Feds Investigate Fifth Third Reconciliation Errors

December 13, 2002
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CINCINNATI — Federal regulators are looking into a $54 million charge against third quarter earnings taken by Firth Third Bancorp and have frozen the bank holding company's ability to make acquisitions.

The $54 million impairment charge resulted from reconciliation errors in Fifth Third's treasury department.

But bank officials don't see the after-tax charge as having any impact on future earnings or revenues, said Paul Reynolds, Fifth Third's general counsel and executive vice president.

The impaired assets were investments of equity owned by the company and did not involve customer accounts, business or personal loans, he said.

The assets were among tens of thousands of securities transactions in the company's investment portfolio.

The charge the bank took in the last quarter was the difference between the credits and debits in the company's system.

"The issue was simply one of record keeping and how they were reflected on our books and records," he said, adding that it wasn't the underlying investments that failed.

"In this case, the credits and debits didn't match up. It doesn't mean they were lost or doesn't mean that they weren't there. What it means is we didn't necessarily record everything properly as it was coming in and going out."

He said it may have involved, for example, a bond or mortgage-backed security that was recorded coming into the portfolio but not recorded exiting the portfolio, or possibly an investment coming in that didn't have interest properly attached to it.

Some of the impaired assets involve internal investments Fifth Third inherited with the acquisition of former Old Kent Bank because the merger pooled the investment portfolios of both banks, he said.

Fifth Third purchased Old Kent in a $4.9 billion deal that was finalized in April 2001.

Reynolds said he didn't know what percentage of the impaired assets were Old Kent's.

He noted that Fifth Third is in the process of going back and reconstructing the account, checking all of the transactions to see where the credits and debits didn't match up.

The holding company could recoup some of those assets in the process, he said.

The reconciliation errors were initially identified in August. Once bank officials verified there was an out-of-balance condition, the company reported it in its Form 8-K filed in September, Reynolds said.

The bank concluded in its federal filing that "certain predominantly treasury-related aged receivable and in-transit reconciliation items were impaired."

The bank realized the issue, reserved for the amount and took the charge in its third quarter earnings, he said.

Though the company absorbed the charge, it was still able to post a 15 percent increase in quarterly earnings.

Prompted by news of the impairment charge, the Securities and Exchange Commission informed Fifth Third on Nov. 12 that it was opening an informal investigation into the after-tax charge and into "the existence or effects of weakness in financial controls" in the bank's treasury and/or trust operations.

Fifth Third also revealed that it had received a supervisory letter from the Federal Reserve Bank of Cleveland and the Ohio Department of Commerce, Division of Financial Institutions, that imposed a moratorium on future acquisitions, including Fifth Third's planned acquisition of Franklin Financial Corp., a Nashville-based bank with $775 million in assets.

The moratorium stays in effect until regulators withdraw the supervisory letter.

According to the filing, the letter related to such matters as procedures for access to the general ledger and other records; procedures for reconciling transactions; the engagement of third party consultants; and efforts to complete the impairment review.

Reynolds said he couldn't predict when the supervisory letter might be withdrawn or when the SEC's investigation might be concluded.

"We're working with the Federal Reserve, just as we are with the SEC, to make sure we can get through whatever review they might want to do as quickly as possible."

He added that the company believes all issues identified are fixable.

A supervisory letter is a letter of understanding that is part of an exam report, explained Kelley Banks, spokesperson for the Federal Reserve Bank of Cleveland.

"It's informal; it doesn't have to be disclosed to the public, and the goal is to help the bank take care of whatever corrective action needs to be taken care of," she said.

On Monday, Banks said in the previous 72 hours the Reserve Bank of Cleveland had received more calls about this particular supervisory letter than it had of any in the last five years.

She said she doesn't know how often supervisory letters are issued because they technically don't have to be made public, and regulators aren't allowed to discuss them.

Similarly, any action regarding a supervisory letter, including when it might be withdrawn, isn't public either, she said. It will be in effect until it's not in effect; it will exist until it's not needed, she added.

Banks also declined to comment on whether a moratorium on acquisitions is a normal procedure in such instances, citing again the non-public nature of the letter.

"If an institution wants to talk about it, we don't stop them from saying anything about their business because it's their business. They announced that there's a letter. We never did."

Reynolds said Fifth Third decided to disclose it because the bank wanted to be "totally open and honest" with its filings.

"In today's environment, we really felt we couldn't afford not to be," he added.

Coming at a time when the market reacts negatively to any hint of accounting difficulties, the bank's stock price fell 11 percent the day of the disclosures.

Company officials don't think the current situation has any impact on the bank's regional headquarters here because of Fifth Third's decentralized management system.

The system creates affiliate banks, each with their own CEO and board of directors. The affiliate banks act autonomously and run their own business, he said.

"We see this as a kind of holding company, Bancorp issue that we work through at the holding company level with the regulators. In our affiliate markets it's business as usual, and we're looking for those affiliates to continue just as they have done in the past."

Could the moratorium on acquisitions, even after it's lifted, make future acquisitions more difficult for Fifth Third?

"I think it depends on the final review by the Federal Reserve. It's really their call as to whether or not they're comfortable with the information we provide them," Reynolds said.           

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