | ||||||||||||
| Employee benefits |
46 | 104 | 30 | 29 | 9 | 65 | — | 283 | ||||||||||||
| Payment processing expense |
— | 17 | — | — | 127 | 1 | — | 145 | ||||||||||||
| Net occupancy expense |
12 | 110 | 6 | 8 | 3 | 82 | — | 221 | ||||||||||||
| Technology and communications |
3 | 13 | 1 | 2 | 31 | 92 | — | 142 | ||||||||||||
| Equipment expense |
1 | 28 | 1 | 1 | 3 | 71 | — | 105 | ||||||||||||
| Other noninterest expense |
434 | 371 | 214 | 203 | 125 | (454 | ) | (121 | ) | 772 | ||||||||||
| Total noninterest expense |
697 | 1,005 | 311 | 383 | 342 | 184 | (121 | ) | 2,801 | |||||||||||
| Income before income taxes |
848 | 796 | 313 | 112 | 189 | (19 | ) | — | 2,239 | |||||||||||
| Applicable income taxes (a) |
248 | 281 | 110 | 40 | 66 | (55 | ) | — | 690 | |||||||||||
| Net income | $ | 600 | 515 | 203 | 72 | 123 | 36 | — | 1,549 | |||||||||||
| Average assets | $ | 31,062 | 41,139 | 20,627 | 4,568 | 502 | 4,978 | — | 102,876 | |||||||||||
| (a) | Includes taxable-equivalent adjustments of $31 million. |
| (b) | Electronic payment processing service revenues provided to the banking segments are eliminated in the Consolidated Statements of Income. |
| (c) | Revenue sharing agreements between Investment Advisors and Branch Banking are eliminated in the Consolidated Statements of Income. |
A-61
Table of Contents
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of Fifth Third Bancorp:
We have audited the internal control over financial reporting of Fifth Third Bancorp and subsidiaries (the “Bancorp”) as of December 31, 2007, 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, included in the accompanying Management’s Assessment as to the Effectiveness of Internal Control over Financial Reporting. Our responsibility is to express an opinion on 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, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
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, the Bancorp maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, 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, 2007 of the Bancorp and our report dated February 22, 2008 expressed an unqualified opinion on those consolidated financial statements.
Cincinnati, Ohio
February 22, 2008
A-62
Table of Contents
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, 2007 and 2006, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. These consolidated financial statements are the responsibility of the Bancorp’s management. Our responsibility is to express an opinion on these consolidated 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, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, 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 Bancorp’s internal control over financial reporting as of December 31, 2007, 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 22, 2008 expressed unqualified opinion on the Bancorp’s internal control over financial reporting.
Cincinnati, Ohio
February 22, 2008
A-63
Table of Contents
Management’s Discussion and Analysis of Financial Condition at December 31, 2007 and 2006 and Results of Operations for each of the years in the three year period ended December 31, 2007, as included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007.
B-1
Table of Contents
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 and weakening in the economy, specifically the real estate market, 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) deteriorating credit quality; (3) political developments, wars or other hostilities may disrupt or increase volatility in securities markets or other economic conditions; (4) changes in the interest rate environment reduce interest margins; (5) prepayment speeds, loan origination and sale volumes, charge-offs and loan loss provisions; (6) Fifth Third’s ability to maintain required capital levels and adequate sources of funding and liquidity; (7) changes and trends in capital markets; (8) competitive pressures among depository institutions increase significantly; (9) effects of critical accounting policies and judgments; (10) changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board or other regulatory agencies; (11) 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; (12) ability to maintain favorable ratings from rating agencies; (13) fluctuation of Fifth Third’s stock price; (14) ability to attract and retain key personnel; (15) ability to receive dividends from its subsidiaries; (16) potentially dilutive effect of future acquisitions on current shareholders’ ownership of Fifth Third; (17) effects of accounting or financial results of one or more acquired entities; (18) difficulties in combining the operations of acquired entities; (19) ability to secure confidential information through the use of computer systems and telecommunications networks; and (20) 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.
B-2
Table of Contents
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) | 2007 | 2006 | 2005 | 2004 | 2003 | |||||||
| Income Statement Data |
||||||||||||
| Net interest income (a) |
$ | 3,033 | 2,899 | 2,996 | 3,048 | 2,944 | ||||||
| Noninterest income |
2,467 | 2,012 | 2,374 | 2,355 | 2,398 | |||||||
| Total revenue (a) |
5,500 | 4,911 | 5,370 | 5,403 | 5,342 | |||||||
| Provision for loan and lease losses |
628 | 343 | 330 | 268 | 399 | |||||||
| Noninterest expense |
3,311 | 2,915 | 2,801 | 2,863 | 2,466 | |||||||
| Net income |
1,076 | 1,188 | 1,549 | 1,525 | 1,665 | |||||||
| Common Share Data |
||||||||||||
| Earnings per share, basic |
$ | 2.00 | 2.14 | 2.79 | 2.72 | 2.91 | ||||||
| Earnings per share, diluted |
1.99 | 2.13 | 2.77 | 2.68 | 2.87 | |||||||
| Cash dividends per common share |
1.70 | 1.58 | 1.46 | 1.31 | 1.13 | |||||||
| Book value per share |
17.20 | 18.02 | 17.00 | 16.00 | 15.29 | |||||||
| Dividend payout ratio |
84.9 | % | 74.2 | 52.7 | 48.9 | 39.4 | ||||||
| Financial Ratios |
||||||||||||
| Return on average assets |
1.05 | % | 1.13 | 1.50 | 1.61 | 1.90 | ||||||
| Return on average equity |
11.2 | 12.1 | 16.6 | 17.2 | 19.0 | |||||||
| Average equity as a percent of average assets |
9.35 | 9.32 | 9.06 | 9.34 | 10.01 | |||||||
| Tangible equity |
6.05 | 7.79 | 6.87 | 8.35 | 8.56 | |||||||
| Net interest margin (a) |
3.36 | 3.06 | 3.23 | 3.48 | 3.62 | |||||||
| Efficiency (a) |
60.2 | 59.4 | 52.1 | 53.0 | 46.2 | |||||||
| Credit Quality |
||||||||||||
| Net losses charged off |
$ | 462 | 316 | 299 | 252 | 312 | ||||||
| Net losses charged off as a percent of average loans and leases |
.61 | % | .44 | .45 | .45 | .63 | ||||||
| Allowance for loan and lease losses as a percent of loans and leases |
1.17 | 1.04 | 1.06 | 1.19 | 1.33 | |||||||
| Allowance for credit losses as a percent of loans and leases |
1.29 | 1.14 | 1.16 | 1.31 | 1.47 | |||||||
| Nonperforming assets as a percent of loans, leases and other assets, including other real estate owned |
1.32 | .61 | .52 | .51 | .61 | |||||||
| Average Balances |
||||||||||||
| Loans and leases, including held for sale |
$ | 78,348 | 73,493 | 67,737 | 57,042 | 52,414 | ||||||
| Total securities and other short-term investments |
11,994 | 21,288 | 24,999 | 30,597 | 28,947 | |||||||
| Total assets |
102,477 | 105,238 | 102,876 | 94,896 | 87,481 | |||||||
| Transaction deposits (b) |
50,987 | 49,678 | 48,177 | 43,260 | 40,372 | |||||||
| Core deposits (c) |
61,765 | 60,178 | 56,668 | 49,468 | 46,798 | |||||||
| Wholesale funding (d) |
27,254 | 31,691 | 33,615 | 33,629 | 28,812 | |||||||
| Shareholders’ equity |
9,583 | 9,811 | 9,317 | 8,860 | 8,754 | |||||||
| Regulatory Capital Ratios |
||||||||||||
| Tier I capital |
7.72 | % | 8.39 | 8.35 | 10.31 | 10.97 | ||||||
| Total risk-based capital |
10.16 | 11.07 | 10.42 | 12.31 | 13.42 | |||||||
| Tier I leverage | 8.50 | 8.44 | 8.08 | 8.89 | 9.11 | |||||||
| (a) | Amounts presented on a fully taxable equivalent basis (“FTE”). The taxable equivalent adjustments for years ending December 31, 2007, 2006, 2005, 2004 and 2003 were $24 million, $26 million, $31 million, $36 million and $39 million, respectively. |
| (b) | Includes demand, interest checking, savings, money market and foreign office deposits. |
| (c) | Includes transaction deposits plus other time deposits. |
| (d) | Includes certificates $100,000 and over, other foreign office deposits, federal funds purchased, short-term borrowings and long-term debt. |
B-3
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 2: QUARTERLY INFORMATION | |||||||||||||||||
| 2007 | 2006 | ||||||||||||||||
| For the three months ended ($ in millions, except per share data) | 12/31 | 9/30 | 6/30 | 3/31 | 12/31 | 9/30 | 6/30 | 3/31 | |||||||||
| Net interest income (FTE) |
$ | 785 | 760 | 745 | 742 | 744 | 719 | 716 | 718 | ||||||||
| Provision for loan and lease losses |
284 | 139 | 121 | 84 | 107 | 87 | 71 | 78 | |||||||||
| Noninterest income |
509 | 681 | 669 | 608 | 181 | 626 | 622 | 584 | |||||||||
| Noninterest expense |
940 | 853 | 765 | 753 | 760 | 731 | 726 | 698 | |||||||||
| Income before cumulative effect |
16 | 325 | 376 | 359 | 66 | 377 | 382 | 359 | |||||||||
| Cumulative effect of change in accounting principle, net of tax |
— | — | — | — | — | — | — | 4 | |||||||||
| Net income |
16 | 325 | 376 | 359 | 66 | 377 | 382 | 363 | |||||||||
| Earnings per share, basic |
.03 | .61 | .69 | .65 | .12 | .68 | .69 | .66 | |||||||||
| Earnings per share, diluted | .03 | .61 | .69 | .65 | .12 | .68 | .69 | .65 | |||||||||
OVERVIEW
B-4
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-5
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RECENT ACCOUNTING STANDARDS
B-6
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
B-7
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-8
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-9
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RISK FACTORS
B-10
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-11
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-12
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-13
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-14
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
STATEMENTS OF INCOME ANALYSIS
B-15
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 3: CONDENSED CONSOLIDATED STATEMENTS OF INCOME | ||||||||||||
| For the years ended December 31 ($ in millions, except per share data) | 2007 | 2006 | 2005 | 2004 | 2003 | |||||||
| Interest income (FTE) |
$ | 6,051 | 5,981 | 5,026 | 4,150 | 4,030 | ||||||
| Interest expense |
3,018 | 3,082 | 2,030 | 1,102 | 1,086 | |||||||
| Net interest income (FTE) |
3,033 | 2,899 | 2,996 | 3,048 | 2,944 | |||||||
| Provision for loan and lease losses |
628 | 343 | 330 | 268 | 399 | |||||||
| Net interest income after provision for loan and lease losses (FTE) |
2,405 | 2,556 | 2,666 | 2,780 | 2,545 | |||||||
| Noninterest income |
2,467 | 2,012 | 2,374 | 2,355 | 2,398 | |||||||
| Noninterest expense |
3,311 | 2,915 | 2,801 | 2,863 | 2,466 | |||||||
| Income from continuing operations before income taxes, minority interest and cumulative effect (FTE) |
1,561 | 1,653 | 2,239 | 2,273 | 2,477 | |||||||
| Fully taxable equivalent adjustment |
24 | 26 | 31 | 36 | 39 | |||||||
| Applicable income taxes |
461 | 443 | 659 | 712 | 786 | |||||||
| Income from continuing operations before minority interest and cumulative effect |
1,076 | 1,184 | 1,549 | 1,525 | 1,652 | |||||||
| Minority interest, net of tax |
— | — | — | — | (20 | ) | ||||||
| Income from continuing operations before cumulative effect |
1,076 | 1,184 | 1,549 | 1,525 | 1,632 | |||||||
| Income from discontinued operations, net of tax |
— | — | — | — | 44 | |||||||
| Income before cumulative effect |
1,076 | 1,184 | 1,549 | 1,525 | 1,676 | |||||||
| Cumulative effect of change in accounting principle, net of tax |
— | 4 | — | — | (11 | ) | ||||||
| Net income | $ | 1,076 | 1,188 | 1,549 | 1,525 | 1,665 | ||||||
| Earnings per share, basic |
$ | 2.00 | 2.14 | 2.79 | 2.72 | 2.91 | ||||||
| Earnings per share, diluted |
1.99 | 2.13 | 2.77 | 2.68 | 2.87 | |||||||
| Cash dividends declared per common share | 1.70 | 1.58 | 1.46 | 1.31 | 1.13 | |||||||
B-16
Table of Contents
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 | 2007 | 2006 | 2005 | |||||||||||||||||||||||||||
| ($ in millions) | Average Balance |
Revenue/ Cost |
Average Yield/ Rate |
Average Balance |
Revenue/ Cost |
Average Yield/ Rate |
Average Balance |
Revenue/ Cost |
Average Yield/ Rate |
|||||||||||||||||||||
| Assets |
||||||||||||||||||||||||||||||
| Interest-earning assets: |
||||||||||||||||||||||||||||||
| Loans and leases (a): |
||||||||||||||||||||||||||||||
| Commercial loans |
$ | 22,351 | $ | 1,639 | 7.33 | % | $ | 20,504 | $ | 1,479 | 7.21 | % | $ | 18,310 | $ | 1,063 | 5.81 | % | ||||||||||||
| Commercial mortgage |
11,078 | 801 | 7.23 | 9,797 | 700 | 7.15 | 8,923 | 551 | 6.17 | |||||||||||||||||||||
| Commercial construction |
5,661 | 421 | 7.44 | 6,015 | 460 | 7.64 | 5,525 | 342 | 6.19 | |||||||||||||||||||||
| Commercial leases |
3,683 | 158 | 4.29 | 3,730 | 185 | 4.97 | 3,495 | 179 | 5.11 | |||||||||||||||||||||
| Subtotal—commercial |
42,773 | 3,019 | 7.06 | 40,046 | 2,824 | 7.05 | 36,253 | 2,135 | 5.89 | |||||||||||||||||||||
| Residential mortgage |
10,489 | 642 | 6.13 | 9,574 | 568 | 5.94 | 8,982 | 495 | 5.51 | |||||||||||||||||||||
| Home equity |
11,887 | 897 | 7.54 | 12,070 | 900 | 7.45 | 11,228 | 683 | 6.08 | |||||||||||||||||||||
| Automobile loans |
10,704 | 675 | 6.30 | 9,570 | 552 | 5.77 | 8,649 | 455 | 5.26 | |||||||||||||||||||||
| Credit card |
1,276 | 132 | 10.39 | 838 | 99 | 11.84 | 728 | 81 | 11.13 | |||||||||||||||||||||
| Other consumer loans and leases |
1,219 | 65 | 5.29 | 1,395 | 68 | 4.87 | 1,897 | 81 | 4.27 | |||||||||||||||||||||
| Subtotal—consumer |
35,575 | 2,411 | 6.78 | 33,447 | 2,187 | 6.54 | 31,484 | 1,795 | 5.70 | |||||||||||||||||||||
| Total loans and leases |
78,348 | 5,430 | 6.93 | 73,493 | 5,011 | 6.82 | 67,737 | 3,930 | 5.80 | |||||||||||||||||||||
| Securities: |
||||||||||||||||||||||||||||||
| Taxable |
11,131 | 566 | 5.08 | 20,306 | 904 | 4.45 | 24,017 | 1,032 | 4.30 | |||||||||||||||||||||
| Exempt from income taxes (a) |
499 | 36 | 7.29 | 604 | 45 | 7.38 | 789 | 58 | 7.39 | |||||||||||||||||||||
| Other short-term investments |
364 | 19 | 5.33 | 378 | 21 | 5.52 | 193 | 6 | 2.89 | |||||||||||||||||||||
| Total interest-earning assets |
90,342 | 6,051 | 6.70 | 94,781 | 5,981 | 6.31 | 92,736 | 5,026 | 5.42 | |||||||||||||||||||||
| Cash and due from banks |
2,315 | 2,495 | 2,758 | |||||||||||||||||||||||||||
| Other assets |
10,613 | 8,713 | 8,102 | |||||||||||||||||||||||||||
| Allowance for loan and lease losses |
(793 | ) | (751 | ) | (720 | ) | ||||||||||||||||||||||||
| Total assets | $ | 102,477 | $ | 105,238 | $ | 102,876 | ||||||||||||||||||||||||
| Liabilities and Shareholders’ Equity |
||||||||||||||||||||||||||||||
| Interest-bearing liabilities: |
||||||||||||||||||||||||||||||
| Interest-bearing core deposits: |
||||||||||||||||||||||||||||||
| Interest checking |
$ | 14,820 | $ | 318 | 2.14 | % | $ | 16,650 | $ | 398 | 2.39 | % | $ | 18,884 | $ | 314 | 1.66 | % | ||||||||||||
| Savings |
14,836 | 456 | 3.07 | 12,189 | 363 | 2.98 | 10,007 | 176 | 1.76 | |||||||||||||||||||||
| Money market |
6,308 | 269 | 4.26 | 6,366 | 261 | 4.10 | 5,170 | 140 | 2.71 | |||||||||||||||||||||
| Foreign office deposits |
1,762 | 73 | 4.15 | 732 | 29 | 3.93 | 248 | 6 | 2.59 | |||||||||||||||||||||
| Other time deposits |
10,778 | 495 | 4.59 | 10,500 | 433 | 4.12 | 8,491 | 263 | 3.09 | |||||||||||||||||||||
| Total interest-bearing core deposits |
48,504 | 1,611 | 3.32 | 46,437 | 1,484 | 3.20 | 42,800 | 899 | 2.10 | |||||||||||||||||||||
| Certificates—$100,000 and over |
6,466 | 328 | 5.07 | 5,795 | 278 | 4.80 | 4,001 | 129 | 3.22 | |||||||||||||||||||||
| Other foreign office deposits |
1,393 | 68 | 4.91 | 2,979 | 148 | 4.97 | 3,719 | 120 | 3.21 | |||||||||||||||||||||
| Federal funds purchased |
3,646 | 184 | 5.04 | 4,148 | 208 | 5.02 | 4,225 | 138 | 3.26 | |||||||||||||||||||||
| Short-term bank notes |
— | — | — | — | — | — | 248 | 6 | 2.60 | |||||||||||||||||||||
| Other short-term borrowings |
3,244 | 140 | 4.32 | 4,522 | 194 | 4.28 | 5,038 | 138 | 2.74 | |||||||||||||||||||||
| Long-term debt |
12,505 | 687 | 5.50 | 14,247 | 770 | 5.40 | 16,384 | 600 | 3.66 | |||||||||||||||||||||
| Total interest-bearing liabilities |
75,758 | 3,018 | 3.98 | 78,128 | 3,082 | 3.94 | 76,415 | 2,030 | 2.66 | |||||||||||||||||||||
| Demand deposits |
13,261 | 13,741 | 13,868 | |||||||||||||||||||||||||||
| Other liabilities |
3,875 | 3,558 | 3,276 | |||||||||||||||||||||||||||
| Total liabilities |
92,894 | 95,427 | 93,559 | |||||||||||||||||||||||||||
| Shareholders’ equity |
9,583 | 9,811 | 9,317 | |||||||||||||||||||||||||||
| Total liabilities and shareholders’ equity | $ | 102,477 | $ | 105,238 | $ | 102,876 | ||||||||||||||||||||||||
| Net interest income |
$ | 3,033 | $ | 2,899 | $ | 2,996 | ||||||||||||||||||||||||
| Net interest margin |
3.36 | % | 3.06 | % | 3.23 | % | ||||||||||||||||||||||||
| Net interest rate spread |
2.72 | 2.37 | 2.76 | |||||||||||||||||||||||||||
| Interest-bearing liabilities to interest earning assets |
83.86 | 82.43 | 82.40 | |||||||||||||||||||||||||||
| (a) | The fully taxable-equivalent adjustments included in the above table are $24 million, $26 million and $31 million for the years ended December 31, 2007, 2006 and 2005, respectively. |
B-17
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 5: CHANGES IN NET INTEREST INCOME (FTE) ATTRIBUTED TO VOLUME AND YIELD/RATE (a) | |||||||||||||||||||
| For the years ended December 31 | 2007 Compared to 2006 | 2006 Compared to 2005 | |||||||||||||||||
| ($ in millions) | Volume | Yield/Rate | Total | Volume | Yield/Rate | Total | |||||||||||||
| Assets |
|||||||||||||||||||
| Increase (decrease) in interest income: |
|||||||||||||||||||
| Loans and leases: |
|||||||||||||||||||
| Commercial loans |
$ | 135 | 25 | 160 | 136 | 280 | 416 | ||||||||||||
| Commercial mortgage |
93 | 8 | 101 | 57 | 92 | 149 | |||||||||||||
| Commercial construction |
(27 | ) | (12 | ) | (39 | ) | 32 | 86 | 118 | ||||||||||
| Commercial leases |
(2 | ) | (25 | ) | (27 | ) | 11 | (5 | ) | 6 | |||||||||
| Subtotal—commercial |
199 | (4 | ) | 195 | 236 | 453 | 689 | ||||||||||||
| Residential mortgage |
56 | 18 | 74 | 34 | 39 | 73 | |||||||||||||
| Home equity |
(14 | ) | 11 | (3 | ) | 54 | 163 | 217 | |||||||||||
| Automobile loans |
69 | 54 | 123 | 51 | 46 | 97 | |||||||||||||
| Credit card |
46 | (13 | ) | 33 | 13 | 5 | 18 | ||||||||||||
| Other consumer loans and leases |
(9 | ) | 6 | (3 | ) | (23 | ) | 10 | (13 | ) | |||||||||
| Subtotal—consumer |
148 | 76 | 224 | 129 | 263 | 392 | |||||||||||||
| Total loans and leases |
347 | 72 | 419 | 365 | 716 | 1,081 | |||||||||||||
| Securities: |
|||||||||||||||||||
| Taxable |
(452 | ) | 114 | (338 | ) | (164 | ) | 36 | (128 | ) | |||||||||
| Exempt from income taxes |
(8 | ) | (1 | ) | (9 | ) | (13 | ) | — | (13 | ) | ||||||||
| Other short-term investments |
(1 | ) | (1 | ) | (2 | ) | 8 | 7 | 15 | ||||||||||
| Total interest-earning assets |
(114 | ) | 184 | 70 | 196 | 759 | 955 | ||||||||||||
| Cash and due from banks |
|||||||||||||||||||
| Other assets |
|||||||||||||||||||
| Allowance for loan and lease losses |
|||||||||||||||||||
| Total change in interest income | (114 | ) | 184 | 70 | 196 | 759 | 955 | ||||||||||||
B-18
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| For the years ended December 31 | 2007 Compared to 2006 | 2006 Compared to 2005 | |||||||||||||||||
| ($ in millions) | Volume | Yield/Rate | Total | Volume | Yield/Rate | Total | |||||||||||||
| Liabilities and Shareholders’ Equity |
|||||||||||||||||||
| Increase (decrease) in interest expense: |
|||||||||||||||||||
| Interest-bearing core deposits: |
|||||||||||||||||||
| Interest checking |
(41 | ) | (39 | ) | (80 | ) | (41 | ) | 125 | 84 | |||||||||
| Savings |
81 | 12 | 93 | 45 | 142 | 187 | |||||||||||||
| Money market |
(2 | ) | 10 | 8 | 38 | 83 | 121 | ||||||||||||
| Foreign office deposits |
43 | 1 | 44 | 18 | 5 | 23 | |||||||||||||
| Other time deposits |
12 | 50 | 62 | 71 | 99 | 170 | |||||||||||||
| Total interest-bearing core deposits |
93 | 34 | 127 | 131 | 454 | 585 | |||||||||||||
| Certificates—$100,000 and over |
34 | 16 | 50 | 71 | 78 | 149 | |||||||||||||
| Other foreign office deposits |
(78 | ) | (2 | ) | (80 | ) | (27 | ) | 55 | 28 | |||||||||
| Federal funds purchased |
(25 | ) | 1 | (24 | ) | (3 | ) | 73 | 70 | ||||||||||
| Short-term bank notes |
— | — | — | (6 | ) | — | (6 | ) | |||||||||||
| Other short-term borrowings |
(55 | ) | 1 | (54 | ) | (15 | ) | 71 | 56 | ||||||||||
| Long-term debt |
(97 | ) | 14 | (83 | ) | (86 | ) | 256 | 170 | ||||||||||
| Total interest-bearing liabilities |
(128 | ) | 64 | (64 | ) | 65 | 987 | 1,052 | |||||||||||
| Demand deposits |
|||||||||||||||||||
| Other liabilities |
|||||||||||||||||||
| Total change in interest expense |
(128 | ) | 64 | (64 | ) | 65 | 987 | 1,052 | |||||||||||
| Shareholders’ equity |
|||||||||||||||||||
| Total liabilities and shareholders’ equity | |||||||||||||||||||
| Total change in net interest income | $ | 14 | 120 | 134 | 131 | (228 | ) | (97 | ) | ||||||||||
| (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. |
B-19
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 6: NONINTEREST INCOME | |||||||||||||
| For the years ended December 31 ($ in millions) | 2007 | 2006 | 2005 | 2004 | 2003 | ||||||||
| Electronic payment processing revenue |
$ | 826 | 717 | 622 | 521 | 509 | |||||||
| Service charges on deposits |
579 | 517 | 522 | 515 | 485 | ||||||||
| Investment advisory revenue |
382 | 367 | 358 | 363 | 335 | ||||||||
| Corporate banking revenue |
367 | 318 | 299 | 228 | 241 | ||||||||
| Mortgage banking net revenue |
133 | 155 | 174 | 178 | 302 | ||||||||
| Other noninterest income |
153 | 299 | 360 | 587 | 442 | ||||||||
| Securities gains (losses), net |
21 | (364 | ) | 39 | (37 | ) | 81 | ||||||
| Securities gains, net—non-qualifying hedges on mortgage servicing rights |
6 | 3 | — | — | 3 | ||||||||
| Total noninterest income | $ | 2,467 | 2,012 | 2,374 | 2,355 | 2,398 | |||||||
B-20
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| * |
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 ALPS Distributors, Inc., member NASD, d/b/a FTAM Funds Distributor, Inc. ALPS Distributors, Inc. and FTAM Funds Distributor, Inc. are affiliated firms through direct ownership, although ALPS Distributors, Inc. and FTAM Funds Distributor, Inc. are not affiliates of Fifth Third Bank. Fifth Third Asset Management, Inc. serves as Investment Adviser to Fifth Third Funds and receives a fee for its services.
B-21
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-22
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
|
TABLE 10: NONINTEREST EXPENSE | ||||||||||||
| For the years ended December 31 ($ in millions) | 2007 | 2006 | 2005 | 2004 | 2003 | |||||||
| Salaries, wages and incentives |
$ | 1,239 | 1,174 | 1,133 | 1,018 | 1,031 | ||||||
| Employee benefits |
278 | 292 | 283 | 261 | 240 | |||||||
| Net occupancy expense |
269 | 245 | 221 | 185 | 159 | |||||||
| Payment processing expense |
244 | 184 | 145 | 114 | 116 | |||||||
| Technology and communications |
169 | 141 | 142 | 120 | 106 | |||||||
| Equipment expense |
123 | 116 | 105 | 84 | 82 | |||||||
| Other noninterest expense |
989 | 763 | 772 | 1,081 | 733 | |||||||
| Total noninterest expense | $ | 3,311 | 2,915 | 2,801 | 2,863 | 2,467 | ||||||
| Efficiency ratio | 60.2 | % | 59.4 | 52.1 | 53.0 | 46.2 | ||||||
B-23
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 12: APPLICABLE INCOME TAXES | ||||||||||||
| For the years ended December 31 ($ in millions) | 2007 | 2006 | 2005 | 2004 | 2003 | |||||||
| Income from continuing operations before income taxes, minority interest and cumulative effect |
$ | 1,537 | 1,627 | 2,208 | 2,237 | 2,438 | ||||||
| Applicable income taxes |
461 | 443 | 659 | 712 | 786 | |||||||
| Effective tax rate | 30.0 | % | 27.2 | 29.9 | 31.8 | 32.3 | ||||||
B-24
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
BUSINESS SEGMENT REVIEW
B-25
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-26
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-27
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-28
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-29
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-30
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-31
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FOURTH QUARTER REVIEW
B-32
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-33
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
BALANCE SHEET ANALYSIS
B-34
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 19: COMPONENTS OF TOTAL LOANS AND LEASES (INCLUDING HELD FOR SALE) | |||||||||||
| As of December 31 ($ in millions) | 2007 | 2006 | 2005 | 2004 | 2003 | ||||||
| Commercial: |
|||||||||||
| Commercial loans |
$ | 26,079 | 20,831 | 19,377 | 16,107 | 14,261 | |||||
| Commercial mortgage |
11,967 | 10,405 | 9,188 | 7,636 | 6,894 | ||||||
| Commercial construction |
5,561 | 6,168 | 6,342 | 4,348 | 3,301 | ||||||
| Commercial leases |
3,737 | 3,841 | 3,698 | 3,426 | 3,264 | ||||||
| Total commercial loans and leases |
47,344 | 41,245 | 38,605 | 31,517 | 27,720 | ||||||
| Consumer: |
|||||||||||
| Residential mortgage loans |
11,433 | 9,905 | 8,991 | 7,912 | 5,865 | ||||||
| Home equity |
11,874 | 12,154 | 11,805 | 10,318 | 8,783 | ||||||
| Automobile loans |
11,183 | 10,028 | 9,396 | 7,734 | 8,606 | ||||||
| Credit card |
1,591 | 1,004 | 788 | 794 | 727 | ||||||
| Other consumer loans and leases |
1,157 | 1,167 | 1,644 | 2,092 | 2,488 | ||||||
| Total consumer loans and leases |
37,238 | 34,258 | 32,624 | 28,850 | 26,469 | ||||||
| Total loans and leases | $ | 84,582 | 75,503 | 71,229 | 60,367 | 54,189 | |||||
B-35
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 20: COMPONENTS OF AVERAGE TOTAL LOANS AND LEASES | |||||||||||
| As of December 31 ($ in millions) | 2007 | 2006 | 2005 | 2004 | 2003 | ||||||
| Commercial: |
|||||||||||
| Commercial loans |
$ | 22,351 | 20,504 | 18,310 | 14,955 | 13,705 | |||||
| Commercial mortgage |
11,078 | 9,797 | 8,923 | 7,391 | 3,097 | ||||||
| Commercial construction |
5,661 | 6,015 | 5,525 | 3,807 | 6,299 | ||||||
| Commercial leases |
3,683 | 3,730 | 3,495 | 3,296 | 3,037 | ||||||
| Total commercial loans and leases (including held for sale) |
42,773 | 40,046 | 36,253 | 29,449 | 26,138 | ||||||
| Consumer: |
|||||||||||
| Residential mortgage loans |
10,489 | 9,574 | 8,982 | 6,801 | 6,880 | ||||||
| Home equity |
11,887 | 12,070 | 11,228 | 9,584 | 8,796 | ||||||
| Automobile loans |
10,704 | 9,570 | 8,649 | 8,128 | 7,403 | ||||||
| Credit card |
1,276 | 838 | 728 | 740 | 559 | ||||||
| Other consumer loans and leases |
1,219 | 1,395 | 1,897 | 2,340 | 2,638 | ||||||
| Total consumer loans and leases (including held for sale) |
35,575 | 33,447 | 31,484 | 27,593 | 26,276 | ||||||
| Total loans and leases (including held for sale) |
$ | 78,348 | 73,493 | 67,737 | 57,042 | 52,414 | |||||
| Total portfolio loans and leases (excluding held for sale) | $ | 76,033 | 72,447 | 66,685 | 55,951 | 49,700 | |||||
| TABLE 21: COMPONENTS OF INVESTMENT SECURITIES (AMORTIZED COST BASIS) | |||||||||||
| As of December 31 ($ in millions) | 2007 | 2006 | 2005 | 2004 | 2003 | ||||||
| Available-for-sale and other: |
|||||||||||
| U.S. Treasury and Government agencies |
$ | 3 | 1,396 | 506 | 503 | 838 | |||||
| U.S. Government sponsored agencies |
160 | 100 | 2,034 | 2,036 | 3,877 | ||||||
| Obligations of states and political subdivisions |
490 | 603 | 657 | 823 | 922 | ||||||
| Agency mortgage-backed securities |
8,738 | 7,999 | 16,127 | 17,571 | 21,101 | ||||||
| Other bonds, notes and debentures |
385 | 172 | 2,119 | 2,862 | 1,401 | ||||||
| Other securities |
1,045 | 966 | 1,090 | 1,006 | 937 | ||||||
| Total available-for-sale and other securities | $ | 10,821 | 11,236 | 22,533 | 24,801 | 29,076 | |||||
| Held-to-maturity: |
|||||||||||
| Obligations of states and political subdivisions |
$ | 351 | 345 | 378 | 245 | 126 | |||||
| Other bonds, notes and debentures |
4 | 11 | 11 | 10 | 9 | ||||||
| Total held-to-maturity | $ | 355 | 356 | 389 | 255 | 135 | |||||
B-36
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 22: CHARACTERISTICS OF AVAILABLE-FOR-SALE AND OTHER SECURITIES | |||||||||||
| As of December 31, 2007 ($ in millions) | Amortized Cost | Fair Value | Weighted-Average Life (in years) |
Weighted-Average Yield |
|||||||
| 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 |
3 | 3 | 12.7 | 5.89 | |||||||
| Total |
3 | 3 | 12.0 | 6.04 | |||||||
| U.S. Government sponsored agencies: |
|||||||||||
| Average life of one year or less |
— | — | — | — | |||||||
| Average life 1 – 5 years |
160 | 160 | 2.2 | 4.44 | |||||||
| Average life 5 – 10 years |
— | — | — | — | |||||||
| Average life greater than 10 years |
— | — | — | — | |||||||
| Total |
160 | 160 | 2.2 | 4.44 | |||||||
| Obligations of states and political subdivisions (a): |
|||||||||||
| Average life of one year or less |
246 | 248 | .4 | 7.31 | |||||||
| Average life 1 – 5 years |
187 | 191 | 2.2 | 7.04 | (b) | ||||||
| Average life 5 – 10 years |
21 | 21 | 6.9 | 7.98 | (b) | ||||||
| Average life greater than 10 years |
36 | 36 | 10.7 | 3.92 | (b) | ||||||
| Total |
490 | 496 | 2.1 | 7.20 | |||||||
| Agency mortgage-backed securities: |
|||||||||||
| Average life of one year or less |
2 | 2 | .6 | 7.04 | |||||||
| Average life 1 – 5 years |
1,879 | 1,868 | 3.6 | 4.97 | |||||||
| Average life 5 – 10 years |
6,577 | 6,462 | 7.7 | 5.23 | |||||||
| Average life greater than 10 years |
280 | 277 | 10.4 | 5.45 | |||||||
| Total |
8,738 | 8,609 | 6.9 | 5.18 | |||||||
| Other bonds, notes and debentures (c): |
|||||||||||
| Average life of one year or less |
93 | 92 | .1 | 5.88 | |||||||
| Average life 1 – 5 years |
110 | 108 | 3.7 | 5.54 | |||||||
| Average life 5 – 10 years |
29 | 29 | 5.2 | 5.59 | |||||||
| Average life greater than 10 years |
153 | 147 | 28.3 | 7.45 | |||||||
| Total |
385 | 376 | 12.7 | 6.38 | |||||||
| Other securities (d) |
1,045 | 1,033 | |||||||||
| Total available-for-sale and other securities | $ | 10,821 | $ | 10,677 | 6.83 | 5.31 | % | ||||
| (a) | Taxable-equivalent yield adjustments included in the above table are 2.41%, 2.31%, 2.63%, 1.29% and 2.37% for securities with an average life of one year or less, 1-5 years, 5-10 years, greater than 10 years and in total, respectively. |
| (b) | Weighted-average yield excludes $3 million, $15 million and $35 million of securities with an average life of 1-5 years, 5-10 years and greater than 10 years, respectively, related to qualified zone academy bonds whose yields are realized through income tax credits. The weighted-average effective yield of these instruments is 6.81%. |
| (c) | Other bonds, notes, and debentures consist of commercial paper, non-agency mortgage backed securities, certain other asset backed securities (primarily automobile and commercial loan backed securities) and corporate bond securities. |
| (d) | Other securities consist of Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank restricted stock holdings that are carried at cost, Federal Home Loan Mortgage Corporation (“FHLMC”) preferred stock holdings, certain mutual fund holdings and equity security holdings. |
B-37
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 23: DEPOSITS | |||||||||||
| As of December 31 ($ in millions) | 2007 | 2006 | 2005 | 2004 | 2003 | ||||||
| Demand |
$ | 14,404 | 14,331 | 14,609 | 13,486 | 12,142 | |||||
| Interest checking |
15,254 | 15,993 | 18,282 | 19,481 | 19,757 | ||||||
| Savings |
15,635 | 13,181 | 11,276 | 8,310 | 7,375 | ||||||
| Money market |
6,521 | 6,584 | 6,129 | 4,321 | 3,201 | ||||||
| Foreign office |
2,572 | 1,353 | 421 | 153 | 16 | ||||||
| Transaction deposits |
54,386 | 51,442 | 50,717 | 45,751 | 42,491 | ||||||
| Other time |
11,440 | 10,987 | 9,313 | 6,837 | 6,201 | ||||||
| Core deposits |
65,826 | 62,429 | 60,030 | 52,588 | 48,692 | ||||||
| Certificates—$100,000 and over |
6,738 | 6,628 | 4,343 | 2,121 | 1,856 | ||||||
| Other foreign office |
2,881 | 323 | 3,061 | 3,517 | 6,547 | ||||||
| Total deposits | $ | 75,445 | 69,380 | 67,434 | 58,226 | 57,095 | |||||
| TABLE 24: AVERAGE DEPOSITS | |||||||||||
| As of December 31 ($ in millions) | 2007 | 2006 | 2005 | 2004 | 2003 | ||||||
| Demand |
$ | 13,261 | 13,741 | 13,868 | 12,327 | 10,482 | |||||
| Interest checking |
14,820 | 16,650 | 18,884 | 19,434 | 18,679 | ||||||
| Savings |
14,836 | 12,189 | 10,007 | 7,941 | 8,020 | ||||||
| Money market |
6,308 | 6,366 | 5,170 | 3,473 | 3,189 | ||||||
| Foreign office |
1,762 | 732 | 248 | 85 | 2 | ||||||
| Transaction deposits |
50,987 | 49,678 | 48,177 | 43,260 | 40,372 | ||||||
| Other time |
10,778 | 10,500 | 8,491 | 6,208 | 6,426 | ||||||
| Core deposits |
61,765 | 60,178 | 56,668 | 49,468 | 46,798 | ||||||
| Certificates—$100,000 and over |
6,466 | 5,795 | 4,001 | 2,403 | 3,832 | ||||||
| Other foreign office |
1,393 | 2,979 | 3,719 | 4,364 | 3,860 | ||||||
| Total deposits | $ | 69,624 | 68,952 | 64,388 | 56,235 | 54,490 | |||||
B-38
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 25: BORROWINGS | |||||||||||
| As of December 31 ($ in millions) | 2007 | 2006 | 2005 | 2004 | 2003 | ||||||
| Federal funds purchased |
$ | 4,427 | 1,421 | 5,323 | 4,714 | 6,928 | |||||
| Short-term bank notes |
— | — | — | 775 | 500 | ||||||
| Other short-term borrowings |
4,747 | 2,796 | 4,246 | 4,537 | 5,742 | ||||||
| Long-term debt |
12,857 | 12,558 | 15,227 | 13,983 | 9,063 | ||||||
| Total borrowings | $ | 22,031 | 16,775 | 24,796 | 24,009 | 22,233 | |||||
RISK MANAGEMENT
B-39
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-40
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 26: COMMERCIAL LOAN AND LEASE PORTFOLIO EXPOSURE (a) | |||||||||||||
| 2007 | 2006 | ||||||||||||
| As of December 31 ($ in millions) | Outstanding | Exposure | Nonaccrual | Outstanding | Exposure | Nonaccrual | |||||||
| By industry: |
|||||||||||||
| Real estate |
$ | 11,564 | 14,450 | 147 | 10,652 | 13,196 | 50 | ||||||
| Manufacturing |
6,570 | 14,365 | 28 | 5,198 | 11,443 | 22 | |||||||
| Construction |
5,226 | 8,534 | 258 | 5,490 | 8,963 | 69 | |||||||
| Retail trade |
4,175 | 7,251 | 29 | 3,655 | 6,515 | 27 | |||||||
| Transportation and warehousing |
2,565 | 3,076 | 21 | 2,097 | 2,432 | 4 | |||||||
| Financial services and insurance |
2,484 | 6,916 | 6 | 1,509 | 4,855 | 8 | |||||||
| Healthcare |
2,347 | 4,007 | 15 | 1,860 | 3,208 | 9 | |||||||
| Business services |
2,266 | 4,251 | 25 | 1,862 | 3,640 | 16 | |||||||
| Wholesale trade |
2,179 | 4,127 | 16 | 1,827 | 3,642 | 11 | |||||||
| Individuals |
1,252 | 1,626 | 15 | 1,364 | 1,785 | 13 | |||||||
| Other services |
1,049 | 1,455 | 17 | 959 | 1,373 | 14 | |||||||
| Accommodation and food |
1,036 | 1,470 | 21 | 860 | 1,323 | 10 | |||||||
| Other |
963 | 1,897 | 59 | 578 | 1,269 | 4 | |||||||
| Communication and information |
741 | 1,439 | 1 | 567 | 1,073 | 1 | |||||||
| Public administration |
737 | 957 | — | 792 | 930 | — | |||||||
| Entertainment and recreation |
617 | 873 | 6 | 602 | 841 | 2 | |||||||
| Agribusiness |
606 | 788 | 3 | 609 | 782 | 8 | |||||||
| Mining |
578 | 1,090 | 3 | 288 | 637 | 3 | |||||||
| Utilities |
389 | 1,210 | 2 | 370 | 1,187 | — | |||||||
| Total | $ | 47,334 | 79,782 | 672 | 41,139 | 69,094 | 271 | ||||||
B-41
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| 2007 | 2006 | ||||||||||||
| As of December 31 ($ in millions) | Outstanding | Exposure | Nonaccrual | Outstanding | Exposure | Nonaccrual | |||||||
| By loan size: |
|||||||||||||
| Less than $200,000 |
3 | % | 3 | 9 | 4 | 3 | 13 | ||||||
| $200,000 to $1 million |
13 | 10 | 24 | 16 | 12 | 34 | |||||||
| $1 million to $5 million |
28 | 23 | 43 | 32 | 27 | 48 | |||||||
| $5 million to $10 million |
26 | 23 | 19 | 17 | 16 | 5 | |||||||
| $10 million to $25 million |
13 | 14 | 5 | 21 | 24 | — | |||||||
| Greater than $25 million |
17 | 27 | — | 10 | 18 | — | |||||||
| Total | 100 | % | 100 | 100 | 100 | 100 | 100 | ||||||
| By state: |
|||||||||||||
| Ohio |
26 | % | 30 | 20 | 25 | 28 | 36 | ||||||
| Michigan |
20 | 18 | 36 | 22 | 19 | 19 | |||||||
| Florida |
11 | 9 | 23 | 10 | 9 | 9 | |||||||
| Illinois |
9 | 9 | 6 | 10 | 10 | 8 | |||||||
| Indiana |
8 | 8 | 9 | 9 | 9 | 15 | |||||||
| Kentucky |
5 | 5 | 2 | 6 | 6 | 8 | |||||||
| Tennessee |
3 | 3 | 1 | 3 | 3 | 1 | |||||||
| Pennsylvania |
2 | 2 | — | 1 | 2 | — | |||||||
| Missouri |
1 | 1 | — | 1 | 1 | — | |||||||
| All other states |
15 | 15 | 3 | 13 | 13 | 4 | |||||||
| Total | 100 | % | 100 | 100 | 100 | 100 | 100 | ||||||
| (a) | Outstanding reflects total commercial customer loan and lease balances, including held for sale and net of unearned income, and exposure reflects total commercial customer lending commitments. |
B-42
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 28: RESIDENTIAL MORTGAGE ORIGINATIONS | ||||||||||||
| For the years ended December 31 ($ in millions) | 2007 | Percent of total |
2006 | Percent of total |
||||||||
| Greater than 80% LTV with no mortgage insurance |
$ | 265 | 2 | % | $ | 679 | 7 | % | ||||
| Interest-only |
1,720 | 15 | 1,283 | 14 | ||||||||
| Greater than 80% LTV and interest-only |
265 | 2 | 180 | 2 | ||||||||
| 80/20 loans |
212 | 2 | 431 | 5 | ||||||||
| 80/20 loans and interest only | 62 | 1 | 17 | — | ||||||||
| TABLE 29: RESIDENTIAL MORTGAGE OUTSTANDINGS | ||||||||||||||||||
| 2007 | 2006 | |||||||||||||||||
| As of December 31 ($ in millions) | Balance | Percent of total |
Delinquency Ratio |
Balance | Percent of total |
Delinquency Ratio |
||||||||||||
| Greater than 80% LTV with no mortgage insurance |
$ | 2,146 | 21 | % | 8.93 | % | $ | 1,893 | 23 | % | 3.79 | % | ||||||
| Interest-only |
1,620 | 16 | 1.83 | 1,227 | 15 | .14 | ||||||||||||
| Greater than 80% LTV and interest-only |
493 | 5 | 5.36 | 560 | 7 | 1.15 | ||||||||||||
| 80/20 loans | — | — | — | 28 | — | .72 | ||||||||||||
B-43
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 30: HOME EQUITY OUTSTANDINGS | ||||||||||||||||||
| 2007 | 2006 | |||||||||||||||||
| As of December 31 ($ in millions) | LTV less than 80% |
LTV greater than 80% |
Delinquency Ratio |
LTV less than 80% |
LTV greater than 80% |
Delinquency Ratio |
||||||||||||
| Ohio |
$ | 1,873 | $ | 2,039 | 1.50 | % | $ | 2,006 | $ | 2,124 | 1.30 | % | ||||||
| Michigan |
1,393 | 1,295 | 2.06 | 1,529 | 1,354 | 1.69 | ||||||||||||
| Indiana |
628 | 641 | 1.95 | 684 | 686 | 1.66 | ||||||||||||
| Illinois |
637 | 545 | 1.66 | 617 | 582 | 1.19 | ||||||||||||
| Kentucky |
508 | 594 | 1.52 | 533 | 631 | 1.11 | ||||||||||||
| Florida |
536 | 291 | 2.93 | 418 | 229 | .96 | ||||||||||||
| All other states |
174 | 689 | 3.07 | 153 | 678 | 1.61 | ||||||||||||
| Total | $ | 5,749 | $ | 6,094 | 1.90 | % | $ | 5,940 | $ | 6,284 | 1.41 | % | ||||||
B-44
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 31: SUMMARY OF NONPERFORMING ASSETS AND DELINQUENT LOANS | ||||||||||||
| As of December 31 ($ in millions) | 2007 | 2006 | 2005 | 2004 | 2003 | |||||||
| Commercial loans |
$ | 175 | 127 | 140 | 105 | 110 | ||||||
| Commercial mortgage loans |
243 | 84 | 51 | 51 | 42 | |||||||
| Commercial construction loans |
249 | 54 | 31 | 13 | 19 | |||||||
| Commercial leases |
5 | 6 | 5 | 5 | 19 | |||||||
| Residential mortgages loans (a) |
121 | 38 | 30 | 24 | 25 | |||||||
| Home equity (b)(d) |
91 | 40 | ||||||||||
| Automobile loans (d) |
3 | 3 | ||||||||||
| Credit card (c) |
5 | — | — | — | — | |||||||
| Other consumer loans and leases (d) |
1 | — | 37 | 30 | 27 | |||||||
| Total nonaccrual loans and leases |
893 | 352 | 294 | 228 | 242 | |||||||
| Commercial renegotiated loans and leases |
— | — | — | 1 | 8 | |||||||
| Repossessed personal property and other real estate owned |
171 | 103 | 67 | 74 | 69 | |||||||
| Total nonperforming assets |
$ | 1,064 | 455 | 361 | 303 | 319 | ||||||
| Commercial loans |
$ | 44 | 38 | 20 | 21 | 14 | ||||||
| Commercial mortgage loans |
73 | 17 | 7 | 8 | 8 | |||||||
| Commercial construction loans |
67 | 6 | 7 | 5 | 4 | |||||||
| Commercial leases |
4 | 2 | 1 | 1 | 1 | |||||||
| Residential mortgages loans (e) |
186 | 68 | 53 | 43 | 51 | |||||||
| Home equity (d) |
72 | 51 | ||||||||||
| Automobile loans (d) |
13 | 11 | ||||||||||
| Credit card |
31 | 16 | 10 | 13 | 13 | |||||||
| Other consumer loans and leases (d) |
1 | 1 | 57 | 51 | 54 | |||||||
| Total 90 days past due loans and leases |
$ | 491 | 210 | 155 | 142 | 145 | ||||||
| Nonperforming assets as a percent of total loans, leases and other assets, including other real estate owned |
1.32 | % | .61 | .52 | .51 | .61 | ||||||
| Allowance for loan and lease losses as a percent of nonperforming assets | 88 | 170 | 206 | 235 | 219 | |||||||
| (a) | Residential mortgage nonaccrual loans include debt restructurings of $29 million as of December 31, 2007. |
| (b) | Home equity nonaccrual loans include debt restructurings of $46 million as of December 31, 2007. |
| (c) | All nonaccrual credit card balances are the result of debt restructurings. |
| (d) | Prior to 2006, other consumer loans and leases include home equity, automobile and other consumer loans and leases. |
| (e) | 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, 2007, 2006 and 2005, these advances were $25 million, $14 million and $13 million, respectively. Information prior to 2004 was not available. |
B-45
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-46
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 32: SUMMARY OF CREDIT LOSS EXPERIENCE | ||||||||||||||||
| For the years ended December 31 ($ in millions) | 2007 | 2006 | 2005 | 2004 | 2003 | |||||||||||
| Losses charged off: |
||||||||||||||||
| Commercial loans |
$ | (121 | ) | (131 | ) | (99 | ) | (95 | ) | (153 | ) | |||||
| Commercial mortgage loans |
(46 | ) | (27 | ) | (13 | ) | (14 | ) | (9 | ) | ||||||
| Commercial construction loans |
(29 | ) | (7 | ) | (5 | ) | (7 | ) | (4 | ) | ||||||
| Commercial leases |
(1 | ) | (4 | ) | (38 | ) | (8 | ) | (24 | ) | ||||||
| Residential mortgage loans |
(43 | ) | (23 | ) | (19 | ) | (15 | ) | (24 | ) | ||||||
| Home equity |
(106 | ) | (65 | ) | (60 | ) | (52 | ) | (52 | ) | ||||||
| Automobile loans |
(117 | ) | (87 | ) | (63 | ) | (56 | ) | (41 | ) | ||||||
| Credit card |
(54 | ) | (36 | ) | (46 | ) | (35 | ) | (31 | ) | ||||||
| Other consumer loans and leases |
(27 | ) | (28 | ) | (30 | ) | (39 | ) | (42 | ) | ||||||
| Total losses |
(544 | ) | (408 | ) | (373 | ) | (321 | ) | (380 | ) | ||||||
| Recoveries of losses previously charged off: |
||||||||||||||||
| Commercial loans |
12 | 24 | 24 | 14 | 16 | |||||||||||
| Commercial mortgage loans |
2 | 3 | 3 | 5 | 2 | |||||||||||
| Commercial construction loans |
— | — | 1 | — | — | |||||||||||
| Commercial leases |
1 | 5 | 1 | 1 | 2 | |||||||||||
| Residential mortgage loans |
— | — | — | — | — | |||||||||||
| Home equity |
9 | 9 | 10 | 10 | 15 | |||||||||||
| Automobile loans |
32 | 30 | 18 | 18 | 12 | |||||||||||
| Credit card |
8 | 5 | 5 | 6 | 5 | |||||||||||
| Other consumer loans and leases |
18 | 16 | 12 | 15 | 16 | |||||||||||
| Total recoveries |
82 | 92 | 74 | 69 | 68 | |||||||||||
| Net losses charged off: |
||||||||||||||||
| Commercial loans |
(109 | ) | (107 | ) | (75 | ) | (81 | ) | (137 | ) | ||||||
| Commercial mortgage loans |
(44 | ) | (24 | ) | (10 | ) | (9 | ) | (7 | ) | ||||||
| Commercial construction loans |
(29 | ) | (7 | ) | (4 | ) | (7 | ) | (4 | ) | ||||||
| Commercial leases |
— | 1 | (37 | ) | (7 | ) | (22 | ) | ||||||||
| Residential mortgage loans |
(43 | ) | (23 | ) | (19 | ) | (15 | ) | (24 | ) | ||||||
| Home equity |
(97 | ) | (56 | ) | (50 | ) | (42 | ) | (37 | ) | ||||||
| Automobile loans |
(85 | ) | (57 | ) | (45 | ) | (38 | ) | (29 | ) | ||||||
| Credit card |
(46 | ) | (31 | ) | (41 | ) | (29 | ) | (26 | ) | ||||||
| Other consumer loans and leases |
(9 | ) | (12 | ) | (18 | ) | (24 | ) | (26 | ) | ||||||
| Total net losses charged off | $ | (462 | ) | (316 | ) | (299 | ) | (252 | ) | (312 | ) | |||||
| Net charge-offs as a percent of average loans and leases (excluding held for sale): |
||||||||||||||||
| Commercial loans |
.49 | % | .53 | .41 | .54 | 1.00 | ||||||||||
| Commercial mortgage loans |
.40 | .25 | .10 | .12 | .10 | |||||||||||
| Commercial construction loans |
.51 | .11 | .08 | .17 | .10 | |||||||||||
| Commercial leases |
.01 | (.03 | ) | 1.06 | .21 | .72 | ||||||||||
| Total commercial loans and leases |
.43 | .34 | .35 | .35 | .64 | |||||||||||
| Residential mortgage loans |
.48 | .27 | .23 | .25 | .53 | |||||||||||
| Home equity |
.82 | .46 | .44 | .44 | .43 | |||||||||||
| Automobile loans |
.83 | .60 | .53 | .48 | .40 | |||||||||||
| Credit card |
3.55 | 3.65 | 5.65 | 3.92 | 4.70 | |||||||||||
| Other consumer loans and leases |
.83 | .91 | 1.06 | .98 | 1.06 | |||||||||||
| Total consumer loans and leases |
.84 | .55 | .57 | .56 | .61 | |||||||||||
| Total net losses charged off | .61 | % | .44 | .45 | .45 | .63 | ||||||||||
B-47
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 33: CHANGES IN ALLOWANCE FOR CREDIT LOSSES | ||||||||||||||||
| For the years ended December 31 ($ in millions) | 2007 | 2006 | 2005 | 2004 | 2003 | |||||||||||
| Balance, beginning of year |
$ | 847 | 814 | 785 | 770 | 683 | ||||||||||
| Net losses charged off |
(462 | ) | (316 | ) | (299 | ) | (252 | ) | (312 | ) | ||||||
| Provision for loan and lease losses |
628 | 343 | 330 | 268 | 399 | |||||||||||
| Net change in reserve for unfunded commitments |
19 | 6 | (2 | ) | (1 | ) | — | |||||||||
| Balance, end of year | $ | 1,032 | 847 | 814 | 785 | 770 | ||||||||||
| Components of allowance for credit losses: |
||||||||||||||||
| Allowance for loan and lease losses |
$ | 937 | 771 | 744 | 713 | 697 | ||||||||||
| Reserve for unfunded commitments |
95 | 76 | 70 | 72 | 73 | |||||||||||
| Total allowance for credit losses | $ | 1,032 | 847 | 814 | 785 | 770 | ||||||||||
B-48
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 34: ATTRIBUTION OF ALLOWANCE FOR LOAN AND LEASE LOSSES TO PORTFOLIO LOANS AND LEASES | ||||||||||||
| As of December 31 ($ in millions) | 2007 | 2006 | 2005 | 2004 | 2003 | |||||||
| Allowance attributed to: |
||||||||||||
| Commercial loans |
$ | 271 | 252 | 201 | 210 | 234 | ||||||
| Commercial mortgage loans |
135 | 95 | 78 | 73 | 77 | |||||||
| Commercial construction loans |
98 | 49 | 46 | 42 | 34 | |||||||
| Residential mortgage loans |
67 | 51 | 38 | 45 | 29 | |||||||
| Consumer loans |
287 | 247 | 183 | 160 | 146 | |||||||
| Lease financing |
32 | 29 | 56 | 47 | 64 | |||||||
| Unallocated |
47 | 48 | 142 | 136 | 113 | |||||||
| Total allowance for loan and lease losses | $ | 937 | 771 | 744 | 713 | 697 | ||||||
| Portfolio loans and leases: |
||||||||||||
| Commercial loans |
$ | 24,813 | 20,831 | 19,253 | 16,107 | 14,244 | ||||||
| Commercial mortgage loans |
11,862 | 10,405 | 9,188 | 7,636 | 6,894 | |||||||
| Commercial construction loans |
5,561 | 6,168 | 6,342 | 4,347 | 3,301 | |||||||
| Residential mortgage loans |
10,540 | 8,830 | 7,847 | 7,366 | 4,760 | |||||||
| Consumer loans |
22,943 | 23,204 | 22,006 | 18,875 | 17,398 | |||||||
| Lease financing |
4,534 | 4,915 | 5,289 | 5,477 | 5,711 | |||||||
| Total portfolio loans and leases | $ | 80,253 | 74,353 | 69,925 | 59,808 | 52,308 | ||||||
| Attributed allowance as a percent of respective portfolio loans: |
||||||||||||
| Commercial loans |
1.09 | % | 1.21 | 1.05 | 1.31 | 1.65 | ||||||
| Commercial mortgage loans |
1.14 | .91 | .85 | .96 | 1.12 | |||||||
| Commercial construction loans |
1.77 | .80 | .72 | .96 | 1.03 | |||||||
| Residential mortgage loans |
.63 | .58 | .49 | .61 | .61 | |||||||
| Consumer loans |
1.25 | 1.06 | .83 | .85 | .84 | |||||||
| Lease financing |
.69 | .59 | 1.06 | .86 | 1.12 | |||||||
| Unallocated (as a percent of total portfolio loans and leases) |
.06 | .06 | .20 | .23 | .22 | |||||||
| Total portfolio loans and leases | 1.17 | % | 1.04 | 1.06 | 1.19 | 1.33 | ||||||
B-49
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-50
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-51
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 37: PORTFOLIO LOAN AND LEASE PRINCIPAL CASH FLOWS | |||||||||
| As of December 31, 2007 ($ in millions) | Less than 1 year | 1-5 years | Greater than 5 years |
Total | |||||
| Commercial loans |
$ | 13,266 | 10,035 | 1,512 | 24,813 | ||||
| Commercial mortgage loans |
5,154 | 4,946 | 1,762 | 11,862 | |||||
| Commercial construction loans |
3,860 | 1,302 | 399 | 5,561 | |||||
| Commercial leases |
615 | 1,523 | 1,599 | 3,737 | |||||
| Residential mortgage loans |
2,795 | 4,066 | 3,679 | 10,540 | |||||
| Home equity |
2,300 | 4,878 | 4,696 | 11,874 | |||||
| Automobile loans |
3,305 | 5,377 | 519 | 9,201 | |||||
| Credit card |
191 | 1,400 | — | 1,591 | |||||
| Other consumer loans and leases |
486 | 536 | 52 | 1,074 | |||||
| Total | $ | 31,972 | 34,063 | 14,218 | 80,253 | ||||
| TABLE 38: PORTFOLIO LOAN AND LEASE PRINCIPAL CASH FLOWS OCCURRING AFTER ONE YEAR | |||||
| Interest Rate | |||||
| As of December 31, 2007 ($ in millions) | Fixed | Floating or Adjustable | |||
| Commercial loans |
$ | 2,546 | 9,001 | ||
| Commercial mortgage loans |
2,339 | 4,369 | |||
| Commercial construction loans |
432 | 1,269 | |||
| Commercial leases |
3,122 | — | |||
| Residential mortgage loans |
4,217 | 3,528 | |||
| Home equity |
1,673 | 7,901 | |||
| Automobile loans |
5,896 | — | |||
| Credit card |
470 | 930 | |||
| Other consumer loans and leases |
579 | 9 | |||
| Total | $ | 21,274 | 27,007 | ||
B-52
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 39: AGENCY RATINGS | ||||||||
| As of December 31, 2007 | Moody’s | Standard and Poor’s | Fitch | DBRS | ||||
| Fifth Third Bancorp: |
||||||||
| Commercial paper |
Prime-1 | A-1 | F1+ | R-1M | ||||
| Senior debt |
Aa3 | A+ | AA- | AAL | ||||
| Subordinated debt |
A1 | A | A+ | A | ||||
| Fifth Third Bank and Fifth Third Bank (Michigan): |
||||||||
| Short-term deposit |
Prime-1 | A-1+ | F1+ | R-1H | ||||
| Long-term deposit |
Aa2 | AA- | AA | AA | ||||
| Senior debt |
Aa2 | AA- | AA- | |||||
| Subordinated debt |
Aa3 | A+ | A+ | |||||
B-53
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-54
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 40: CAPITAL RATIOS | ||||||||||||
| As of December 31 ($ in millions) | 2007 | 2006 | 2005 | 2004 | 2003 | |||||||
| Average equity as a percent of average assets |
9.35 | % | 9.32 | 9.06 | 9.34 | 10.01 | ||||||
| Tangible equity as a percent of tangible assets |
6.05 | 7.79 | 6.87 | 8.35 | 8.56 | |||||||
| Tier I capital |
$ | 8,924 | 8,625 | 8,209 | 8,522 | 8,168 | ||||||
| Total risk-based capital |
11,733 | 11,385 | 10,240 | 10,176 | 9,992 | |||||||
| Risk-weighted assets |
115,529 | 102,823 | 98,293 | 82,633 | 74,477 | |||||||
| Regulatory capital ratios: |
||||||||||||
| Tier I capital |
7.72 | % | 8.39 | 8.35 | 10.31 | 10.97 | ||||||
| Total risk-based capital |
10.16 | 11.07 | 10.42 | 12.31 | 13.42 | |||||||
| Tier I leverage |
8.50 | 8.44 | 8.08 | 8.89 | 9.11 | |||||||
| TABLE 41: SHARE REPURCHASES | ||||||||||
| For the years ended December 31 | 2007 | 2006 | 2005 | |||||||
| Shares authorized for repurchase at January 1 |
15,807,045 | 17,846,953 | 35,685,112 | |||||||
| Additional authorizations |
30,000,000 | — | 20,000,000 | |||||||
| Shares repurchases (a) |
(26,605,527 | ) | (2,039,908 | ) | (37,838,159 | ) | ||||
| Shares authorized for repurchase at December 31 | 19,201,518 | 15,807,045 | 17,846,953 | |||||||
| Average price paid per share | $ | 40.70 | 39.72 | 43.19 | ||||||
| (a) | Excludes 365,867, 357,612 and 134,435 shares repurchased during 2007, 2006 and 2005, respectively, in connection with various employee compensation plans. These repurchases are not included in the calculation for average price paid and do not count against the maximum number of shares that may yet be repurchased under the Board of Directors’ authorization. |
B-55
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
B-56
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| TABLE 42: CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS | |||||||||||
| As of December 31, 2007 ($ in millions) | Less 1 year |
1-3 years |
3-5 years |
Greater 5 years |
Total | ||||||
| Contractually obligated payments due by period: |
|||||||||||
| Total deposits (a) |
$ | 73,528 | 308 | 60 | 1,549 | 75,445 | |||||
| Long-term debt (b) |
2,225 | 3,623 | 1,008 | 6,001 | 12,857 | ||||||
| Short-term borrowings (c) |
9,174 | — | — | — | 9,174 | ||||||
| Noncancelable leases (d) |
78 | 142 | 120 | 394 | 734 | ||||||
| Partnership investment commitments (e) |
307 | — | — | — | 307 | ||||||
| Pension obligations (f) |
20 | 41 | 38 | 83 | 182 | ||||||
| Capital expenditures (g) |
94 | — | — | — | 94 | ||||||
| Purchase obligations (h) |
17 | 27 | 8 | — | 52 | ||||||
| Total contractually obligated payments due by period | $ | 85,443 | 4,141 | 1,234 | 8,027 | 98,845 | |||||
| Other commitments by expiration period: |
|||||||||||
| Commitments to extend credit (i) |
$ | 28,571 | 21,217 | — | — | 49,788 | |||||
| Letters of credit (j) |
2,759 | 3,419 | 1,849 | 495 | 8,522 | ||||||
| Total other commitments by expiration period | $ | 31,330 | 24,636 | 1,849 | 495 | 58,310 | |||||
| (a) | Includes demand, interest checking, savings, money market, other time, certificates $100,000 and over and foreign office deposits. For additional information, see the Deposits discussion in the Balance Sheet Analysis section of Management’s Discussion and Analysis. |
| (b) | 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 13 of the Notes to Consolidated Financial Statements for additional information on these debt instruments. |
B-57
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
| (c) | Includes federal funds purchased and borrowings with an original maturity of less than one year. For additional information, see Note 12 of the Notes to Consolidated Financial Statements. |
| (d) | Includes both operating and capital leases. |
| (e) | Includes low-income housing, historic tax and venture capital partnership investments. |
| (f) | See Note 22 of the Notes to Consolidated Financial Statements for additional information on pension obligations. |
| (g) | Includes commitments to various general contractors for work related to banking center construction. |
| (h) | Represents agreements to purchase goods or services. |
| (i) | Commitments to extend credit are agreements to lend, typically having fixed expiration dates or other termination clauses that may require payment of a fee. Many of the commitments to extend credit may expire without being drawn upon. The total commitment amounts do not necessarily represent future cash flow requirements. |
| (j) | Letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. |
B-58
Table of Contents
MANAGEMENT’S ASSESSMENT AS TO THE EFFECTIVENESS OF INTERNAL CONTROL OVER FINANCIAL REPORTING
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 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 accounting principles generally accepted in the United States of America. The Bancorp’s management assessed the effectiveness of the Bancorp’s internal control over financial reporting as of December 31, 2007. 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, 2007. Based on this assessment, management believes that the Bancorp maintained effective internal control over financial reporting as of December 31, 2007. 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, 2007. This report appears on page 51 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.
 |
 | |
| Kevin T. Kabat | Christopher G. Marshall | |
| President and Chief Executive Officer | Executive Vice President and Chief Financial Officer | |
| February 22, 2008 | February 22, 2008 | |
B-59
Table of Contents
Unaudited Condensed Consolidated Financial Statements (including Notes thereto) at September 30, 2008 and September 30, 2007, and for the three and nine months ended September 30, 2008 and September 30, 2007, as included in our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2008.
C-1
Table of Contents
Fifth Third Bancorp and Subsidiaries
Condensed Consolidated Financial Statements and Notes (Item 1)
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
| As of | ||||||||||
| ($ in millions, except share data) | September 30, 2008 |
December 31, 2007 |
September 30, 2007 |
|||||||
| Assets |
||||||||||
| Cash and due from banks |
$ | 2,774 | 2,660 | 2,494 | ||||||
| Available-for-sale and other securities (a) |
13,177 | 10,677 | 10,777 | |||||||
| Held-to-maturity securities (b) |
360 | 355 | 346 | |||||||
| Trading securities |
915 | 171 | 155 | |||||||
| Other short-term investments |
229 | 620 | 765 | |||||||
| Loans held for sale (c) |
1,000 | 4,329 | 2,761 | |||||||
| Portfolio loans and leases: |
||||||||||
| Commercial loans |
29,424 | 24,813 | 22,649 | |||||||
| Commercial mortgage loans |
13,355 | 11,862 | 11,090 | |||||||
| Commercial construction loans |
6,002 | 5,561 | 5,463 | |||||||
| Commercial leases |
3,642 | 3,737 | 3,710 | |||||||
| Residential mortgage loans (d) |
9,351 | 10,540 | 9,057 | |||||||
| Home equity |
12,599 | 11,874 | 11,737 | |||||||
| Automobile loans |
8,306 | 9,201 | 10,006 | |||||||
| Credit card |
1,688 | 1,591 | 1,460 | |||||||
| Other consumer loans and leases |
1,131 | 1,074 | 1,082 | |||||||
| Portfolio loans and leases |
85,498 | 80,253 | 76,254 | |||||||
| Allowance for loan and lease losses |
(2,058 | ) | (937 | ) | (827 | ) | ||||
| Portfolio loans and leases, net |
83,440 | 79,316 | 75,427 | |||||||
| Bank premises and equipment |
2,470 | 2,223 | 2,127 | |||||||
| Operating lease equipment |
369 | 353 | 283 | |||||||
| Goodwill |
3,592 | 2,470 | 2,192 | |||||||
| Intangible assets |
188 | 147 | 138 | |||||||
| Servicing rights |
687 | 618 | 626 | |||||||
| Other assets |
7,093 | 7,023 | 6,174 | |||||||
| Total Assets | $ | 116,294 | 110,962 | 104,265 | ||||||
| Liabilities |
||||||||||
| Deposits: |
||||||||||
| Demand |
$ | 14,241 | 14,404 | 13,174 | ||||||
| Interest checking |
13,251 | 15,254 | 14,294 | |||||||
| Savings |
15,955 | 15,635 | 15,599 | |||||||
| Money market |
5,352 | 6,521 | 6,163 | |||||||
| Other time |
11,778 | 11,440 | 10,267 | |||||||
| Certificates—$100,000 and over |
13,173 | 6,738 | 5,973 | |||||||
| Foreign office |
3,710 | 5,453 | 3,912 | |||||||
| Total deposits |
77,460 | 75,445 | 69,382 | |||||||
| Federal funds purchased |
2,521 | 4,427 | 5,130 | |||||||
| Other short-term borrowings |
8,791 | 4,747 | 3,796 | |||||||
| Accrued taxes, interest and expenses |
1,757 | 2,427 | 2,295 | |||||||
| Other liabilities |
2,122 | 1,898 | 1,871 | |||||||
| Long-term debt |
12,947 | 12,857 | 12,498 | |||||||
| Total Liabilities |
105,598 | 101,801 | 94,972 | |||||||
| Shareholders’ Equity |
||||||||||
| Common stock (e) |
1,295 | 1,295 | 1,295 | |||||||
| Preferred stock (f) |
1,082 | 9 | 9 | |||||||
| Capital surplus |
597 | 1,779 | 1,768 | |||||||
| Retained earnings |
8,013 | 8,413 | 8,593 | |||||||
| Accumulated other comprehensive income |
(60 | ) | (126 | ) | (198 | ) | ||||
| Treasury stock |
(231 | ) | (2,209 | ) | (2,174 | ) | ||||
| Total Shareholders’ Equity |
10,696 | 9,161 | 9,293 | |||||||
| Total Liabilities and Shareholders’ Equity | $ | 116,294 | 110,962 | 104,265 | ||||||
| (a) | Amortized cost: September 30, 2008—$13,249, December 31, 2007—$10,821 and September 30, 2007—$11,007. |
| (b) | Market values: September 30, 2008—$360, December 31, 2007—$355 and September 30, 2007—$346. |
| (c) | Includes $844 of residential mortgage loans held for sale measured at fair value at September 30, 2008. |
C-2
Table of Contents
Fifth Third Bancorp and Subsidiaries
Condensed Consolidated Financial Statements and Notes (continued)
| (d) | Includes $5 of residential mortgage loans held for investment measured at fair value at September 30, 2008. |
| (e) | Common shares: Stated value $2.22 per share; authorized 2,000,000,000; outstanding at September 30, 2008—577,486,544 (excludes 5,912,013 treasury shares), December 31, 2007—532,671,925 (excludes 51,516,339 treasury shares) and September 30, 2007—532,626,990 (excludes 50,800,114 treasury shares). |
| (f) | 444,750 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; 8.5% non-cumulative Series G convertible (into 2,159.8272 common shares) perpetual preferred stock with a $25,000 liquidation preference: 46,000 authorized, 44,300 issued and outstanding at September 30, 2008. |
See Notes to Condensed Consolidated Financial Statements.
C-3
Table of Contents
Fifth Third Bancorp and Subsidiaries
Condensed Consolidated Financial Statements and Notes (continued)
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)
| For the three months ended September 30, |
For the nine months ended September 30, | |||||||||||
| ($ in millions, except per share data) | 2008 | 2007 | 2008 | 2007 | ||||||||
| Interest Income |
||||||||||||
| Interest and fees on loans and leases |
$ | 1,378 | 1,376 | $ | 3,718 | 4,032 | ||||||
| Interest on securities |
165 | 147 | 472 | 433 | ||||||||
| Interest on other short-term investments |
5 | 6 | 12 | 12 | ||||||||
| Total interest income |
1,548 | 1,529 | 4,202 | 4,477 | ||||||||
| Interest Expense |
||||||||||||
| Interest on deposits |
291 | 511 | 967 | 1,514 | ||||||||
| Interest on short-term borrowings |
64 | 93 | 193 | 224 | ||||||||
| Interest on long-term debt |
130 | 171 | 421 | 510 | ||||||||
| Total interest expense |
485 | 775 | 1,581 | 2,248 | ||||||||
| Net Interest Income |
1,063 | 754 | 2,621 | 2,229 | ||||||||
| Provision for loan and lease losses |
941 | 139 | 2,203 | 344 | ||||||||
| Net Interest Income After Provision for Loan and Lease Losses |
122 | 615 | 418 | 1,885 | ||||||||
| Noninterest Income |
||||||||||||
| Electronic payment processing revenue |
235 | 212 | 682 | 602 | ||||||||
| Service charges on deposits |
172 | 151 | 478 | 419 | ||||||||
| Corporate banking revenue |
104 | 91 | 323 | 261 | ||||||||
| Investment advisory revenue |
90 | 95 | 275 | 288 | ||||||||
| Mortgage banking net revenue |
45 | 26 | 228 | 107 | ||||||||
| Other noninterest income |
112 | 93 | 339 | 267 | ||||||||
| Securities (losses) gains, net |
(63 | ) | 13 | (45 | ) | 14 | ||||||
| Securities gains, net—non-qualifying hedges on mortgage servicing rights |
22 | — | 24 | — | ||||||||
| Total noninterest income |
717 | 681 | 2,304 | 1,958 | ||||||||
| Noninterest Expense |
||||||||||||
| Salaries, wages and incentives |
321 | 310 | 1,000 | 912 | ||||||||
| Employee benefits |
72 | 67 | 216 | 222 | ||||||||
| Net occupancy expense |
77 | 66 | 222 | 199 | ||||||||
| Payment processing expense |
70 | 65 | 203 | 176 | ||||||||
| Technology and communications |
47 | 41 | 142 | 122 | ||||||||
| Equipment expense |
34 | 30 | 95 | 90 | ||||||||
| Other noninterest expense |
346 | 274 | 665 | 649 | ||||||||
| Total noninterest expense |
967 | 853 | 2,543 | 2,370 | ||||||||
| Income (Loss) Before Income Taxes |
(128 | ) | 443 | 179 | 1,473 | |||||||
| Applicable income taxes |
(72 | ) | 118 | 150 | 414 | |||||||
| Net Income (Loss) |
(56 | ) | 325 | 29 | 1,059 | |||||||
| Dividends on preferred stock |
25 | — | 26 | — | ||||||||
| Net Income (Loss) Available to Common Shareholders | $ | (81 | ) | 325 | $ | 3 | 1,059 | |||||
| Earnings Per Share |
$ | (0.14 | ) | 0.61 | $ | 0.01 | 1.96 | |||||
| Earnings Per Diluted Share | $ | (0.14 | ) | 0.61 | $ | 0.01 | 1.95 | |||||
See Notes to Condensed Consolidated Financial Statements.
C-4
Table of Contents
Fifth Third Bancorp and Subsidiaries
Condensed Consolidated Financial Statements and Notes (continued)
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (unaudited)
| For the nine months ended September 30, |
|||||||
| ($ in millions, except per share data) | 2008 | 2007 | |||||
| Total Shareholders’ Equity, beginning |
$ | 9,161 | 10,022 | ||||
| Net income |
29 | 1,059 | |||||
| Other comprehensive income, net of tax: |
|||||||
| Change in unrealized gains and (losses): |
|||||||
| Available-for-sale securities |
47 | (30 | ) | ||||
| Qualifying cash flow hedges |
15 | 7 | |||||
| Change in accumulated other comprehensive income related to employee benefit plans |
4 | 4 | |||||
| Comprehensive income |
95 | 1,040 | |||||
| Cash dividends declared: |
|||||||
| Common stock (2008—$.74 per share and 2007—$1.26 per share) |
(408 | ) | (680 | ) | |||
| Preferred stock |
(26 | ) | (1 | ) | |||
| Issuance of preferred stock |
1,072 | — | |||||
| Stock-based awards exercised, including treasury shares issued |
— | 46 | |||||
| Stock-based compensation expense |
43 | 46 | |||||
| Loans repaid related to the exercise of stock-based awards, net |
2 | 3 | |||||
| Change in corporate tax benefit related to stock-based compensation |
(15 | ) | 4 | ||||
| Shares issued in an acquisition |
770 | — | |||||
| Shares acquired for treasury |
— | (1,084 | ) | ||||
| Impact of diversification of nonqualified deferred compensation plan |
— | (18 | ) | ||||
| Impact of cumulative effect of change in accounting principle (a) |
— | (98 | ) | ||||
| Other |
2 | 13 | |||||
| Total Shareholders’ Equity, ending | $ | 10,696 | 9,293 | ||||
| (a) | 2007 includes $96 million impact due to the adoption of 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” on January 1, 2007 and $2 million impact due to the adoption of FIN 48, “Accounting for Uncertainty in Income Taxes-An Interpretation of FASB Statement No. 109”, on January 1, 2007. |
See Notes to Condensed Consolidated Financial Statements.
C-5
Table of Contents
Fifth Third Bancorp and Subsidiaries
Condensed Consolidated Financial Statements and Notes (continued)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
| For the nine months ended September 30, ($ in millions) | 2008 | 2007 | |||||
| Operating Activities |
|||||||
| Net income |
$ | 29 | 1,059 | ||||
| Adjustments to reconcile net income to net cash provided by (used in) operating activities: |
|||||||
| Provision for loan and lease losses |
2,203 | 344 | |||||
| Depreciation, amortization and accretion |
268 | 275 | |||||
| Stock-based compensation expense |
43 | 46 | |||||
| Provision for deferred income taxes |
84 | 2 | |||||
| Realized securities gains |
(34 | ) | (15 | ) | |||
| Realized securities gains – non-qualifying hedges on mortgage servicing rights |
(24 | ) | — | ||||
| Realized securities losses |
79 | 1 | |||||
| Loss on recalculation of the timing of tax benefits on leveraged leases |
130 | — | |||||
| Loans originated for sale, net of repayments |
(9,602 | ) | (9,347 | ) | |||
| Proceeds from sales of loans held for sale |
9,379 | 8,785 | |||||
| Net (gains) losses on sales of loans |
(56 | ) | 6 | ||||
| Capitalized mortgage servicing rights |
(155 | ) | (159 | ) | |||
| Decrease in trading securities |
406 | 32 | |||||
| Decrease (increase) in other assets |
789 | (183 | ) | ||||
| Decrease in accrued taxes, interest and expenses |
(701 | ) | (67 | ) | |||
| Excess tax benefit related to stock-based compensation |
— | (4 | ) | ||||
| Increase (decrease) in other liabilities |
345 | (565 | ) | ||||
| Net Cash Provided by Operating Activities |
3,183 | 210 | |||||
| Investing Activities |
|||||||
| Proceeds from sales of available-for-sale securities |
4,176 | 1,581 | |||||
| Proceeds from calls, paydowns and maturities of available-for-sale securities |
49,903 | 4,927 | |||||
| Purchases of available-for-sale securities |
(56,045 | ) | (6,233 | ) | |||
| Proceeds from calls, paydowns and maturities of held-to-maturity securities |
3 | 10 | |||||
| Purchases of held-to-maturity securities |
(10 | ) | (1 | ) | |||
| Decrease in other short-term investments |
393 | 75 | |||||
| Net increase in loans and leases |
(5,268 | ) | (4,020 | ) | |||
| Proceeds from sale of loans |
4,439 | 783 | |||||
| Increase in operating lease equipment |
(39 | ) | (95 | ) | |||
| Purchases of bank premises and equipment |
(324 | ) | (356 | ) | |||
| Proceeds from disposal of bank premises and equipment |
30 | 37 | |||||
| Net cash paid in acquisitions |
(154 | ) | — | ||||
| Net Cash Used In Investing Activities |
(2,896 | ) | (3,292 | ) | |||
| Financing Activities |
|||||||
| Decrease in core deposits |
(6,434 | ) | (918 | ) | |||
| Increase in certificates—$100,000 and over, including other foreign office |
4,606 | 920 | |||||
| (Decrease) increase in federal funds purchased |
(2,117 | ) | 3,709 | ||||
| Increase in other short-term borrowings |
3,311 | 1,000 | |||||
| Proceeds from issuance of long-term debt |
2,151 | 3,946 | |||||
| Repayment of long-term debt |
(2,190 | ) | (4,090 | ) | |||
| Payment of cash dividends |
(577 | ) | (676 | ) | |||
| Exercise of stock-based awards, net |
2 | 49 | |||||
| Purchases of treasury stock |
— | (1,084 | ) | ||||
| Issuance of preferred stock |
1,072 | — | |||||
| Excess tax benefit related to stock-based compensation |
1 | 4 | |||||
| Other |
2 | 11 | |||||
| Net Cash (Used In) Provided by Financing Activities |
(173 | ) | 2,871 | ||||
| Increase (Decrease) in Cash and Due from Banks |
114 | (211 | ) | ||||
| Cash and Due from Banks at Beginning of Period |
2,660 | 2,705 | |||||
| Cash and Due from Banks at End of Period | $ | 2,774 | 2,494 | ||||
| Supplemental Cash Flow Information |
|||||||
| Cash Payments |
|||||||
| Interest |
$ | 1,580 | 2,260 | ||||
| Income taxes |
408 | 427 | |||||
| Noncash items |
|||||||
| Transfers of loans to securities |
790 | — | |||||
| Transfers of portfolio loans to loans held for sale |
59 | 1,704 | |||||
| Transfers of loans held for sale to portfolio loans |
1,627 | 647 | |||||
| Acquisitions: |
|||||||
| Fair value of tangible assets acquired (noncash) |
$ | 4,321 | — | ||||
| Goodwill and identifiable intangible assets acquired |
1,206 | — | |||||
| Liabilities assumed |
(4,603 | ) | — | ||||
| Common stock issued |
(770 | ) | — | ||||
See Notes to Condensed Consolidated Financial Statements.
C-6
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
1. Basis of Presentation
The Condensed Consolidated Financial Statements include the accounts of the Bancorp and its majority-owned subsidiaries and variable interest entities in which the Bancorp has been determined to be the primary beneficiary. Other entities, including certain joint ventures, in which there is greater than 20% ownership, but upon which the Bancorp does not possess and cannot 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.
In the opinion of management, the unaudited Condensed Consolidated Financial Statements include all adjustments, which consist of normal recurring accruals, necessary to present fairly the financial position as of September 30, 2008 and 2007, the results of operations for the three and nine months ended September 30, 2008 and 2007, the cash flows for the nine months ended September 30, 2008 and 2007 and the changes in shareholders’ equity for the nine months ended September 30, 2008 and 2007. In accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the United States Securities and Exchange Commission for interim financial information, these statements do not include certain information and footnote disclosures required for complete annual financial statements and it is suggested that these condensed financial statements be read in conjunction with the latest annual financial statements. The results of operations for the three and nine months ended September 30, 2008 and 2007 and the cash flows for the nine months ended September 30, 2008 and 2007 are not necessarily indicative of the results to be expected for the full year. Financial information as of December 31, 2007 has been derived from the annual Consolidated Financial Statements of the Bancorp.
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. Certain reclassifications have been made to prior periods’ Condensed Consolidated Financial Statements and related notes to conform to the current period presentation.
2. New Accounting Pronouncements
In July 2006, the FASB issued FASB Staff Position (“FSP”) No. 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 are 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 during the lease term. If 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. In the year of 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 where 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
C-7
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
tax positions in a leveraged lease must be measured in accordance with FIN 48, “Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109”, issued in July 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. Furthermore, due to recent court decisions related to leveraged leases and uncertainty regarding the outcome of outstanding litigation involving certain of the Bancorp’s leveraged leases, the Bancorp recognized after-tax charges relating to leveraged leases of $229 million and $3 million in the second and third quarters of 2008, respectively. See Note 9 for additional information.
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 was effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The adoption of SFAS No. 157 on January 1, 2008 did not have a material effect on the Bancorp’s Condensed Consolidated Financial Statements. In February 2008, the FASB issued FSP No. FAS 157-2, “Effective Date of FASB Statement No. 157”, which delayed the effective date of SFAS No. 157 for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years beginning after November 15, 2008. In October 2008, the FASB issued FSP No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active”, which clarifies the application of SFAS No. 157 in a market that is not active. FSP No. FAS 157-3 was effective upon issuance, including prior periods for which financial statements had not been issued. The adoption of FSP No. FAS 157-3 did not have a material impact on the Bancorp’s Condensed Consolidated Financial Statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115.” This Statement permits an entity to choose to measure certain financial instruments and certain other items at fair value, on an instrument-by-instrument basis. Once an entity has elected to record eligible items at fair value, the decision is irrevocable and the entity should report unrealized gains and losses on items for which the fair value option has been elected in earnings. On January 1, 2008, upon adoption of this Statement, the Bancorp elected to prospectively measure at fair value, residential mortgage loans originated on or after January 1, 2008 that have a designation as held for sale. Based on this prospective election, the adoption of the fair value option did not have a material effect on the Bancorp’s Condensed Consolidated Financial Statements.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” which replaces SFAS No. 141, “Business Combinations.” This Statement retains the fundamental requirements in SFAS No. 141 that the acquisition method of accounting (formerly referred to as purchase method) be used for all business combinations and that an acquirer be identified for each business combination. SFAS No. 141(R) defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as of the date that the acquirer achieves control. This Statement requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values. SFAS No. 141(R) requires the acquirer to generally recognize acquisition-related costs and restructuring costs separately from the business combination as period expenses. This Statement is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, with early adoption prohibited.
C-8
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an Amendment to ARB No. 51.” This Statement establishes new accounting and reporting standards that require the ownership interests in subsidiaries held by parties other than the parent be clearly identified, labeled, and presented in the consolidated statement of financial position within equity, but separate from the parent’s equity. SFAS No. 160 also requires the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income. In addition, when a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary shall be initially measured at fair value, with the gain or loss on the deconsolidation of the subsidiary measured using the fair value of any noncontrolling equity investment rather than the carrying amount of that retained investment. SFAS No. 160 also clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. The Statement also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interest. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, with early adoption prohibited. The adoption of this Statement is not expected to have a material impact on the Bancorp’s Condensed Consolidated Financial Statements.
In June 2008, the FASB issued FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” This FSP provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method described in paragraphs 60 and 61 of SFAS No. 128, “Earnings per Share”. This FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. All prior-period earnings per share data presented shall be adjusted retrospectively (including interim financial statements, summaries of earnings, and selected financial data) to conform with the provisions of this FSP. Early application is not permitted. The Bancorp’s adoption of this FSP on January 1, 2009 is not expected to have a material impact on Bancorp’s Condensed Consolidated Financial Statements.
In June 2008, the Emerging Issues Task Force issued EITF Issue No. 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock.” This Issue provides guidance an entity should use to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock. This Issue is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within that period. Early adoption is not permitted. The Bancorp is currently in the process of evaluating the impact of adopting this Issue on the Bancorp’s Condensed Consolidated Financial Statements.
In November 2007, the SEC issued Staff Accounting Bulletin (“SAB”) No. 109, “Written Loan Commitments Recorded at Fair Value through Earnings.” This SAB supersedes SAB No. 105, “Application of Accounting Principles to Loan Commitments”, and expresses the current view of the staff that, consistent with guidance in SFAS No. 156 and SFAS No. 159, the expected net future cash flows related to the associated servicing of a loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. Additionally, this SAB expands the SAB No. 105 view that internally-developed intangible assets should not be recorded as part of the fair value for any written loan commitments that are accounted for at fair value through earnings. This SAB was effective for fiscal quarters beginning after December 15, 2007. The adoption of SAB 109 on January 1, 2008 did not have a material impact on the Bancorp’s Condensed Consolidated Financial Statements.
In September 2008, the FASB issued FSP FAS 133-1 and FIN 45-4, “Disclosures about Credit Derivatives and Certain Guarantees—An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161.” This FSP applies to: (a) credit derivatives within the scope of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”; (b) hybrid
C-9
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
instruments that have embedded credit derivatives; and (c) guarantees within the scope of FIN No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” This FSP amends SFAS No. 133 to require disclosures by sellers of credit derivatives, including credit derivatives embedded in a hybrid instrument similar to the disclosures required by FIN 45. This FSP also amends FIN 45 to require an additional disclosure about the current status of the payment/performance risk of a guarantee. In addition, this FSP clarifies the FASB’s intent that the disclosures required by SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities”, should be provided for any reporting period (annual or interim) beginning after November 15, 2008. The provisions of this FSP that amend SFAS No. 133 and FIN 45 are effective for reporting periods (annual or interim) ending after November 15, 2008.
3. Intangible Assets and Goodwill
Intangible assets consist of servicing rights, core deposit intangibles, customer lists, non-compete agreements and cardholder relationships. Intangible assets, 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 September 30, 2008 of 3.8 years. 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. For further information on servicing rights, see Note 4.
| ($ in millions) | Gross Carrying Amount |
Accumulated Amortization |
Valuation Allowance |
Net Carrying Amount | |||||||
| As of September 30, 2008: |
|||||||||||
| Mortgage servicing rights |
$ | 1,573 | (841 | ) | (48 | ) | 684 | ||||
| Other consumer and commercial servicing rights |
14 | (11 | ) | — | 3 | ||||||
| Core deposit intangibles |
485 | (333 | ) | — | 152 | ||||||
| Other |
67 | (31 | ) | — | 36 | ||||||
| Total intangible assets | $ | 2,139 | (1,216 | ) | (48 | ) | 875 | ||||
| As of December 31, 2007: |
|||||||||||
| Mortgage servicing rights |
$ | 1,417 | (755 | ) | (49 | ) | 613 | ||||
| Other consumer and commercial servicing rights |
24 | (19 | ) | — | 5 | ||||||
| Core deposit intangibles |
430 | (302 | ) | — | 128 | ||||||
| Other |
44 | (25 | ) | — | 19 | ||||||
| Total intangible assets | $ | 1,915 | (1,101 | ) | (49 | ) | 765 | ||||
| As of September 30, 2007: |
|||||||||||
| Mortgage servicing rights |
$ | 1,372 | (730 | ) | (21 | ) | 621 | ||||
| Other consumer and commercial servicing rights |
24 | (19 | ) | — | 5 | ||||||
| Core deposit intangibles |
410 | (293 | ) | — | 117 | ||||||
| Other |
46 | (25 | ) | — | 21 | ||||||
| Total intangible assets | $ | 1,852 | (1,067 | ) | (21 | ) | 764 | ||||
As of September 30, 2008, all of the Bancorp’s intangible assets were being amortized. Amortization expense recognized on intangible assets, including servicing rights, for the three months ended September 30, 2008 and 2007 was $39 million and $33 million, respectively. For the nine months ended September 30, 2008 and 2007, amortization expense was $127 million and $99 million, respectively.
C-10
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
Estimated amortization expense, including servicing rights, for the years ending December 31, 2008 through 2012 is as follows:
| ($ in millions) | |||
| 2008 (a) |
$ | 152 | |
| 2009 |
137 | ||
| 2010 |
117 | ||
| 2011 |
88 | ||
| 2012 | 73 | ||
| (a) | Includes nine months actual and three months estimated. |
Changes in the net carrying amount of goodwill by reporting segment for the nine months ended September 30, 2008 and 2007 were as follows:
| ($ in millions) | Commercial Banking |
Branch Banking |
Consumer Lending |
Processing Solutions |
Investment Advisors |
Total | |||||||||
| Balance as of December 31, 2007 |
$ | 995 | 950 | 182 | 205 | 138 | 2,470 | ||||||||
| Acquisition activity |
375 | 704 | 33 | — | 10 | 1,122 | |||||||||
| Balance as of September 30, 2008 | $ | 1,370 | 1,654 | 215 | 205 | 148 | 3,592 | ||||||||
| Balance as of December 31, 2006 |
$ | 871 | 797 | 182 | 205 | 138 | 2,193 | ||||||||
| Acquisition activity |
— | (1 | ) | — | — | — | (1 | ) | |||||||
| Balance as of September 30, 2007 | $ | 871 | 796 | 182 | 205 | 138 | 2,192 | ||||||||
The Bancorp completed its annual goodwill impairment test as of September 30, 2008 and determined that no impairment existed. The Bancorp evaluates goodwill at the segment level for impairment. Acquisition activity includes acquisitions in the respective period in addition to purchase accounting adjustments related to previous acquisitions. During 2008, purchase accounting adjustments were made relating to the initial goodwill recorded from prior acquisitions. During the second quarter of 2008, the Bancorp acquired First Charter, which resulted in the recognition of $1.1 billion of goodwill and $56 million of core deposit intangibles.
4. Sales of Receivables and Servicing Rights
The Bancorp sold fixed and adjustable rate residential mortgage loans during 2008 and 2007. In those sales, the Bancorp obtained servicing responsibilities. The Bancorp receives annual servicing fees based on a percentage of the outstanding balance. The investors have no recourse to the Bancorp’s other assets for failure of debtors to pay when due. The Bancorp identifies classes of servicing assets based on financial asset type and interest rates. For the three months ended September 30, 2008 and 2007, the Bancorp recognized pre-tax gains of $43 million and $9 million, respectively, on origination fees and the sales of residential mortgage loans. Additionally, the Bancorp recognized $39 million and $37 million, respectively, in servicing fees on residential mortgages for the three months ended September 30, 2008 and 2007. For the nine months ended September 30, 2008 and 2007, the Bancorp recognized pre-tax gains of $214 million and $61 million, respectively, on origination fees and the sales of residential mortgage loans. Additionally, the Bancorp recognized $122 million and $105 million in servicing fees on residential mortgages for the nine months ended September 30, 2008 and 2007, respectively. The gains on sales of residential mortgages and servicing fees related to residential mortgages are included in mortgage banking net revenue in the Condensed Consolidated Statements of Income. Initial carrying values of servicing rights recognized during the nine months ended September 30, 2008 and 2007 were $156 million and $162 million, respectively.
C-11
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
During the first quarter of 2008, the Bancorp securitized and sold $2.7 billion of automobile loans in three separate transactions. Each transaction isolated the related loans through the use of a securitization trust or a conduit, formed as QSPEs, to facilitate the securitization process in accordance with SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” The Bancorp recognized pre-tax gains of $15 million on the sale of automobile loans offset by $26 million in losses on related hedges. In each of those sales, the Bancorp obtained servicing responsibility, but no servicing asset or liability was recorded as the market based servicing fee was considered adequate compensation. The initial carrying amounts of the interests that continue to be held by the Bancorp were estimated at the date of the sales using discounted projected cash flows. As of September 30, 2008, the Bancorp held automobile-related subordinated tranche security interests totaling $60 million and related residual interests totaling $141 million. These interests are net of a $12 million impairment charge recognized during the three months ended September 30, 2008 as a result of a decline in estimated cash flows.
The key economic assumptions used in measuring the initial carrying values of the mortgage interests and automobile residual interests that continue to be held by the Bancorp were as follows:
| September 30, 2008 | September 30, 2007 | ||||||||||||||||||||||
| Rate | Weighted- (in years) |
Prepayment (annual) |
Discount (annual) |
Weighted- Average Default Rate |
Weighted- (in years) |
Prepayment (annual) |
Discount (annual) |
Weighted- Average Default Rate | |||||||||||||||
| Residential mortgage loans: |
|||||||||||||||||||||||
| Servicing assets |
Fixed | 7.0 | 11.8 | % | 9.6 | % | N/A | 6.8 | 9.9 | % | 9.7 | % | N/A | ||||||||||
| Servicing assets |
Adjustable | 2.9 | 29.8 | 11.0 | N/A | 3.3 | 26.2 | 12.5 | N/A | ||||||||||||||
| Automobile loans: |
|||||||||||||||||||||||
| Residual interest | Fixed | 1.8 | 22.9 | 8.0 | 1.5 | % | N/A | N/A | N/A | N/A | |||||||||||||
During 2008 and 2007, the Bancorp sold student loans and certain commercial loans and obtained servicing responsibilities. In addition, the Bancorp transferred certain commercial loans to an unconsolidated QSPE that is wholly owned by an independent third party. See Note 8 for further information. At September 30, 2008 and 2007, the value of the servicing asset and subordinated interests related to these sales were immaterial to the Bancorp’s Condensed Consolidated Financial Statements.
Based on historical credit experience, expected credit losses for residential mortgage loan servicing assets have been deemed immaterial. At September 30, 2008 and 2007, the Bancorp serviced $39.8 billion and $33.1 billion, respectively, of residential mortgage loans for other investors.
The value of interests that continue to be held by the Bancorp is subject to credit, prepayment and interest rate risks on the sold financial assets. At September 30, 2008, the sensitivity of a decline in the current fair value of residual cash flows to immediate 10% and 20% adverse changes in those assumptions are as follows:
| ($ in millions) |
Rate | Fair Value |
Weighted Average Life (in years) |
Prepayment Speed Assumption |
Residual Servicing Cash Flows |
Weighted-Average Default | |||||||||||||||||||||||||
| Rate | Impact of Adverse Change on Fair Value |
Discount Rate |
Impact of Adverse Change on Fair Value |
Rate | Impact of Adverse Change on Fair Value | ||||||||||||||||||||||||||
| 10% | 20% | 10% | 20% | 10% | 20% | ||||||||||||||||||||||||||
| Residential mortgage loans: |
|||||||||||||||||||||||||||||||
| Servicing assets |
Fixed | $ | 655 | 6.4 | 11.2 | % | $ | 27 | 52 | 9.8 | % | $ | 25 | 48 | — | % | $ | — | — | ||||||||||||
| Servicing assets |
Adjustable | 44 | 2.3 | 29.6 | 3 | 6 | 11.8 | 1 | 2 | — | — | — | |||||||||||||||||||
| Automobile loans: |
|||||||||||||||||||||||||||||||
| Residual interest |
Fixed | $ | 141 | 2.0 | 23.9 | % | $ | 3 | 6 | 11.4 | % | $ | 3 | 7 | 1.6 | % | $ | 3 | 6 | ||||||||||||
C-12
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
These sensitivities are hypothetical and should be used with caution as 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 interests that continue to be held by the transferor 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 might magnify or counteract the sensitivities.
Changes in the servicing asset related to residential mortgage loans for the nine months ended September 30 were:
| ($ in millions) | 2008 | 2007 | |||||
| Carrying amount as of the beginning of period |
$ | 662 | 546 | ||||
| Servicing obligations that result from transfer of residential mortgage loans |
155 | 162 | |||||
| Acquisitions |
1 | — | |||||
| Amortization |
(86 | ) | (66 | ) | |||
| Carrying amount before valuation allowance |
$ | 732 | 642 | ||||
| Valuation allowance for servicing assets: |
|||||||
| Beginning balance |
$ | (49 | ) | (27 | ) | ||
| Servicing valuation recovery |
1 | 6 | |||||
| Ending balance |
(48 | ) | (21 | ) | |||
| Carrying amount as of the end of the period | $ | 684 | 621 | ||||
Temporary impairment or impairment recovery, effected through a change in the MSR valuation allowance, is captured as a component of mortgage banking net revenue in the Condensed Consolidated Statements of Income.
The fair value of the servicing asset is based on the present value of expected future cash flows. The following table displays the beginning and ending fair value for the nine months ended September 30:
| ($ in millions) | 2008 | 2007 | |||
| Fixed rate residential mortgage loans: |
|||||
| Fair value at beginning of period (December 31, 2007 and 2006) |
$ | 565 | 483 | ||
| Fair value at end of period |
655 | 586 | |||
| Adjustable rate residential mortgage loans: |
|||||
| Fair value at beginning of period (December 31, 2007 and 2006) |
50 | 45 | |||
| Fair value at end of period |
44 | 50 | |||
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). The interest 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. For the nine months ended September 30, 2008, the Bancorp recognized a net gain of $24 million, classified as a securities gains in noninterest income, related to sales of available-for-sale securities purchased to economically hedge the MSR portfolio and net loss of $23 million, classified as mortgage banking net revenue in noninterest income, related to changes in fair value and settlement of free-standing derivatives purchased to economically hedge the MSR
C-13
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
portfolio. For the nine months ended September 30, 2007, the Bancorp recognized a net gain of $1 million related to changes in fair value and settlement of free-standing derivatives purchased to economically hedge the MSR portfolio. There was no gain or loss recognized for the nine months ended September 30, 2007 related to sales of available-for-sale securities purchased to economically hedge the MSR portfolio. See Note 7 for information on the types and amount of free-standing derivatives used to economically hedge the MSR portfolio. As of September 30, 2008 and 2007, the available-for-sale securities portfolio included $1.1 billion and $314 million, respectively, of securities related to the non-qualifying hedging strategy.
5. Loans Acquired in a Transfer
In 2008 and 2007, the Bancorp acquired certain loans, primarily related to the Crown and First Charter acquisitions, for which there was evidence of deterioration of credit quality since origination and for which it was probable, at acquisition, that all contractually required payments would not be collected. These loans were evaluated either individually or segregated into pools based on common risk characteristics and accounted for under Statement of Position 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” (“SOP 03-3”). SOP 03-3 requires acquired loans within its scope to be recorded at fair value and prohibits carrying over valuation allowances when applying purchase accounting. Loans carried at fair value, mortgage loans held for sale and loans under revolving credit agreements are excluded from the scope of SOP 03-3. During the three and nine months ended September 30, 2008, the Bancorp recorded provision expense for loans accounted for under SOP 03-3 of $11 million and $18 million, respectively, in the Condensed Consolidated Statements of Income. As of September 30, 2008, the Bancorp maintained an allowance for loan and lease losses of $6 million on loans accounted for under SOP 03-3.
The following table reflects the outstanding balance of all contractually required payments and carrying amount of those loans accounted for under SOP 03-3 as of:
| ($ in millions) | September 30, 2008 |
December 31, 2007 | ||||
| Commercial |
$ | 129 | $ | 94 | ||
| Consumer |
98 | 135 | ||||
| Outstanding balance |
$ | 227 | $ | 229 | ||
| Carrying amount |
$ | 107 | $ | 101 | ||
At the acquisition date, the Bancorp determines the excess of the loan’s contractually required payments over all cash flows expected to be collected as an amount that should not be accreted into interest income (nonaccretable difference). The remaining amount representing the difference in the expected cash flows of acquired loans and the basis in the acquired loans is accreted into interest income over the remaining life of the loan or pool of loans (accretable yield). A summary of activity is provided below.
| ($ in millions) | Accretable Yield | |||
| Balance as of December 31, 2007 |
$ | 6 | ||
| Additions |
5 | |||
| Accretion |
(10 | ) | ||
| Reclassifications from (to) nonaccretable difference |
7 | |||
| Balance as of September 30, 2008 | $ | 8 | ||
C-14
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
The following table reflects loans acquired, for which it was probable at acquisition that all contractually required payments would not be collected as of:
| ($ in millions) | September 30, 2008 |
December 31, 2007 | ||||
| Contractually required payments receivable at acquisition date: |
||||||
| Commercial |
$ | 63 | $ | 99 | ||
| Consumer |
34 | 136 | ||||
| Total | $ | 97 | $ | 235 | ||
| Cash flows expected to be collected at acquisition date |
$ | 44 | $ | 113 | ||
| Fair value of acquired loans at acquisition date | 39 | 105 | ||||
6. Bank-Owned Life Insurance
The Bancorp purchases life insurance policies on the lives of certain directors, officers and employees and is the owner and beneficiary of the policies. The Bancorp invests in these policies, known as BOLI, to provide an efficient form of funding for long-term retirement and other employee benefits costs. Therefore, the Bancorp’s BOLI policies are intended to be long-term investments to provide funding for future payment of long-term liabilities. The Bancorp records these BOLI policies within other assets in the Condensed Consolidated Balance Sheets at each policy’s respective cash surrender value, with changes recorded in noninterest income in the Condensed Consolidated Statements of Income.
Certain BOLI policies have a stable value agreement through either a large, well-rated bank or multi-national insurance carrier that provides limited cash surrender value protection from declines in the value of each policy’s underlying investments. During the second half of 2007 and throughout 2008, the value of the investments underlying one of the Bancorp’s BOLI policies declined significantly due to disruptions in the credit markets, widening of credit spreads between U.S. treasuries/swaps versus municipal bonds and bank trust preferred securities, and illiquidity in the asset-backed securities market. These factors caused the decline in the cash surrender value to exceed the protection provided by the stable value agreement.
As a result of further exceeding the cash surrender value protection, the Bancorp recorded a charge of $27 million during the third quarter of 2008 and $181 million for the nine months ended September 30, 2008 to reflect the change in cash surrender value related to this BOLI policy. The cash surrender value of the policy was $324 million at September 30, 2008 and may increase or decrease further depending on the impact of market conditions on the underlying investments.
At September 30, 2008, the cash surrender value protection had not been exceeded for any other BOLI policies.
7. Derivative Financial Instruments
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. Additionally, the Bancorp holds derivative instruments for the benefit of its commercial customers. The Bancorp does not enter into derivative instruments for speculative purposes.
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
C-15
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
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, options and interest rate swaps) to economically hedge prepayment volatility. Principal-only swaps are total return swaps based on changes in the value of the underlying mortgage principal-only trust.
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. The Bancorp may economically hedge significant exposures related to these free-standing derivatives by entering into offsetting third-party contracts with approved, reputable 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.
The Bancorp holds certain derivative instruments that qualify for hedge accounting treatment under SFAS No. 133 and are designated as fair value hedges or cash flow hedges. Derivative instruments that do not qualify for hedge accounting treatment under SFAS No. 133, or for which hedge accounting is not established, are held as free-standing derivatives and provide the Bancorp an economic hedge. All customer accommodation derivatives are held as free-standing derivatives.
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 through consideration of the asset/liability mix of the Bancorp, the desired asset/liability sensitivity and interest rate levels. For the three and nine months ended September 30, 2008 and 2007, 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 a quarterly assessment of hedge effectiveness and measurement of ineffectiveness. 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. The ineffectiveness on interest rate swaps hedging long-term debt is reported within interest expense in the Condensed Consolidated Statements of Income.
C-16
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
The following table reflects the change in fair value for interest rate contracts and the related hedged items included in the Condensed Consolidated Statements of Income:
| Income statement caption | For the three months ended September 30, |
For the nine months ended September 30, |
||||||||||||||
| ($ in millions) | 2008 | 2007 | 2008 | 2007 | ||||||||||||
| Interest rate contracts: |
||||||||||||||||
| Change in fair value on interest rate swaps—derivative |
Interest on long-term debt | $ | 69 | 83 | $ | 62 | 108 | |||||||||
| Change in fair value on long-term debt—hedged item |
Interest on long-term debt | (60 | ) | (83 | ) | (51 | ) | (111 | ) | |||||||
The Bancorp previously entered into forward contracts that met the criteria for fair value hedge accounting to hedge its residential mortgage loans held for sale. Upon adoption of SFAS No. 159 on January 1, 2008 and the Bancorp’s election to carry residential mortgage loans held for sale at fair value, all new forward contracts held to hedge its residential mortgage loans held for sale were held as free-standing derivative instruments. For the three and nine months ended September 30, 2007, the ineffectiveness of the hedging relationships related to residential mortgage loans held for sale was insignificant to the Bancorp’s Condensed Consolidated Statements of Income.
The following table reflects fair value hedges included in the Condensed Consolidated Balance Sheets:
| September 30, 2008 | December 31, 2007 | September 30, 2007 | ||||||||||||
| ($ in millions) | Notional Amount |
Fair Value |
Notional Amount |
Fair Value |
Notional Amount |
Fair Value | ||||||||
| Interest rate contracts included in other assets: |
||||||||||||||
| Interest rate swaps related to debt |
$ | 3,705 | $ | 127 | 3,000 | 67 | 500 | 9 | ||||||
| Forward contracts related to mortgage loans held for sale |
— | — | 183 | 1 | 489 | 2 | ||||||||
| Total included in other assets | $ | 127 | 68 | 11 | ||||||||||
| Interest rate contracts included in other liabilities: |
||||||||||||||
| Interest rate swaps related to debt |
$ | 1,725 | $ | 19 | 775 | 21 | 2,575 | 77 | ||||||
| Forward contracts related to mortgage loans held for sale |
— | — | 511 | 4 | 896 | 8 | ||||||||
| Total included in other liabilities | $ | 19 | 25 | 85 | ||||||||||
During 2006, 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 will be amortized as an adjustment to interest expense over the remaining term of the long-term debt. For the three months ended September 30, 2008 and 2007, $1 million and $2 million in net deferred losses on the terminated fair value hedges were amortized into interest expense, respectively. For the nine months ended September 30, 2008 and 2007, $6 million and $8 million, respectively, in net deferred losses on the terminated fair value hedges were amortized into interest expense.
Cash Flow Hedges
The Bancorp may enter into interest rate swaps to convert floating-rate assets and liabilities to fixed rates or to hedge certain forecasted transactions. The assets or liabilities are typically grouped and share the same risk exposure for which they are being hedged. The Bancorp may also enter into interest rate caps and floors to limit
C-17
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
cash flow variability of floating rate assets and liabilities. As of September 30, 2008, all hedges designated as cash flow hedges are assessed for effectiveness using regression analysis. Ineffectiveness is generally measured as the amount by which the cumulative change in the fair value of the hedging instrument exceeds the present value of the cumulative change in the hedged item’s expected cash flows. Ineffectiveness is reported within other noninterest income in the Condensed Consolidated Statements of Income.
The effective portion of the gains or losses on derivative contracts are reported within accumulated other comprehensive income and are reclassified from accumulated other comprehensive income to current period earnings when the forecasted transaction affects earnings. Reclassified gains and losses on interest rate floors related to commercial loans and interest rate caps related to debt are recorded within interest income and interest expense, respectively. As of September 30, 2008, $40 million of deferred gains, net of tax, on cash flow hedges are recorded in accumulated other comprehensive income.
The following table presents the net gains (losses) recorded in the Condensed Consolidated Statements of Income and accumulated other comprehensive income relating to cash flow derivative instruments:
| Amount of gain (loss) recognized in OCI |
Amount of gain (loss) into net interest income |
Amount of ineffectiveness recognized in other noninterest income |
||||||||||||
| ($ in millions) | 2008 | 2007 | 2008 | 2007 | 2008 | 2007 | ||||||||
| For the three months ended September 30: |
||||||||||||||
| Interest rate contracts |
$ | 17 | 23 | 8 | 2 | 1 | (1 | ) | ||||||
| For the nine months ended September 30: |
||||||||||||||
| Interest rate contracts | 25 | 12 | 2 | 1 | 1 | (1 | ) | |||||||
As of September 30, 2008, $6 million in net deferred gains, net of tax, recorded in accumulated other comprehensive income are expected to be reclassified into earnings during the next twelve months.
The following table reflects the notional amount and fair value of all cash flow hedges included in the Condensed Consolidated Balance Sheets:
| September 30, 2008 | December 31, 2007 | September 30, 2007 | ||||||||||||
| ($ in millions) | Notional Amount |
Fair Value |
Notional Amount |
Fair Value |
Notional Amount |
Fair Value | ||||||||
| Interest rate contracts included in other assets: |
||||||||||||||
| Interest rate floors related to commercial loans |
$ | 1,500 | $ | 113 | 1,500 | 107 | 1,500 | 67 | ||||||
| Interest rate caps related to debt |
1,750 | 12 | 1,750 | 11 | 1,750 | 20 | ||||||||
| Total included in other assets | $ | 125 | 118 | 87 | ||||||||||
| Interest rate contracts included in other liabilities: |
||||||||||||||
| Interest rate swaps related to consumer loans |
$ | — | $ | — | 1,000 | 11 | 1,000 | 8 | ||||||
| Total included in other liabilities | $ | — | 11 | 8 | ||||||||||
Free-Standing Derivative Instruments—Risk Management
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 these
C-18
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
instruments against the foreign 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 Condensed Consolidated Statements of Income, as are revaluation gains and losses on foreign denominated loans.
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 these swaps appreciate in value as a result of tightening spreads. Principal-only swaps 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. The Bancorp may also enter into forward swaps to economically hedge the change in fair value of certain commercial 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. The Bancorp also enters into risk participation agreements, which are included in interest rate contracts for customers, to share some of the credit exposure with other counterparties related to interest rate derivative contracts or to take on credit exposure for interest rate derivative contracts. The Bancorp only enters into these risk participation agreements in instances in which the Bancorp has participated in the loan that the interest rate derivative contract was designed to hedge. The Bancorp will make/receive payments under these guarantees if a customer defaults on its obligation to perform under certain credit agreements.
Revaluation gains and losses from free-standing derivatives related to mortgage banking activity are recorded as a component of mortgage banking net revenue in the Condensed Consolidated Statements of Income.
Additionally, the Bancorp occasionally may enter into free-standing derivative instruments (options, swaptions and interest rate swaps) in order to minimize significant fluctuations in earnings and cash flows caused by interest rate volatility. The gains and losses on these derivative contracts are recorded within other noninterest income in the Condensed Consolidated Statements of Income.
The net gains (losses) recorded in the Condensed Consolidated Statements of Income relating to free-standing derivative instruments used for risk management are summarized below:
| Income Statement Caption | For the three months ended September 30, |
For the nine months ended September 30, |
|||||||||||||
| ($ in millions) | 2008 | 2007 | 2008 | 2007 | |||||||||||
| Interest rate contracts: |
|||||||||||||||
| Forward contracts related to commercial mortgage loans held for sale |
Corporate banking revenue | $ | — | (3 | ) | $ | (8 | ) | (2 | ) | |||||
| Forward contracts related to residential mortgage loans held for sale |
Mortgage banking net revenue | 6 | (17 | ) | 16 | (9 | ) | ||||||||
| Derivative instruments related to MSR portfolio |
Mortgage banking net revenue | 8 | 13 | (23 | ) | 1 | |||||||||
| Derivative instruments related to interest rate risk |
Other noninterest income | 1 | — | — | (1 | ) | |||||||||
| Foreign exchange contracts: |
|||||||||||||||
| Foreign exchange contracts |
Other noninterest income | 6 | (10 | ) | 10 | (19 | ) | ||||||||
C-19
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
The following table reflects the notional amount and fair value of free-standing derivatives used for risk management included in the Condensed Consolidated Balance Sheets:
| September 30, 2008 | December 31, 2007 | September 30, 2007 | |||||||||||||
| ($ in millions) | Notional Amount |
Fair Value |
Notional Amount |
Fair Value |
Notional Amount |
Fair Value | |||||||||
| Interest rate contracts included in other assets: |
|||||||||||||||
| Derivative instruments related to MSR portfolio |
$ | 3,222 | 69 | $ | 3,062 | 70 | $ | 3,160 | 32 | ||||||
| Derivative instruments related to held for sale mortgages |
1,153 | 16 | 229 | 1 | 35 | — | |||||||||
| Derivative instruments related to interest rate risk |
510 | 6 | 1 | — | 4 | — | |||||||||
| Total included in other assets | 91 | 71 | 32 | ||||||||||||
| Interest rate contracts included in other liabilities: |
|||||||||||||||
| Derivative instruments related to MSR portfolio |
$ | 1,980 | 21 | $ | 1,280 | 16 | $ | 2,382 | 8 | ||||||
| Derivative instruments related to held for sale mortgages |
542 | 6 | 588 | 9 | 218 | 2 | |||||||||
| Derivative instruments related to interest rate risk |
491 | 6 | — | — | 34 | — | |||||||||
| Foreign exchange contracts included in other liabilities: |
|||||||||||||||
| Foreign exchange contracts |
156 | 1 | 153 | 1 | 147 | 8 | |||||||||
| Total included in other liabilities | 34 | 26 | 18 | ||||||||||||
Free-Standing Derivative Instruments—Customer Accommodation
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 Condensed Consolidated Balance Sheets or to forecasted transactions and, therefore, do not qualify for hedge accounting. These instruments include foreign exchange derivative contracts entered into for the benefit of commercial customers involved in international trade to hedge their exposure to foreign currency fluctuations, 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 its interest rate exposure on commercial customer transactions by executing offsetting swap agreements with primary dealers. Revaluation gains and losses on foreign exchange, commodity and other commercial customer derivative contracts are recorded as a component of corporate banking revenue in the Condensed Consolidated Statements of Income.
The Bancorp previously offered its customers an equity-linked certificate of deposit that had a return linked to equity indices. Under SFAS No. 133, a certificate of deposit that pays interest based on changes on an equity index is a hybrid instrument that requires separation into a host contract (the certificate of deposit) and an embedded derivative contract (written equity call option). The Bancorp entered into an offsetting derivative contract to economically hedge the exposure taken through the issuance of equity-linked certificates of deposit. Both the embedded derivative and derivative contract entered into by the Bancorp were recorded as free-standing derivatives and recorded at fair value with offsetting gains and losses recognized within noninterest income in the Condensed Consolidated Statements of Income.
C-20
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
The net gains (losses) recorded in the Condensed Consolidated Statements of Income relating to free-standing derivative instruments used for customer accommodation are summarized in the following table:
| Income Statement Caption | For the three months ended September 30, |
For the nine months ended September 30, | ||||||||||
| ($ in millions) | 2008 | 2007 | 2008 | 2007 | ||||||||
| Interest rate contracts: |
||||||||||||
| Interest rate lock commitments |
Mortgage banking net revenue | $ | 9 | 4 | $ | 11 | 4 | |||||
| Commodity contracts: |
||||||||||||
| Commodity contracts for customers |
Corporate banking revenue | 2 | 1 | 3 | 1 | |||||||
| Foreign exchange contracts: |
||||||||||||
| Foreign exchange contracts for customers |
Corporate banking revenue | 27 | 15 | 77 | 43 | |||||||
The following table reflects the notional amount and fair value of free-standing derivatives used for customer accommodation included in the Condensed Consolidated Balance Sheets:
| September 30, 2008 | December 31, 2007 | September 30, 2007 | ||||||||||||||
| ($ in millions) | Notional Amount |
Fair Value |
Notional Amount |
Fair Value |
Notional Amount |
Fair Value | ||||||||||
| Interest rate contracts included in other assets: |
||||||||||||||||
| Interest rate contracts for customers |
$ | 14,557 | $ | 449 | $ | 12,265 | 391 | $ | 11,169 | 170 | ||||||
| Interest rate lock commitments |
392 | 2 | 656 | 3 | 601 | 4 | ||||||||||
| Commodity contracts included in other assets: |
||||||||||||||||
| Commodity contracts for customers |
565 | 111 | 167 | 28 | 200 | 14 | ||||||||||
| Foreign exchange contracts included in other assets: |
||||||||||||||||
| Foreign exchange contracts for customers |
7,845 | 294 | 7,132 | 255 | 5,486 | 287 | ||||||||||
| Equity contracts included in other assets: |
||||||||||||||||
| Derivative instruments related to equity-linked CD |
57 | 2 | 50 | 5 | 38 | 4 | ||||||||||
| Total included in other assets | $ | 858 | 682 | 479 | ||||||||||||
| Interest rate contracts included in other liabilities: |
||||||||||||||||
| Interest rate contracts for customers |
$ | 15,544 | $ | 450 | $ | 12,430 | 391 | $ | 11,378 | 170 | ||||||
| Interest rate lock commitments |
679 | 4 | 253 | 1 | 217 | 1 | ||||||||||
| Commodity contracts included in other liabilities: |
||||||||||||||||
| Commodity contracts for customers |
557 | 104 | 163 | 22 | 199 | 13 | ||||||||||
| Foreign exchange contracts included in other liabilities: |
||||||||||||||||
| Foreign exchange contracts for customers |
7,192 | 250 | 6,642 | 234 | 5,292 | 270 | ||||||||||
| Equity contracts included in other liabilities: |
||||||||||||||||
| Derivative instruments related to equity-linked CD |
57 | 2 | 50 | 5 | 38 | 4 | ||||||||||
| Total included in other liabilities | $ | 810 | 653 | 458 | ||||||||||||
8. Commitments, Contingent Liabilities and Guarantees
The Bancorp, in the normal course of business, enters into financial instruments and various agreements to meet the financing needs of its customers. The Bancorp also enters in certain transactions and agreements to manage its interest rate and prepayment risks, provide funding, equipment and locations for its operations and
C-21
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
invest in its communities. These instruments and agreements involve, to varying degrees, elements of credit risk, counterparty risk and market risk in excess of the amounts recognized in the Bancorp’s Condensed Consolidated Balance Sheets. Creditworthiness for all instruments and agreements is evaluated on a case-by-case basis in accordance with the Bancorp’s credit policies. The Bancorp’s significant commitments, contingent liabilities and guarantees in excess of the amounts recognized in the Condensed Consolidated Balance Sheets are summarized as follows:
Commitments
The Bancorp has certain commitments to make future payments under contracts. A summary of significant commitments at September 30:
| ($ in millions) | 2008 | 2007 | |||
| Commitments to extend credit |
$ | 50,301 | 47,072 | ||
| Letters of credit (including standby letters of credit) |
8,899 | 8,330 | |||
| Forward contracts to sell mortgage loans |
1,695 | 1,552 | |||
| Noncancelable lease obligations |
910 | 770 | |||
| Purchase obligations |
87 | 60 | |||
| Capital expenditures | 83 | 92 | |||
Commitments to extend credit are agreements to lend, typically having fixed expiration dates or other termination clauses that may require payment of a fee. Since many of the commitments to extend credit may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash flow requirements. The Bancorp is exposed to credit risk in the event of nonperformance for the amount of the contract. Fixed-rate commitments are also subject to market risk resulting from fluctuations in interest rates and the Bancorp’s exposure is limited to the replacement value of those commitments. As of September 30, 2008 and 2007, the Bancorp had a reserve for probable credit losses on unfunded commitments totaling $132 million and $79 million, respectively, included in other liabilities in the Condensed Consolidated Balance Sheets.
Standby and commercial letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. At September 30, 2008, approximately $3.2 billion of standby letters of credit expire within one year, $5.3 billion expire between one to five years and $0.4 billion expire thereafter. At September 30, 2008, letters of credit of approximately $53 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 September 30, 2008, the reserve related to these standby letters of credit was $2 million. Approximately 69% and 72% of the total standby letters of credit were secured as of September 30, 2008 and 2007, respectively. 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.
At September 30, 2008, the Bancorp had outstanding letters of credit that were supporting certain securities issued as variable rate demand notes (“VRDNs”). The Bancorp facilitates financing for its commercial customers, which consist of companies and municipalities, by marketing the VRDNs to investors. The VRDNs pay interest to holders at a rate of interest that fluctuates based upon market demand. The VRDNs generally have long-term maturity dates, but can be tendered by the holder for purchase at par upon proper advance notice. When the VRDNs are tendered, a remarketing agent generally finds another investor to purchase the VRDNs to keep the securities outstanding in the market. FTS acts as the remarketing agent to issuers on approximately $4.6 billion of VRDNs at September 30, 2008. As remarketing agent, FTS is responsible for finding purchasers for investors that put VRDNs. The Bancorp issues letters of credit, as a credit enhancement, to the VRDNs remarketed by FTS, in addition to approximately $2.1 billion in VRDNs remarketed by third parties at
C-22
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
September 30, 2008. At September 30, 2008, FTS held $163 million of these securities in its portfolio and classified them as trading securities. The Bancorp purchased $203 million of the VRDNs from the market, through FTS, and held them in its trading securities portfolio at September 30, 2008. For the VRDNs remarketed by third parties, in some cases, the remarketing agent has failed to remarket the securities and has instructed the indenture trustee to draw upon approximately $335 million of letters of credit issued by the Bancorp. The Bancorp recorded these draws as commercial loans in its Condensed Consolidated Balance Sheets at September 30, 2008.
The Bancorp’s subsidiaries have entered into a number of noncancelable lease agreements. The minimum rental commitments under noncancelable lease agreements are shown in the previous table. The Bancorp or its subsidiaries have also entered into a limited number of agreements for work related to banking center construction and to purchase goods or services.
Contingent Liabilities
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 incurring a contingent liability arising from chargebacks is relatively low, as most products or services are delivered when purchased and credits are issued on returned items. For the nine months ended September 30, 2008 and 2007, the Bancorp processed approximately $100 million and $102 million, respectively, of chargebacks presented by issuing banks, resulting in no material losses to the Bancorp. The Bancorp accrues for probable losses based on historical experience and did not carry a credit loss reserve related to such chargebacks at September 30, 2008 and 2007.
There are legal claims pending against the Bancorp and its subsidiaries that have arisen in the normal course of business. See Note 9 for additional information regarding these proceedings.
Guarantees
The Bancorp has performance obligations upon the occurrence of certain events under financial guarantees provided in certain contractual arrangements.
Through September 30, 2008 and 2007, the Bancorp had transferred, subject to credit recourse, certain primarily floating-rate, short-term, investment grade commercial loans to an unconsolidated QSPE that is wholly owned by an independent third-party. 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. Under current accounting provisions, QSPEs are exempt from consolidation and, therefore, not included in the Bancorp’s Condensed Consolidated Financial Statements. The outstanding balance of these loans at September 30, 2008 and 2007 was $2.5 billion and $3.0 billion, respectively. As of September 30, 2008, the loans transferred had a weighted average life of 2.3 years. 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, ineligible loans transferred by the Bancorp to the QSPE, and the ability of the QSPE to issue commercial paper. The maximum amount of credit risk in the event of nonperformance by the underlying borrowers is approximately equivalent to the total outstanding balance. During the nine months ended September 30, 2008 and 2007, the QSPE did not transfer any loans back to the Bancorp as a result of a credit
C-23
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
event. In addition, there have been no material changes in the overall ratings of the loans transferred to the QSPE. For the nine months ended September 30, 2008, the Bancorp collected $501 million in net cash proceeds from loan transfers and $10 million in fees from the QSPE. For the nine months ended September 30, 2007, the Bancorp collected $1.1 billion in cash proceeds from loan transfers and $21 million in fees from the QSPE.
The QSPE issues commercial paper and uses the proceeds to fund the acquisition of commercial loans transferred to it by the Bancorp. The ability of the QSPE to issue commercial paper is a function of general market conditions and the credit rating of the liquidity provider. In the event the QSPE is unable to issue commercial paper, the Bancorp has agreed to provide liquidity support to the QSPE in the form of purchases of commercial paper, a line of credit to the QSPE and the repurchase of assets from the QSPE. As of September 30, 2008 and 2007, the liquidity asset purchase agreement was $3.0 billion and $4.0 billion, respectively. During the third quarter of 2008, the disruption in the short-term funding market continued causing the QSPE difficulty in obtaining sufficient funding through the issuance of commercial paper. As a result, the Bancorp provided liquidity support to the QSPE during the third quarter through purchases of commercial paper, a line of credit to the QSPE, and the repurchase of assets from the QSPE under the liquidity asset purchase agreement. As of September 30, 2008, the Bancorp held approximately $1.0 billion of asset-backed commercial paper issued by the QSPE, representing 39% of the total commercial paper issued by the QSPE.
During the third quarter of 2008, the Bancorp repurchased $513 million of commercial loans at par from the QSPE under the liquidity asset purchase agreement. A fair value adjustment charge of $3 million was recorded on the loans upon repurchase. As of September 30, 2008, there were no delinquent repurchased loans. As of September 30, 2008, there were no outstanding balances on the line of credit from the Bancorp to the QSPE. At September 30, 2008 and 2007, the Bancorp’s loss reserve related to the liquidity support and credit enhancement provided to the QSPE was $27 million and $13 million, respectively, and was recorded in other liabilities in the Condensed 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 commercial loans held in its loan portfolio.
At September 30, 2008 and 2007, the Bancorp had provided credit recourse on residential mortgage loans sold to unrelated third parties of approximately $1.4 billion and $1.6 billion, respectively. 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 securing the loan. The Bancorp maintained an estimated credit loss reserve of approximately $13 million and $18 million relating to these residential mortgage loans sold at September 30, 2008 and 2007, respectively, recorded in other liabilities on the Condensed 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.
FTS, a subsidiary of the Bancorp, guarantees the collection of all margin account balances held by its brokerage clearing agent for the benefit of FTS customers. FTS is responsible for payment to its brokerage clearing agent for any loss, liability, damage, cost or expense incurred as a result of customers failing to comply with margin or margin maintenance calls on all margin accounts. The margin account balance held by the brokerage clearing agent as of September 30, 2008 was $17 million compared to $48 million as of September 30, 2007. 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, the Bancorp does not maintain a loss reserve related to the margin accounts.
As of September 30, 2008 and 2007, the Bancorp had fully and unconditionally guaranteed certain long-term borrowing obligations issued by wholly-owned issuing trust entities of $2.8 billion and $1.4 billion, respectively. Refer to Note 10 for more information regarding long-term debt issued by the Bancorp.
C-24
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
The Bancorp, as a member bank of Visa, Inc. (“Visa”) prior to Visa’s completion of their initial public offering (“IPO”) on March 19, 2008, had certain indemnification obligations pursuant to Visa’s certificate of incorporation and bylaws and in accordance with their membership agreements. In accordance with Visa’s by-laws prior to the IPO, the Bancorp could have been required to indemnify Visa for the Bancorp’s proportional share of losses based on the pre-IPO membership interests. In contemplation of the IPO, Visa announced that it had completed restructuring transactions during the fourth quarter of 2007. As part of this restructuring, the Bancorp’s indemnification obligation was modified to include only certain known litigation as of the date of the restructuring. This modification triggered a requirement to recognize the fair value of the indemnification obligation in accordance with FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” Accordingly, the Bancorp recorded an indemnification liability under FIN 45 of $3 million. Additionally, during 2007, the Bancorp recorded $169 million for its share of litigation formally settled by Visa and for probable future litigation settlements. During the third quarter of 2008, the Bancorp recorded an additional $45 million related to Visa’s pending litigation settlement with Discover. These amounts were accrued under SFAS No. 5, “Accounting for Contingencies.” In connection with the IPO, Visa retained a portion of the proceeds to fund an escrow account in order to resolve existing litigation settlements as well as fund potential future litigation settlements. As of September 30, 2008, the Bancorp has recorded its proportional share of $124 million of the Visa escrow account net against the current Visa litigation reserve of $189 million.
9. Legal and Regulatory Proceedings
As previously disclosed, during May 2005, the Bancorp filed suit in the United States District Court for the Southern District of Ohio against the IRS seeking a refund of taxes paid as a result of the audit of the 1997 tax year. This suit involves a determination of the correct tax treatment of certain leveraged leases entered into by the Bancorp. The outcome of this litigation will likely impact a number of leveraged leases entered into during 1997 through 2004. After a jury trial, the jury rendered a verdict in the form of answers to interrogatories, some of which favored Fifth Third and some of which favored the IRS. No judgment has been entered by the court in the case and the parties dispute the judgment that should be entered in light of the jury’s responses to the interrogatories. During the third quarter of 2008, the IRS announced a global settlement initiative relating to disputed leveraged leases. Because Fifth Third is currently engaged in litigation on this matter, the Bancorp has not been invited to participate in the settlement initiative. However, the Bancorp is currently in settlement discussions with the IRS. The nature and timing of a potential settlement and/or any future decision by the court are uncertain. During the second quarter of 2008, decisions in two other cases involving the tax treatment of leveraged leases were issued where the courts ruled in favor of the IRS. To date, the decisions issued have been dependent on the specific facts in each case. The Bancorp continues to believe that the facts and circumstances related to its leveraged leases are different from these other cases, that its tax treatment was proper under the tax law as it existed at the time the tax benefits were reported, and that the facts in its case support its position. The Bancorp is required under applicable accounting standards to assess the likeliness of a favorable outcome of this litigation. In light of recent decisions and uncertainty related to its own case, the Bancorp concluded during the second quarter that previously recognized benefits from the transactions at issue in the litigation and certain other leveraged leases described above must be remeasured as required by FIN 48 and recorded an increase to tax expense of approximately $140 million, or $0.26 per share, both pre-tax and after-tax, for interest related to previous tax years pursuant to FIN 48 and a charge of approximately $130 million pre-tax, or $0.16 per share after-tax, to reflect a projected change in the timing of tax benefits pursuant to FSP No. FAS 13-2. The Bancorp believes these charges address the downside risk it has related to leveraged leases should there be a negative outcome in its case.
C-25
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
During April 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. In addition to being a named defendant, the Bancorp is also subject to an indemnification obligation of Visa as discussed in Note 8. Accordingly, in the third and fourth quarters of 2007, the Bancorp recorded a contingent liability included in the $172 million litigation reserve. In connection with Visa’s IPO, Visa retained a portion of the proceeds to fund an escrow account in order to resolve existing litigation settlements as well as fund potential future litigation settlements. As of September 30, 2008, the Bancorp has recorded its proportional share of $124 million of the Visa escrow account net against the current Visa litigation reserve of $189 million. This antitrust litigation is still in the discovery phase.
Several putative class action complaints have been filed against the Bancorp in various federal and state courts. The federal cases were consolidated by the Judicial Panel on Multidistrict Litigation and are now known as “In Re TJX Security Breach Litigation.” The state court actions have been removed to federal court and have been consolidated into that same case. The complaints relate to the alleged intrusion of The TJX Companies, Inc.’s (“TJX”) computer system and the potential theft of their customers’ non-public information and alleged violations of the Gramm-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 the alleged intrusion. Another was filed by financial institutions and seeks unquantified damages on behalf of other similarly situated entities that suffered losses in relation to the alleged intrusion. The U.S. District Court (“Court”) has granted the Bancorp’s motion to dismiss certain of the claims, but additional claims remain pending. On November 29, 2007, the U.S. District Court, District of Massachusetts (“District Court”) issued an order denying Plaintiffs’ Motion for Class Certification in the consolidated cases brought by financial institutions (the “Financial Institution Track”). On December 18, 2007, the District Court entered its final order in the Financial Institution Track litigation that i) denied Plaintiffs’ Motion for Leave to Amend their Complaint, without prejudice; ii) dismissed the case for lack of subject matter jurisdiction; and iii) transferred the case from the United States District Court to the Massachusetts Superior Court in and for the County of Middlesex (“Massachusetts State Court”). On December 18, 2007, TJX Companies, Inc. filed a Notice of Appeal to the United States Court of Appeals for the First Circuit (“First Circuit”) as to that portion of the Court’s December 18 order transferring the case to Massachusetts State Court and an emergency motion to stay the Massachusetts State Court proceedings pending the appeal. On December 19, 2007, the First Circuit granted the request for stay until further order of the Court. On December 20, 2007, the Bancorp likewise filed a Notice of Appeal to the First Circuit solely as to that portion of the District Court’s December 18 Order transferring the case to the Massachusetts State Court. On December 21, 2007, Plaintiffs also filed a Notice of Appeal in the First Circuit as to the entirety of the District Court’s December 18 Order and also as to all other prior “adverse rulings” including, without limitation, the District Court’s denial of class certification and dismissal of various claims. Both TJX and the Bancorp amended their Notices of Appeal to likewise appeal all adverse rulings by the District Court. Separately, on January 16, 2008, the two remaining financial institution plaintiff banks who had not reached a settlement with TJX filed a new lawsuit against the Bancorp and TJX in Massachusetts State Court asserting similar allegations to those set forth in the Financial Institution Track litigation. After TJX and the Bancorp removed the case to the District Court, it was remanded to Massachusetts State Court and a motion to stay those proceedings is now pending. In regards to the consumer track litigation, on January 9, 2008, the District Court issued an Order of Preliminary Approval of a proposed class action settlement funded solely by TJX. A Final Fairness Hearing was held July 15, 2008, at which time the Court approved the proposed settlement with certain changes that are subject to objection by the parties.
C-26
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
In September 2007, Ronald A. Katz Technology Licensing, L.P. (“Katz”) filed a suit in the United States District Court for the Southern District of Ohio against the Bancorp and its Ohio banking subsidiary. In the suit, Katz alleges that the Bancorp and its Ohio bank are infringing on Katz’s patents for interactive call processing technology by offering certain automated telephone banking and other services. This lawsuit is one of many related patent infringement suits brought by Katz in various courts against numerous other defendants. Katz is seeking unspecified monetary damages and penalties as well as injunctive relief in the suit. Management believes there are substantial defenses to these claims and intends to defend them vigorously. The impact of the final disposition of this lawsuit cannot be assessed at this time.
In June through September of 2008, five putative securities class action complaints were filed against the Bancorp and its Chief Executive Officer, among other parties, and are currently pending in the United States District Court for the Southern District of Ohio. The lawsuits allege violations of federal securities laws related to disclosures made by the Bancorp in press releases and filings with the Securities and Exchange Commission regarding its quality and sufficiency of capital, credit losses and related matters, and seeking unquantified damages on behalf of putative classes of persons who either purchased the Bancorp’s securities, or acquired the Bancorp’s securities pursuant to the First Charter Corporation Acquisition. In addition to the foregoing, two cases were filed in the United States District Court for the Southern District of Ohio against the Bancorp and certain officers alleging violations of ERISA based on allegations similar to those set forth in the securities class action cases filed during the same period of time. Also, in July 2008, a shareholder of the Bancorp filed a shareholder derivative suit in the Court of Common Pleas for Hamilton County, Ohio, against the members of the Bancorp’s Board of Directors and, nominally, the Bancorp, alleging breach of fiduciary duty in connection with the Bancorp’s alleged violations of federal and state securities laws, among other charges, in relation to its previous statements regarding its quality and sufficiency of capital, credit losses and related matters. The suit seeks unspecified compensatory damages in favor of the Bancorp from the Board of Directors, punitive damages, and interest, as well as costs, disbursements and attorney and other expert fees to the plaintiff. The impact of the final disposition of these lawsuits cannot be assessed at this time.
The Bancorp and its subsidiaries are not parties to any other material litigation. However, there are other litigation matters that 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, results of operations or cash flows.
10. Long-term Debt
In March 2008, the Bancorp issued $1.0 billion of subordinated notes to third party investors. The subordinated notes bear a fixed rate of interest of 8.25% per annum. The notes are unsecured, subordinated obligations of the Bancorp. Payment of the full principal amount of the notes will be due upon maturity on March 1, 2038. The notes will not be subject to redemption at the Bancorp’s option at any time prior to maturity.
In April 2008, the Bancorp issued $750 million of senior notes to third party investors. The senior notes bear a fixed rate of interest of 6.25% per annum. The notes are unsecured, senior obligations of the Bancorp. Payment of the full principal amount of the notes will be due upon maturity on May 1, 2013. The notes will not be subject to redemption at the Bancorp’s option at any time prior to maturity.
In May 2008, Fifth Third Capital Trust VII (“Trust VII”), a wholly-owned non-consolidated subsidiary of the Bancorp, issued $400 million of Tier 1-qualifying trust preferred securities to third party investors and invested these proceeds in junior subordinated notes (“JSN VII”) issued by the Bancorp. The Bancorp’s obligations under the transaction documents, taken together, have the effect of providing a full and unconditional
C-27
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
guarantee by the Bancorp, on a subordinated basis, of the payment obligations of the Trust VII. No other subsidiaries of the Bancorp are guarantors of the JSN VII. The JSN VII will mature on May 15, 2068. The JSN VII held by the Trust VII bear a fixed rate of interest of 8.875% until May 15, 2058. After May 15, 2058, the JSN VII bear interest at a variable rate of three-month LIBOR plus 5.00%. The Bancorp has subsequently entered into hedges related to these notes. The JSN VII may be redeemed at the option of the Bancorp on or after May 15, 2013, or in certain other limited circumstances, at a redemption price of 100% of the principal amount plus accrued but unpaid interest. All redemptions are subject to certain conditions and generally require approval by the Federal Reserve Board.
In August 2008, $839 million of senior extendable notes matured and were paid. The extendable notes were issued in November 2004 to third-party investors and paid interest at one-month LIBOR plus 1 bp. In September 2008, an additional $800 million of the senior extendable notes matured.
In August 2008, $500 million of senior fixed-rate bank notes issued in July of 2003 matured and were paid. These long-term bank notes were issued to third-party investors at a fixed rate of 3.375%.
11. Income Taxes
The actual effective tax rate for the nine months ended September 30, 2008 has been used in the computation of the applicable income taxes (benefits) of $(72) million and $150 million for the three and nine months ended September 30, 2008, respectively.
The Bancorp accounts for its uncertain tax positions in accordance with FIN 48. At September 30, 2008 and December 31, 2007, the Bancorp had unrecognized tax benefits of $969 million and $469 million, respectively. Those balances included $83 million and $100 million of tax positions that, if recognized, would impact the effective tax rate and $2 million and $6 million in tax positions that would impact goodwill. The remaining $884 million and $363 million is related to tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of the deductions. A significant portion of these tax positions relate to the leveraged lease litigation discussed in Note 9.
It is reasonably possible that the amount of the unrecognized benefit with respect to certain of the Bancorp’s uncertain tax positions could significantly increase or decrease during the next 12 months. An estimate of the range of the reasonably possible changes to the unrecognized tax benefits cannot be made at this time.
Any interest and penalties incurred in connection with income taxes are accrued as a component of tax expense. At September 30, 2008 and December 31, 2007, the Bancorp had accrued interest liabilities of $210 million and $67 million, net of the related tax benefits. A significant portion of the interest accrued as well as the increase during the year relates to the leveraged lease charge discussed in Note 9. No liabilities were recorded for penalties. At September 30, 2008, the Bancorp had an approximately $1 billion deposit with the IRS to mitigate the risk associated with the disputed leases. This deposit enables the Bancorp to stop the accrual of interest, to the extent of the deposits, if the Bancorp is not ultimately successful in its legal dispute.
The statute of limitations for Federal income tax returns remains open for tax years 2004 through 2007. In addition, limited statute extensions have been agreed to for tax years 1997 through 2003 primarily for leasing uncertainties. With the exception of the state impact of the Federal items discussed above as well as a few states with insignificant uncertain liabilities, the statutes of limitations for state income tax returns remain open for tax years in accordance with the various states’ statutes.
C-28
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
12. Retirement and Benefit Plans
Net periodic pension cost is recorded as a component of employee benefits expense in the Condensed Consolidated Statements of Income. 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. Based on the current year actuarial assumptions, the Bancorp did not make any cash contributions to its pension plans during the nine months ended September 30, 2008, and does not expect to contribute to the plans during the remainder of 2008.
The following table summarizes the components of net periodic pension cost:
| For the three months ended September 30, |
For the nine months ended September 30, |
|||||||||||||
| ($ in millions) | 2008 | 2007 | 2008 | 2007 | ||||||||||
| Service cost |
$ | — | — | $ | — | — | ||||||||
| Interest cost |
3 | 3 | 10 | 10 | ||||||||||
| Expected return on assets |
(4 | ) | (5 | ) | (14 | ) | (15 | ) | ||||||
| Amortization of actuarial loss |
2 | 2 | 5 | 6 | ||||||||||
| Amortization of net prior service cost |
— | — | — | 1 | ||||||||||
| Settlement |
7 | 6 | 7 | 6 | ||||||||||
| Net periodic pension cost | $ | 8 | 6 | $ | 8 | 8 | ||||||||
13. Stock-Based Compensation
Stock-based compensation awards are eligible for issuance under the 2008 Incentive Compensation Plan to key employees and directors of the Bancorp and its subsidiaries. The Incentive Compensation Plan provides for incentive and non-qualified stock options, stock appreciation rights (“SARs”), restricted stock and restricted stock units, and performance share and restricted stock awards. All of the Bancorp’s stock-based awards are to be settled with stock with the exception of a portion of the performance shares that are to be settled in cash. The Bancorp has historically used treasury stock to settle stock-based awards, when available. Stock options, issued at fair market value based on the closing price of the Bancorp’s common stock on the date of grant, have up to ten-year terms and vest and become fully exercisable ratably over a three or four year period of continued employment. SARs, issued at fair market value based on the closing price of the Bancorp’s common stock on the date of grant, have up to ten-year terms and vest and become exercisable either ratably or fully over a four year period of continued employment. The Bancorp does not grant discounted stock options or SARs, re-price previously granted stock options or SARs, or grant reload stock options. Restricted stock grants vest either fully after four years or ratably after three, four and five years of continued employment and include dividend and voting rights. Performance share and performance restricted stock awards have three-year cliff vesting terms with performance or market conditions as defined by the plan.
For stock options, approximately 1.1 million options were issued in conjunction with acquisitions, 1,000 were granted, 200,000 were exercised, and 2.9 million were forfeited or expired during the nine months ended September 30, 2008. Approximately 5,000 options were granted, 2.7 million were exercised, and 556,000 were forfeited or expired during the nine months ended September 30, 2007. For SARs, approximately 6.8 million were granted and 1.7 million were forfeited or expired during the nine months ended September 30, 2008. No SARs were exercised during the nine months ended September 30, 2008. Approximately 6.6 million SARs
C-29
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
were granted, 43,000 were exercised, and 1.3 million were forfeited or expired during the nine months ended September 30, 2007. For restricted stock awards, approximately 3.1 million awards were granted, 412,000 awards vested and were released, and 506,000 awards were forfeited during the nine months ended September 30, 2008. Approximately 1.6 million awards were granted, 74,000 awards vested and were released, and 290,000 awards were forfeited during the nine months ended September 30, 2007.
The Bancorp uses assumptions, which are evaluated and revised as necessary, in estimating the grant-date fair value of each SAR grant. For the nine months ended September 30, 2008 and 2007, the weighted-average assumptions were as follows:
| 2008 | 2007 | |||||
| Expected life (in years) |
6 | 6 | ||||
| Expected volatility |
30 | % | 22 | % | ||
| Expected dividend yield |
8.69 | % | 4.44 | % | ||
| Risk-free interest rate | 3.25 | % | 4.56 | % |
The expected 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 common stock. The expected dividend yield is based on annual dividends divided by the Bancorp’s stock price at the date of the grant. The risk-free 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 $15 million and $12 million for the three months ended September 30, 2008 and 2007, respectively, and $42 million and $48 million for the nine months ended September 30, 2008 and 2007, respectively, and is included in salaries, wages and incentives expense in the Condensed Consolidated Statements of Income.
14. Accumulated Other Comprehensive Income
The Bancorp has elected to present the disclosures required by SFAS No. 130, “Reporting Comprehensive Income,” in the Condensed Consolidated Statements of Changes in Shareholders’ Equity and in the following table. Disclosure of the reclassification adjustments, related tax effects allocated to other comprehensive income and accumulated other comprehensive income for the nine months ended September 30 were as follows:
| ($ in millions) | Pre-Tax Activity |
Tax Effect |
Net Activity |
Beginning Balance |
Net Activity |
Ending Balance |
|||||||||||||
| 2008 |
|||||||||||||||||||
| Unrealized holding gains on available-for-sale securities arising during period |
$ | 51 | (18 | ) | 33 | ||||||||||||||
| Reclassification adjustment for net losses included in net income |
21 | (7 | ) | 14 | |||||||||||||||
| Net unrealized gains (losses) on available-for-sale securities |
72 | (25 | ) | 47 | $ | (94 | ) | 47 | (47 | ) | |||||||||
| Unrealized holding gains on cash flow hedge derivatives |
25 | (9 | ) | 16 | |||||||||||||||
| Reclassification adjustment for net gains on cash flow hedge derivatives included in net income |
(2 | ) | 1 | (1 | ) | ||||||||||||||
| Net unrealized gains on cash flow hedge derivatives |
23 | (8 | ) | 15 | 25 | 15 | 40 | ||||||||||||
| Defined benefit plans: |
|||||||||||||||||||
| Net prior service cost |
— | — | — | ||||||||||||||||
| Net gain |
6 | (2 | ) | 4 | |||||||||||||||
| Defined benefit plans, net |
6 | (2 | ) | 4 | (57 | ) | 4 | (53 | ) | ||||||||||
| Total other comprehensive income |
$ | 101 | (35 | ) | 66 | ||||||||||||||
| Total accumulated other comprehensive income | $ | (126 | ) | 66 | (60 | ) | |||||||||||||
C-30
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
| ($ in millions) | Pre-Tax Activity |
Tax Effect |
Net Activity |
Beginning Balance |
Net Activity |
Ending Balance |
||||||||||||||
| 2007 |
||||||||||||||||||||
| Unrealized holding losses on available-for-sale securities arising during period |
$ | (33 | ) | 12 | (21 | ) | ||||||||||||||
| Reclassification adjustment for net gains included in net income |
(14 | ) | 5 | (9 | ) | |||||||||||||||
| Net unrealized losses on available-for-sale securities |
(47 | ) | 17 | (30 | ) | $ | (119 | ) | (30 | ) | (149 | ) | ||||||||
| Unrealized holding gains on cash flow hedge derivatives |
12 | (4 | ) | 8 | ||||||||||||||||
| Reclassification adjustment for net gains on cash flow hedge derivatives included in net income |
(1 | ) | — | (1 | ) | |||||||||||||||
| Net unrealized gains on cash flow hedge derivatives |
11 | (4 | ) | 7 | (1 | ) | 7 | 6 | ||||||||||||
| Defined benefit plans: |
||||||||||||||||||||
| Net prior service cost |
— | — | — | |||||||||||||||||
| Net gain |
6 | (2 | ) | 4 | ||||||||||||||||
| Defined benefit plans, net |
6 | (2 | ) | 4 | (59 | ) | 4 | (55 | ) | |||||||||||
| Total other comprehensive income |
$ | (30 | ) | 11 | (19 | ) | ||||||||||||||
| Total accumulated other comprehensive income | $ | (179 | ) | (19 | ) | (198 | ) | |||||||||||||
15. Earnings Per Share
The calculation of earnings per share and the reconciliation of earnings per share and earnings per diluted share were as follows:
| 2008 | 2007 | |||||||||||||||||
| For the three months ended September 30: ($ in millions, except per share data) |
Income | Average Shares |
Per Share Amount |
Income | Average Shares |
Per Share Amount | ||||||||||||
| Earnings per share: |
||||||||||||||||||
| Net income (loss) |
$ | (56 | ) | $ | 325 | |||||||||||||
| Dividends on preferred stock |
25 | — | ||||||||||||||||
| Net income (loss) available to common shareholders |
$ | (81 | ) | 572 | $ | (0.14 | ) | $ | 325 | 530 | $ | 0.61 | ||||||
| Earnings per diluted share: |
||||||||||||||||||
| Net income (loss) available to common shareholders |
$ | (81 | ) | 572 | $ | (0.14 | ) | $ | 325 | 530 | $ | 0.61 | ||||||
| Effect of dilutive securities: |
||||||||||||||||||
| Stock based awards |
— | — | 2 | — | ||||||||||||||
| Convertible preferred stock (a) |
— | — | — | — | — | — | ||||||||||||
| Net income (loss) available to common shareholders plus assumed conversions |
$ | (81 | ) | 572 | $ | (0.14 | ) | $ | 325 | 532 | $ | 0.61 | ||||||
| 2008 | 2007 | ||||||||||||||||
| For the nine months ended September 30: ($ in millions except per share data) |
Income | Average Shares |
Per Share Amount |
Income | Average Shares |
Per Share Amount |
|||||||||||
| Earnings per share: |
|||||||||||||||||
| Net income |
$ | 29 | $ | 1,059 | |||||||||||||
| Dividends on preferred stock |
26 | — | |||||||||||||||
| Net income available to common shareholders |
$ | 3 | 547 | $ | 0.01 | $ | 1,059 | 540 | $ | 1.96 | |||||||
| Earnings per diluted share: |
|||||||||||||||||
| Net income available to common shareholders |
$ | 3 | 547 | $ | 0.01 | $ | 1,059 | 540 | $ | 1.96 | |||||||
| Effect of dilutive securities: |
|||||||||||||||||
| Stock based awards |
2 | — | 3 | (0.01 | ) | ||||||||||||
| Convertible preferred stock (a) |
— | — | — | — | — | — | |||||||||||
| Net income available to common shareholders plus assumed conversions | $ | 3 | 549 | $ | 0.01 | $ | 1,059 | 543 | $ | 1.95 | |||||||
| (a) | The effect of dilutive securities on the dividends on preferred stock for the three and nine months ended September 30, 2008 was included in the calculation of net income available to common shareholders, however, it was excluded from assumed conversions because the effect would be anti-dilutive. |
C-31
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
Due to the net loss for the three months ended September 30, 2008, the diluted earnings per share calculation excludes all common stock equivalents, including 44 million stock options and stock appreciation rights, 6 million shares of restricted stock and 96 million shares of convertible preferred stock as their inclusion would have been anti-dilutive to earnings per share.
Options to purchase 38 million shares outstanding during the three months ended September 30, 2007 were not included in the computation of net income per diluted share as the effect would have been anti-dilutive. The outstanding shares consist of options and stock appreciation rights that have not yet been exercised, and unvested restricted stock. These options and stock appreciation rights are excluded from the computation of net income per diluted share for the three months ended September 30, 2007 because the exercise price of the shares is greater than the average market price of the common shares and, therefore, the effect would be anti-dilutive. Restricted shares are excluded from the calculation until vested.
Options to purchase 81 million shares outstanding, including 36 million shares of convertible preferred stock, and 34 million shares outstanding during the nine months ended September 30, 2008 and September 30, 2007, respectively, were not included in the computation of net income per diluted share as the effect would have been anti-dilutive.
16. Fair Value Measurements
Effective January 1, 2008, the Bancorp adopted SFAS No. 157, “Fair Value Measurements”, which provides a framework for measuring fair value under accounting principles generally accepted in the United States of America. SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 also establishes a fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the instrument’s fair value measurement. The three levels within the fair value hierarchy are described as follows:
Level 1—Quoted prices (unadjusted) in active markets for identical assets or liabilities that the Bancorp has the ability to access at the measurement date.
Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include: quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3—Unobservable inputs for the asset or liability for which there is little, if any, market activity at the measurement date. Unobservable inputs reflect the Bancorp’s own assumptions about what market participants would use to price the asset or liability. The inputs are developed based on the best information available in the circumstances, which might include the Bancorp’s own financial data such as internally developed pricing models, discounted cash flow methodologies, as well as instruments for which the fair value determination requires significant management judgment.
There were no financial instruments measured at fair value that moved to a lower level in the fair value hierarchy due to the lack of observable quotes in inactive markets for those instruments at September 30, 2008.
C-32
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
Effective January 1, 2008, the Bancorp adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115”, which allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on an instrument-by-instrument basis. Upon election of the fair value option in accordance with SFAS No. 159, subsequent changes in fair value are recorded as an adjustment to earnings.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table summarizes assets and liabilities measured at fair value on a recurring basis, including financial instruments in which the Bancorp has elected the fair value option in accordance with SFAS No. 159.
| Fair Value Measurements Using | |||||||||||
| As of September 30, 2008 ($ in millions) | Quoted Prices in (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
Total Fair Value | |||||||
| Assets: |
|||||||||||
| Available-for-sale securities (a) |
$ | 427 | 11,805 | 149 | (f) | $ | 12,381 | ||||
| Trading securities |
3 | 912 | — | 915 | |||||||
| Loans held for sale (b) |
— | 844 | — | 844 | |||||||
| Residential mortgage loans (c) |
— | — | 5 | 5 | |||||||
| Other assets (d) |
16 | 1,181 | 4 | 1,201 | |||||||
| Total assets |
$ | 446 | 14,742 | 158 | $ | 15,346 | |||||
| Liabilities: |
|||||||||||
| Other liabilities (e) |
$ | 33 | 846 | 14 | $ | 893 | |||||
| Total liabilities | $ | 33 | 846 | 14 | $ | 893 | |||||
| (a) | Excludes FHLB and FRB stock totaling $544 million and $252 million, respectively, which are carried at par. |
| (b) | Includes residential mortgage loans held for sale. |
| (c) | Includes residential mortgage loans originated as held for sale and subsequently transferred to held for investment. |
| (d) | Includes derivatives with a positive fair value. |
| (e) | Includes derivatives with a negative fair value, short positions and certain deferred compensation liabilities. |
| (f) | See Note 4 for a sensitivity analysis on residual interests from securitizations of automobile loans. |
The following is a description of the valuation methodologies used for significant instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.
Available-for-sale and Trading securities
Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include government bonds and exchange traded equities. If quoted market prices are not available, then fair values are estimated using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. Examples of such instruments, which would generally be classified within Level 2 of the valuation hierarchy, include corporate and municipal bonds, mortgage-backed securities, and asset-backed securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. Securities classified within Level 3 include residual interests in securitizations of automobile and home equity loans.
C-33
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
Residential mortgage loans held for sale
For residential mortgage loans held for sale, fair value is estimated based upon mortgage-backed securities prices and spreads to those prices or, for certain assets, discounted cash flow models that may incorporate the anticipated portfolio composition, credit spreads of asset-backed securities with similar collateral, and market conditions. Residential mortgage loans held for sale are classified within Level 2 of the valuation hierarchy.
Derivatives
Exchange-traded derivatives valued using quoted prices are classified within Level 1 of the valuation hierarchy. However, few classes of derivative contracts are listed on an exchange. The majority of the Bancorp’s derivative positions are valued utilizing models that use as their basis readily observable market parameters and are classified within Level 2 of the valuation hierarchy. Such derivatives include basic and structured interest rate swaps and options. Derivatives that are valued based upon models with significant unobservable market parameters are classified within Level 3 of the valuation hierarchy. Interest rate lock commitments on residential mortgage loans are an example of derivatives designated as Level 3.
The following table is a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2008.
| Fair Value Measurements Using Significant Unobservable Inputs (Level 3) | ||||||||||||||||||||||||||||
| Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||
| ($ in millions) | Available- for-Sale Securities |
Residential Mortgage Loans |
Derivatives, Net (a) |
Total Fair Value |
Available- for-Sale Securities |
Residential Mortgage Loans |
Derivatives, Net (a) |
Total Fair Value |
||||||||||||||||||||
| Beginning balance |
$ | 173 | — | (7 | ) | $ | 166 | $ | 10 | — | (4 | ) | $ | 6 | ||||||||||||||
| Total gains or losses (realized/unrealized): |
||||||||||||||||||||||||||||
| Included in earnings |
(10 | ) | (1 | ) | 11 | — | (8 | ) | (1 | ) | — | (9 | ) | |||||||||||||||
| Included in other comprehensive income |
(1 | ) | — | — | (1 | ) | 1 | — | — | 1 | ||||||||||||||||||
| Purchases, sales, issuances, settlements-net |
(13 | ) | 6 | (14 | ) | (21 | ) | 146 | 6 | (6 | ) | 146 | ||||||||||||||||
| Transfers in and/or out of Level 3 |
— | — | — | — | — | — | — | — | ||||||||||||||||||||
| Ending balance |
$ | 149 | 5 | (10 | ) | $ | 144 | $ | 149 | 5 | (10 | ) | $ | 144 | ||||||||||||||
| The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at September 30, 2008 (b) |
$ | (10 | ) | (1 | ) | (7 | ) | $ | (18 | ) | $ | (8 | ) | (1 | ) | (7 | ) | $ | (16 | ) | ||||||||
| (a) | Net derivatives include derivative assets of $4 million and derivative liabilities of $14 million at September 30, 2008. |
| (b) | Includes interest income and expense. |
C-34
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
The total gains and losses included in earnings for the three and nine months ended September 30, 2008 for assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) were recorded in the Condensed Consolidated Statements of Income as follows:
| ($ in millions) | Gains (Losses) For Three Months Ended |
Gains (Losses) For Nine Months Ended |
||||||
| Interest income |
$ | 2 | $ | 5 | ||||
| Corporate banking revenue |
— | (5 | ) | |||||
| Mortgage banking net revenue |
8 | 10 | ||||||
| Other noninterest income |
2 | (5 | ) | |||||
| Securities gains (losses), net |
(12 | ) | (14 | ) | ||||
| Total gains (losses) | $ | — | $ | (9 | ) | |||
The total gains and losses included in earnings for the three and nine months ended September 30, 2008 attributable to changes in unrealized gains and losses related to assets still held at September 30, 2008 were recorded in the Condensed Consolidated Statements of Income as follows:
| ($ in millions) | Gains (Losses) For Three Months Ended |
Gains (Losses) For Nine Months Ended |
||||||
| Interest income |
$ | 2 | $ | 5 | ||||
| Corporate banking revenue |
1 | 1 | ||||||
| Mortgage banking net revenue |
(3 | ) | (3 | ) | ||||
| Other noninterest income |
(6 | ) | (5 | ) | ||||
| Securities gains (losses), net |
(12 | ) | (14 | ) | ||||
| Total gains (losses) | $ | (18 | ) | $ | (16 | ) | ||
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Certain assets and liabilities are measured at fair value on a nonrecurring basis. These assets and liabilities are not measured at fair value on an ongoing basis; however, they are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment.
| Carrying Value at September 30, 2008 | Total Gains (Losses) | |||||||||||||||||
| ($ in millions) | Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other |
Significant Unobservable Inputs (Level 3) |
Total | Three Months Ended September 30, 2008 |
Nine months Ended September 30, 2008 |
||||||||||||
| Commercial loans |
$ | — | — | 356 | $ | 356 | $ | (70 | ) | $ | (207 | ) | ||||||
| Commercial mortgage loans |
— | — | 205 | 205 | (83 | ) | (150 | ) | ||||||||||
| Commercial construction loans |
— | — | 293 | 293 | (116 | ) | (237 | ) | ||||||||||
| Servicing rights |
— | — | 294 | 294 | (23 | ) | 1 | |||||||||||
| Total | $ | — | — | 1,148 | $ | 1,148 | $ | (292 | ) | $ | (593 | ) | ||||||
During 2008, certain loans included in the Bancorp’s loan portfolio were deemed impaired in accordance with SFAS No. 114. The fair value of the impaired commercial loans totaled $167 million at September 30, 2008. The losses from fair value adjustments relating to impairment on these commercial loans totaled $67 million and $204 million for the three and nine months ended September 30, 2008. The fair value and
C-35
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
impairment on commercial mortgage and commercial construction loans is shown in the previous table. The fair value was calculated based on the fair value of the underlying collateral. Therefore, these loans were classified within Level 3 of the valuation hierarchy.
During the third quarter of 2008, the Bancorp repurchased $513 million of commercial loans at par from a QSPE under its liquidity asset purchase agreement. A fair value charge of $3 million was recorded on $213 million of the loans upon repurchase. The fair value of these commercial loans was $189 million at September 30, 2008. The fair value of the commercial loans was valued based on the difference between the existing interest rate spread on each commercial loan and the target spread and utilization of a discounted cash flow analysis. Therefore, these loans were classified within Level 3 of the valuation hierarchy. See Note 8 for further information on the loans repurchased from the QSPE.
During the first quarter of 2008, the Bancorp recognized temporary impairment of $56 million in certain classes of the MSR portfolio in which the carrying value of the MSRs was written down to the fair value as of March 31, 2008. In the second quarter of 2008, the Bancorp recognized a recovery of the impairment of $80 million. During the third quarter of 2008, the Bancorp recognized temporary impairment of $23 million in certain classes of the MSR portfolio in which the carrying value of the MSRs was written down to the fair value as of September 30, 2008. MSRs do not trade in an active, open market with readily observable prices. While sales of MSRs do occur, the precise terms and conditions typically are not readily available. Accordingly, the Bancorp estimates the fair value of MSRs using discounted cash flow models with certain unobservable inputs, primarily prepayment speed assumptions, resulting in a classification within Level 3 of the valuation hierarchy.
Fair Value Option
The Bancorp elected on January 1, 2008 to measure residential mortgage loans held for sale at fair value in accordance with SFAS No. 159. The election was prospective, at the instrument level, for residential mortgage loans that have a designation as held for sale on the day the specific loan closes. Existing loans held for sale as of December 31, 2007 were not included in the fair value option election and were valued at the lower of cost or market. Electing to measure residential mortgage loans held for sale at fair value reduces certain timing differences, better matches changes in the value of these assets with changes in the value of derivatives used as economic hedges for these assets and eliminates the complex hedge accounting requirements that were followed prior to the adoption of SFAS No. 159.
Management’s intent to sell residential mortgage loans classified as held for sale may change over time due to such factors as changes in the overall liquidity markets or changes in characteristics specific to certain loans held for sale. Consequently, these loans may be reclassified to loans held for investment and maintained in the Bancorp’s loan portfolio. In such cases, the loans will continue to be measured at fair value in accordance with SFAS No. 159. Residential loans with a fair value of $5 million at September 30, 2008, including fair value losses of $1 million, were transferred to the Bancorp’s portfolio during the three and nine months ended September 30, 2008.
Fair value changes included in earnings for instruments for which the fair value option was elected included gains of $1 million and $9 million, respectively, for the three and nine months ended September 30, 2008 and are reported as mortgage banking net revenue in the Condensed Consolidated Statements of Income.
Losses included in earnings attributable to changes in instrument-specific credit risk for residential mortgage loans reclassified from held for sale to held for investment were $1 million for the three and nine months ended September 30, 2008. Instrument-specific credit risk for residential mortgage loans held for sale measured at fair value are immaterial to the Bancorp’s Condensed Consolidated Financial Statements due to the short time period between the origination and sale of the loans, and the lack of delinquent loans at September 30,
C-36
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
2008. Interest on residential mortgage loans measured at fair value is accrued as it is earned using the effective interest method and is reported as interest income in the Condensed Consolidated Statements of Income.
The following table summarizes the difference between the aggregate fair value and the aggregate unpaid principal balance for residential mortgage loans measured at fair value as of September 30, 2008.
| ($ in millions) | Aggregate Fair Value | Aggregate Unpaid Principal Balance |
Difference | |||||
| Residential mortgage loans measured at fair value |
$ | 849 | 832 | $ | 17 | |||
| Past due loans of 90 days or more |
— | — | — | |||||
| Nonaccrual loans | — | — | — | |||||
17. Business Segments
Results of operations and selected financial information by business segment are as follows:
| ($ in millions) | Commercial Banking |
Branch Banking |
Consumer Lending |
Processing Solutions |
Investment Advisors |
General Corporate and Other |
Eliminations | Total | ||||||||||||||
| Three months ended September 30, 2008: |
||||||||||||||||||||||
| Net interest income (a) |
$ | 502 | 442 | 141 | 1 | 46 | (64 | ) | — | 1,068 | ||||||||||||
| Provision for loan and lease losses |
235 | 87 | 124 | 3 | 12 | 480 | — | 941 | ||||||||||||||
| Net interest income after provision for loan and lease losses (a) |
267 | 355 | 17 | (2 | ) | 34 | (544 | ) | — | 127 | ||||||||||||
| Noninterest income: |
||||||||||||||||||||||
| Electronic payment processing revenue |
— | 49 | — | 201 | — | (1 | ) | (14 | )(b) | 235 | ||||||||||||
| Service charges on deposits |
46 | 124 | — | — | 2 | — | — | 172 | ||||||||||||||
| Corporate banking revenue |
98 | 3 | — | — | 3 | — | — | 104 | ||||||||||||||
| Investment advisory revenue |
1 | 20 | — | — | 89 | (1 | ) | (19 | )(c) | 90 | ||||||||||||
| Mortgage banking net revenue |
— | 1 | 44 | — | — | — | — | 45 | ||||||||||||||
| Other noninterest income |
16 | 15 | 8 | 12 | 2 | 59 | — | 112 | ||||||||||||||
| Securities gains (losses), net |
— | — | 21 | — | — | (62 | ) | — | (41 | ) | ||||||||||||
| Total noninterest income |
161 | 212 | 73 | 213 | 96 | (5 | ) | (33 | ) | 717 | ||||||||||||
| Noninterest expense: |
||||||||||||||||||||||
| Salaries, wages and incentives |
68 | 104 | 25 | 17 | 33 | 74 | — | 321 | ||||||||||||||
| Employee benefits |
10 | 25 | 6 | 3 | 5 | 23 | — | 72 | ||||||||||||||
| Net occupancy expense |
4 | 41 | 2 | 1 | 3 | 26 | — | 77 | ||||||||||||||
| Payment processing expense |
— | 2 | — | 68 | — | — | — | 70 | ||||||||||||||
| Technology and communications |
(1 | ) | 4 | — | 12 | 1 | 31 | — | 47 | |||||||||||||
| Equipment expense |
1 | 11 | — | — | — | 22 | — | 34 | ||||||||||||||
| Other noninterest expense |
146 | 123 | 48 | 43 | 48 | (29 | ) | (33 | ) | 346 | ||||||||||||
| Total noninterest expense |
228 | 310 | 81 | 144 | 90 | 147 | (33 | ) | 967 | |||||||||||||
| Income (loss) before income taxes (a) |
200 | 257 | 9 | 67 | 40 | (696 | ) | — | (123 | ) | ||||||||||||
| Applicable income taxes (a) |
45 | 91 | 3 | 24 | 14 | (244 | ) | — | (67 | ) | ||||||||||||
| Net income (loss) |
155 | 166 | 6 | 43 | 26 | (452 | ) | — | (56 | ) | ||||||||||||
| Dividends on preferred stock |
— | — | — | — | — | 25 | — | 25 | ||||||||||||||
| Net income (loss) available to common shareholders |
155 | 166 | 6 | 43 | 26 | (477 | ) | — | (81 | ) | ||||||||||||
| Average assets | $ | 48,387 | 46,068 | 22,497 | 969 | 5,082 | (8,219 | ) | — | 114,784 | ||||||||||||
C-37
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
| (a) | Includes fully taxable-equivalent adjustment of $5 million for the three months ended September 30, 2008. |
| (b) | Electronic payment processing service revenues provided to the banking segments are eliminated in the Condensed Consolidated Statements of Income. |
| (c) | Revenue sharing agreements between Investment Advisors and Branch Banking are eliminated in the Condensed Consolidated Statements of Income. |
| ($ in millions) | Commercial Banking |
Branch Banking |
Consumer Lending |
Processing Solutions |
Investment Advisors |
General Corporate and Other |
Eliminations | Total | |||||||||||||
| Three months ended September 30, 2007: |
|||||||||||||||||||||
| Net interest income (a) |
$ | 330 | 374 | 97 | (3 | ) | 39 | (77 | ) | — | 760 | ||||||||||
| Provision for loan and lease losses |
22 | 44 | 40 | 3 | 5 | 25 | — | 139 | |||||||||||||
| Net interest income after provision for loan and lease losses (a) |
308 | 330 | 57 | (6 | ) | 34 | (102 | ) | — | 621 | |||||||||||
| Noninterest income: |
|||||||||||||||||||||
| Electronic payment processing revenue |
(1 | ) | 44 | — | 180 | — | — | (11 | )(b) | 212 | |||||||||||
| Service charges on deposits |
37 | 113 | — | — | 2 | (1 | ) | — | 151 | ||||||||||||
| Corporate banking revenue |
82 | 3 | — | 1 | 3 | 2 | — | 91 | |||||||||||||
| Investment advisory revenue |
1 | 23 | — | — | 96 | (2 | ) | (23 | )(c) | 95 | |||||||||||
| Mortgage banking net revenue |
— | 1 | 24 | — | — | 1 | — | 26 | |||||||||||||
| Other noninterest income |
17 | 19 | 22 | 9 | 1 | 25 | — | 93 | |||||||||||||
| Securities gains, net |
— | — | — | — | — | 13 | — | 13 | |||||||||||||
| Total noninterest income |
136 | 203 | 46 | 190 | 102 | 38 | (34 | ) | 681 | ||||||||||||
| Noninterest expense: |
|||||||||||||||||||||
| Salaries, wages and incentives |
54 | 96 | 11 | 15 | 35 | 99 | — | 310 | |||||||||||||
| Employee benefits |
9 | 23 | 6 | 3 | 6 | 20 | — | 67 | |||||||||||||
| Net occupancy expense |
4 | 34 | 2 | 1 | 2 | 23 | — | 66 | |||||||||||||
| Payment processing expense |
— | 2 | — | 63 | — | — | — | 65 | |||||||||||||
| Technology and communications |
1 | 3 | — | 8 | 1 | 28 | — | 41 | |||||||||||||
| Equipment expense |
1 | 9 | — | 1 | — | 19 | — | 30 | |||||||||||||
| Other noninterest expense |
124 | 110 | 41 | 33 | 52 | (52 | ) | (34 | ) | 274 | |||||||||||
| Total noninterest expense |
193 | 277 | 60 | 124 | 96 | 137 | (34 | ) | 853 | ||||||||||||
| Income (loss) before income taxes (a) |
251 | 256 | 43 | 60 | 40 | (201 | ) | — | 449 | ||||||||||||
| Applicable income taxes (a) |
68 | 90 | 15 | 21 | 14 | (84 | ) | — | 124 | ||||||||||||
| Net income (loss) |
183 | 166 | 28 | 39 | 26 | (117 | ) | — | 325 | ||||||||||||
| Dividends on preferred stock |
— | — | — | — | — | — | — | — | |||||||||||||
| Net income (loss) available to common shareholders (d) |
183 | 166 | 28 | 39 | 26 | (117 | ) | — | 325 | ||||||||||||
| Average assets | $ | 38,693 | 44,405 | 23,715 | 906 | 5,835 | (11,423 | ) | — | 102,131 | |||||||||||
| (a) | Includes fully taxable-equivalent adjustment of $6 million for the three months ended September 30, 2007. |
| (b) | Electronic payment processing service revenues provided to the banking segments are eliminated in the Condensed Consolidated Statements of Income. |
| (c) | Revenue sharing agreements between Investment Advisors and Branch Banking are eliminated in the Condensed Consolidated Statements of Income. |
| (d) | Dividends on preferred stock were $.185 million for the three months ended September 30, 2007. |
C-38
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
| ($ in millions) | Commercial Banking |
Branch Banking |
Consumer Lending |
Processing Solutions |
Investment Advisors |
General Corporate and Other |
Eliminations | Total | ||||||||||||||
| Nine months ended September 30, 2008: |
||||||||||||||||||||||
| Net interest income (a) |
$ | 1,210 | 1,226 | 361 | 3 | 137 | (299 | ) | — | 2,638 | ||||||||||||
| Provision for loan and lease losses |
517 | 226 | 305 | 11 | 21 | 1,123 | — | 2,203 | ||||||||||||||
| Net interest income after provision for loan and lease losses (a) |
693 | 1,000 | 56 | (8 | ) | 116 | (1,422 | ) | — | 435 | ||||||||||||
| Noninterest income: |
||||||||||||||||||||||
| Electronic payment processing revenue |
(2 | ) | 141 | — | 593 | 1 | (3 | ) | (48 | )(b) | 682 | |||||||||||
| Service charges on deposits |
136 | 336 | — | — | 7 | (1 | ) | — | 478 | |||||||||||||
| Corporate banking revenue |
301 | 9 | — | — | 12 | 1 | — | 323 | ||||||||||||||
| Investment advisory revenue |
4 | 65 | — | — | 276 | (5 | ) | (65 | )(c) | 275 | ||||||||||||
| Mortgage banking net revenue |
— | 12 | 215 | — | 1 | — | — | 228 | ||||||||||||||
| Other noninterest income |
40 | 53 | 32 | 35 | 1 | 178 | — | 339 | ||||||||||||||
| Securities gains (losses), net |
— | — | 24 | — | — | (45 | ) | — | (21 | ) | ||||||||||||
| Total noninterest income |
479 | 616 | 271 | 628 | 298 | 125 | (113 | ) | 2,304 | |||||||||||||
| Noninterest expense: |
||||||||||||||||||||||
| Salaries, wages and incentives |
194 | 302 | 84 | 50 | 99 | 271 | — | 1,000 | ||||||||||||||
| Employee benefits |
36 | 81 | 20 | 10 | 21 | 48 | — | 216 | ||||||||||||||
| Net occupancy expense |
13 | 118 | 6 | 3 | 8 | 74 | — | 222 | ||||||||||||||
| Payment processing expense |
— | 5 | — | 197 | — | 1 | — | 203 | ||||||||||||||
| Technology and communications |
(2 | ) | 12 | 2 | 31 | 2 | 97 | — | 142 | |||||||||||||
| Equipment expense |
2 | 31 | 1 | 1 | 1 | 59 | — | 95 | ||||||||||||||
| Other noninterest expense |
423 | 366 | 145 | 129 | 154 | (439 | ) | (113 | ) | 665 | ||||||||||||
| Total noninterest expense |
666 | 915 | 258 | 421 | 285 | 111 | (113 | ) | 2,543 | |||||||||||||
| Income (loss) before income taxes (a) |
506 | 701 | 69 | 199 | 129 | (1,408 | ) | — | 196 | |||||||||||||
| Applicable income taxes (a) |
102 | 247 | 24 | 70 | 46 | (322 | ) | — | 167 | |||||||||||||
| Net income (loss) |
404 | 454 | 45 | 129 | 83 | (1,086 | ) | — | 29 | |||||||||||||
| Dividends on preferred stock |
— | — | — | — | — | 26 | — | 26 | ||||||||||||||
| Net income (loss) available to common shareholders |
404 | 454 | 45 | 129 | 83 | (1,112 | ) | — | 3 | |||||||||||||
| Average assets | $ | 46,786 | 45,556 | 23,133 | 988 | 5,601 | (9,332 | ) | — | 112,732 | ||||||||||||
| (a) | Includes fully taxable-equivalent adjustment of $17 million for the nine months ended September 30, 2008. |
| (b) | Electronic payment processing service revenues provided to the banking segments are eliminated in the Condensed Consolidated Statements of Income. |
| (c) | Revenue sharing agreements between Investment Advisors and Branch Banking are eliminated in the Condensed Consolidated Statements of Income. |
C-39
Table of Contents
Fifth Third Bancorp and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
| ($ in millions) | Commercial Banking |
Branch Banking |
Consumer Lending |
Processing Solutions |
Investment Advisors |
General Corporate and Other |
Eliminations | Total | |||||||||||||
| Nine months ended September 30, 2007: |
|||||||||||||||||||||
| Net interest income (a) |
$ | 976 | 1,081 | 298 | (4 | ) | 113 | (217 | ) | — | 2,247 | ||||||||||
| Provision for loan and lease losses |
71 | 104 | 93 | 8 | 10 | 58 | — | 344 | |||||||||||||
| Net interest income after provision for loan and lease losses (a) |
905 | 977 | 205 | (12 | ) | 103 | (275 | ) | — | 1,903 | |||||||||||
| Noninterest income: |
|||||||||||||||||||||
| Electronic payment processing revenue |
(5 | ) | 129 | — | 510 | 1 | (1 | ) | (32 | )(b) | 602 | ||||||||||
| Service charges on deposits |
112 | 304 | — | (1 | ) | 5 | (1 | ) | — | 419 | |||||||||||
| Corporate banking revenue |
238 | 9 | — | 2 | 8 | 4 | — | 261 | |||||||||||||
| Investment advisory revenue |
2 | 69 | — | — | 291 | (4 | ) | (70 | )(c) | 288 | |||||||||||
| Mortgage banking net revenue |
— | 4 | 99 | — | 1 | 3 | — | 107 | |||||||||||||
| Other noninterest income |
51 | 56 | 55 | 29 | 2 | 74 | — | 267 | |||||||||||||
| Securities gains, net |
— | — | — | — | — | 14 | — | 14 | |||||||||||||
| Total noninterest income |
398 | 571 | 154 | 540 | 308 | 89 | (102 | ) | 1,958 | ||||||||||||
| Noninterest expense: |
|||||||||||||||||||||
| Salaries, wages and incentives |
161 | 279 | 36 | 46 | 104 | 286 | — | 912 | |||||||||||||
| Employee benefits |
35 | 75 | 20 | 9 | 21 | 62 | — | 222 | |||||||||||||
| Net occupancy expense |
11 | 101 | 6 | 3 | 7 | 71 | — | 199 | |||||||||||||
| Payment processing expense |
— | 5 | — | 171 | — | — | — | 176 | |||||||||||||
| Technology and communications |
4 | 11 | 1 | 23 | 2 | 81 | — | 122 | |||||||||||||
| Equipment expense |
2 | 27 | 1 | 3 | 1 | 56 | — | 90 | |||||||||||||
| Other noninterest expense |
370 | 325 | 124 | 97 | 163 | (328 | ) | (102 | ) | 649 | |||||||||||
| Total noninterest expense |
583 | 823 | 188 | 352 | 298 | 228 | (102 | ) | 2,370 | ||||||||||||
| Income (loss) before income taxes (a) |
720 | 725 | 171 | 176 | 113 | (414 | ) | — | 1,491 | ||||||||||||
| Applicable income taxes (a) |
189 | 256 | 60 | 62 | 40 | (175 | ) | — | 432 | ||||||||||||
| Net income (loss) |
531 | 469 | 111 | 114 | 73 | (239 | ) | — | 1,059 | ||||||||||||
| Dividends on preferred stock |
— | — | — | — | — | — | — | — | |||||||||||||
| Net income (loss) available to common shareholders (d) |
531 | 469 | 111 | 114 | 73 | (239 | ) | — | 1,059 | ||||||||||||
| Average assets | $ | 37,797 | 44,706 | 23,385 | 1,093 | 5,887 | (12,161 | ) | — | 100,707 | |||||||||||
| (a) | Includes fully taxable-equivalent adjustment of $18 million for the nine months ended September 30, 2007. |
| (b) | Electronic payment processing service revenues provided to the banking segments are eliminated in the Condensed Consolidated Statements of Income. |
| (c) | Revenue sharing agreements between Investment Advisors and Branch Banking are eliminated in the Condensed Consolidated Statements of Income. |
| (d) | Dividends on preferred stock were $.555 million for the nine months ended September 30, 2007. |
18. Subsequent Event
On October 14, 2008, the U.S. Department of Treasury announced the creation of a voluntary Capital Purchase Program as part of its efforts to provide a firmer capital foundation for financial institutions and to increase credit availability to consumers and businesses. As part of the program, eligible financial institutions will be able to sell equity interests to the U.S. Department of Treasury in amounts equal to 1 percent to 3 percent of the institution’s risk-weighted assets. These equity interests will constitute Tier 1 capital. On October 28, 2008, the Bancorp received notification that the U.S Department of Treasury intends to invest approximately $3.45 billion in senior preferred stock and related warrants under the terms of the Capital Purchase Program.
C-40
Table of Contents
Management’s Discussion and Analysis of Financial Condition at September 30, 2008 and September 30, 2007, and Results of Operations for the three and nine months ended September 30, 2008 and September 30, 2007, as included in our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2008.
D-1
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 2)
The following is management’s discussion and analysis of certain significant factors that have affected Fifth Third Bancorp’s (“Bancorp” or “Fifth Third”) financial condition, results of operations and cash flows during the periods included in the Condensed Consolidated Financial Statements, which are a part of this filing. Reference to the Bancorp incorporates the parent holding company and all consolidated subsidiaries.
TABLE 1: Selected Financial Data
| For the three months ended September 30, |
For the nine months ended September 30, |
|||||||||||||||||
| ($ in millions, except per share data) | 2008 | 2007 | Percent Change |
2008 | 2007 | Percent Change |
||||||||||||
| Income Statement Data |
||||||||||||||||||
| Net interest income (a) |
$ | 1,068 | 760 | 41 | $ | 2,638 | 2,247 | 17 | ||||||||||
| Noninterest income |
717 | 681 | 5 | 2,304 | 1,958 | 18 | ||||||||||||
| Total revenue (a) |
1,785 | 1,441 | 24 | 4,942 | 4,205 | 18 | ||||||||||||
| Provision for loan and lease losses |
941 | 139 | 578 | 2,203 | 344 | 541 | ||||||||||||
| Noninterest expense |
967 | 853 | 13 | 2,543 | 2,370 | 7 | ||||||||||||
| Net income (loss) |
(56 | ) | 325 | NM | 29 | 1,059 | (97 | ) | ||||||||||
| Net income (loss) available to common shareholders |
(81 | ) | 325 | NM | 3 | 1,059 | (100 | ) | ||||||||||
| Common Share Data |
||||||||||||||||||
| Earnings (loss) per share, basic |
$ | (.14 | ) | .61 | NM | $ | .01 | 1.96 | (99 | ) | ||||||||
| Earnings (loss) per share, diluted |
(.14 | ) | .61 | NM | .01 | 1.95 | (99 | ) | ||||||||||
| Cash dividends per common share |
.15 | .42 | (64 | ) | .74 | 1.26 | (41 | ) | ||||||||||
| Book value per share |
16.65 | 17.43 | (4 | ) | ||||||||||||||
| Dividend payout ratio |
(155.7 | )% | 68.7 | NM | NM | 64.1 | NM | |||||||||||
| Financial Ratios |
||||||||||||||||||
| Return on assets |
(.19 | )% | 1.26 | NM | .03 | % | 1.41 | (98 | ) | |||||||||
| Return on average common equity |
(3.3 | ) | 13.8 | NM | — | 14.7 | (100 | ) | ||||||||||
| Average equity as a percent of average assets |
9.45 | 9.13 | 4 | 8.83 | % | 9.56 | (8 | ) | ||||||||||
| Tangible equity |
6.19 | 7.00 | (12 | ) | ||||||||||||||
| Tangible common equity |
5.23 | 6.99 | (25 | ) | ||||||||||||||
| Net interest margin (a) |
4.24 | 3.34 | 27 | 3.57 | 3.38 | 6 | ||||||||||||
| Efficiency (a) |
54.2 | 59.2 | (8 | ) | 51.4 | 56.4 | (9 | ) | ||||||||||
| Credit Quality |
||||||||||||||||||
| Net losses charged off |
$ | 463 | 115 | 303 | $ | 1,082 | 288 | 276 | ||||||||||
| Net losses charged off as a percent of average loans and leases |
2.17 | % | .60 | 262 | 1.74 | % | .51 | 241 | ||||||||||
| Allowance for loan and lease losses as a percent of loans and leases |
2.41 | 1.08 | 123 | |||||||||||||||
| Allowance for credit losses as a percent of loans and |
2.56 | 1.19 | 115 | |||||||||||||||
| Nonperforming assets as a percent of loans, leases and other assets, including other real estate owned |
3.30 | .92 | 255 | |||||||||||||||
| Average Balances |
||||||||||||||||||
| Loans and leases, including held for sale |
$ | 85,772 | 78,243 | 10 | $ | 85,302 | 77,059 | 11 | ||||||||||
| Total securities and other short-term investments |
14,515 | 12,169 | 19 | 13,494 | 11,875 | 14 | ||||||||||||
| Total assets |
114,784 | 102,131 | 12 | 112,732 | 100,707 | 12 | ||||||||||||
| Transaction deposits (c) |
52,399 | 50,922 | 3 | 53,204 | 50,657 | 5 | ||||||||||||
| Core deposits (d) |
63,179 | 61,212 | 3 | 63,599 | 61,357 | 4 | ||||||||||||
| Wholesale funding (e) |
37,036 | 28,001 | 32 | 35,145 | 25,875 | 36 | ||||||||||||
| Shareholders’ equity |
10,843 | 9,324 | 16 | 9,953 | 9,628 | 3 | ||||||||||||
| Regulatory Capital Ratios |
||||||||||||||||||
| Tier 1 capital |
8.57 | % | 8.46 | 1 | ||||||||||||||
| Total risk-based capital |
12.30 | 10.87 | 13 | |||||||||||||||
| Tier 1 leverage | 8.77 | 9.23 | (5 | ) | ||||||||||||||
D-2
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
| (a) | Amounts presented on a fully taxable equivalent basis. The taxable equivalent adjustments for the three months ended September 30, 2008 and 2007 are $5 million and $6 million, respectively, and for the nine months ended September 30, 2008 and 2007 are $17 million and $18 million, respectively. |
| (b) | The allowance for credit losses is the sum of the allowance for loan and lease losses and the reserve for unfunded commitments. |
| (c) | Includes demand, interest checking, savings, money market and foreign office deposits. |
| (d) | Includes transaction deposits plus other time deposits. |
| (e) | Includes certificates $100,000 and over, other foreign office deposits, federal funds purchased, short-term borrowings and long-term debt. |
| NM: | Not meaningful |
OVERVIEW
This overview of management’s discussion and analysis highlights selected information in the financial results of the Bancorp and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources 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, results of operations and cash flows.
The Bancorp is a diversified financial services company headquartered in Cincinnati, Ohio. At September 30, 2008, the Bancorp had $116.3 billion in assets, operated 18 affiliates with 1,298 full-service Banking Centers including 93 Bank Mart® locations open seven days a week inside select grocery stores and 2,329 Jeanie® ATMs in the Midwestern and Southeastern regions of the United States. The Bancorp reports on five business segments: Commercial Banking, Branch Banking, Consumer Lending, Fifth Third Processing Solutions (“FTPS”) and Investment Advisors.
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 dependent on both net interest income and noninterest income. For the three months ended September 30, 2008, net interest income, on a fully taxable equivalent (“FTE”) basis, and noninterest income provided 60% and 40% of total revenue, respectively. 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 incurred on liabilities such as deposits, short-term borrowings and long-term debt. 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 pays 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 due to a weakening economy within the Bancorp’s footprint.
D-3
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
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. Noninterest expense is primarily driven by personnel costs and occupancy expenses, in addition to expenses incurred in the processing of credit and debit card transactions for its customers and merchant and financial institution clients.
Earnings Summary
During the third quarter of 2008, the Bancorp continued to be affected by the economic slowdown and market disruptions. The Bancorp’s net loss was $81 million, or $.14 per diluted share, which included $25 million in preferred stock dividends. Net income was $325 million, or $.61 per diluted share, for the same period last year. Results for both periods reflect a number of significant items.
Items affecting the third quarter of 2008 include:
| • | $226 million of net interest income due to the accretion of purchase accounting adjustments related to the second quarter acquisition of First Charter Corporation (“First Charter”); |
| • | $76 million of noninterest income, offset by $36 million in related litigation expense, from the resolution of a court case related to goodwill created in the 1998 acquisition of CitFed (the “CitFed litigation”); |
| • | $51 million reduction to noninterest income due to other than temporary impairment charges on Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“FHLMC”) preferred stock; |
| • | $27 million reduction to noninterest income to lower the cash surrender value of one of the Bancorp’s Bank Owned Life Insurance (“BOLI”) policies; and |
| • | $45 million of noninterest expense related to Visa’s pending litigation settlement with Discover. |
For comparison purposes, items affecting the third quarter of 2007 include:
| • | $16 million of noninterest income from the sale of non-strategic credit card accounts; |
| • | $15 million of other noninterest income from the sale of FDIC deposit insurance credits; and |
| • | $78 million of other noninterest expense relating to the Visa settlement with American Express. |
Excluding the items above, net income decreased $596 million from the third quarter of 2007, due to an increase of $802 million in the provision for loan and lease losses over the same time period. Overall, trends in net interest income and noninterest income remain positive as net interest income and noninterest income both increased 11% compared to the same quarter in the prior year.
Net interest income (FTE) increased to $1.1 billion, from $760 million in the same period last year. This growth directly reflects the benefit from the accretion of purchase accounting adjustments related to the second quarter acquisition of First Charter totaling $226 million, and was also driven by average earning asset growth of 11%. Net interest margin was 4.24% in the third quarter of 2008, an increase of 90 basis points (“bp”) from the third quarter of 2007.
D-4
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Noninterest income increased five percent, from $681 million to $717 million, over the same quarter last year. The increase in noninterest income was impacted by growth in mortgage banking revenues of 74% and in service charges on deposits of 13% since the third quarter of 2007. The aforementioned gain of $76 million from the resolution of litigation relating to goodwill offset the FNMA and FHLMC other than temporary impairment charges and reduction to the cash surrender value of one of the Bancorp’s BOLI policies.
Noninterest expense increased $114 million, or 13%, compared to the third quarter of 2007. Noninterest expense in the third quarter of 2008 included the $45 million related to Visa’s pending settlement with Discover mentioned above, and $36 million related to the resolution of the CitFed litigation. Noninterest expense in the third quarter of 2007 included the $78 million related to Visa’s settlement with American Express. The growth in noninterest expense can also be attributed to increases in loan and lease processing costs from higher collection activities costs over the past year along with increased volume-related processing expenses.
The Bancorp maintains a conservative approach to both lending and investing activities as it does not originate subprime loans, does not hold credit default swaps, nor does it hold asset-backed securities backed by subprime loans in its securities portfolio. However, the Bancorp has exposure to the housing markets, which continued to weaken during the third quarter of 2008, particularly in the upper Midwest and Florida. Consequently, the provision for loan and lease losses increased to $941 million for the three months ended September 30, 2008 compared to $139 million during the third quarter of 2007. In addition, net charge-offs as a percent of average loans and leases were 2.17% in the third quarter of 2008 compared to .60% in the third quarter of 2007. At September 30, 2008, nonperforming assets as a percent of loans, leases and other assets, including other real estate owned increased to 3.30% from .92% at September 30, 2007. Refer to the Credit Risk Management section in Management’s Discussion and Analysis for more information on credit quality.
In response to the current economic operating environment and uncertain future trends, the Bancorp continues to strengthen its capital position. During the second quarter of 2008, management raised its capital target to an eight to nine percent Tier 1 capital ratio. 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 September 30, 2008, the Tier 1 capital ratio was 8.57%, the Tier 1 leverage ratio was 8.77% and the total risk-based capital ratio was 12.30%. On October 28, 2008, the Bancorp received approval for participation in the U.S. Treasury Capital Purchase Program. As a result, the Bancorp expects to receive approximately $3.45 billion and issue senior preferred stock and warrants under the terms of the program. The Bancorp currently has senior debt ratings of “A1” from Moody’s, “A+” from Standard & Poor’s, “A” from Fitch Ratings and “AAL” from DBRS Ltd., which indicate the Bancorp’s strong capacity to meet financial commitments. * Additional information on credit ratings is as follows:
| • | Moody’s A1 rating is considered upper-medium-grade obligations and is the third highest ranking within its overall classification system; |
| • | Standard & Poor’s A+ rating indicates the obligor’s capacity to meet its financial commitment is STRONG and is the third highest ranking within its overall classification system; |
| • | Fitch Ratings’ A rating is considered high credit quality and is the third highest ranking within its overall classification system; and |
| • | DBRS Ltd.’s AAL rating is considered superior credit quality and is the second highest ranking within its overall classification system. |
| * | As an investor, you should be aware that a security rating is not a recommendation to buy, sell or hold securities, that it may be subject to revision or withdrawal at any time by the assigning rating organization, and that each rating should be evaluated independently of any other rating. |
D-5
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
RECENT ACCOUNTING STANDARDS
Note 2 of the Notes to Condensed Consolidated Financial Statements provides a discussion of the significant new accounting standards adopted by the Bancorp during 2008 and 2007 and the expected impact of significant accounting standards issued but not yet required to be adopted.
CRITICAL ACCOUNTING POLICIES
The Bancorp’s Condensed Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States of America. Certain accounting policies require management to exercise judgment in determining methodologies, economic assumptions and estimates that may materially affect the value of the Bancorp’s assets or liabilities and results of operations and cash flows. The Bancorp has five critical accounting policies, which include the accounting for allowance for loan and lease losses, reserve for unfunded commitments, income taxes, valuation of servicing rights and fair value measurements.
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 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 large credit exposures and loans experiencing deterioration of credit quality.
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 and other sources of cash flow, as well as an evaluation of legal options available to the Bancorp. The review of individual loans includes those loans that are impaired as provided in Statement of Financial 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 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. Historical loss rates are applied to 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 historical 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 and residential mortgage, are not individually risk graded. Rather, standard credit scoring systems and delinquency monitoring are used to assess credit risks. Allowances are established for each pool of loans based on the expected net charge-offs. Loss rates are based on the average net charge-off history by loan category. Historical loss rates for commercial and consumer loans may be adjusted for significant factors that, in management’s judgment, are necessary to reflect losses inherent in the portfolio. Factors that management considers in the analysis include the effects of the national and local economies; trends in the nature and volume of delinquencies, charge-offs and nonaccrual loans; changes in mix;
D-6
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
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 above specified thresholds 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 credit impairment at acquisition. Reductions to the carrying value of the acquired loans as a result of credit impairment are recorded as an adjustment to goodwill. The Bancorp does not carry over the acquired company’s allowance for loan and lease losses, nor does the Bancorp add to its existing allowance for the acquired loans as part of purchase accounting.
The Bancorp’s determination of the allowance for commercial 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 $125 million at September 30, 2008. 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 consumer loans would increase by approximately $71 million at September 30, 2008. 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 estimated loss rates and do not imply any expectation of future deterioration in the risk ratings or loss rates. Given current processes employed by the Bancorp, management believes the risk grades and estimated loss rates currently assigned are appropriate.
The Bancorp’s primary market areas for lending are the Midwestern and Southeastern regions of the United States. When evaluating the adequacy of allowances, consideration is given to these regional geographic concentrations 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 determining its allowance for loan and lease losses. There have been no material changes in criteria 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. The determination of the adequacy of the reserve is based upon an evaluation of the unfunded credit facilities, including an assessment of historical commitment utilization experience, credit risk grading and credit grade migration. Net adjustments to the reserve for unfunded commitments are included in other noninterest expense in the Condensed Consolidated Statements of Income.
D-7
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Income Taxes
The Bancorp estimates income tax expense based on amounts expected to be owed to the various tax jurisdictions in which the Bancorp conducts business. On a quarterly basis, management assesses the reasonableness of its effective tax rate based upon its current estimate of the amount and components of net income, tax credits and the applicable statutory tax rates expected for the full year. The estimated income tax expense is recorded in the Condensed Consolidated Statements of Income.
Deferred income tax assets and liabilities are determined using the balance sheet method. 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. Deferred taxes are reported in accrued taxes, interest and expenses in the Condensed Consolidated Balance Sheets.
Accrued taxes represent the net estimated amount due to taxing jurisdictions and are reported in accrued taxes, interest and expenses in the Condensed 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 9 of the Notes to Condensed Consolidated Financial Statements, the Internal Revenue Service (“IRS”) is currently challenging the Bancorp’s tax treatment of certain leasing transactions. For additional information on income taxes, see Note 11 of the Notes to Condensed Consolidated Financial Statements.
Valuation of Servicing Rights
When the Bancorp sells loans through either securitizations or individual loan sales in accordance with its investment policies, it often obtains servicing rights. Servicing rights resulting from loan sales are initially recorded at fair value and subsequently amortized in proportion to, and over the period of, estimated net servicing 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 speeds of the underlying 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 servicing portfolio. For purposes of measuring impairment, the servicing rights are stratified into classes based on the financial asset type and interest rates. Fees received for servicing loans owned by investors are based on a percentage of the outstanding monthly principal balance of such loans and are included in noninterest income as loan payments are received. Costs of servicing loans are charged to expense as incurred.
The change in the fair value of mortgage servicing rights (“MSRs”) at September 30, 2008 due to immediate 10% and 20% adverse changes in the current prepayment assumption would be approximately $30 million and $58 million, respectively, and due to immediate 10% and 20% favorable changes in the current prepayment
D-8
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
assumption would be approximately $33 million and $69 million, respectively. The change in the fair value of the MSR portfolio at September 30, 2008 due to immediate 10% and 20% adverse changes in the discount rate assumption would be approximately $26 million and $50 million, respectively, and due to immediate 10% and 20% favorable changes in the discount rate assumption would be approximately $28 million and $58 million, respectively. The sensitivity analysis related to other consumer and commercial servicing rights is not material to the Bancorp’s Condensed 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% and 20% variation in assumptions typically cannot be extrapolated because the relationship of the change in assumptions to the change in fair value may not be linear. Also, the effect of variation in a particular assumption on the fair value of the interests that continue to be held by the transferor 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.
Fair Value Measurements
Effective January 1, 2008, the Bancorp adopted SFAS No. 157, “Fair Value Measurements”, which provides a framework for measuring fair value under accounting principles generally accepted in the United States of America. SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 addresses the valuation techniques used to measure fair value. These valuation techniques include the market approach, income approach and cost approach. The market approach uses prices or relevant information generated by market transactions involving identical or comparable assets or liabilities. The income approach involves converting future amounts to a single present amount. The measurement is valued based on current market expectations about those future amounts. The cost approach is based on the amount that currently would be required to replace the service capacity of the asset.
SFAS No. 157 establishes a fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the instrument’s fair value measurement. The three levels within the fair value hierarchy are described as follows:
Level 1—Quoted prices (unadjusted) in active markets for identical assets or liabilities that the Bancorp has the ability to access at the measurement date.
Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include: quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3—Unobservable inputs for the asset or liability for which there is little, if any, market activity at the measurement date. Unobservable inputs reflect the Bancorp’s own assumptions about what market participants would use to price the asset or liability. The inputs are developed based on the best information available in the circumstances, which might include the Bancorp’s own financial data such as internally developed pricing models, discounted cash flow methodologies, as well as instruments for which the fair value determination requires significant management judgment.
The Bancorp measures financial assets and liabilities at fair value in accordance with SFAS No. 157. These measurements involve various valuation techniques and models, which involve inputs that are observable, when
D-9
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
available, and include the following significant financial instruments: available-for-sale securities, residential mortgage loans held for sale and certain derivatives. The following is a summary of valuation techniques utilized by the Bancorp for its significant financial assets and liabilities measured at fair value on a recurring basis.
Available-for-sale securities
Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows and classified within Level 2 of the fair value hierarchy. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. A significant portion of the Bancorp’s available-for-sale securities are agency mortgage-backed securities that are fair valued using a market approach and the Bancorp has determined them to be Level 2 in the fair value hierarchy.
Residential mortgage loans held for sale
For residential mortgage loans held for sale, fair value is estimated based upon mortgage backed securities prices and spreads to those prices or, for certain assets, discounted cash flow models that may incorporate the anticipated portfolio composition, credit spreads of asset-backed securities with similar collateral, and market conditions. Residential mortgage loans held for sale are fair valued using a market approach and the Bancorp has determined them to be Level 2 in the fair value hierarchy.
Derivatives
Exchange-traded derivatives valued using quoted prices are classified within Level 1 of the valuation hierarchy. However, few classes of derivative contracts are listed on an exchange. Derivative positions that are valued utilizing models that use as their basis readily observable market parameters are classified within Level 2 of the valuation hierarchy. Derivatives that are valued based upon models with significant unobservable market parameters are classified within Level 3 of the valuation hierarchy. A majority of the derivatives are fair valued using an income approach and the Bancorp has determined them to be Level 2 in the fair value hierarchy.
Valuation techniques and models utilized for measuring financial assets and liabilities are reviewed and validated by the Bancorp on a quarterly basis. Additionally, the Bancorp monitors the fair values of significant assets and liabilities using a variety of methods including the evaluation of pricing runs and exception reports based on certain analytical criteria, comparison to previous trades, and overall review and assessments for reasonableness.
Other significant areas include purchase price allocations and the analysis of potential impairment of goodwill. No material changes have been made during the nine months ended September 30, 2008 to the valuation techniques or models described previously.
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 (includes transaction deposits and other time deposits) and wholesale funding (includes certificates $100,000 and over, other foreign office deposits, federal funds purchased, short-term borrowings and long-term debt). The net interest margin is calculated by
D-10
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
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 typically 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.
Net interest income (FTE) was $1.1 billion for the third quarter of 2008, compared to $760 million earned in the third quarter of 2007 and $744 million in the second quarter of 2008. Net interest income was affected by the amortization and accretion of premiums and discounts on acquired loans and deposits that increased interest income by $226 million during the third quarter of 2008, compared to a decrease of less than $1 million for the third quarter of 2007 and an increase of $39 million during the second quarter of 2008. Additionally, the sequential comparison is affected by the recalculation of cash flows on certain leveraged leases that reduced interest income on commercial leases during the second quarter of 2008 by approximately $130 million. Exclusive of the items above, net interest income increased $83 million compared to the third quarter of 2007 and $8 million compared to the second quarter of 2008. This increase from the third quarter of 2007 resulted from a 10% increase in average loan and lease balances combined with a 33 bp increase in net interest spread. Sequentially, net interest income was modestly higher as increases in earning assets offset higher short-term borrowing costs.
Reported net interest margin was 4.24% in the third quarter of 2008, compared to 3.34% in the third quarter of 2007 and 3.04% in the second quarter of 2008. Net interest margin was affected by the amortization and accretion of premiums and discounts on acquired loans and deposits that increased net interest margin approximately 90 bp in the third quarter of 2008 and 16 bp in the second quarter of 2008. Second quarter 2008 net interest margin was also affected by the recalculation of cash flows on certain leveraged leases, which decreased net interest margin approximately 53 bp. Exclusive of the adjustments above, net interest margin was flat on a year-over-year basis as widening credit spreads were offset by a greater concentration in lower yielding commercial loans. Sequentially, net interest margin modestly decreased as increased loan spreads were offset by higher nonaccrual balances and increased market rates on short-term funding.
Total average interest-earning assets increased 11% from the third quarter of 2007 and increased two percent on a sequential basis. On a year-over-year basis, average total commercial loans increased 20% and the investment portfolio increased 19%, while consumer loans decreased three percent. Commercial mortgage and commercial construction loans increased primarily as a result of acquisitions during the past year. Commercial and industrial loans increased due to the origination for portfolio of investment grade loans that historically were sold to the Bancorp’s off balance sheet commercial paper conduit, coupled with the use of contingent liquidity facilities related to certain off-balance sheet programs that were drawn upon in the third quarter of 2008. Sequentially, increases in loans and leases due to the full quarter effect of the First Charter acquisition, particularly in commercial mortgage, commercial construction and home equity balances, were offset by overall decreases in loan production. Increases in the investment portfolio relate to the Bancorp’s overall balance sheet growth and the purchase of securities as part of the Bancorp’s non-qualifying hedging strategy related to mortgage servicing rights.
Interest income (FTE) from loans and leases increased $3 million compared to the third quarter of 2007 and increased $329 million compared to the second quarter of 2008. Exclusive of the amortization and accretion of premiums and discounts on acquired loans and the leveraged lease adjustment during the second quarter of 2008, interest income (FTE) from loans and leases decreased $216 million, or 16%, compared to the prior year quarter and increased $16 million, or one percent, compared to the sequential quarter. The year-over-year decrease in interest income is a result of the repricing of variable rate loans in a declining rate environment, partially offset by the increase in average loan and lease balances. The sequential increase in interest income is a result of an increase in loans and leases due to the full quarter effect of the First Charter acquisition. At the end of the third quarter of 2008, the Bancorp’s prime rate was 5.00% compared to 7.75% at the end of the third quarter of 2007.
D-11
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Interest income (FTE) from investment securities and short-term investments increased ten percent compared to the third quarter of 2007 and eight percent compared to the second quarter of 2008. The increase in interest income from investment securities was a result of increases in the average investment portfolio offset by a decrease in the weighted-average yield.
Core deposits increased $2.0 billion, or three percent, compared to the third quarter of last year and decreased modestly compared to the sequential quarter. The cost of interest-bearing core deposits was 1.64% in the third quarter of 2008, which was a decrease of 172 bp from 3.36% in the third quarter of 2007 and a 4 bp increase from the 1.60% paid in the second quarter of 2008. The year over year decrease is a result of the decrease in short-term market interest rates as, over the past year, the federal funds target rate decreased 275 bp to a target of 2.00% at September 30, 2008 compared to 4.75% at September 30, 2007. The sequential increase in core deposit interest expense is a result of the highly competitive deposit rate environment created by the disruption in the credit markets.
D-12
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
TABLE 2: Consolidated Average Balance Sheets and Analysis of Net Interest Income (FTE)
| For the three months ended | September 30, 2008 | September 30, 2007 | Attribution of Change in Net Interest Income (a) |
|||||||||||||||||||||||||||||
| ($ in millions) | Average Balance |
Revenue/ Cost |
Average Rate |
Average Balance |
Revenue/ Cost |
Average Rate |
Volume | Yield/ Rate |
Total | |||||||||||||||||||||||
| Assets |
||||||||||||||||||||||||||||||||
| Interest-earning assets: |
||||||||||||||||||||||||||||||||
| Loans and leases (b): |
||||||||||||||||||||||||||||||||
| Commercial loans |
$ | 28,284 | $ | 389 | 5.46 | % | $ | 22,345 | $ | 420 | 7.45 | % | $ | 95 | $ | (126 | ) | $ | (31 | ) | ||||||||||||
| Commercial mortgage |
13,257 | 290 | 8.71 | 11,117 | 205 | 7.31 | 43 | 42 | 85 | |||||||||||||||||||||||
| Commercial construction |
6,110 | 107 | 6.97 | 5,499 | 105 | 7.55 | 11 | (9 | ) | 2 | ||||||||||||||||||||||
| Commercial leases |
3,642 | 35 | 3.85 | 3,700 | 39 | 4.23 | (1 | ) | (3 | ) | (4 | ) | ||||||||||||||||||||
| Subtotal—commercial |
51,293 | 821 | 6.37 | 42,661 | 769 | 7.15 | 148 | (96 | ) | 52 | ||||||||||||||||||||||
| Residential mortgage loans |
10,711 | 190 | 7.05 | 10,396 | 160 | 6.12 | 5 | 25 | 30 | |||||||||||||||||||||||
| Home equity |
12,534 | 181 | 5.76 | 11,752 | 226 | 7.63 | 14 | (59 | ) | (45 | ) | |||||||||||||||||||||
| Automobile loans |
8,303 | 132 | 6.32 | 10,865 | 174 | 6.34 | (41 | ) | (1 | ) | (42 | ) | ||||||||||||||||||||
| Credit card |
1,720 | 43 | 9.93 | 1,366 | 34 | 10.03 | 9 | — | 9 | |||||||||||||||||||||||
| Other consumer loans/leases |
1,211 | 15 | 4.93 | 1,203 | 16 | 5.29 | — | (1 | ) | (1 | ) | |||||||||||||||||||||
| Subtotal—consumer |
34,479 | 561 | 6.47 | 35,582 | 610 | 6.80 | (13 | ) | (36 | ) | (49 | ) | ||||||||||||||||||||
| Total loans and leases |
85,772 | 1,382 | 6.41 | 78,243 | 1,379 | 6.99 | 135 | (132 | ) | 3 | ||||||||||||||||||||||
| Securities: |
||||||||||||||||||||||||||||||||
| Taxable |
13,310 | 161 | 4.81 | 11,180 | 141 | 5.00 | 25 | (5 | ) | 20 | ||||||||||||||||||||||
| Exempt from income |
315 | 5 | 7.38 | 490 | 9 | 7.17 | (4 | ) | — | (4 | ) | |||||||||||||||||||||
| Other short-term investments |
890 | 5 | 2.21 | 499 | 6 | 4.93 | 3 | (4 | ) | (1 | ) | |||||||||||||||||||||
| Total interest-earning assets |
100,287 | 1,553 | 6.16 | 90,412 | 1,535 | 6.73 | 159 | (141 | ) | 18 | ||||||||||||||||||||||
| Cash and due from banks |
2,468 | 2,189 | ||||||||||||||||||||||||||||||
| Other assets |
13,683 | 10,330 | ||||||||||||||||||||||||||||||
| Allowance for loan and lease losses |
(1,654 | ) | (800 | ) | ||||||||||||||||||||||||||||
| Total assets | $ | 114,784 | $ | 102,131 | ||||||||||||||||||||||||||||
| Liabilities |
||||||||||||||||||||||||||||||||
| Interest-bearing liabilities: |
||||||||||||||||||||||||||||||||
| Interest checking |
$ | 13,843 | $ | 27 | 0.78 | % | $ | 14,334 | $ | 77 | 2.14 | % | $ | (3 | ) | $ | (47 | ) | $ | (50 | ) | |||||||||||
| Savings |
16,154 | 53 | 1.29 | 15,390 | 122 | 3.15 | 6 | (75 | ) | (69 | ) | |||||||||||||||||||||
| Money market |
6,051 | 25 | 1.67 | 6,247 | 69 | 4.35 | (3 | ) | (41 | ) | (44 | ) | ||||||||||||||||||||
| Foreign office deposits |
2,126 | 7 | 1.37 | 1,808 | 20 | 4.33 | 3 | (16 | ) | (13 | ) | |||||||||||||||||||||
| Other time deposits |
10,780 | 90 | 3.31 | 10,290 | 119 | 4.61 | 6 | (35 | ) | (29 | ) | |||||||||||||||||||||
| Certificates—$100,000 and over |
11,623 | 87 | 2.97 | 6,062 | 78 | 5.11 | 51 | (42 | ) | 9 | ||||||||||||||||||||||
| Other foreign office deposits |
395 | 2 | 1.83 | 1,981 | 26 | 5.12 | (13 | ) | (11 | ) | (24 | ) | ||||||||||||||||||||
| Federal funds purchased |
1,013 | 5 | 1.78 | 4,322 | 56 | 5.15 | (28 | ) | (23 | ) | (51 | ) | ||||||||||||||||||||
| Other short-term borrowings |
9,613 | 59 | 2.46 | 3,285 | 37 | 4.50 | 45 | (23 | ) | 22 | ||||||||||||||||||||||
| Long-term debt |
14,392 | 130 | 3.63 | 12,351 | 171 | 5.47 | 24 | (65 | ) | (41 | ) | |||||||||||||||||||||
| Total interest-bearing liabilities |
85,990 | 485 | 2.25 | 76,070 | 775 | 4.04 | 88 | (378 | ) | (290 | ) | |||||||||||||||||||||
| Demand deposits |
14,225 | 13,143 | ||||||||||||||||||||||||||||||
| Other liabilities |
3,721 | 3,594 | ||||||||||||||||||||||||||||||
| Total liabilities |
103,936 | 92,807 | ||||||||||||||||||||||||||||||
| Shareholders’ equity |
10,848 | 9,324 | ||||||||||||||||||||||||||||||
| Total liabilities and shareholders’ equity |
$ | 114,784 | $ | 102,131 | ||||||||||||||||||||||||||||
| Net interest income |
$ | 1,068 | $ | 760 | $ | 71 | $ | 237 | $ | 308 | ||||||||||||||||||||||
| Net interest margin |
4.24 | % | 3.34 | % | ||||||||||||||||||||||||||||
| Net interest rate spread |
3.91 | 2.69 | ||||||||||||||||||||||||||||||
| Interest-bearing liabilities to interest-earning assets |
85.74 | 84.14 | ||||||||||||||||||||||||||||||
D-13
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
| (a) | Changes in interest not solely due to volume or yield/rate are allocated in proportion to the absolute dollar amount of change in volume and yield/rate. |
| (b) | The fully taxable-equivalent adjustments included in the above table are $5 million and $6 million for the three months ended September 30, 2008 and 2007. |
TABLE 3: Consolidated Average Balance Sheets and Analysis of Net Interest Income (FTE)
| For the nine months ended | September 30, 2008 | September 30, 2007 | Attribution of Change in Net Interest Income (a) |
||||||||||||||||||||||||||||||
| ($ in millions) | Average Balance |
Revenue/ Cost |
Average Rate |
Average Balance |
Revenue/ Cost |
Average Rate |
Volume | Yield/ Rate |
Total | ||||||||||||||||||||||||
| Assets |
|||||||||||||||||||||||||||||||||
| Interest-earning assets: |
|||||||||||||||||||||||||||||||||
| Loans and leases (b): |
|||||||||||||||||||||||||||||||||
| Commercial loans |
$ | 27,821 | $ | 1,143 | 5.49 | % | $ | 21,619 | $ | 1,207 | 7.47 | % | $ | 301 | $ | (365 | ) | $ | (64 | ) | |||||||||||||
| Commercial mortgage |
12,635 | 664 | 7.02 | 10,906 | 596 | 7.31 | 92 | (24 | ) | 68 | |||||||||||||||||||||||
| Commercial construction |
5,797 | 262 | 6.04 | 5,701 | 327 | 7.67 | 5 | (70 | ) | (65 | ) | ||||||||||||||||||||||
| Commercial leases |
3,704 | (16 | ) | (.57 | ) | 3,680 | 118 | 4.29 | 1 | (135 | ) | (134 | ) | ||||||||||||||||||||
| Subtotal—commercial |
49,957 | 2,053 | 5.49 | 41,906 | 2,248 | 7.17 | 399 | (594 | ) | (195 | ) | ||||||||||||||||||||||
| Residential mortgage loans |
11,216 | 539 | 6.42 | 10,255 | 471 | 6.13 | 46 | 22 | 68 | ||||||||||||||||||||||||
| Home equity |
12,132 | 539 | 5.94 | 11,902 | 682 | 7.66 | 14 | (157 | ) | (143 | ) | ||||||||||||||||||||||
| Automobile loans |
9,092 | 431 | 6.33 | 10,551 | 494 | 6.26 | (69 | ) | 6 | (63 | ) | ||||||||||||||||||||||
| Credit card |
1,694 | 120 | 9.46 | 1,213 | 98 | 10.82 | 35 | (13 | ) | 22 | |||||||||||||||||||||||
| Other consumer loans/leases |
1,211 | 46 | 5.14 | 1,232 | 48 | 5.29 | (1 | ) | (1 | ) | (2 | ) | |||||||||||||||||||||
| Subtotal—consumer |
35,345 | 1,675 | 6.33 | 35,153 | 1,793 | 6.82 | 25 | (143 | ) | (118 | ) | ||||||||||||||||||||||
| Total loans and leases |
85,302 | 3,728 | 5.84 | 77,059 | 4,041 | 7.01 | 424 | (737 | ) | (313 | ) | ||||||||||||||||||||||
| Securities: |
|||||||||||||||||||||||||||||||||
| Taxable |
12,477 | 459 | 4.92 | 11,054 | 414 | 5.01 | 53 | (8 | ) | 45 | |||||||||||||||||||||||
| Exempt from income taxes (b) |
360 | 20 | 7.34 | 511 | 28 | 7.32 | (8 | ) | — | (8 | ) | ||||||||||||||||||||||
| Other short-term investments |
657 | 12 | 2.47 | 310 | 12 | 5.17 | 9 | (9 | ) | — | |||||||||||||||||||||||
| Total interest-earning assets |
98,796 | 4,219 | 5.70 | 88,934 | 4,495 | 6.76 | 478 | (754 | ) | (276 | ) | ||||||||||||||||||||||
| Cash and due from banks |
2,354 | 2,224 | |||||||||||||||||||||||||||||||
| Other assets |
12,847 | 10,333 | |||||||||||||||||||||||||||||||
| Allowance for loan and lease losses |
(1,265 | ) | (784 | ) | |||||||||||||||||||||||||||||
| Total assets | $ | 112,732 | $ | 100,707 | |||||||||||||||||||||||||||||
| Liabilities |
|||||||||||||||||||||||||||||||||
| Interest-bearing liabilities: |
|||||||||||||||||||||||||||||||||
| Interest checking |
$ | 14,357 | $ | 108 | 1.00 | % | $ | 14,964 | $ | 248 | 2.22 | % | $ | (9 | ) | $ | (131 | ) | $ | (140 | ) | ||||||||||||
| Savings |
16,270 | 173 | 1.42 | 14,573 | 350 | 3.21 | 38 | (215 | ) | (177 | ) | ||||||||||||||||||||||
| Money market |
6,511 | 101 | 2.08 | 6,289 | 208 | 4.42 | 7 | (114 | ) | (107 | ) | ||||||||||||||||||||||
| Foreign office deposits |
2,246 | 30 | 1.79 | 1,598 | 52 | 4.35 | 16 | (38 | ) | (22 | ) | ||||||||||||||||||||||
| Other time deposits |
10,395 | 289 | 3.72 | 10,700 | 369 | 4.61 | (10 | ) | (70 | ) | (80 | ) | |||||||||||||||||||||
| Certificates—$100,000 and over |
8,545 | 218 | 3.40 | 6,416 | 247 | 5.14 | 68 | (97 | ) | (29 | ) | ||||||||||||||||||||||
| Other foreign office deposits |
2,394 | 48 | 2.69 | 1,032 | 40 | 5.19 | 34 | (26 | ) | 8 | |||||||||||||||||||||||
| Federal funds purchased |
3,297 | 66 | 2.67 | 3,462 | 135 | 5.24 | (6 | ) | (63 | ) | (69 | ) | |||||||||||||||||||||
| Other short-term borrowings |
6,735 | 127 | 2.51 | 2,689 | 89 | 4.41 | 89 | (51 | ) | 38 | |||||||||||||||||||||||
| Long-term debt |
14,174 | 421 | 3.97 | 12,276 | 510 | 5.55 | 71 | (160 | ) | (89 | ) | ||||||||||||||||||||||
| Total interest-bearing liabilities |
84,924 | 1,581 | 2.49 | 73,999 | 2,248 | 4.06 | 298 | (965 | ) | (667 | ) | ||||||||||||||||||||||
| Demand deposits |
13,820 | 13,233 | |||||||||||||||||||||||||||||||
| Other liabilities |
4,033 | 3,847 | |||||||||||||||||||||||||||||||
| Total liabilities |
102,777 | 91,079 | |||||||||||||||||||||||||||||||
| Shareholders’ equity |
9,955 | 9,628 | |||||||||||||||||||||||||||||||
| Total liabilities and shareholders’ equity |
$ | 112,732 | $ | 100,707 | |||||||||||||||||||||||||||||
| Net interest income |
$ | 2,638 | $ | 2,247 | $ | 180 | $ | 211 | $ | 391 | |||||||||||||||||||||||
| Net interest margin |
3.57 | % | 3.38 | % | |||||||||||||||||||||||||||||
| Net interest rate spread |
3.21 | 2.70 | |||||||||||||||||||||||||||||||
| Interest-bearing liabilities to interest-earning assets |
85.96 | 83.21 | |||||||||||||||||||||||||||||||
D-14
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
| (a) | Changes in interest not solely due to volume or yield/rate are allocated in proportion to the absolute dollar amount of change in volume and yield/rate. |
| (b) | The fully taxable-equivalent adjustments included in the above table are $17 million and $18 million for the nine months ended September 30, 2008 and 2007. |
Interest expense on wholesale funding decreased 23% compared to the prior year quarter as declining interest rates more than offset a 32% increase in average balances. Interest expense on wholesale funding increased $10 million, or 4%, since the second quarter of 2008 primarily due to increased balances.
Overall, the growth in average loans and leases since the third quarter of 2007 outpaced core deposit growth by $5.6 billion. In the third quarter of 2008, wholesale funding represented 43% of interest-bearing liabilities, up from 37% in the third quarter of 2007. The increase in wholesale funding as a percentage of interest-bearing liabilities was the result of the issuance of $2.2 billion of trust preferred securities during 2007, $750 million of senior notes in April 2008 and $400 million of trust preferred securities in May 2008, partially offset by the repurchase of $690 million of mandatorily redeemable securities, which occurred in the fourth quarter of 2007. The Bancorp’s net free funding position modestly increased from the third quarter of 2007 and the second quarter of 2008 as a result of increased demand deposits.
Provision for Loan and Lease Losses
The Bancorp provides as an expense an amount for probable loan and lease losses within the loan and lease portfolio that is based on factors previously 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 Condensed Consolidated Balance Sheets is referred to as charge-offs. Net charge-offs include current period charge-offs less recoveries on previously charged-off loans and leases.
The provision for loan and lease losses increased to $941 million in the third quarter of 2008 compared to $139 million in the same period last year. The primary factors in the increase were the increase in commercial impaired loans, increase in delinquencies, the deterioration in real estate collateral values in certain of the Bancorp’s key lending markets and declines in general economic conditions. As of September 30, 2008, the allowance for loan and lease losses as a percent of loans and leases increased to 2.41% from 1.08% at September 30, 2007.
Refer to the Credit Risk Management section for more detailed information on the provision for loan and lease losses including an analysis of loan portfolio composition, non-performing assets, 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.
D-15
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Noninterest Income
For the three months ended September 30, 2008, noninterest income increased by $36 million, or five percent, on a year-over-year basis. The components of noninterest income for these periods are as follows:
TABLE 4: Noninterest Income
| ($ in millions) | For the three months ended September 30, |
Percent Change |
For the nine months ended September 30, |
Percent Change |
|||||||||||||||
| 2008 | 2007 | 2008 | 2007 | ||||||||||||||||
| Electronic payment processing revenue |
$ | 235 | 212 | 11 | $ | 682 | $ | 602 | 13 | ||||||||||
| Service charges on deposits |
172 | 151 | 13 | 478 | 419 | 14 | |||||||||||||
| Corporate banking revenue |
104 | 91 | 15 | 323 | 261 | 23 | |||||||||||||
| Investment advisory revenue |
90 | 95 | (5 | ) | 275 | 288 | (5 | ) | |||||||||||
| Mortgage banking net revenue |
45 | 26 | 74 | 228 | 107 | 113 | |||||||||||||
| Other noninterest income |
112 | 93 | 21 | 339 | 267 | 27 | |||||||||||||
| Securities (losses) gains, net |
(63 | ) | 13 | NM | (45 | ) | 14 | NM | |||||||||||
| Securities gains, net—non-qualifying hedges on mortgage servicing rights |
22 | — | NM | 24 | — | NM | |||||||||||||
| Total noninterest income | $ | 717 | 681 | 5 | $ | 2,304 | 1,958 | 18 | |||||||||||
| NM: | Percentage change is not meaningful. |
Electronic payment processing revenue increased $23 million, or 11%, in the third quarter of 2008 compared to the same period last year as the Bancorp continued to realize growth in each of its three main product lines. Merchant processing revenue increased nine percent, to $89 million, compared to the same period in 2007. Financial institutions revenue increased to $82 million, up $5 million or six percent, compared to the third quarter of 2007 due to higher transaction volumes as a result of continued success in attracting financial institution customers. Card issuer interchange increased 19%, to $64 million, compared to the same period in 2007 due to continued growth related to debit and credit card usage and increases in the average dollar amount per debit card transaction. The Bancorp processes over 26.7 billion transactions annually and handles electronic processing for over 160,000 merchant locations worldwide.
Service charges on deposits increased to $172 million, up $21 million, or 13%, in the third quarter of 2008 compared to the same period last year. Commercial deposit revenue increased $13 million, or 21%, compared to the same quarter last year. This increase was primarily impacted by a decrease in earnings credits on compensating balances resulting from the decline in short-term interest rates. Commercial customers receive earnings credits to offset the fees charged for banking services on their deposit accounts such as account maintenance, lockbox, ACH transactions, wire transfers and other ancillary corporate treasury management services. Earnings credits are based on the customer’s average balance in qualifying deposits multiplied by the crediting rate. Qualifying deposits include demand deposits and interest-bearing checking accounts. The Bancorp has a standard crediting rate that is adjusted as necessary based on competitive market conditions and changes in short-term interest rates. Retail deposit revenue increased eight percent, to $97 million, in the third quarter of 2008 compared to the same period last year. The increase in retail service charges was attributable to higher customer activity. Growth in the number of customer deposit account relationships and deposit generation continues to be a primary focus of the Bancorp.
Corporate banking revenue increased $13 million, or 15%, in the third quarter of 2008 over the same period in 2007. The growth in corporate banking revenue was largely attributable to higher foreign exchange derivative income of $27 million, an increase of $12 million compared to the prior year quarter. Growth also occurred in institutional sales and asset securitization fees, which grew $2 million and $3 million, respectively, compared to the third quarter of 2007. 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.
D-16
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Investment advisory revenue decreased $5 million, or five percent, from the third quarter of 2007. The Bancorp experienced broad-based decreases in several categories within investment advisory revenue. Brokerage fee income, which includes Fifth Third Securities income, decreased 16%, or $4 million, in the third quarter of 2008 as investors continued to migrate balances from stock and bond funds to money markets funds due to market volatility. Mutual fund revenue decreased 6%, to $14 million, in the third quarter of 2008 due to the declining market. Private client services increased 2%, to $36 million, in the third quarter of 2008 as growth was seen in wealth planning services. As of September 30, 2008, the Bancorp had approximately $196 billion in assets under care and managed $30 billion in assets for individuals, corporations and not-for-profit organizations.
Mortgage banking net revenue increased to $45 million in the third quarter of 2008 from $26 million in the same period last year. The components of mortgage banking net revenue for the three and nine months ended September 30, 2008 and 2007 are shown in Table 5.
TABLE 5: Components of Mortgage Banking Net Revenue
| ($ in millions) | For the three months ended September 30, |
For the nine months ended September 30, |
||||||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||||||
| Origination fees and gains on loan sales |
$ | 43 | 9 | $ | 214 | 61 | ||||||||
| Servicing revenue: |
||||||||||||||
| Servicing fees |
39 | 37 | 122 | 105 | ||||||||||
| Servicing rights amortization |
(22 | ) | (23 | ) | (86 | ) | (66 | ) | ||||||
| Net valuation adjustments on servicing rights and free-standing derivatives entered into to economically hedge MSR |
(15 | ) | 3 | (22 | ) | 7 | ||||||||
| Net servicing revenue |
2 | 17 | 14 | 46 | ||||||||||
| Mortgage banking net revenue | $ | 45 | 26 | $ | 228 | 107 | ||||||||
Mortgage banking net revenue increased compared to the same period last year due to higher sales margins on loans held for sale, higher sales volume of portfolio loans and the impact of the adoption of SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115”, for residential mortgage loans held for sale, offset by lower net valuation adjustments. Mortgage originations decreased 31%, from $3.0 billion to $2.0 billion, in comparison to the same quarter last year as application volumes decreased as a result of market disruptions. The increase in sales margins on loans held for sale and sales volume of portfolio loans contributed $30 million and $6 million, respectively, to the increase in mortgage banking net revenue. The adoption of SFAS No. 159 on January 1, 2008 for residential mortgage loans held for sale also contributed approximately $11 million to the increase in mortgage banking net revenue. Prior to adoption, mortgage loan origination costs were capitalized as part of the carrying amount of the loan and recognized as a reduction of mortgage banking net revenue upon the sale of the loans. Subsequent to the adoption, mortgage loan origination costs are recognized as expense when incurred and included in noninterest expense within the Condensed Consolidated Statements of Income.
Mortgage net servicing revenue decreased $15 million compared to the third quarter of 2007. 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. Temporary impairment on servicing rights, partially offset by gains on derivatives economically hedging the mortgage servicing rights (“MSRs”), resulted in lower mortgage net servicing revenue compared to the third quarter of 2007. The Bancorp’s total residential mortgage loans serviced at September 30, 2008 and 2007 was $50.1 billion and $43.1 billion, respectively, with $39.8 billion and $33.1 billion, respectively, of residential mortgage loans serviced for others.
D-17
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Servicing rights are deemed temporarily impaired when a 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 4 of the Notes to the Condensed Consolidated Financial Statements. The Bancorp maintains a non-qualifying hedging strategy to manage a portion of the risk associated with changes in impairment on the MSR portfolio. The Bancorp recognized a gain from MSR derivatives of $8 million, offset by a temporary impairment of $23 million, resulting in a net loss of $15 million for the three months ended September 30, 2008 related to changes in fair value and settlement of free-standing derivatives purchased to economically hedge the MSR portfolio. See Note 7 of the Notes to the Condensed Consolidated Financial Statements for more information on the free-standing derivatives used to hedge the MSR portfolio. Additionally, the Bancorp had net securities gains on non-qualifying hedges on mortgage service rights of $22 million in the third quarter of 2008 that is included in noninterest income within the Condensed Consolidated Statements of Income, but is shown separate from mortgage banking net revenue.
The major components of other noninterest income are as follows:
TABLE 6: Components of Other Noninterest Income
| For the three months ended September 30, |
For the nine months ended September 30, | ||||||||||||||
| ($ in millions) | 2008 | 2007 | 2008 | 2007 | |||||||||||
| Litigation settlement |
$ | 76 | — | $ | 76 | — | |||||||||
| Cardholder fees |
15 | 14 | 43 | 40 | |||||||||||
| Consumer loan and lease fees |
13 | 13 | 39 | 33 | |||||||||||
| Operating lease income |
13 | 8 | 34 | 22 | |||||||||||
| Insurance income |
7 | 8 | 28 | 24 | |||||||||||
| Banking center income |
7 | 7 | 24 | 20 | |||||||||||
| Gain on redemption of Visa, Inc. ownership interests |
— | — | 273 | — | |||||||||||
| Gain on sale of FDIC deposit insurance credits |
— | 15 | — | 15 | |||||||||||
| Loss on sale of other real estate owned |
(12 | ) | (2 | ) | (38 | ) | (6) | ||||||||
| Bank owned life insurance (loss) income |
(13 | ) | 17 | (136 | ) | 59 | |||||||||
| Other |
6 | 13 | (4 | ) | 60 | ||||||||||
| Total other noninterest income | $ | 112 | 93 | $ | 339 | 267 | |||||||||
Other noninterest income increased $19 million in the third quarter of 2008 compared to the same period last year. The increase was primarily due to a $76 million gain related to the satisfactory resolution of the CitFed litigation. This increase was offset by higher losses from the sale of other real estate owned properties and a $27 million charge to lower the current cash surrender value of one of the Bancorp’s BOLI policies.
Net securities losses totaled $63 million in the third quarter of 2008 compared to $13 million of net securities gains during the same period last year. The net securities losses in the current quarter include other than temporary impairment charges of $28 million and $23 million relating to FNMA and FHLMC preferred stock, respectively, along with a $12 million impairment charge on subordinated tranches and residual interests related to previous automobile loan securitizations.
Noninterest Expense
Total noninterest expense increased $114 million, or 13%, in the third quarter of 2008 compared to the same period last year. Noninterest expense in the third quarter of 2008 includes a $45 million charge related to Visa’s pending settlement with Discover, $36 million in legal expenses related to the litigation settlement from a prior
D-18
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
acquisition and $31 million of additional operating expenses from acquisitions since the same period in 2007. Noninterest expense in the third quarter of 2007 included $78 million related to Visa’s settlement with American Express. Excluding these items, noninterest expense increased $80 million, or 10%, due to higher personnel costs, increased volume-related processing expenses, increased provision for unfunded commitments and higher loan processing costs resulting from increased collections activities.
The Bancorp continues to focus on efficiency initiatives, as part of its core emphasis on operating leverage and on expense control. The efficiency ratio (noninterest expense divided by the sum of net interest income (FTE) and noninterest income) was 54.2% and 59.2% for the third quarter of 2008 and 2007, respectively. The Bancorp views investments in information technology and banking center expansion as its platform for future growth and increasing expense efficiency.
The major components of noninterest expense are as follows:
TABLE 7: Noninterest Expense
| For the three months ended September 30, |
Percent Change |
For the nine months ended September 30, |
Percent Change |
||||||||||||
| ($ in millions) | 2008 | 2007 | 2008 | 2007 | |||||||||||
| Salaries, wages and incentives |
$ | 321 | 310 | 4 | $ | 1,000 | 912 | 10 | |||||||
| Employee benefits |
72 | 67 | 8 | 216 | 222 | (2 | ) | ||||||||
| Net occupancy expense |
77 | 66 | 16 | 222 | 199 | 12 | |||||||||
| Payment processing expense |
70 | 65 | 8 | 203 | 176 | 16 | |||||||||
| Technology and communications |
47 | 41 | 14 | 142 | 122 | 17 | |||||||||
| Equipment expense |
34 | 30 | 12 | 95 | 90 | 5 | |||||||||
| Other noninterest expense |
346 | 274 | 26 | 665 | 649 | 2 | |||||||||
| Total noninterest expense | $ | 967 | 853 | 13 | $ | 2,543 | 2,370 | 7 | |||||||
Total personnel costs (salaries, wages and incentives plus employee benefits) increased 4% from September 30, 2007 due primarily to approximately $11 million in mortgage origination costs that prior to the adoption of SFAS No. 159 on January 1, 2008, were included as a component of mortgage banking net revenue. Full time equivalent employees totaled 21,522 as of September 30, 2008 compared to 20,775 as of September 30, 2007.
Net occupancy expenses increased $11 million, or 16%, in the third quarter of 2008 over the same period last year due to the addition of 117 banking centers since September 30, 2007. Growth in the number of banking centers was primarily driven by acquisitions, which added 96 banking centers since the third quarter of 2007. Payment processing expense includes third-party processing expenses, card management fees and other bankcard processing expenses. Payment processing expense increased eight percent compared to the same period last year due to higher network charges of $4 million from increased processing volumes for both the merchant and financial institutions businesses.
D-19
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
The major components of other noninterest expense are as follows:
TABLE 8: Components of Other Noninterest Expense
| ($ in millions) | For the three months ended September 30, |
For the nine months ended September 30, | |||||||||
| 2008 | 2007 | 2008 | 2007 | ||||||||
| Professional services fees |
$ | 50 | 14 | $ | 78 | 37 | |||||
| Loan processing |
46 | 29 | 123 | 84 | |||||||
| Marketing |
29 | 19 | 74 | 57 | |||||||
| FDIC insurance and other taxes |
17 | 9 | 47 | 23 | |||||||
| Affordable housing investments |
17 | 13 | 48 | 36 | |||||||
| Provision for unfunded commitments and letters of credit |
17 | 2 | 35 | 3 | |||||||
| Intangible asset amortization |
17 | 10 | 40 | 31 | |||||||
| Travel |
14 | 14 | 41 | 40 | |||||||
| Postal and courier |
14 | 13 | 41 | 38 | |||||||
| Operating lease |
9 | 5 | 23 | 15 | |||||||
| Supplies |
8 | 8 | 24 | 22 | |||||||
| Recruitment and education |
7 | 10 | 24 | 30 | |||||||
| Visa litigation settlement (accrual) |
45 | 78 | (107 | ) | 78 | ||||||
| Other |
56 | 50 | 174 | 155 | |||||||
| Total other noninterest expense | $ | 346 | 274 | $ | 665 | 649 | |||||
Total other noninterest expense increased by $72 million from the same quarter last year. The increased professional service fees compared to the same quarter last year resulted from legal expenses of $36 million stemming from the CitFed litigation. FDIC insurance and other taxes were higher due to the depletion of the Bancorp’s prior FDIC insurance premium credits in the third quarter of 2008. Loan processing expense was higher in comparison to the same quarter last year as a result of increased collection activities. In addition, the provision for unfunded commitments increased $15 million compared to the third quarter of 2007 due to higher estimates of inherent losses resulting from deterioration in credit quality.
Applicable Income Taxes
The Bancorp’s income (loss) before income taxes, applicable income tax expense and effective tax rate for each of the periods indicated are as follows:
TABLE 9: Applicable Income Taxes
| ($ in millions) | For the three months ended September 30, |
For the nine months ended September 30, | ||||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||||
| Income (loss) before income taxes |
$ | (128 | ) | 443 | $ | 179 | 1,473 | |||||
| Applicable income taxes |
(72 | ) | 118 | 150 | 414 | |||||||
| Effective tax rate | 56.6 | % | 26.7 | 84.0 | % | 28.1 | ||||||
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. The effective tax rate for the three months ended September 30, 2008 was primarily impacted by lower projected pre-tax income for 2008. The effective tax rate for the nine months ended September 30, 2008 was primarily impacted by the charge to tax expense of approximately $140 million in the second quarter of 2008 required for interest related to the tax treatment of certain of the Bancorp’s leveraged leases for previous tax years.
D-20
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
BUSINESS SEGMENT REVIEW
The Bancorp reports on five business segments: Commercial Banking, Branch Banking, Consumer Lending, Processing Solutions and Investment Advisors. Further detailed financial information on each business segment is included in Note 17 of the Notes to Condensed Consolidated Financial Statements.
Results of the Bancorp’s business segments are presented based on its management structure and management accounting practices. The structure and accounting 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. During the fourth quarter of 2007, the Bancorp changed the reporting of Processing Solutions to include certain revenues and expenses related to credit card processing that were previously listed under the Commercial and Branch Banking segments. Revisions to the Bancorp’s methodologies are applied on a retroactive basis.
The Bancorp manages interest rate risk centrally at the corporate level by employing a funds transfer pricing (“FTP”) methodology. This methodology insulates the business segments from interest rate volatility, enabling them to focus on serving customers through loan originations and deposit taking. The FTP system assigns charge rates and credit rates to classes of assets and liabilities, respectively, based on expected duration and the LIBOR swap curve. Matching duration 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 the 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 is captured in General Corporate and Other.
Management made several changes to the FTP methodology in the fourth quarter of 2007 to more appropriately calculate FTP charges and credits to each of the Bancorp’s business segments. Changes to the FTP methodology were applied retroactively and included adding a liquidity premium to loans and deposits to properly reflect the Bancorp’s marginal cost of longer term funding. In addition, an FTP charge on fixed assets was added to the new FTP methodology.
D-21
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
The business segments are charged provision expense based on the actual net charge-offs experienced by the loans owned by each segment. Provision expense attributable to loan growth and changes in factors in the allowance for loan and lease losses are captured in General Corporate and Other. The financial results of the business segments include allocations for shared services and headquarters expenses. Even with these allocations, the financial results are not necessarily indicative of the business segments’ financial condition and results of operations as if they were to exist as independent entities. Additionally, the business segments form synergies by taking advantage of cross-sell opportunities and when funding operations by accessing the capital markets as a collective unit. Net income (loss) by business segment is summarized as follows:
TABLE 10: Business Segment Results
| ($ in millions) | For the three months ended September 30, |
For the nine months ended September 30, |
||||||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||||||
| Commercial Banking |
$ | 155 | 183 | $ | 404 | 531 | ||||||||
| Branch Banking |
166 | 166 | 454 | 469 | ||||||||||
| Consumer Lending |
6 | 28 | 45 | 111 | ||||||||||
| Processing Solutions |
43 | 39 | 129 | 114 | ||||||||||
| Investment Advisors |
26 | 26 | 83 | 73 | ||||||||||
| General Corporate and Other |
(452 | ) | (117 | ) | (1,086 | ) | (239 | ) | ||||||
| Net income (loss) |
(56 | ) | 325 | 29 | 1,059 | |||||||||
| Dividends on preferred stock |
25 | — | 26 | — | ||||||||||
| Net income (loss) available to common shareholders | $ | (81 | ) | 325 | $ | 3 | 1,059 | |||||||
Commercial Banking
Commercial Banking offers banking, cash management and financial services to large and middle-market businesses, government and professional customers. In addition to the traditional lending and depository offerings, Commercial Banking products and services include, among others, 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.
D-22
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
TABLE 11: Commercial Banking
| ($ in millions) | For the three months ended September 30, |
For the nine months ended September 30, | ||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||
| Income Statement Data |
||||||||||
| Net interest income (FTE) (a) |
$ | 502 | 330 | $ | 1,210 | 976 | ||||
| Provision for loan and lease losses |
235 | 22 | 517 | 71 | ||||||
| Noninterest income: |
||||||||||
| Corporate banking revenue |
98 | 82 | 301 | 238 | ||||||
| Service charges on deposits |
46 | 37 | 136 | 112 | ||||||
| Other noninterest income |
17 | 17 | 42 | 48 | ||||||
| Noninterest expense: |
||||||||||
| Salaries, incentives and benefits |
78 | 63 | 230 | 196 | ||||||
| Other noninterest expenses |
150 | 130 | 436 | 387 | ||||||
| Income before taxes |
200 | 251 | 506 | 720 | ||||||
| Applicable income taxes (a) |
45 | 68 | 102 | 189 | ||||||
| Net income | $ | 155 | 183 | $ | 404 | 531 | ||||
| Average Balance Sheet Data |
||||||||||
| Commercial loans |
$ | 43,829 | 35,580 | $ | 42,505 | 34,831 | ||||
| Demand deposits |
6,328 | 5,843 | 6,066 | 5,903 | ||||||
| Interest checking |
4,397 | 4,055 | 4,540 | 4,007 | ||||||
| Savings and money market |
4,009 | 4,377 | 4,389 | 4,509 | ||||||
| Certificates over $100,000 and other time |
2,184 | 1,687 | 1,932 | 1,878 | ||||||
| Foreign office deposits |
1,842 | 1,531 | 1,935 | 1,332 | ||||||
| (a) | Includes taxable-equivalent adjustments of $4 million for the three months ended September 30, 2008 and 2007 and $11 million and $10 million for the nine months ended September 30, 2008 and 2007, respectively. |
Net income decreased $28 million, or 15%, compared to the third quarter of 2007 as strong growth in net interest income and corporate banking revenue was more than offset by increased provision for loan and lease losses. Net interest income increased $172 million, or 52%, compared to the same period last year. The accretion of purchase accounting adjustments, totaling $154 million, related to the second quarter acquisition of First Charter drove the increase in net interest income with the remainder attributed to the growth in loans, partially funded by an increase in deposits. Average commercial loans and leases were up 23%, to $43.9 billion, over the same quarter last year due to solid loan production across most of the Bancorp’s footprint and the result of acquisitions since the third quarter of 2007. Excluding acquisitions, commercial loans increased approximately 18% compared to the third quarter of 2007. Average core deposits increased five percent due to growth in interest checking and foreign office deposits. The segment is focusing on growing deposits through deeper penetration of its premium customer base. Net charge-offs as a percent of average loans and leases increased to 213 bp from 25 bp in the third quarter of 2007. Net charge-offs increased in comparison to the prior year quarter due to weakening economies and the continuing deterioration of credit within the Bancorp’s footprint, particularly in Michigan and Florida, involving commercial and commercial construction loans. Higher charge-offs were particularly concentrated in homebuilder and developer loans, where these loans accounted for approximately 69% of net charge-offs during the third quarter of 2008.
Noninterest income increased $25 million compared to the same quarter last year due to corporate banking revenue growth of $16 million, or 19%, and an increase in service charges on deposits of $9 million, or 25%. Corporate banking revenue increased as a result of growth in foreign exchange derivative income, which increased $11 million, to $24 million, during the third quarter of 2008. Service charges on deposits increased 25%, to $46 million, compared to the third quarter of 2007. The increase in service charges was a result of higher business service charges (net of discounts) and a reduction in the amount of offsetting earnings credits as short-term rates remain lower than the third quarter of 2007.
D-23
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Noninterest expense increased $35 million, or 18%, compared to the third quarter of 2007 primarily due to sales incentives increasing 36% to $28 million compared to the third quarter of 2007. Additionally, loan expenses increased $10 million, to $17 million, during the third quarter of 2007 due to increased collection activities.
Branch Banking
Branch Banking provides a full range of deposit and loan and lease products to individuals and small businesses through 1,298 full-service banking centers. Branch Banking offers depository and loan products, such as checking and savings accounts, home equity loans and lines of credit, credit cards and loans for automobile and other personal financing needs, as well as products designed to meet the specific needs of small businesses, including cash management services. The table below contains selected financial data for the Branch Banking segment.
TABLE 12: Branch Banking
| ($ in millions) | For the three months ended September 30, |
For the nine months ended September 30, | ||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||
| Income Statement Data |
||||||||||
| Net interest income |
$ | 442 | 374 | $ | 1,226 | 1,081 | ||||
| Provision for loan and lease losses |
87 | 44 | 226 | 104 | ||||||
| Noninterest income: |
||||||||||
| Service charges on deposits |
124 | 113 | 336 | 304 | ||||||
| Electronic payment processing |
49 | 44 | 141 | 129 | ||||||
| Investment advisory income |
20 | 23 | 65 | 69 | ||||||
| Other noninterest income |
19 | 23 | 74 | 69 | ||||||
| Noninterest expense: |
||||||||||
| Salaries, incentives and benefits |
129 | 119 | 383 | 354 | ||||||
| Net occupancy and equipment expenses |
52 | 43 | 149 | 128 | ||||||
| Other noninterest expenses |
129 | 115 | 383 | 341 | ||||||
| Income before taxes |
257 | 256 | 701 | 725 | ||||||
| Applicable income taxes |
91 | 90 | 247 | 256 | ||||||
| Net income | $ | 166 | 166 | $ | 454 | 469 | ||||
| Average Balance Sheet Data |
||||||||||
| Consumer loans |
$ | 12,738 | 11,872 | $ | 12,551 | 11,731 | ||||
| Commercial loans |
5,850 | 5,133 | 5,559 | 5,149 | ||||||
| Demand deposits |
6,205 | 5,734 | 5,972 | 5,760 | ||||||
| Interest checking |
7,876 | 8,310 | 7,986 | 8,909 | ||||||
| Savings and money market |
16,239 | 15,167 | 16,270 | 14,316 | ||||||
| Certificates over $100,000 and other time |
13,256 | 13,073 | 12,935 | 13,626 | ||||||
Net income was flat compared to the third quarter of 2007 as increases in net interest income and service fees were offset by a higher provision for loan and lease losses and increases in salaries and net occupancy expense. Net interest income increased 18% compared to the third quarter of 2007 due to loan growth and the accretion of purchase accounting adjustments, totaling $27 million, related to the second quarter acquisition of First Charter. Average loans and leases increased nine percent compared to the third quarter of 2007 as home equity loans grew nine percent due to acquisitions since the third quarter of 2007. The segment grew credit card balances by $318 million, or 26%, resulting from an increased focus on relationships with its current customers through the cross-selling of credit cards. Average core deposits were up 4% compared to the third quarter of 2007
D-24
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
with growth in savings and money market accounts and CDs offset by a decrease in interest checking deposits. The growth in core deposits was driven by acquisitions since the third quarter of 2007. Net charge-offs as a percent of average loan and leases increased to 187 bp from 103 bp in the third quarter of 2007. Net charge-offs increased in comparison to the prior year quarter as the Bancorp experienced higher charge-offs involving home equity lines of and loans of $19 million reflecting borrower stress and a decrease in home prices within the Bancorp’s footprint. Charge-offs involving credit cards increased $11 million compared to the third quarter of 2007 due to higher card balances and maturing of the portfolio.
Noninterest income increased $9 million compared to the third quarter of 2007 primarily due to an increase in service charges on deposits of $11 million, or nine percent. The increase in deposit fees, including consumer overdraft fees, is attributed to higher customer activity in comparison to the prior year quarter. Noninterest expense increased $33 million, or 12%, compared to the third quarter of 2007 as net occupancy and equipment costs increased 19% as a result of additional banking centers. Since the third quarter of 2007, the Bancorp’s banking centers have increased by 117 to 1,298 as of September 30, 2008, mainly due to acquisitions, which contributed 96 banking centers. Other noninterest expense increased 12%, which can be attributed to higher loan cost associated with collections. The Bancorp continues to position itself for sustained long-term growth through new banking center additions in key markets.
Consumer Lending
Consumer Lending includes the Bancorp’s mortgage, home equity, automobile and other indirect lending activities. Mortgage and home equity lending activities include the origination, retention and servicing of mortgage and home equity loans or lines of credit, sales and securitizations of those loans or pools of loans or lines of credit and all associated hedging activities. Other indirect lending activities include loans to consumers through mortgage brokers, automobile dealers and federal and private student education loans. The table below contains selected financial data for the Consumer Lending segment.
TABLE 13: Consumer Lending
| ($ in millions) | For the three months ended September 30, |
For the nine months ended September 30, | ||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||
| Income Statement Data |
||||||||||
| Net interest income |
$ | 141 | 97 | $ | 361 | 298 | ||||
| Provision for loan and lease losses |
124 | 40 | 305 | 93 | ||||||
| Noninterest income: |
||||||||||
| Mortgage banking net revenue |
44 | 24 | 215 | 99 | ||||||
| Other noninterest income |
29 | 22 | 56 | 55 | ||||||
| Noninterest expense: |
||||||||||
| Salaries, incentives and benefits |
31 | 17 | 104 | 56 | ||||||
| Other noninterest expenses |
50 | 43 | 154 | 132 | ||||||
| Income before taxes |
9 | 43 | 69 | 171 | ||||||
| Applicable income taxes |
3 | 15 | 24 | 60 | ||||||
| Net income | $ | 6 | 28 | $ | 45 | 111 | ||||
| Average Balance Sheet Data |
||||||||||
| Residential mortgage loans |
$ | 10,574 | 10,026 | $ | 10,869 | 9,960 | ||||
| Automobile loans |
7,376 | 9,844 | 8,138 | 9,565 | ||||||
| Home equity |
1,114 | 1,318 | 1,164 | 1,347 | ||||||
| Consumer leases |
815 | 872 | 798 | 952 | ||||||
D-25
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Net income decreased $22 million, compared to the third quarter of 2007 as the increases in net interest income and mortgage banking net revenue, net of related expenses, were more than offset by growth in provision for loan and lease losses. The accretion of purchase accounting adjustments, totaling $38 million, primarily related to the second quarter acquisition of First Charter drove the growth in net interest income compared to the third quarter of 2007. Average residential mortgage loans increased six percent compared to the prior year quarter due primarily to acquisitions, including R-G Crown Bank (“Crown”) and First Charter. Excluding acquisitions, residential mortgage loans decreased 12% from the same quarter last year. Average automobile loans decreased 25% compared to the same quarter last year due to the securitization of $2.7 billion of automobile loans in the first quarter of 2008. Net charge-offs as a percent of average loan and leases increased from 77 bp in the third quarter of 2007 to 261 bp in the third quarter of 2008. Net charge-offs, primarily in residential mortgage loans, increased in comparison to the prior year quarter due to the continuing deterioration of real estate values within the Bancorp’s footprint, particularly in Florida. The segment continues to focus on managing credit risk through the restructuring of certain residential mortgage loans and careful consideration of underwriting and collection standards. As of September 30, 2008, the Bancorp had restructured approximately $360 million and $170 million of residential mortgage loans and home equity loans, respectively, to mitigate losses due to declining collateral values.
Mortgage originations decreased to $2.0 billion in the third quarter of 2008 from $3.0 billion in the third quarter of 2007 due to lower application volumes resulting from market disruptions. The increase in sales margins on loans held for sale and sales volume of portfolio loans were the primary reasons for increased mortgage banking net revenue compared to the third quarter of 2007. Also contributing to the increase in mortgage banking net revenue in the third quarter of 2008 was the $11 million impact from the adoption of SFAS No. 159, as of January 1, 2008, on residential mortgage loans held for sale. Prior to adoption, mortgage loan origination costs were capitalized as part of the carrying amount of the loan and recognized as a reduction of mortgage banking net revenue upon the sale of the loans. Subsequent to the adoption, mortgage loan origination costs are recognized in earnings when incurred, which primarily drove the increase in salaries and incentives of $14 million in comparison to the same quarter last year.
Processing Solutions
Fifth Third Processing Solutions provides electronic funds transfer, debit, credit and merchant transaction processing, operates the Jeanie® ATM network and provides other data processing services to affiliated and unaffiliated customers. The table below contains selected financial data for the Processing Solutions segment.
TABLE 14: Processing Solutions
| ($ in millions) | For the three months ended September 30, |
For the nine months ended September 30, |
||||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||||
| Income Statement Data |
||||||||||||
| Net interest income |
$ | 1 | (3 | ) | $ | 3 | (4 | ) | ||||
| Provision for loan and lease losses |
3 | 3 | 11 | 8 | ||||||||
| Noninterest income: |
||||||||||||
| Financial institutions processing |
90 | 80 | 276 | 239 | ||||||||
| Merchant processing |
89 | 83 | 255 | 224 | ||||||||
| Card issuer interchange |
22 | 17 | 62 | 47 | ||||||||
| Other noninterest income |
12 | 10 | 35 | 30 | ||||||||
| Noninterest expense: |
||||||||||||
| Salaries, incentives and benefits |
20 | 18 | 60 | 55 | ||||||||
| Payment processing expense |
68 | 63 | 197 | 171 | ||||||||
| Other noninterest expenses |
56 | 43 | 164 | 126 | ||||||||
| Income before taxes |
67 | 60 | 199 | 176 | ||||||||
| Applicable income taxes |
24 | 21 | 70 | 62 | ||||||||
| Net income | $ | 43 | 39 | $ | 129 | 114 | ||||||
D-26
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Net income increased $4 million, or 11%, compared to the third quarter of 2007 as the segment continues to increase its presence in the electronic payment processing business. The segment continues to realize year-over-year growth in transaction volumes and revenue growth, despite the slowdown in consumer spending, due to the addition and conversion of large national clients over the past year and current initiatives involving merchant pricing and sales. Financial institutions processing revenues increased $10 million, or 12%, driven by higher debit card usage volumes. Merchant processing revenue increased $6 million, or 7%, over the same quarter last year. Growth in card issuer interchange of $5 million, or 30%, can be attributed to organic growth in the Bancorp’s credit card portfolio. The Bancorp continues to see significant opportunities to attract new financial institution customers and retailers within this business segment.
Payment processing expense increased seven percent from the third quarter of 2007 due to higher network charges, increasing 10% to $48 million, resulting from increased transaction volumes. Financial institution transactions and merchant transactions processed both increased in comparison to the third quarter of 2007. Other noninterest expense increased due to higher technology and communications expense.
Investment Advisors
Investment Advisors provides a full range of investment alternatives for individuals, companies and not-for-profit organizations. The Bancorp’s primary services include investments, trust, asset management, retirement plans and custody. Fifth Third Securities, Inc., (“FTS”) an indirect wholly-owned subsidiary of the Bancorp, offers full service retail brokerage services to individual clients and broker dealer services to the institutional marketplace. Fifth Third Asset Management, Inc., an indirect wholly-owned subsidiary of the Bancorp, provides asset management services and also advises the Bancorp’s proprietary family of mutual funds. The table below contains selected financial data for the Investment Advisors segment.
TABLE 15: Investment Advisors
| ($ in millions) | For the three months ended September 30, |
For the nine months ended September 30, | ||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||
| Income Statement Data |
||||||||||
| Net interest income |
$ | 46 | 39 | $ | 137 | 113 | ||||
| Provision for loan and lease losses |
12 | 5 | 21 | 10 | ||||||
| Noninterest income: |
||||||||||
| Investment advisory income |
89 | 96 | 276 | 291 | ||||||
| Other noninterest income |
7 | 6 | 22 | 17 | ||||||
| Noninterest expense: |
||||||||||
| Salaries, incentives and benefits |
38 | 41 | 120 | 125 | ||||||
| Other noninterest expenses |
52 | 55 | 165 | 173 | ||||||
| Income before taxes |
40 | 40 | 129 | 113 | ||||||
| Applicable income taxes |
14 | 14 | 46 | 40 | ||||||
| Net income | $ | 26 | 26 | $ | 83 | 73 | ||||
| Average Balance Sheet Data |
||||||||||
| Loans |
$ | 3,599 | 3,229 | $ | 3,548 | 3,168 | ||||
| Core deposits |
4,308 | 4,918 | 4,751 | 4,969 | ||||||
Net income was flat compared to the third quarter of 2007 as higher net interest income was offset by lower investment advisory income. The segment grew loans and benefited from an overall decrease in interest rates to increase net interest income $7 million, or 18%, as spreads widened due to decreases in funding costs. Investment advisors realized average loan growth of 11% and a decrease in average core deposits of 12% compared to the third quarter of 2007. Core deposits decreased due to a 21% decline in interest checking balances.
D-27
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Noninterest income decreased $6 million, or six percent, compared to the third quarter of 2007, as investment advisory income decreased eight percent, to $89 million. Mutual fund fees decreased as a result of the decline in the equity markets since the third quarter of 2007. In addition, the decrease in broker income was driven by clients moving to lower fee, cash based products from equity products due to extreme market volatility and a decline in transaction based revenues. Noninterest expense decreased $6 million compared to the prior year quarter as the segment continues to focus on expense control. As of September 30, 2008, the Bancorp had $196 billion in assets under care and $30 billion in managed assets, modestly lower than the previous year quarter.
General Corporate and Other
General Corporate and Other includes the unallocated portion of the investment securities portfolio, securities gains/losses, certain non-core deposit funding, unassigned equity, provision expense in excess of net charge-offs, the payment of preferred stock dividends and certain support activities and other items not attributed to the business segments.
The results of General Corporate and Other were primarily impacted by the significant increase in the provision for loan and lease losses, which increased from $25 million in the third quarter of 2007 to $480 million in the third quarter of 2008. The results also included $45 million related to Visa’s pending litigation settlement with Discover, a net benefit of $40 million from the resolution of the CitFed litigation, the other than temporary impairment of FNMA and FHLMC preferred stock of $51 million and the charge related to a reduction in the current cash surrender value of one of the Bancorp’s BOLI policies of $27 million.
BALANCE SHEET ANALYSIS
Loans and Leases
The following tables summarize the end of period and average total loans and leases, including loans held for sale. The Bancorp classifies its loans and leases based upon the primary purpose of the loan.
TABLE 16: Components of Total Loans and Leases (includes held for sale)
| ($ in millions) | September 30, 2008 | December 31, 2007 | September 30, 2007 | ||||||||||||
| Balance | % of Total |
Balance | % of Total |
Balance | % of Total | ||||||||||
| Commercial: |
|||||||||||||||
| Commercial loans |
$ | 29,424 | 34 | $ | 26,079 | 31 | $ | 23,317 | 29 | ||||||
| Commercial mortgage loans |
13,355 | 16 | 11,967 | 14 | 11,178 | 14 | |||||||||
| Commercial construction loans |
6,002 | 7 | 5,561 | 6 | 5,463 | 7 | |||||||||
| Commercial leases |
3,642 | 4 | 3,737 | 5 | 3,710 | 5 | |||||||||
| Subtotal—commercial |
52,423 | 61 | 47,344 | 56 | 43,668 | 55 | |||||||||
| Consumer: |
|||||||||||||||
| Residential mortgage loans |
10,292 | 12 | 11,433 | 14 | 9,945 | 13 | |||||||||
| Home equity |
12,599 | 14 | 11,874 | 14 | 11,737 | 15 | |||||||||
| Automobile loans |
8,306 | 10 | 11,183 | 13 | 11,043 | 14 | |||||||||
| Credit card |
1,688 | 2 | 1,591 | 2 | 1,460 | 2 | |||||||||
| Other consumer loans and leases |
1,190 | 1 | 1,157 | 1 | 1,162 | 1 | |||||||||
| Subtotal—consumer |
34,075 | 39 | 37,238 | 44 | 35,347 | 45 | |||||||||
| Total loans and leases | $ | 86,498 | 100 | $ | 84,582 | 100 | $ | 79,015 | 100 | ||||||
D-28
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Total loans and leases increased $7.5 billion, or 10%, over the third quarter of 2007. The growth in total loans and leases was due to acquisitions since the third quarter of 2007, the use of contingent liquidity facilities related to certain off-balance sheet programs and increased loan production across the Bancorp’s footprint.
Total commercial loans and leases increased $8.8 billion, or 20%, compared to September 30, 2007. The increase was primarily due to strong growth in commercial loans of 26% compared to the third quarter of 2007 resulting from increased loan production, acquisitions since the third quarter of 2007 and an additional $1.5 billion from the use of contingent liquidity facilities related to certain off-balance sheet programs that were drawn upon in the third quarter of 2008. Included within the contingent liquidity facilities were approximately $335 million in draws on outstanding letters of credit that were supporting certain securities issued as variable rate demand notes (“VRDNs”). Draws on these outstanding letters of credit have continued in October with outstanding draws of approximately $909 million as of October 31, 2008. For further information on these arrangements, see the Off-Balance Sheet Arrangements section and Note 8 of the Notes to Condensed Consolidated Financial Statements. Commercial mortgage loans increased 19% over the third quarter of 2007, which included the impact of acquisitions since the third quarter of 2007 of $1.1 billion. The overall mix of commercial loans and leases is relatively consistent with prior periods.
Total consumer loans and leases decreased $1.3 billion, or four percent, compared to the third quarter of 2007, as a result of the decrease in automobile loans partially offset by credit card and home equity loan growth. Credit card loans increased to $1.7 billion, an increase of 16% over the third quarter of 2007, due to continued success in cross-selling credit cards to its existing retail customer base. Home equity loans increased $862 million, primarily due to acquisitions since the third quarter of 2007. Residential mortgage loans were $10.3 billion at September 30, 2008, an increase of four percent over the third quarter of 2007, with growth driven by approximately $1.5 billion of loans from acquisitions. Automobile loans decreased by approximately $2.7 billion, or 25%, due largely to automobile loan securitizations during the first quarter of 2008.
Average total commercial loans and leases increased $8.6 billion, or 20%, compared to the third quarter of 2007. The increase in average total commercial loans and leases was primarily driven by growth in commercial loans and commercial mortgage loans, which increased 27% and 19%, respectively, over the third quarter of 2007. Commercial construction loans increased 11% compared to the same quarter last year. The growth in commercial mortgage loans and commercial construction loans included the impact of acquisitions since the third quarter of 2007 of $1.0 billion and $588 million, respectively. Growth in overall average commercial loans and leases was realized in the majority of the Bancorp’s markets, including 15% growth in Chicago and approximately $1.5 billion of loans in North Carolina from acquisitions.
Average total consumer loans and leases decreased $1.1 billion, or three percent, compared to the third quarter of 2007 as a result of a decrease in automobile loans of 24% largely due to the aforementioned automobile securitizations that occurred in the first quarter. The decline was partially offset by growth in credit card balances of $354 million, or 26%, and home equity loans of $783 million, or seven percent. Acquisitions since the third quarter of 2007 impacted the change in residential mortgage loans and home equity loans by $1.7 billion and $627 million, respectively. The Bancorp experienced a decrease in average consumer loans and leases in a majority of its markets.
D-29
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
TABLE 17: Components of Average Total Loans and Leases (includes held for sale)
| ($ in millions) | September 30, 2008 |
December 31, 2007 |
September 30, 2007 | ||||||||||||
| Balance | % of Total |
Balance | % of Total |
Balance | % of Total | ||||||||||
| Commercial: |
|||||||||||||||
| Commercial loans |
$ | 28,284 | 33 | $ | 24,526 | 30 | $ | 22,345 | 29 | ||||||
| Commercial mortgage loans |
13,257 | 16 | 11,588 | 14 | 11,117 | 14 | |||||||||
| Commercial construction loans |
6,110 | 7 | 5,544 | 7 | 5,499 | 7 | |||||||||
| Commercial leases |
3,643 | 4 | 3,692 | 4 | 3,700 | 5 | |||||||||
| Subtotal—commercial |
51,294 | 60 | 45,350 | 55 | 42,661 | 55 | |||||||||
| Consumer: |
|||||||||||||||
| Residential mortgage loans |
10,711 | 12 | 11,181 | 14 | 10,396 | 13 | |||||||||
| Home equity |
12,534 | 15 | 11,843 | 15 | 11,752 | 15 | |||||||||
| Automobile loans |
8,303 | 10 | 11,158 | 13 | 10,865 | 14 | |||||||||
| Credit card |
1,720 | 2 | 1,461 | 2 | 1,366 | 2 | |||||||||
| Other consumer loans and leases |
1,210 | 1 | 1,179 | 1 | 1,204 | 1 | |||||||||
| Subtotal—consumer |
34,478 | 40 | 36,822 | 45 | 35,583 | 45 | |||||||||
| Total average loans and leases | $ | 85,772 | 100 | $ | 82,172 | 100 | $ | 78,244 | 100 | ||||||
| Total portfolio loans and leases (excludes held for sale) | $ | 84,695 | $ | 78,174 | $ | 76,295 | |||||||||
Investment Securities
The Bancorp uses investment securities as a means of managing interest rate risk, providing liquidity support and providing collateral for pledging purposes. As of September 30, 2008, total investment securities were $14.5 billion compared to $11.3 billion at September 30, 2007. 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 on the basis of both the duration of the decline in value of the security and the severity of that decline, and maintains the intent and ability to hold these securities to the earlier of the recovery of the losses or maturity.
D-30
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
At September 30, 2008, the Bancorp’s investment portfolio primarily consisted of AAA-rated agency mortgage-backed securities. The investment portfolio includes FHLMC preferred stock and FNMA preferred securities with a remaining carrying value of $4 million after recognizing other than temporary impairment charges of $64 million during the second and third quarters of 2008. The Bancorp did not hold asset-backed securities backed by subprime loans in its investment portfolio at September 30, 2008. Additionally, there were no material securities below investment grade as of September 30, 2008.
TABLE 18: Components of Investment Securities (amortized cost basis)
| ($ in millions) | September 30, 2008 |
December 31, 2007 |
September 30, 2007 | ||||
| Available-for-sale and other: |
|||||||
| U.S. Treasury and Government agencies |
$ | 187 | 3 | 3 | |||
| U.S. Government sponsored agencies |
329 | 160 | 500 | ||||
| Obligations of states and political subdivisions |
357 | 490 | 538 | ||||
| Agency mortgage-backed securities |
9,773 | 8,738 | 8,290 | ||||
| Other bonds, notes and debentures |
1,552 | 385 | 705 | ||||
| Other securities |
1,051 | 1,045 | 971 | ||||
| Total available-for-sale and other securities | $ | 13,249 | 10,821 | 11,007 | |||
| Held-to-maturity: |
|||||||
| Obligations of states and political subdivisions |
$ | 355 | 351 | 344 | |||
| Other bonds, notes and debentures |
5 | 4 | 2 | ||||
| Total held-to-maturity | $ | 360 | 355 | 346 | |||
On an amortized cost basis, at the end of the third quarter of 2008, available-for-sale securities increased $2.2 billion since September 30, 2007. At September 30, 2008 and 2007, available-for-sale securities were 13% and 12%, respectively, of interest-earning assets. Increases in the available-for-sale securities portfolio relate to the Bancorp’s overall balance sheet growth and the purchase of securities as a part of the Bancorp’s non-qualifying hedging strategy related to mortgage servicing rights. The estimated weighted-average life of the debt securities in the available-for-sale portfolio was 6.0 years at September 30, 2008 compared to 5.7 years at September 30, 2007. At September 30, 2008, the fixed-rate securities within the available-for-sale securities portfolio had a weighted-average yield of 5.26% compared to 5.51% at September 30, 2007.
Trading securities increased from $171 million and $241 million as of December 31, 2007 and June 30, 2008, respectively, to $915 million as of September 30, 2008. The increase was driven by a residential mortgage loan securitization in the third quarter of 2008 in which the Bancorp continued to hold the underlying securities of $359 million. Additionally, as of September 30, 2008, the Bancorp held $366 million of VRDNs in its trading securities portfolio. These securities were purchased from the market, through FTS, who was also the remarketing agent. The overall position in VRDNs has continued to increase and was $1.6 billion as of October 31, 2008. For more information on the Bancorp’s obligations in remarketing variable rate demand notes, see Note 8 in the Notes to Condensed Consolidated Financial Statements.
D-31
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Information presented in Table 19 is on a weighted-average life basis, anticipating future prepayments. Yield information is presented on an FTE basis and is computed using historical cost balances. Maturity and yield calculations for the total available-for-sale portfolio exclude equity securities that have no stated yield or maturity.
TABLE 19: Characteristics of Available-for-Sale and Other Securities
| As of September 30, 2008 ($ in millions) | Amortized Cost |
Fair Value |
Weighted- Average Life (in years) |
Weighted- Average Yield |
|||||||
| U.S. Treasury and Government agencies: |
|||||||||||
| Average life of one year or less |
$ | 41 | $ | 41 | 1.0 | 2.14 | % | ||||
| Average life 1 – 5 years |
144 | 145 | 1.8 | 2.12 | |||||||
| Average life 5 – 10 years |
— | — | — | — | |||||||
| Average life greater than 10 years |
2 | 2 | 11.5 | 2.85 | |||||||
| Total |
187 | 188 | 1.7 | 2.14 | |||||||
| U.S. Government sponsored agencies: |
|||||||||||
| Average life of one year or less |
60 | 61 | 0.5 | 4.84 | |||||||
| Average life 1 – 5 years |
269 | 269 | 2.1 | 3.51 | |||||||
| Average life 5 – 10 years |
— | — | — | — | |||||||
| Average life greater than 10 years |
— | — | — | — | |||||||
| Total |
329 | 330 | 1.8 | 3.75 | |||||||
| Obligations of states and political subdivisions (a): |
|||||||||||
| Average life of one year or less |
189 | 190 | 0.3 | 7.36 | |||||||
| Average life 1 – 5 years |
105 | 107 | 2.2 | 7.16 | (b) | ||||||
| Average life 5 – 10 years |
63 | 63 | 6.6 | 7.66 | (b) | ||||||
| Average life greater than 10 years |
— | — | — | — | |||||||
| Total |
357 | 360 | 2.0 | 7.30 | |||||||
| Agency mortgage-backed securities: |
|||||||||||
| Average life of one year or less |
2 | 2 | 0.8 | 4.78 | |||||||
| Average life 1 – 5 years |
1,863 | 1,873 | 3.7 | 4.89 | |||||||
| Average life 5 – 10 years |
7,851 | 7,839 | 7.6 | 5.26 | |||||||
| Average life greater than 10 years |
57 | 57 | 10.0 | 5.70 | |||||||
| Total |
9,773 | 9,771 | 6.9 | 5.19 | |||||||
| Other bonds, notes and debentures (c): |
|||||||||||
| Average life of one year or less |
1,048 | 1,047 | 0.1 | 5.38 | |||||||
| Average life 1 – 5 years |
282 | 274 | 3.6 | 6.69 | |||||||
| Average life 5 – 10 years |
65 | 50 | 8.2 | 6.78 | |||||||
| Average life greater than 10 years |
157 | 114 | 17.1 | 7.53 | |||||||
| Total |
1,552 | 1,485 | 2.7 | 5.89 | |||||||
| Other securities (d) |
1,051 | 1,043 | |||||||||
| Total available-for-sale and other securities | $ | 13,249 | $ | 13,177 | 6.0 | 5.26 | % | ||||
| (a) | Taxable-equivalent yield adjustments included in the above table are 2.48%, 2.40%, 2.58%, 1.26% and 2.45% for securities with an average life of one year or less, 1-5 years, 5-10 years, greater than 10 years and in total, respectively. |
| (b) | Weighted-average yield excludes $1 million and $52 million of securities with an average life of 1-5 years and 5-10 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 commercial paper, non-agency mortgage backed securities, certain other asset backed securities (primarily automobile and commercial loan backed securities) and corporate bond securities. |
| (d) | Other securities consist of Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank restricted stock holdings that are carried at par, FHLMC and FNMA preferred stock holdings, certain mutual fund holdings and equity security holdings. |
D-32
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Interest rate spreads in mortgage products contracted during the third quarter, reversing the considerable widening that took place during the second quarter of 2008, resulting in a net unrealized loss on agency mortgage-backed securities of $2 million as of September 30, 2008. In addition, credit spreads on corporate bonds increased, resulting in an increase in unrealized losses on other bonds, notes and debentures of $67 million as of September 30, 2008. Total net unrealized losses on the available-for-sale securities portfolio was $72 million at September 30, 2008 compared to an unrealized loss of $144 million at December 31, 2007 and a $230 million unrealized loss at September 30, 2007.
Deposits
Deposit balances represent an important source of funding and revenue growth opportunity. The Bancorp is continuing to focus on core deposit growth in its retail and commercial franchises by expanding its retail franchise through acquisitions and its de novo strategy and enhancing its product offerings. At September 30, 2008, core deposits represented 54% of the Bancorp’s asset funding base, compared to 59% at September 30, 2007.
Included in core deposits are foreign office deposits, which are Eurodollar sweep accounts for the Bancorp’s commercial customers. These accounts bear interest at rates slightly higher than money market accounts, but the Bancorp does not have to pay FDIC insurance nor hold collateral. The remaining foreign office balances are brokered deposits and the Bancorp uses these, as well as certificates of deposit $100,000 and over, as a method to fund earning asset growth.
TABLE 20: Deposits
| ($ in millions) | September 30, 2008 | December 31, 2007 | September 30, 2007 | ||||||||||||
| Balance | % of Total |
Balance | % of Total |
Balance | % of Total | ||||||||||
| Demand |
$ | 14,241 | 18 | $ | 14,404 | 19 | $ | 13,174 | 19 | ||||||
| Interest checking |
13,251 | 17 | 15,254 | 20 | 14,294 | 21 | |||||||||
| Savings |
15,955 | 21 | 15,635 | 21 | 15,599 | 22 | |||||||||
| Money market |
5,352 | 7 | 6,521 | 9 | 6,163 | 9 | |||||||||
| Foreign office |
1,999 | 3 | 2,572 | 4 | 2,014 | 3 | |||||||||
| Transaction deposits |
50,798 | 66 | 54,386 | 73 | 51,244 | 74 | |||||||||
| Other time |
11,778 | 15 | 11,440 | 15 | 10,267 | 15 | |||||||||
| Core deposits |
62,576 | 81 | 65,826 | 88 | 61,511 | 89 | |||||||||
| Certificates—$100,000 and over |
13,173 | 17 | 6,738 | 9 | 5,973 | 8 | |||||||||
| Other foreign office |
1,711 | 2 | 2,881 | 3 | 1,898 | 3 | |||||||||
| Total deposits | $ | 77,460 | 100 | $ | 75,445 | 100 | $ | 69,382 | 100 | ||||||
Core deposits increased two percent compared to the third quarter of 2007 due to acquisitions during the past year. Exclusive of acquisitions, core deposits decreased three percent as five percent growth in demand deposits was more than offset by a five percent decrease in interest-bearing core deposits as a result of increased competitor pricing on time deposits. A majority of the increase in deposit pricing was the result of illiquidity in the marketplace that provided other financial institutions limited access to alternative funding sources. The Bancorp increased its rates at the end of the third quarter to approximate competitor rates and realized stabilization in its interest-bearing core deposit products. The Bancorp is committed to its Everyday Great Rates strategy that places each customer in the best deposit product for his/her rate and service need.
D-33
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Certificates $100,000 and over at September 30, 2008 increased compared to December 31, 2007 and September 30, 2007 primarily due to actions taken by the Bancorp as a liquidity management strategy, which involved extending the average duration of wholesale borrowings to reduce exposure to high levels of market volatility.
TABLE 21: Average Deposits
| ($ in millions) | September 30, 2008 | December 31, 2007 | September 30, 2007 | ||||||||||||
| Balance | % of Total |
Balance | % of Total |
Balance | % of Total | ||||||||||
| Demand |
$ | 14,225 | 19 | $ | 13,345 | 19 | $ | 13,143 | 19 | ||||||
| Interest checking |
13,843 | 18 | 14,394 | 20 | 14,334 | 20 | |||||||||
| Savings |
16,154 | 22 | 15,616 | 22 | 15,390 | 22 | |||||||||
| Money market |
6,051 | 8 | 6,363 | 9 | 6,247 | 9 | |||||||||
| Foreign office |
2,126 | 3 | 2,249 | 3 | 1,808 | 3 | |||||||||
| Transaction deposits |
52,399 | 70 | 51,967 | 73 | 50,922 | 73 | |||||||||
| Other time |
10,780 | 14 | 11,011 | 15 | 10,290 | 15 | |||||||||
| Core deposits |
63,179 | 84 | 62,978 | 88 | 61,212 | 88 | |||||||||
| Certificates—$100,000 and over |
11,623 | 15 | 6,613 | 9 | 6,062 | 9 | |||||||||
| Other foreign office |
395 | 1 | 2,464 | 3 | 1,981 | 3 | |||||||||
| Total deposits | $ | 75,197 | 100 | $ | 72,055 | 100 | $ | 69,255 | 100 | ||||||
On an average basis, core deposits increased three percent primarily due to acquisitions that occurred since the third quarter of 2007. Exclusive of acquisitions, average core deposits decreased two percent as increases in demand deposits due to decreased earnings credit rates was more than offset by the decrease in interest-bearing core deposit products.
Borrowings
Total short-term borrowings were $11.3 billion at September 30, 2008 compared to $8.9 billion at September 30, 2007. As of both September 30, 2008 and September 30, 2007, total borrowings as a percentage of interest-bearing liabilities were 28%, as the Bancorp continues to explore additional alternatives regarding the level and cost of various other sources of funding.
TABLE 22: Borrowings
| ($ in millions) | September 30, 2008 |
December 31, 2007 |
September 30, 2007 | |||||
| Federal funds purchased |
$ | 2,521 | 4,427 | $ | 5,130 | |||
| Other short-term borrowings |
8,791 | 4,747 | 3,796 | |||||
| Long-term debt |
12,947 | 12,857 | 12,498 | |||||
| Total borrowings | $ | 24,259 | 22,031 | $ | 21,424 | |||
Total borrowings increased $2.8 billion, or 13%, over the third quarter of 2007, as growth in loans and declines in core deposits dictated a larger amount of funding needed from borrowings. The increase in other short-term borrowings of $5.0 billion, partially offset by a decrease in federal funds purchased of $2.6 billion, was utilized to meet these funding needs. Current economic conditions and market illiquidity were the primary drivers of this mix shift in the past year, causing a decrease in the availability of federal funds. Growth in other short-term borrowings occurred primarily through FHLB advances and Term Auction Facility funds.
D-34
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Long-term debt at September 30, 2008 was consistent with December 31, 2007 as debt issuances during the first and second quarters of 2008 were offset by $2.1 billion of long-term bank notes maturing during the third quarter of 2008. In February 2008, the Bancorp issued $1.0 billion of 8.25% subordinated notes, a portion of which were subsequently hedged to floating, with a maturity date of March 1, 2038. In April 2008, the Bancorp issued $750 million of 6.25% senior notes with a maturity date of May 1, 2013. The notes are not subject to redemption at the Bancorp’s option at any time prior to maturity. Additionally, in May 2008, a deconsolidated trust issued $400 million of Tier 1-qualifying trust preferred securities and invested these proceeds in junior subordinated notes issued by the Bancorp. The notes mature on May 15, 2068 and bear a fixed rate of 8.875% until May 15, 2058. After May 15, 2058, the notes bear interest at a variable rate of three-month LIBOR plus 5.00%. The Bancorp has subsequently entered into hedges related to these notes.
Information on the average rates paid on borrowings is located in the Statements of Income Analysis. In addition, refer to the Liquidity Risk Management section for a discussion on the role of borrowings in the Bancorp’s liquidity management.
D-35
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (Item 3)
RISK MANAGEMENT—OVERVIEW
Managing risk is an essential component of successfully operating a financial services company. The Bancorp’s risk management function is responsible for the 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 (“ERM”), 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. In addition, the Internal Audit division provides an independent assessment of the Bancorp’s internal control structure and related systems and processes. The risks faced by the Bancorp include, but are not limited to, credit, market, liquidity, operational and regulatory compliance. ERM 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; |
| • | 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 exposure, and appropriate accounting for charge-offs, non-accrual status and specific reserves and reports directly to the Risk and Compliance Committee of the Board of Directors; |
| • | Consumer Credit Risk Management—responsible for credit risk management in consumer lending, including oversight of underwriting and credit administration processes as well as analytics and reporting functions; |
| • | 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; |
| • | Compliance Risk Management—responsible for oversight of compliance with all banking regulations; |
| • | Operational Risk Management—responsible for enterprise operational risk programs such as risk self-assessments, new products review, the key risk indicator program, and root cause analysis and corrective action plans relating to identified operational losses; |
| • | Bank Protection—responsible for fraud prevention and detection, and investigations and recovery; |
| • | Insurance Risk Management—responsible for all property, casualty and liability insurance policies including the claims administration process for the Bancorp; |
| • | Investment Advisors Risk Management—responsible for trust compliance, fiduciary risk, trading risk and credit risk in the Investment Advisors line of business; and |
| • | Risk Strategies and Reporting—responsible for quantitative analytics and Board of Directors and senior management reporting on credit, market and operational risk metrics. |
Designated risk managers have been assigned to all business lines. Affiliate risk management is handled by regional risk managers who are responsible for multiple affiliates and who report to ERM.
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 five 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. These committees include the Market Risk Committee, the Corporate Credit Committee, the Credit Policy Committee, the Operational Risk Committee and the Executive Asset Liability Committee. There are
D-36
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
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.
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 underwriting, documentation and collection standards. The Bancorp’s credit risk management strategy also emphasizes diversification on a geographic, industry and customer level as well as 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. Underwriting activities are centralized, while ERM manages the policy and the authority delegation process directly. The Credit Risk Review function, within ERM, provides objective assessments of the quality of underwriting and documentation, the accuracy of risk grades and the charge-off, nonaccrual and reserve analysis process. The Bancorp’s credit review process and overall assessment of required allowances is based on 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 probabilities 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 its 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 commercial credit risk. Scoring systems, various analytical tools and delinquency monitoring are used to assess the credit risk in the Bancorp’s homogenous consumer loan portfolios.
Commercial Portfolio
The Bancorp’s credit risk management strategy includes minimizing concentrations of risk through diversification. Table 23 provides breakouts of the total commercial loan and lease portfolio, including held for sale, by major industry classification (as defined by the North American Industry Classification System), by loan size and by state, illustrating the diversity and granularity of the Bancorp’s portfolio. Table 24 provides further information on the location of commercial real estate and construction industry loans and leases.
At September 30, 2008, homebuilder exposure represents the most significant weakness in the commercial portfolio. As of September 30, 2008, the Bancorp had homebuilder exposure of $4.3 billion and outstanding loans of $3.1 billion with $702 million in nonaccrual loans. As of September 30, 2008, approximately 41% of the outstanding loans to homebuilders are located in the states of Michigan and Florida and represent approximately 59% of the nonaccrual loans. As of December 31, 2007, the Bancorp had homebuilder exposure of $4.4 billion, outstanding loans of $2.9 billion with $176 million in nonaccrual loans. The increase in homebuilder balances during 2008 is primarily attributable to the acquisition of First Charter.
D-37
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
TABLE 23: Commercial Loan and Lease Portfolio (a)
| As of September 30 ($ in millions) | 2008 | 2007 | ||||||||||||
| Outstanding | Exposure | Nonaccrual | Outstanding | Exposure | Nonaccrual | |||||||||
| By industry: |
||||||||||||||
| Real estate |
$ | 12,728 | 15,669 | 636 | 11,003 | 13,708 | 97 | |||||||
| Manufacturing |
7,602 | 14,502 | 113 | 5,856 | 12,546 | 25 | ||||||||
| Construction |
5,656 | 8,575 | 748 | 5,293 | 8,631 | 133 | ||||||||
| Retail trade |
3,878 | 7,193 | 113 | 3,982 | 7,170 | 23 | ||||||||
| Financial services and insurance |
3,512 | 7,991 | 29 | 1,695 | 5,915 | 6 | ||||||||
| Healthcare |
3,013 | 4,974 | 17 | 2,113 | 3,725 | 13 | ||||||||
| Business services |
2,760 | 5,172 | 36 | 2,048 | 3,947 | 22 | ||||||||
| Transportation and warehousing |
2,754 | 3,255 | 33 | 2,368 | 2,888 | 18 | ||||||||
| Wholesale trade |
2,611 | 4,635 | 18 | 2,048 | 3,888 | 32 | ||||||||
| Other services |
1,159 | 1,672 | 19 | 1,015 | 1,452 | 14 | ||||||||
| Individuals |
1,153 | 1,505 | 45 | 1,163 | 1,505 | 15 | ||||||||
| Accommodation and food |
1,137 | 1,582 | 63 | 919 | 1,357 | 14 | ||||||||
| Communication and information |
937 | 1,546 | 10 | 760 | 1,360 | 1 | ||||||||
| Mining |
788 | 1,278 | 18 | 478 | 858 | 5 | ||||||||
| Public administration |
740 | 959 | — | 751 | 965 | — | ||||||||
| Entertainment and recreation |
734 | 992 | 23 | 590 | 857 | 5 | ||||||||
| Agribusiness |
639 | 814 | 8 | 622 | 816 | — | ||||||||
| Utilities |
483 | 1,228 | — | 332 | 1,141 | 2 | ||||||||
| Other |
139 | 318 | 4 | 632 | 1,572 | 6 | ||||||||
| Total | $ | 52,423 | 83,860 | 1,933 | 43,668 | 74,301 | 431 | |||||||
| By loan size: |
||||||||||||||
| Less than $200,000 |
3 | % | 2 | 4 | 4 | 3 | 11 | |||||||
| $200,000 to $1 million |
12 | 9 | 15 | 15 | 11 | 27 | ||||||||
| $1 million to $5 million |
26 | 22 | 38 | 29 | 24 | 41 | ||||||||
| $5 million to $10 million |
14 | 13 | 21 | 16 | 15 | 16 | ||||||||
| $10 million to $25 million |
23 | 24 | 20 | 22 | 24 | 5 | ||||||||
| Greater than $25 million |
22 | 30 | 2 | 14 | 23 | — | ||||||||
| Total | 100 | % | 100 | 100 | 100 | 100 | 100 | |||||||
| By state: |
||||||||||||||
| Ohio |
25 | % | 29 | 12 | 25 | 29 | 26 | |||||||
| Michigan |
18 | 17 | 32 | 21 | 19 | 34 | ||||||||
| Florida |
10 | 8 | 26 | 10 | 8 | 9 | ||||||||
| Illinois |
9 | 9 | 5 | 10 | 10 | 11 | ||||||||
| Indiana |
7 | 7 | 7 | 9 | 8 | 11 | ||||||||
| Kentucky |
5 | 5 | 5 | 6 | 6 | 4 | ||||||||
| North Carolina |
3 | 3 | 2 | — | — | — | ||||||||
| Tennessee |
3 | 2 | 3 | 3 | 3 | 2 | ||||||||
| All other states |
20 | 20 | 8 | 16 | 17 | 3 | ||||||||
| Total | 100 | % | 100 | 100 | 100 | 100 | 100 | |||||||
| (a) | Outstanding reflects total commercial customer loan and lease balances, including held for sale and net of unearned income, and exposure reflects total commercial customer lending commitments. |
D-38
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
TABLE 24: Outstanding Commercial Real Estate and Construction Loans by State
| As of September 30 ($ in millions) | 2008 | 2007 | |||
| Michigan |
$ | 4,547 | 4,595 | ||
| Ohio |
4,369 | 4,088 | |||
| Florida |
2,853 | 2,591 | |||
| Illinois |
1,427 | 1,378 | |||
| Indiana |
1,210 | 1,302 | |||
| North Carolina |
827 | 14 | |||
| Kentucky |
815 | 785 | |||
| Tennessee |
483 | 476 | |||
| All other states |
1,853 | 1,067 | |||
| Total |
$ | 18,384 | 16,296 | ||
Residential Mortgage Portfolio
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.
Certain mortgage products have contractual features that may increase the risk of loss to the Bancorp in the event of a decline in housing prices. These types of mortgage products offered by the Bancorp include loans with 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 25 shows the Bancorp’s originations of these products for the three and nine months ended September 30, 2008 and 2007. The Bancorp does not originate mortgage loans that permit customers to defer principal payments or make payments that are less than the accruing interest.
TABLE 25: Residential Mortgage Originations
| ($ in millions) | 2008 | 2007 | ||||||||||
| Amount | Percent of total |
Amount | Percent of total |
|||||||||
| For the three months ended September 30: |
||||||||||||
| Greater than 80% LTV with no mortgage insurance |
$ | 4 | — | % | $ | 45 | 2 | % | ||||
| Interest-only |
98 | 5 | 438 | 16 | ||||||||
| 80/20 loans |
1 | — | 66 | 2 | ||||||||
| For the nine months ended September 30: |
||||||||||||
| Greater than 80% LTV with no mortgage insurance |
14 | — | 243 | 3 | ||||||||
| Interest-only |
721 | 8 | 1,496 | 17 | ||||||||
| Greater than 80% LTV and interest-only |
2 | — | 19 | — | ||||||||
| 80/20 loans |
36 | — | 177 | 2 | ||||||||
| 80/20 loans and interest-only |
— | — | 44 | 1 | ||||||||
D-39
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
Table 26 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 September 30, 2008 and 2007. Reset of rates on adjustable rate mortgages are not expected to have a material impact on credit cost as two-thirds of adjustable rate mortgages have an LTV less than 80%. Geographically, the Bancorp’s residential mortgage portfolio is dominated by three states with Florida, Ohio and Michigan representing 30%, 24% and 14% of the portfolio, respectively.
TABLE 26: Residential Mortgage Outstandings
| As of September 30 ($ in millions) | 2008 | 2007 | ||||||||||||||||
| Amount | Percent of total |
Delinquency Ratio |
Amount | Percent of total |
Delinquency Ratio |
|||||||||||||
| Greater than 80% LTV with no mortgage insurance |
$ | 2,060 | 22 | % | 9.72 | % | $ | 1,855 | 21 | % | 6.89 | % | ||||||
| Interest-only |
1,686 | 18 | 2.83 | 1,567 | 18 | 1.44 | ||||||||||||
| Greater than 80% LTV and interest-only |
424 | 5 | 7.51 | 514 | 6 | 3.68 | ||||||||||||
| 80/20 loans | 1 | — | — | — | — | — | ||||||||||||
The Bancorp previously originated certain non-conforming residential mortgage loans known as “Alt-A” loans. Borrower qualifications were comparable to other conforming residential mortgage products. As of September 30, 2008, the Bancorp held $118 million of Alt-A mortgage loans in its portfolio with approximately $13 million in nonaccrual.
The Bancorp previously sold certain mortgage products in the secondary market with recourse. The outstanding balances and delinquency rates for those loans sold with recourse as of September 30, 2008 and 2007 were $1.4 billion and 4.98%, and $1.6 billion and 2.36%, respectively. The Bancorp maintained an estimated credit loss reserve of approximately $13 million and $18 million relating to these residential mortgage loans sold at September 30, 2008 and 2007, respectively.
Home Equity Portfolio
The home equity portfolio is characterized by 73% of outstanding balances within the Bancorp’s Midwest footprint of Ohio, Michigan, Kentucky, Indiana and Illinois. The portfolio has an average FICO score of 735 as of September 30, 2008, comparable with 734 at September 30, 2007. Further detail on location and origination LTV ratios is included in Table 27.
TABLE 27: Home Equity Outstandings
| As of September 30 ($ in millions) | 2008 | 2007 | ||||||||||||||
| LTV less than 80% |
LTV greater than 80% |
Delinquency Ratio |
LTV less than 80% |
LTV greater than 80% |
Delinquency Ratio |
|||||||||||
| Ohio |
$ | 1,922 | 2,011 | 1.45 | % | $ | 1,876 | 2,057 | 1.44 | % | ||||||
| Michigan |
1,415 | 1,279 | 2.31 | 1,411 | 1,305 | 2.02 | ||||||||||
| Indiana |
619 | 604 | 2.11 | 635 | 648 | 1.91 | ||||||||||
| Illinois |
763 | 567 | 1.84 | 614 | 545 | 1.53 | ||||||||||
| Kentucky |
520 | 566 | 1.65 | 502 | 599 | 1.47 | ||||||||||
| Florida |
665 | 293 | 3.34 | 446 | 246 | 2.19 | ||||||||||
| All other states |
424 | 951 | 2.81 | 166 | 687 | 2.83 | ||||||||||
| Total | $ | 6,328 | 6,271 | 2.05 | % | $ | 5,650 | 6,087 | 1.78 | % | ||||||
As of September 30, 2008 the home equity portfolio contains $2.4 billion, or 19%, of brokered home equity balances primarily located in the Midwest. The Bancorp stopped origination of this product in 2007.
D-40
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
Analysis of Nonperforming Assets
A summary of nonperforming assets is included in Table 28. 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) restructured consumer loans which have not yet met the requirements to be classified as a performing asset; 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 is not expected. Additionally, loans are placed on nonaccrual status upon deterioration of the financial condition of the borrower or upon the restructuring of the loan. 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 $2.8 billion at September 30, 2008, compared to $1.1 billion at December 31, 2007 and $706 million at September 30, 2007. Nonperforming assets as a percentage of total loans, leases and other assets, including other real estate owned, as of September 30, 2008 was 3.30% compared to 1.32% as of December 31, 2007 and .92% as of September 30, 2007. The composition of nonaccrual credits continues to be concentrated in real estate as 82% of nonaccrual credits were secured by real estate as of September 30, 2008 compared to approximately 84% as of December 31, 2007 and approximately 74% as of September 30, 2007.
Commercial nonaccrual credits increased from $431 million at September 30, 2007 and $672 million at December 31, 2007 to $1.9 billion as of September 30, 2008. Sequentially, commercial nonaccrual credits increased $447 million, or 30%. The majority of the increase was driven by the real estate and construction industries in the states of Florida and Michigan. These states combined represent 57% of total commercial nonaccrual credits as of September 30, 2008. As shown in Table 23, the real estate and construction industries contributed to approximately three-fourths of the year-over-year increase in nonaccrual credits. Of the $1.4 billion of real estate and construction nonaccrual credits, $702 million is related to homebuilders or developers. During 2008, due to the deterioration in real estate prices in Michigan and Florida, the Bancorp has charged off $239 million against the loans that make up homebuilder and developer nonaccrual credits and, as of September 30, 2008, has provided an additional $142 million in reserves held against these loans. For additional information on credit reserves, see the discussion on allowance for credit losses later in this section.
Consumer nonaccrual credits increased from $138 million as of September 30, 2007 and $221 million as of December 31, 2007 to $673 million as of September 30, 2008. Sequentially, consumer nonaccrual credits increased $171 million, or 34%. The increase in consumer nonperforming assets is primarily attributable to declines in the housing markets in the Michigan and Florida markets and the restructuring of certain high risk loans. Michigan and Florida accounted for 52% of the increase in consumer nonperforming assets and, as of September 30, 2008, represented 58% of total consumer nonperforming assets. The Bancorp has devoted significant attention to loss mitigation activities and has proactively restructured certain loans. Consumer restructured loans are recorded as nonaccrual credits until there is a sustained period of payment by the borrower, generally a minimum of six months of payments in accordance with the loans’ modified terms. Consumer restructured loans contributed approximately $427 million to nonaccrual loans as of September 30, 2008 compared to $22 million in restructured loans as of September 30, 2007.
D-41
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
TABLE 28: Summary of Nonperforming Assets and Delinquent Loans
| ($ in millions) | September 30, 2008 |
December 31, 2007 |
September 30, 2007 | |||||
| Nonperforming loans and leases: |
||||||||
| Commercial loans |
$ | 550 | 175 | 175 | ||||
| Commercial mortgage loans |
724 | 243 | 146 | |||||
| Commercial construction loans |
636 | 249 | 105 | |||||
| Commercial leases |
23 | 5 | 5 | |||||
| Residential mortgage loans |
216 | 92 | 68 | |||||
| Home equity |
27 | 45 | 45 | |||||
| Automobile loans |
3 | 3 | 3 | |||||
| Other consumer loans and leases |
— | 1 | — | |||||
| Restructured loans and leases: |
||||||||
| Residential mortgage loans |
258 | 29 | 6 | |||||
| Home equity |
142 | 46 | 16 | |||||
| Automobile loans |
7 | — | — | |||||
| Credit card |
20 | 5 | — | |||||
| Total nonaccrual loans and leases |
2,606 | 893 | 569 | |||||
| Repossessed personal property |
24 | 21 | 19 | |||||
| Other real estate owned |
198 | 150 | 118 | |||||
| Total nonperforming assets |
$ | 2,828 | 1,064 | 706 | ||||
| Commercial loans |
$ | 109 | 44 | 45 | ||||
| Commercial mortgage loans |
157 | 73 | 41 | |||||
| Commercial construction loans |
84 | 67 | 54 | |||||
| Commercial leases |
3 | 4 | 3 | |||||
| Residential mortgage loans (a) |
185 | 186 | 116 | |||||
| Home equity |
72 | 72 | 64 | |||||
| Automobile loans |
16 | 13 | 24 | |||||
| Credit card |
44 | 31 | 12 | |||||
| Other consumer loans and leases |
1 | 1 | 1 | |||||
| Total 90 days past due loans and leases |
$ | 671 | 491 | 360 | ||||
| Nonperforming assets as a percent of total loans, leases and other assets, including other real estate owned |
3.30 | % | 1.32 | .92 | ||||
| Allowance for loan and lease losses as a percent of total nonperforming assets |
73 | 88 | 117 | |||||
| (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 September 30, 2008, December 31, 2007 and September 30, 2007, these advances were $32 million, $25 million and $19 million, respectively. |
Analysis of Net Charge-offs
Net charge-offs as a percent of average loans and leases were 217 bp for the third quarter of 2008, compared to 89 bp for the fourth quarter of 2007 and 60 bp for the third quarter of 2007. Table 29 provides a summary of credit loss experience and net charge-offs as a percentage of average loans and leases outstanding by loan category.
D-42
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
The ratio of commercial loan net charge-offs to average commercial loans outstanding increased to 207 bp in the third quarter of 2008 compared to 66 bp in the fourth quarter of 2007 and 33 bp in the third quarter of 2007, as homebuilders, developers and related suppliers were affected by the downturn in the real estate markets. Charge-offs for the third quarter of 2008 included $163 million, or 61%, related to homebuilders and developers.
The ratio of consumer loan net charge-offs to average consumer loans outstanding increased to 233 bp in the third quarter of 2008 compared to 118 bp in the fourth quarter of 2007 and 93 bp in the third quarter of 2007. Residential mortgage charge-offs increased to $77 million in the third quarter of 2008 compared to $18 million in the fourth quarter of 2007 and $9 million in the third quarter of 2007, reflecting increased foreclosure rates in the Bancorp’s key lending markets coupled with an increase in severity of loss on mortgage loans. Florida, Michigan and Ohio continue to rank among the top states in total mortgage foreclosures. These foreclosures not only added to the volume of charge-offs, but also hampered the Bancorp’s ability to recover the value of the homes collateralizing the mortgages as they contributed to declining home prices. Florida affiliates continue to experience the most stress and accounted for over half of the residential mortgage charge-offs in the third quarter. While Michigan residential mortgage charge-offs remain elevated above historical norms, there was no increase in charge-offs in the third quarter of 2008 compared to the first and second quarters of 2008. Home equity charge-offs increased to $55 million and 177 bp of average loans, primarily due to increases in the Michigan and Florida affiliates and among those products originated through a broker channel. Brokered home equity loans represented 54% of home equity charge-offs during the third quarter of 2008 despite representing 19% of home equity lines and loans as of September 30, 2008. Management responded to the performance of the brokered home equity portfolio by reducing originations in 2007 of this product by 64% compared to 2006 and, at the end of 2007, eliminating this channel of origination. Management actively manages lines of credits and makes reductions in lending limits when it believes it is necessary based on FICO score deterioration and property devaluation. The ratio of automobile loan net charge-offs to average automobile loans was 151 bp for the third quarter of 2008, an increase of 60 bp compared to the third quarter 2007 displaying an expected increase due to a shift in the portfolio to a higher percentage of used automobiles and an increase in loss severity due to increased market depreciation of used automobiles. The net charge-off ratio on credit card balances increased compared to the same quarter last year as the Bancorp increased originations of card balances throughout the past year. The credit characteristics of the credit card portfolio have been maintained during the origination of new cards, including the weighted average FICO and average line outstanding, however, the Bancorp does expect the charge-off ratio to increase as the portfolio matures. The Bancorp employs a risk-adjusted pricing methodology to help ensure adequate compensation is received for those products that have higher credit costs.
D-43
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
TABLE 29: Summary of Credit Loss Experience
| ($ in millions) | For the three months ended September 30, |
For the nine months ended September 30, |
||||||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||||||
| Losses charged off: |
||||||||||||||
| Commercial loans |
$ | (89 | ) | (24 | ) | $ | (237 | ) | (71 | ) | ||||
| Commercial mortgage loans |
(94 | ) | (8 | ) | (150 | ) | (30 | ) | ||||||
| Commercial construction loans |
(88 | ) | (5 | ) | (209 | ) | (17 | ) | ||||||
| Commercial leases |
— | — | — | (1 | ) | |||||||||
| Residential mortgage loans |
(77 | ) | (9 | ) | (175 | ) | (25 | ) | ||||||
| Home equity |
(58 | ) | (29 | ) | (157 | ) | (70 | ) | ||||||
| Automobile loans |
(40 | ) | (32 | ) | (118 | ) | (80 | ) | ||||||
| Credit card |
(25 | ) | (14 | ) | (69 | ) | (37 | ) | ||||||
| Other consumer loans and leases |
(10 | ) | (6 | ) | (24 | ) | (20 | ) | ||||||
| Total losses |
(481 | ) | (127 | ) | (1,139 | ) | (351 | ) | ||||||
| Recoveries of losses previously charged off: |
||||||||||||||
| Commercial loans |
4 | 1 | 9 | 10 | ||||||||||
| Commercial mortgage loans |
— | — | 2 | 1 | ||||||||||
| Commercial construction loans |
— | — | — | — | ||||||||||
| Commercial leases |
— | — | — | 1 | ||||||||||
| Residential mortgage loans |
— | — | — | — | ||||||||||
| Home equity |
3 | 2 | 6 | 6 | ||||||||||
| Automobile loans |
8 | 7 | 27 | 25 | ||||||||||
| Credit card |
1 | 1 | 5 | 6 | ||||||||||
| Other consumer loans and leases |
2 | 1 | 8 | 14 | ||||||||||
| Total recoveries |
18 | 12 | 57 | 63 | ||||||||||
| Net losses charged off: |
||||||||||||||
| Commercial loans |
(85 | ) | (23 | ) | (228 | ) | (61 | ) | ||||||
| Commercial mortgage loans |
(94 | ) | (8 | ) | (148 | ) | (29 | ) | ||||||
| Commercial construction loans |
(88 | ) | (5 | ) | (209 | ) | (17 | ) | ||||||
| Commercial leases |
— | — | — | — | ||||||||||
| Residential mortgage loans |
(77 | ) | (9 | ) | (175 | ) | (25 | ) | ||||||
| Home equity |
(55 | ) | (27 | ) | (151 | ) | (64 | ) | ||||||
| Automobile loans |
(32 | ) | (25 | ) | (91 | ) | (55 | ) | ||||||
| Credit card |
(24 | ) | (13 | ) | (64 | ) | (31 | ) | ||||||
| Other consumer loans and leases |
(8 | ) | (5 | ) | (16 | ) | (6 | ) | ||||||
| Total net losses charged off | $ | (463 | ) | (115 | ) | $ | (1,082 | ) | (288 | ) | ||||
| Net charge-offs as a percent of average loans and leases (excluding held for sale): |
||||||||||||||
| Commercial loans |
1.19 | % | .41 | 1.11 | % | .38 | ||||||||
| Commercial mortgage loans |
2.82 | .26 | 1.56 | .36 | ||||||||||
| Commercial construction loans |
5.71 | .35 | 4.81 | .40 | ||||||||||
| Commercial leases |
(.03 | ) | (.01 | ) | (.02 | ) | .01 | |||||||
| Total commercial loans |
2.07 | .33 | 1.57 | .35 | ||||||||||
| Residential mortgage loans |
3.16 | .41 | 2.33 | .39 | ||||||||||
| Home equity |
1.77 | .94 | 1.66 | .72 | ||||||||||
| Automobile loans |
1.51 | .91 | 1.41 | .70 | ||||||||||
| Credit card |
5.45 | 3.59 | 5.06 | 3.40 | ||||||||||
| Other consumer loans and leases |
2.84 | 1.99 | 1.99 | .49 | ||||||||||
| Total consumer loans |
2.33 | .93 | 1.98 | .72 | ||||||||||
| Total net losses charged off | 2.17 | % | .60 | 1.74 | % | .51 | ||||||||
D-44
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
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 an 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 Bancorp also considers overall asset quality trends, credit administration and portfolio management practices, risk identification practices, credit policy and underwriting practices, overall portfolio growth, portfolio concentrations and current national and local economic conditions that might impact the portfolio. The Bancorp continues to monitor recent developments in the credit markets.
In the current year, the Bancorp has not substantively changed any material aspect of 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 recorded in other liabilities in the Condensed Consolidated Balance Sheets. 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 in the Condensed Consolidated Statements of Income.
TABLE 30: Changes in Allowance for Credit Losses
| ($ in millions) | For the three months ended September 30, |
For the nine months ended September 30, |
||||||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||||||
| Allowance for loan and lease losses: |
||||||||||||||
| Beginning balance |
$ | 1,580 | 803 | $ | 937 | 771 | ||||||||
| Net losses charged off |
(463 | ) | (115 | ) | (1,082 | ) | (288 | ) | ||||||
| Provision for loan and lease losses |
941 | 139 | 2,203 | 344 | ||||||||||
| Ending balance | $ | 2,058 | 827 | $ | 2,058 | 827 | ||||||||
| Reserve for unfunded commitments: |
||||||||||||||
| Beginning balance |
$ | 115 | 77 | $ | 95 | 76 | ||||||||
| Provision for unfunded commitments |
17 | 2 | 35 | 3 | ||||||||||
| Acquisitions |
— | — | 2 | — | ||||||||||
| Ending balance | $ | 132 | 79 | $ | 132 | 79 | ||||||||
The allowance for loan and lease losses as a percent of the total loan and lease portfolio increased to 2.41% at September 30, 2008, compared to 1.17% at December 31, 2007 and 1.08% at September 30, 2007. This increase is reflective of a number of factors including: the increase in delinquencies, increased loss estimates due to the real estate price deterioration in some of the Bancorp’s key lending markets and declines in general economic conditions. These factors were the primary drivers of the increased reserve amounts for most of the Bancorp’s loan categories.
As discussed previously, nonperforming assets increased to $2.8 billion as of September 30, 2008. Impaired commercial loans increased $752 million from the fourth quarter of 2007; impaired commercial loans above
D-45
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
specified thresholds require individual review to determine loan and lease reserves. Delinquency trends also increased across most product lines and credit grades from the prior year leading to increases in loss factors for those products.
Real estate price deterioration, as measured by the Home Price Index, was most prevalent in Florida due to past real estate price appreciation, and related over-development, and in Michigan due in part to cutbacks by automobile manufacturers. The year-over-year deterioration in home prices has been as high as 20% in some of the Bancorp’s hardest hit geographies. The deterioration in real estate values increased the expected loss once a loan became delinquent, particularly for residential mortgage, home equity and residential homebuilder loans with high loan-to-value ratios.
Compared to the prior year, negative trends in general economic conditions, as measured by items such as unemployment rate, home sales and inventory, consumer price index and bankruptcy filings in the national and local economies, also caused increases in reserve factors used to determine the losses inherent within the loan and lease portfolio.
The Bancorp continually reviews its credit administration and loan and lease portfolio and makes changes based on the performance of its products. Over the past year, the Bancorp has reduced its lending to homebuilders and developers and borrowers with non-owner occupied real estate as collateral, eliminated brokered home equity production and engaged in significant loss mitigation strategies.
MARKET RISK MANAGEMENT
Market risk arises from the potential for market fluctuations in interest rates, foreign exchange rates and equity prices that may result in potential reductions in 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 expected 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 originations, the value of servicing rights and other sources of the Bancorp’s earnings. Stability of the Bancorp’s net income is largely dependent upon the effective management of interest rate risk. Management continually reviews the Bancorp’s balance sheet composition and earnings flows and models the interest rate risk, and possible actions to reduce this risk, given numerous possible future interest rate scenarios.
Earnings 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 the sensitivity of net interest income and certain noninterest items to changing interest rates. The model is based on contractual and assumed 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. 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.
D-46
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
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 ERM that provides independent oversight of market risk activities. The Bancorp’s current interest rate risk exposure is evaluated by measuring the anticipated change in net interest income and mortgage banking net revenue over 12-month and 24-month horizons assuming a 200 bp parallel ramped increase and a 100 bp parallel ramped increase or decrease in interest rates. The Fed Funds interest rate would be negative in a 200 bp parallel ramped decrease scenario; therefore, that scenario was omitted from all interest rate risk analyses in the third quarter of 2008. 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 ALCO policy limits as of September 30, 2008:
TABLE 31: Estimated Earnings Sensitivity Profile
| Change in Interest Rates (bp) | Change in Earnings (FTE) | ALCO Policy Limits | ||||||||||
| 12 Months | 13 to 24 Months | 12 Months | 13 to 24 Months | |||||||||
| +200 |
.11 | % | 2.10 | (5.00 | ) | (7.00 | ) | |||||
| +100 |
(.06 | ) | .65 | — | — | |||||||
| -100 |
(1.44 | ) | (3.28 | ) | (5.00 | )(a) | (7.00 | )(a) | ||||
| (a) | (5.00) and (7.00) are the—200 bp policy limits. There are no specific policy limits for the—100 bp scenario. |
Economic Value of Equity
The Bancorp also employs economic value of equity (“EVE”) as a measurement tool in managing interest rate risk. Whereas the earnings 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 earnings 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 used in the earnings simulation model. As with the earnings 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 and the ALCO policy limits as of September 30, 2008:
TABLE 32: Estimated EVE Sensitivity Profile
| Change in Interest Rates (bp) | Change in EVE | ALCO Policy Limits | ||||
| +200 |
(4.2 | )% | (20.0 | ) | ||
| +100 |
(1.7 | ) | — | |||
| -100 |
(.3 | ) | (20.0 | )(a) |
| (a) | (20.0) is the—200 bp policy limit. There is no specific policy limit for the—100 bp scenario. |
D-47
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
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 earnings 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 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 for as free-standing derivatives to economically hedge interest rate lock commitments that are also considered free-standing derivatives. In addition, the Bancorp also economically hedges its exposure to mortgage loans held for sale.
The Bancorp also establishes derivative contracts with major financial institutions 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 September 30, 2008 are included in Note 7 of the Notes to Condensed 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 33 summarizes the expected principal cash flows of the Bancorp’s portfolio loans and leases as of September 30, 2008:
TABLE 33: Portfolio Loan and Lease Principal Cash Flows
| ($ in millions) | Less than 1 year | 1 – 5 years | Greater than 5 years |
Total | ||||||
| Commercial loans |
$ | 15,528 | 11,941 | 1,955 | $ | 29,424 | ||||
| Commercial mortgage loans |
5,286 | 5,821 | 2,248 | 13,355 | ||||||
| Commercial construction loans |
4,440 | 1,343 | 219 | 6,002 | ||||||
| Commercial leases |
592 | 1,536 | 1,514 | 3,642 | ||||||
| Subtotal—commercial loans |
25,846 | 20,641 | 5,936 | 52,423 | ||||||
| Residential mortgage loans |
2,264 | 3,484 | 3,603 | 9,351 | ||||||
| Home equity |
1,801 | 4,330 | 6,468 | 12,599 | ||||||
| Automobile loans |
3,049 | 4,728 | 529 | 8,306 | ||||||
| Credit card |
147 | 1,541 | — | 1,688 | ||||||
| Other consumer loans and leases |
498 | 612 | 21 | 1,131 | ||||||
| Subtotal—consumer loans |
7,759 | 14,695 | 10,621 | 33,075 | ||||||
| Total | $ | 33,605 | 35,336 | 16,557 | $ | 85,498 | ||||
D-48
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
Segregated by interest rate type, the following is a summary of expected principal cash flows occurring after one year as of September 30, 2008:
TABLE 34: Portfolio Loan and Lease Principal Cash Flows Occurring After One Year
| ($ in millions) | Interest Rate | ||||
| Fixed | Floating or Adjustable | ||||
| Commercial loans |
$ | 3,111 | 10,785 | ||
| Commercial mortgage loans |
3,087 | 4,982 | |||
| Commercial construction loans |
189 | 1,373 | |||
| Commercial leases |
3,050 | — | |||
| Subtotal—commercial loans |
9,437 | 17,140 | |||
| Residential mortgage loans |
4,060 | 3,027 | |||
| Home equity |
1,689 | 9,109 | |||
| Automobile loans |
5,215 | 42 | |||
| Credit card |
825 | 716 | |||
| Other consumer loans and leases |
630 | 3 | |||
| Subtotal—consumer loans |
12,419 | 12,897 | |||
| Total | $ | 21,856 | 30,037 | ||
Mortgage Servicing Rights and Interest Rate Risk
The net carrying amount of the MSR portfolio was $684 million and $621 million as of September 30, 2008 and 2007, respectively. 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 Bancorp maintains a non-qualifying hedging strategy relative to its mortgage banking activity in order to manage a portion of the risk associated with changes in the value of its MSR portfolio as a result of changing interest rates.
Mortgage rates decreased during the third quarter of 2008. This decrease in rates caused prepayment assumptions to increase and led to $23 million in temporary impairment during the three months ended September 30, 2008 compared to the $9 million in temporary impairment in the third quarter of 2007. Servicing rights are deemed temporarily impaired when a 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. Offsetting the mortgage servicing rights valuation, the Bancorp recognized net gains of $30 million and $12 million on its non-qualifying hedging strategy for the three months ended September 30, 2008 and 2007, respectively. See Note 4 of the Notes to Condensed Consolidated Financial Statements for further discussion on servicing rights.
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 in other noninterest income in the Condensed Consolidated Statements of Income. The balance of the Bancorp’s foreign denominated loans at September 30, 2008 and September 30, 2007 was approximately $330 million and $262 million, respectively. 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
D-49
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
fluctuations. The Bancorp has internal controls in place to help ensure excessive risk is not being taken in providing this service to customers. These controls include an independent determination of currency volatility and credit equivalent exposure on these contracts, counterparty credit approvals and country limits.
LIQUIDITY RISK MANAGEMENT
The goal of liquidity management is to provide adequate funds to meet changes in loan and lease demand, unexpected deposit withdrawals and other contractual obligations. Mitigating liquidity risk is accomplished by maintaining liquid assets in the form of investment securities, maintaining sufficient unused borrowing capacity in the debt markets and delivering consistent growth in core deposits. The estimated weighted-average life of the available-for-sale portfolio was 6.0 years at September 30, 2008, based on current prepayment expectations. Of the $13.2 billion of securities in the portfolio at September 30, 2008, $3.3 billion in principal and interest is expected to be received in the next 12 months, and an additional $1.7 billion is expected to be received in the next 13 to 24 months. In addition to the securities 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 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 automobile loans and other consumer loans are also capable of being securitized, sold or transferred off-balance sheet. For the three months ended September 30, 2008 and 2007, loans totaling $2.4 billion and $9.4 billion, respectively, were sold, securitized or transferred off-balance sheet.
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 69% of its average total assets during the third quarter of 2008. In addition to core deposit funding, the Bancorp also accesses a variety of other short-term and long-term funding sources, which include the use of various regional Federal Home Loan Banks as a funding source. Certificates carrying a balance of $100,000 or more and deposits in the Bancorp’s foreign branch located in the Cayman Islands are wholesale funding tools utilized to fund asset growth. Management does not rely on any one source of liquidity and manages availability in response to changing balance sheet needs.
The Bancorp has a shelf registration in place with the SEC permitting ready access to the public debt markets and qualifies as a “well-known seasoned issuer” under SEC rules. As of September 30, 2008, $4.4 billion of debt or other securities were available for issuance from this shelf registration under the current Bancorp’s Board of Directors’ authorizations. The Bancorp also has $16.2 billion of funding available for issuance through private offerings of debt securities pursuant to its bank note program and currently has approximately $14.2 billion of borrowing capacity available through secured borrowing sources including the Federal Home Loan Banks and Federal Reserve Banks. The Bancorp has no significant unsecured borrowings that will mature during the remainder of 2008 and approximately $1.3 billion of unsecured borrowings that will mature during 2009.
CAPITAL MANAGEMENT
Management and the Bancorp’s Board of Directors regularly reviews its capital position to help ensure that the Bancorp is appropriately positioned under various operating environments. Due to the deterioration in credit trends over the past year and the uncertainty involving future economic trends, on June 18, 2008, the Bancorp’s Board of Directors approved the following actions to strengthen its capital position;
| • | The issuance of approximately $1 billion in Tier 1 capital in the form of convertible preferred shares; |
D-50
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
| • | A reduction in the quarterly dividend level. The Bancorp declared its third quarter cash dividend on its common stock and set the level at $0.15 per share, a reduction from the first quarter of 2008 dividend of $0.44 per share; and |
| • | The anticipated sale of certain non-strategic businesses that, if successfully completed, would supplement common equity capital by an estimated additional $1 billion or more. |
In addition, on October 14, 2008, the U.S. Department of Treasury announced a series of initiatives to strengthen market stability, improve the strength of financial institutions, and enhance market liquidity. Among the initiatives, the U.S. Department of Treasury created a voluntary Capital Purchase Program (“CPP”) as part of its efforts to provide a firmer capital foundation for financial institutions and to increase credit availability to consumers and businesses. As part of the program, eligible financial institutions will be able to sell equity interests to the U.S. Department of Treasury in amounts equal to 1 percent to 3 percent of the institution’s risk-weighted assets. These equity interests will constitute Tier 1 capital. On October 28, 2008, the Bancorp received notification that the U.S Department of Treasury intends to invest approximately $3.45 billion in senior preferred stock and related warrants under the terms of the CPP. As of September 30, 2008, this investment would have increased the Bancorp’s Tier 1 capital ratio to approximately 11.5% and the total risk-based capital ratio to approximately 15.3%. If the U.S. Department of Treasury and the Bancorp are unable to reach mutual agreement on final terms and conditions for this investment, then the Bancorp may not be able to consummate the CPP investment, or may be unable to consummate such investment on terms favorable to the Bancorp. The CPP investment would provide capital in excess of the Bancorp’s previously planned levels, on terms the Bancorp believes are favorable to its investors. As a result, while the Bancorp will continue to evaluate its businesses from a strategic planning prospective, the sale of non-core assets is no longer a part of the Bancorp’s near-term capital planning.
The Federal Reserve Board established quantitative measures that assign risk weightings to assets and off-balance sheet items and also define and set minimum regulatory capital requirements (risk-based capital ratios). Additionally, the guidelines define “well-capitalized” ratios for Tier 1 and total risk-based capital as 6% and 10%, respectively. The Bancorp exceeded these “well-capitalized” ratios for all periods presented.
TABLE 35: Regulatory Capital
| ($ in millions) | September 30, 2008 |
December 31, 2007 |
September 30, 2007 | |||||
| Tier 1 capital |
$ | 9,735 | 8,924 | 9,201 | ||||
| Total risk-based capital |
13,973 | 11,733 | 11,824 | |||||
| Risk-weighted assets |
113,601 | 115,529 | 108,754 | |||||
| Regulatory capital ratios: |
||||||||
| Tier 1 capital |
8.57 | % | 7.72 | 8.46 | ||||
| Total risked-based capital |
12.30 | 10.16 | 10.87 | |||||
| Tier 1 leverage |
8.77 | 8.50 | 9.23 | |||||
At September 30, 2008, shareholders’ equity was $10.7 billion, compared to $9.2 billion at December 31, 2007 and $9.3 billion at September 30, 2007. Tangible equity as a percent of tangible assets was 6.19% at September 30, 2008, 6.14% at December 31, 2007 and 7.00% at September 30, 2007. The increase in shareholders’ equity from the third quarter of 2007 is primarily a result of the approximately $1.1 billion issuance of convertible preferred stock and $770 million in shares issued in the First Charter acquisition in June 2008.
Dividend Policy and Stock Repurchase Program
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. The Bancorp’s quarterly dividend
D-51
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
for the third quarter 2008 was $.15 per share, consistent with the $.15 per share declared in second quarter 2008 and a decrease compared to the $.42 per share declared in the third quarter of 2007. The decrease in the dividend provides the Bancorp with an estimated $170 million per quarter in additional capital that may be needed during a difficult operating environment.
The Bancorp’s stock repurchase strategy is an important element of its capital planning activities. The Bancorp’s repurchase of equity securities is shown in Table 36. On May 21, 2007, the Bancorp announced that its Board of Directors had authorized management to purchase 30 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 September 30, 2008, the Bancorp had approximately 19 million shares remaining under the current Board of Directors’ authorization.
As previously discussed, the Bancorp has received notification that the U.S. Department of Treasury intends to invest approximately $3.45 billion in senior preferred stock and related warrants under the terms of the CPP. Although the Bancorp has not yet executed definitive agreements with the U.S. Department of Treasury, the Bancorp anticipates that participation in this program will impact its future ability to alter the current dividend policy and repurchase of the Bancorp’s equity securities, among other restrictions.
TABLE 36: Share Repurchases
| Period | Total Number of Shares Purchased (a) |
Average Price Paid Per Share |
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs |
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs | |||||
| July 1, 2008—July 31, 2008 |
— | $ | — | — | 19,201,518 | ||||
| August 1, 2008—August 31, 2008 |
— | — | — | 19,201,518 | |||||
| September 1, 2008—September 30, 2008 |
— | — | — | 19,201,518 | |||||
| Total | — | $ | — | — | 19,201,518 | ||||
| (a) | The Bancorp repurchased 346 shares during the third quarter of 2008 in connection with various employee compensation plans. These purchases are not included in the calculation for average price paid per share and do not count against the maximum number of shares that may yet be purchased under the Board of Directors’ authorization. |
OFF-BALANCE SHEET ARRANGEMENTS
The Bancorp consolidates all of its majority-owned subsidiaries and variable interest entities for which the Bancorp is the primary beneficiary. Other entities, including certain joint ventures in which there is greater than 20% ownership, but upon which the Bancorp does not possess and cannot exert significant influence or control, are accounted for by the equity method of 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.
In the ordinary course of business, the Bancorp enters into financial transactions to extend credit, and various forms of commitments and guarantees that may be considered off-balance sheet arrangements. These transactions involve varying elements of market, credit and liquidity risk. The nature and extent of these transactions are provided in Note 8 of the Notes to Condensed Consolidated Financial Statements. In addition, the Bancorp uses conduits, asset securitizations and certain defined guarantees to provide a source of funding. The use of these investment vehicles involves differing degrees of risk. A summary of these transactions is provided below.
Through September 30, 2008 and 2007, the Bancorp had transferred, subject to credit recourse, certain primarily floating-rate, short-term, investment grade commercial loans to an unconsolidated qualified special purpose entity (“QSPE”) that is wholly owned by an independent third-party. Generally, the loans transferred
D-52
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
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. Under current accounting provisions, QSPEs are exempt from consolidation and, therefore, not included in the Bancorp’s Condensed Consolidated Financial Statements. The outstanding balance of these loans at September 30, 2008 and 2007 was $2.5 billion and $3.0 billion, respectively. As of September 30, 2008, the loans transferred had a weighted average life of 2.3 years. 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, ineligible loans transferred by the Bancorp to the QSPE, and the ability of the QSPE to issue commercial paper. The maximum amount of credit risk in the event of nonperformance by the underlying borrowers is approximately equivalent to the total outstanding balance. During the nine months ended September 30, 2008 and 2007, the QSPE did not transfer any loans back to the Bancorp as a result of a credit event. In addition, there have been no material changes in the overall ratings of the loans transferred to the QSPE. For the nine months ended September 30, 2008, the Bancorp collected $501 million in net cash proceeds from loan transfers and $10 million in fees from the QSPE. For the nine months ended September 30, 2007, the Bancorp collected $1.1 billion in cash proceeds from loan transfers and $21 million in fees from the QSPE.
The QSPE issues commercial paper and uses the proceeds to fund the acquisition of commercial loans transferred to it by the Bancorp. The ability of the QSPE to issue commercial paper is a function of general market conditions and the credit rating of the liquidity provider. In the event the QSPE is unable to issue commercial paper, the Bancorp has agreed to provide liquidity support to the QSPE in the form of purchases of commercial paper, a line of credit to the QSPE and the repurchase of assets from the QSPE. As of September 30, 2008 and 2007, the liquidity asset purchase agreement was $3.0 billion and $4.0 billion, respectively. During the third quarter of 2008, the dislocation in the short-term funding market continued, causing the QSPE difficulty in obtaining sufficient funding through the issuance of commercial paper. As a result, the Bancorp provided liquidity support to the QSPE during the third quarter through purchases of commercial paper, a line of credit to the QSPE, and the repurchase of assets from the QSPE under the liquidity asset purchase agreement. As of September 30, 2008, the Bancorp held approximately $1.0 billion of asset-backed commercial paper issued by the QSPE, representing 39% of the total commercial paper issued by the QSPE.
During the third quarter of 2008, the Bancorp repurchased $513 million of commercial loans at par from the QSPE under the liquidity asset purchase agreement. A fair value adjustment charge of $3 million was recorded on the loans in the third quarter upon repurchase. As of September 30, 2008, there were no delinquent repurchased loans. As of September 30, 2008, there were no outstanding balances on the line of credit from the Bancorp to the QSPE. At September 30, 2008 and 2007, the Bancorp’s loss reserve related to the liquidity support and credit enhancement provided to the QSPE was $27 million and $13 million, respectively, and was recorded in other liabilities in the Condensed 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.
The Bancorp utilizes securitization trusts and conduits, formed as QSPEs, to facilitate the securitization process of certain floating-rate home equity lines of credit and certain automobile loans. In each of the securitization trusts and conduits, the Bancorp sold the loans without recourse and does not maintain control over the assets. The Bancorp’s securitization policy permits the retention of subordinated tranches, servicing rights, interest-only strips and residual interests. The cash flows to and from the securitization trusts and QSPEs are principally limited to the initial proceeds from the securitization trust at the time of sale, with subsequent cash flows relating to interests that continue to be held by the Bancorp. At September 30, 2008, the Bancorp had retained servicing assets totaling $1 million, subordinated tranche security interests totaling $61 million and residual interests totaling $149 million. At September 30, 2007, the Bancorp had retained servicing assets totaling $2 million, subordinated tranche security interests totaling $4 million and residual interests totaling
D-53
Table of Contents
Quantitative and Qualitative Disclosures About Market Risk (continued)
$11 million. For the nine months ended September 30, 2008 and 2007, cash proceeds from transfers reinvested in revolving-period securities totaled $56 million and $55 million, respectively. Additionally, for the nine months ended September 30, 2008 and 2007, the Bancorp received fees of $8 million and $2 million, respectively, from securitization trusts and conduits. See Note 4 of the Notes to Condensed Consolidated Financial Statements for more information on securitizations and the interests that continue to be held by the Bancorp.
At September 30, 2008 and 2007, the Bancorp had provided credit recourse on approximately $1.4 billion and $1.6 billion, respectively, of residential mortgage loans previously 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 $13 million and $18 million relating to these residential mortgage loans sold at September 30, 2008 and 2007, 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.
D-54
Table of Contents
Controls and Procedures (Item 4)
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, at the reasonable assurance level, to ensure that information required to be disclosed in the reports the Bancorp files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required and to provide reasonable assurance that information required to be disclosed by the Bancorp in such reports is accumulated and communicated to the Bancorp’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
The Bancorp’s management also conducted an evaluation of internal control over financial reporting to determine whether any changes occurred during the period 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 period covered by this report.
D-55
Table of Contents
38 Fountain Square Plaza
Cincinnati, Ohio 45263
(800) 972-3030
Table of Contents
 |
VOTE BY INTERNET | WWW.CESVOTE.COM | ||||
|
Use the Internet to submit your proxy until 8:30 a.m., Eastern time, on the morning of the Special Meeting, December 29, 2008. Have your proxy card in hand when you access the website listed above and follow the instructions provided.
| ||||||
| VOTE BY TELEPHONE | 1-888-693-8683 | |||||
|
Use any touch-tone telephone to submit your proxy until 8:30 a.m., Eastern time, on the morning of the Special Meeting, December 29, 2008. Have your proxy card in hand when you call and follow the instructions provided.
| ||||||
| VOTE BY MAIL | ||||||
|
Please mark, sign, date and promptly mail your proxy card using the postage-paid envelope provided or return your proxy card to: Fifth Third Bancorp, c/o Corporate Election Services, PO Box 3230, Pittsburgh PA 15230 to ensure that your vote is received prior to the Special Meeting on December 29, 2008.
| ||||||
| Vote by Telephone Call Toll-Free using a touch-tone telephone: 1-888-693-8683
|
Vote by Internet Access the Website and submit your proxy: www.cesvote.com
|
Vote by Mail Sign and return your proxy in the postage-paid envelope provided.
|
|
Control Number è
|
IF YOU HAVE NOT VOTED VIA THE INTERNET OR TELEPHONE, DETACH ALONG THE PERFORATION,
ê MARK, SIGN, DATE AND RETURN THE BOTTOM PORTION USING THE ENCLOSED ENVELOPE. ê
|
FIFTH THIRD BANCORP |
SPECIAL MEETING PROXY CARD |
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS.
The undersigned hereby appoints Kevin T. Kabat and Dr. Mitchel D. Livingston with FULL power of substitution, as proxies to vote, as designated below, FOR and in the name of the undersigned all shares of stock of FIFTH THIRD BANCORP which the undersigned is entitled to vote at the Special Meeting of the Shareholders of said COMPANY scheduled to be held December 29, 2008 at the The Bankers Club, 511 Walnut Street, 30th Floor, Cincinnati, Ohio, or at any adjournment thereof.
In their discretion, the PROXIES are authorized to vote upon such other business as may properly come before the meeting. This PROXY when executed will be voted in the manner directed herein by the undersigned SHAREHOLDER(S). If no direction is made, this PROXY will be voted FOR Proposals 1, 2, 3 and 4.
ALL FORMER PROXIES ARE HEREBY REVOKED.
|
|
, 2008 | |||||
| Stockholder Sign Here | Date | |||||
|
|
, 2008 | |||||
| Stockholder (Joint Owner) Sign Here | Date | |||||
|
Please sign exactly as name appears on this proxy card. If shares are held jointly, each holder should sign. When signing as attorney, executor, administrator, corporation, trustee, guardian or custodian, please give full title as such. If a corporation, please sign in full corporate name by President or other authorized officer. If a partnership, please sign in partnership name by authorized person. | ||||||
Table of Contents
Special Meeting of
Fifth Third Bancorp Shareholders
The Bankers Club of Cincinnati
511 Walnut Street, 30th Floor, Cincinnati, Ohio, at 9:00 a.m., E.S.T., December 29, 2008.
Upon arrival, please present this
admission ticket and photo identification
at the registration desk.
Please tear off this Admission Ticket. If you plan to attend the Special Meeting of shareholders, you will need this ticket to gain entrance to the meeting. This ticket is valid to admit the shareholder to the Special Meeting.
The Special Meeting of shareholders will be held at the following address: The Bankers Club, 511 Walnut Street, 30th Floor, Cincinnati, Ohio, at 9:00 a.m., E.S.T., December 29, 2008. You must present this ticket to gain admission to the meeting. You should send in your proxy or vote electronically even if you plan to attend the meeting.
| IF YOU HAVE NOT VOTED VIA THE INTERNET OR TELEPHONE, DETACH ALONG THE PERFORATION, ê MARK, SIGN, DATE AND RETURN THE BOTTOM PORTION USING THE ENCLOSED ENVELOPE. ê
|
The Board of Directors recommends a vote FOR Proposals 1, 2, 3 and 4.
| 1. | Proposal to amend Article Fourth, Section (A)2)(d)1. of the Amended Articles of Incorporation to revise the terms of the authorized, unissued shares of Preferred Stock, without par value, available for issuance by Fifth Third Bancorp to allow for limited voting rights for a new series of Preferred Stock that will meet the requirements for participation in the Capital Purchase Program established by the United States Department of Treasury pursuant to the Economic Stabilization Act of 2008 and to amend Article III, Sections 13 and 14 of the Code of Regulations, as amended, to provide that the standard for removing Directors as set forth in the Articles shall prevail over any standard for removing Directors as set forth in the Regulations, and to provide that the procedures for filling vacancies on the Board of Directors set forth in the Articles shall prevail over any procedures for filling vacancies on the Board of Directors set forth in the Regulations. In the event that both Proposals 1 and 3 are approved by shareholders, the Company will not implement the amendments contemplated by Proposal 1 (such amendments would be superseded by the amendments in Proposal 3). The proposed amendments are attached as Annex 1 to the proxy statement and are incorporated by reference therein. |
¨ FOR ¨ AGAINST ¨ ABSTAIN
| 2. | Proposal to amend Article Fourth, Section (A)2)(c)6. of the Amended Articles of Incorporation to revise the express terms of the issued and outstanding shares of the Series G Preferred Stock of Fifth Third Bancorp to allow the Series G Preferred Stock to have certain of the voting rights as may be granted by Fifth Third Bancorp if it authorizes and issues a new series of Preferred Stock pursuant to the Capital Purchase Program established by the United States Department of Treasury pursuant to the Economic Stabilization Act of 2008. The proposed amendment is attached as Annex 2 to the proxy statement and is incorporated by reference therein. |
¨ FOR ¨ AGAINST ¨ ABSTAIN
| 3. | Proposal to amend Article Fourth, Section (A)2)(d) of the Amended Articles of Incorporation to revise the terms of the authorized, unissued shares of Preferred Stock, without par value, available for issuance by Fifth Third Bancorp to provide greater flexibility in the terms of preferred stock that Fifth Third Bancorp may offer and sell in the future, including but not limited to shares of preferred stock that may be issued to the United States Department of Treasury, and to clarify the ability of Fifth Third Bancorp to issue shares of preferred stock without stockholder approval in accordance with the terms of Ohio law and to amend Article III, Sections 13 and 14 of the Code of Regulations, as amended, to provide that the standard for removing Directors as set forth in the Articles shall prevail over any standard for removing Directors as set forth in the Regulations, and to provide that the procedures for filling vacancies on the Board of Directors set forth in the Articles shall prevail over any procedures for filling vacancies on the Board of Directors set forth in the Regulations. In the event that both Proposals 1 and 3 are approved by shareholders, the Company will not implement the amendments contemplated by Proposal 1 (such amendments would be superseded by the amendments in Proposal 3). The proposed amendments are attached as Annex 3 to the proxy statement and are incorporated by reference therein. |
¨ FOR ¨ AGAINST ¨ ABSTAIN
| 4. | Proposal to approve the adjournment of the Special Meeting, if necessary, to solicit additional proxies in the event that there are not sufficient votes at the time of the Special Meeting to adopt the proposed amendments to Article Fourth of our Amended Articles of Incorporation. |
¨ FOR ¨ AGAINST ¨ ABSTAIN
(Continued, and please sign on reverse side.)
Table of Contents
Fifth Third Bancorp
Voting instructions solicited on behalf of board of directors
for Special Meeting of holders of Non-Cumulative Perpetual Convertible
Preferred Stock, Series G
December 29, 2008
The undersigned, having received the Notice of Special Meeting of Shareholders and Proxy Statement, appoints and and each or any of them, as proxies, with full power of substitution and resubstitution, to represent the undersigned, and directs Wilmington Trust Company to vote all shares of Non-Cumulative Perpetual Convertible Preferred Stock, Series G of Fifth Third Bancorp (the “Series G Preferred Stock”) which represent Series G Depositary Shares held by the undersigned at the Special Meeting of Holders of Fifth Third Bancorp’s Series G Preferred Stock to be held on Monday, December 29, 2008, at 9:00 a.m., and any and all adjournments thereof, in the manner specified.
1. To amend Article Fourth, Section (A)2)(d)1. of the Amended Articles of Incorporation to revise the terms of the authorized, unissued shares of Preferred Stock, without par value, available for issuance by Fifth Third Bancorp to allow for limited voting rights for a new series of Preferred Stock that will meet the requirements for participation in the Capital Purchase Program established by the United States Department of Treasury pursuant to the Economic Stabilization Act of 2008 and to amend Article III, Sections 13 and 14 of the Code of Regulations, as amended, to provide that the standard for removing Directors as set forth in the Articles, shall prevail over any standard for removing Directors as set forth in the Regulations, and to provide that the procedures for filling vacancies on the Board of Directors set forth in the Articles, shall prevail over any procedures for filling vacancies on the Board of Directors set forth in the Regulations. In the event that both Proposals 1 and 3 are approved by shareholders, the Company will not implement the amendments contemplated by Proposal 1 (such amendments would be superseded by the amendments in Proposal 3). The proposed amendments are attached as Annex 1 to the proxy statement and are incorporated by reference therein. (“Proposal 1”)
¨ FOR ¨ AGAINST ¨ ABSTAIN
2. To amend Article Fourth, Section (A)2)(c)6. of the Amended Articles of Incorporation to revise the express terms of the issued and outstanding shares of the Series G Preferred Stock of Fifth Third Bancorp to allow the Series G Preferred Stock to have certain of the voting rights as may be granted by Fifth Third Bancorp if it authorizes and issues a new series of Preferred Stock pursuant to the Capital Purchase Program established by the United States Department of Treasury pursuant to the Economic Stabilization Act of 2008. The proposed amendment is attached as Annex 2 to the proxy statement and is incorporated by reference therein. (“Proposal 2”)
¨ FOR ¨ AGAINST ¨ ABSTAIN
3. To amend Article Fourth, Section (A)2)(d) of the Amended Articles of Incorporation to revise the terms of the authorized, unissued shares of Preferred Stock, without par value, available for issuance by Fifth Third Bancorp to provide greater flexibility in the terms of Preferred Stock that Fifth Third Bancorp may offer and sell in the future, including but not limited to shares of Preferred Stock that may be issued to the United States Department of Treasury, and to clarify the ability of Fifth Third Bancorp to issue shares of Preferred Stock without stockholder approval in accordance with the terms of Ohio law and to amend Article III, Sections 13 and 14 of the Code of Regulations, as amended, to provide that the standard for removing Directors as set forth in the Articles, shall prevail over any standard for removing Directors as set forth in the Regulations, and to provide that the procedures for filling vacancies on the Board of Directors set forth in the Articles, shall prevail over any procedures for filling vacancies on the Board of Directors set forth in the Regulations. In the event that both Proposals 1 and 3 are approved by shareholders, the Company will not implement the amendments contemplated by Proposal 1 (such amendments would be superseded by the amendments in Proposal 3). The proposed amendments are attached as Annex 3 to the proxy statement and are incorporated by reference therein. (“Proposal 3”)
¨ FOR ¨ AGAINST ¨ ABSTAIN
4. To approve the adjournment of the Special Meeting, if necessary, to solicit additional proxies in the event that there are not sufficient votes at the time of the Special Meeting to adopt the proposed amendments to Article Fourth of our Amended Articles of Incorporation. (“Proposal 4”)
¨ FOR ¨ AGAINST ¨ ABSTAIN
(Continued and to be SIGNED and dated on the reverse side.)
Table of Contents
THIS PROXY WILL BE VOTED AS DIRECTED. IF NO DIRECTION IS INDICATED, THE DEPOSITORY WILL NOT VOTE WITH RESPECT TO THE PROPOSAL.
Should any other matters requiring a vote of the holders of Series G Preferred Stock arise, the above named proxies are authorized to vote the same in accordance with their best judgment in the interest of Fifth Third Bancorp. The Board of Directors is not aware of any matter which is to be presented for action at the meeting other than the matters set forth herein.
Dated: , 200
| (SEAL) | ||
| (SEAL) | ||
(Please sign exactly as name or names appear on Series G Depositary Shares. If depositary shares are held by joint tenants, both should sign. When signing as attorney, executor, administrator, trustee or other representative, please give full title as such. If a corporation, please sign in corporation’s name by an authorized officer. If a partnership, please sign in the partnership name by authorized person.)