Why did Fifth Third's earnings fall so sharply in 2006?

Most of the drop came from a fourth-quarter 2006 decision to reduce the size of the balance sheet and lower exposure to an inverted yield curve. The company sold $11.3 billion of securities, causing a $398 million pretax loss on sales, plus $17 million in hedge losses and $39 million in debt termination charges, for a total pretax hit of $454 million. Net interest margin also compressed because of rising short-term rates and a fixed-rate securities portfolio.

Will the balance sheet repositioning help future earnings?

Management expects the actions to add about $110-120 million to annualized net interest income before hedging costs, and to improve the net interest margin by roughly 35-40 basis points in 2007. The repositioning also reduced wholesale borrowings and fixed-rate assets, lowering interest rate sensitivity. The benefit depends on market rate expectations, which the company notes are subject to uncertainty.

How strong is Fifth Third's capital position?

Capital remains well above regulatory 'well-capitalized' thresholds, with a Tier 1 capital ratio of 8.39% and a total risk-based capital ratio of 11.07% at year-end 2006. The tangible equity to tangible assets ratio improved to 7.79% from 6.87%, and management targets about 7% at year-end 2007. Shareholders' equity was $10.0 billion, and the dividend was raised to $1.58 per share from $1.46.

What are the key risks and the 2007 outlook?

Management expects net interest income growth in the high single digits, a net interest margin of 3.35-3.45%, and loan growth in the high single digits. It expects net charge-offs in the low-to-mid 50 basis point range and an effective tax rate of 29-30%. The company warned of upward pressure on credit costs, its Midwest exposure to slower economic growth, and ongoing IRS challenges to certain leveraged lease tax positions, for which it made a $356 million deposit in January 2007.

FITB 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed February 20, 2007. Cited figures are marked; the original filing is the authoritative source.

Fifth Third Bancorp's 2006 results were sharply lower, with net income of $1.19 billion^a ($2.13 diluted EPS) down 23% from $1.55 billion ($2.77) in 2005.

The decline was driven mainly by a fourth-quarter balance sheet repositioning: the company sold $11.3 billion^b of available-for-sale securities, repaid $8.5 billion of wholesale borrowings and terminated about $1.1 billion of repurchase agreements, producing a pretax loss of $454 million (about $291 million after tax, or $0.52 per share). Return on average assets fell to 1.13% from 1.50% and return on equity to 12.1% from 16.6%. Management says the repositioning should add $110-120 million to annualized net interest income and reduces exposure to the inverted yield curve.

Core operations were more mixed. Net interest income fell 3% to $2.9 billion^c as net interest margin compressed to 3.06% from 3.23%, even though average loans grew 8% and core deposits grew 5%. Electronic payment processing, the largest fee line, grew 15%, while noninterest income overall fell 14% to $2.2 billion because of $415 million in securities and derivative losses.

Noninterest expense rose 4% to $3.1 billion^d. Credit quality remained stable, with net charge-offs at 0.44% of average loans, though nonperforming assets rose to 0.61% from 0.52%. Tangible equity to tangible assets ended at 7.79%, up from 6.87%.

Leadership also changed. CEO George Schaefer will hand the CEO role to President Kevin Kabat effective April 17, 2007, and remain as Chairman.

For 2007, management guides to high-single-digit growth in net interest income and loans, a net interest margin of 3.35-3.45%, net charge-offs in the low-to-mid 50 basis points, and a year-end tangible equity ratio target of about 7%. Management also expects upward pressure on credit costs.

02—Key points

Key Highlights

Net income fell 23% to $1.19 billion ($2.13 diluted EPS), largely due to a $454 million pretax loss from Q4 2006 balance sheet repositioning.
Net interest income declined 3% to $2.9 billion; net interest margin contracted 17 bp to 3.06%, though average loans grew 8% and core deposits grew 5%.
Noninterest income fell 14% to $2.2 billion after $415 million in securities and derivative losses; excluding these, it rose about 3%, led by 15% growth in electronic payment processing revenue.
ROA fell to 1.13% and ROE to 12.1%, versus 1.50% and 16.6% in 2005; the efficiency ratio rose to 60.5% from 53.2%.
Balance sheet repositioning is expected to add $110-120 million to 2007 net interest income, and the tangible equity ratio rose to 7.79% from 6.87%.
Credit quality stayed solid, with net charge-offs at 0.44% of loans, but nonperforming assets rose to 0.61% and management expects upward pressure on credit in 2007.
CEO transition: Kevin Kabat succeeds George Schaefer as CEO effective April 17, 2007, with Schaefer remaining Chairman.

03—Questions

Frequently Asked Questions

Why did Fifth Third's earnings fall so sharply in 2006?
Most of the drop came from a fourth-quarter 2006 decision to reduce the size of the balance sheet and lower exposure to an inverted yield curve. The company sold $11.3 billion of securities, causing a $398 million pretax loss on sales, plus $17 million in hedge losses and $39 million in debt termination charges, for a total pretax hit of $454 million. Net interest margin also compressed because of rising short-term rates and a fixed-rate securities portfolio.
Will the balance sheet repositioning help future earnings?
Management expects the actions to add about $110-120 million to annualized net interest income before hedging costs, and to improve the net interest margin by roughly 35-40 basis points in 2007. The repositioning also reduced wholesale borrowings and fixed-rate assets, lowering interest rate sensitivity. The benefit depends on market rate expectations, which the company notes are subject to uncertainty.
How strong is Fifth Third's capital position?
Capital remains well above regulatory 'well-capitalized' thresholds, with a Tier 1 capital ratio of 8.39% and a total risk-based capital ratio of 11.07% at year-end 2006. The tangible equity to tangible assets ratio improved to 7.79% from 6.87%, and management targets about 7% at year-end 2007. Shareholders' equity was $10.0 billion, and the dividend was raised to $1.58 per share from $1.46.
What are the key risks and the 2007 outlook?
Management expects net interest income growth in the high single digits, a net interest margin of 3.35-3.45%, and loan growth in the high single digits. It expects net charge-offs in the low-to-mid 50 basis point range and an effective tax rate of 29-30%. The company warned of upward pressure on credit costs, its Midwest exposure to slower economic growth, and ongoing IRS challenges to certain leveraged lease tax positions, for which it made a $356 million deposit in January 2007.

04—Continue

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