Fifth Third Bancorp — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods unless otherwise noted. Fifth Third is a diversified U.S. bank headquartered in Cincinnati, with four reporting segments: Commercial Banking, Branch Banking, Consumer Lending, and Wealth and Asset Management. It reported $140.7 billion in assets at quarter-end.
Key financial results
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net interest income, GAAP ($ millions) | 1,020 | 939 | 2,016 | 1,872 |
| Noninterest income ($ millions) | 743 | 564 | 1,652 | 1,087 |
| Total revenue ($ millions) | 1,767 | 1,509 | 3,675 | 2,971 |
| Provision for loan and lease losses ($ millions) | 33 | 52 | 56 | 126 |
| Noninterest expense ($ millions) | 1,037 | 957 | 2,083 | 1,943 |
| Net income available to common shareholders ($ millions) | 563 | 344 | 1,252 | 634 |
| Diluted earnings per share | $0.80 | $0.45 | $1.77 | $0.83 |
- Quarterly revenue increased 17%; first-half revenue increased 24%. Common earnings rose 64% in Q2 and 97% in the first half.
- Net interest income on a fully taxable equivalent (FTE, non-GAAP) basis was $1.024 billion in Q2 and $2.023 billion in the first half, up 8% and 7%, respectively. FTE net interest margin was 3.21% in Q2 and 3.19% for the first half, versus 3.01% in both 2017 periods. Higher loan yields and securities balances, and Federal Reserve rate increases, supported results; higher deposit and debt costs partly offset the benefit.
- The FTE efficiency ratio improved to 58.7% in Q2 from 63.4%, and to 56.7% for the first half from 65.4%.
- Effective tax rates declined to 15.5% in Q2 and 15.7% in the first half, from 25.9% and 24.5%, respectively, primarily reflecting the lower federal corporate tax rate under the Tax Cuts and Jobs Act.
Balance sheet, credit, liquidity and capital
- At June 30, assets were $140.7 billion, deposits $104.1 billion, portfolio loans and leases $91.9 billion, and total borrowings $16.7 billion. Deposits were up $1.0 billion and portfolio loans were broadly unchanged from December 31, 2017. Core deposits increased $814 million; noninterest-bearing demand deposits declined $2.6 billion, partly as balances migrated to interest checking and money market accounts.
- Borrowings declined $2.4 billion from year-end, mainly due to lower FHLB advances. Fifth Third issued $650 million of 3.95% ten-year fixed-rate senior notes and $250 million of three-year floating-rate notes at three-month LIBOR plus 47 basis points during the first half.
- Operating cash flow was $1.293 billion for the first half, investing cash flow was $484 million, and financing cash flow was negative $2.239 billion. Cash and due from banks decreased $462 million to $2.052 billion.
- Net charge-offs were $94 million in Q2 and $175 million in the first half; annualized charge-off rates were 0.41% and 0.38%, versus 0.28% and 0.34% in the comparable periods. The provision declined, which management attributed mainly to fewer criticized commercial assets and improved overall credit quality. The allowance for loan and lease losses was $1.077 billion, or 1.17% of portfolio loans, down from $1.196 billion and 1.30% at year-end.
- Nonperforming assets were $503 million, compared with $495 million at year-end; nonperforming portfolio assets were 0.52% of portfolio loans and leases and OREO, versus 0.53% at year-end. Management noted increased risks to monitor in retail commercial real estate and continued industry-wide easing of automobile credit standards.
- Regulatory capital ratios were 10.91% CET1, 12.02% Tier 1 risk-based, 15.21% total risk-based and 10.24% Tier 1 leverage. Modified liquidity coverage ratio was 116%. Management said capital ratios exceeded well-capitalized requirements; it also reported $42.5 billion in secured borrowing capacity.
- Available-for-sale securities had $628 million of net unrealized losses at June 30, versus $174 million of net unrealized gains at year-end. The resulting market-value movements contributed to accumulated other comprehensive loss of $552 million, compared with accumulated other comprehensive income of $73 million at year-end.
Material changes, outlook and unusual items
- Worldpay transactions materially lifted reported income. Fifth Third recorded a $414 million gain in Q1 associated with dilution of its Vantiv Holding interest following the Worldpay combination, and a $205 million gain in Q2 from selling five million Worldpay shares. It retained an approximately 3.3% interest, carried at $426 million. These gains contributed substantially to the increase in noninterest income; the filing does not provide a directly comparable adjusted earnings figure excluding them.
- Fifth Third also recorded a $16 million gain related to the GreenSky IPO investment. Separately, Q2 noninterest income included $33 million of branch and property impairment losses under the branch optimization plan. The Visa total-return swap produced negative valuation adjustments of $49 million for the first half, compared with $22 million in 2017.
- Branch network plan: Over the next two to three years, the company plans to close 100–125 branches in mature markets and open 100–125 in higher-growth markets. It had identified 29 closures for completion before year-end 2018 and elected to sell 21 parcels of land.
- Capital returns: Following Federal Reserve non-objection to the capital plan, Fifth Third announced a quarterly common dividend increase to $0.22 beginning in Q4 2018 and $0.24 beginning in Q2 2019. The plan permits up to $1.651 billion of common share repurchases from July 2018 through June 2019, with additional repurchases potentially funded by after-tax Worldpay share-sale proceeds and certain Worldpay tax receivable agreement proceeds. After quarter-end, the company repurchased approximately $500 million of shares through early August.
- Pending MB Financial acquisition: Announced May 21, 2018, the transaction was valued at approximately $4.7 billion and was expected to close in Q1 2019, subject to shareholder and regulatory approvals. MB Financial shareholders would receive 1.45 Fifth Third shares and $5.54 cash per share. Fifth Third disclosed risks of dilution, financing needs, integration costs, execution challenges and potential regulatory delay or conditions.
- After quarter-end, the Bank issued $1.55 billion of senior bank notes on July 26, 2018. The filing also notes a $26 million Visa swap payment made July 17 following Visa escrow funding.
- Management identified interest-rate, deposit-pricing, credit, liquidity, cybersecurity, operational, regulatory and litigation risks. Its rate-sensitivity model estimated that a 100-basis-point decline in rates would reduce FTE net interest income by 3.75% over 12 months and 9.11% over months 13–24; results depend on assumptions, including deposit betas and balances. The company expects the new lease accounting standard to materially increase balance-sheet assets and liabilities when adopted in 2019, and expects the expected-credit-loss standard in 2020 to increase the allowance, with the amount still under evaluation.
- Legal matters include payment-card interchange litigation, the Visa litigation-related swap, and other proceedings. Fifth Third estimated reasonably possible legal and regulatory losses of up to approximately $5 million above accrued amounts for matters where it could estimate a range, while noting some potential losses could not be estimated. The Visa interchange settlement remained subject to finalization and court approval.
- No numerical earnings or revenue guidance for future periods is provided in the supplied filing text. Management described a generally positive economic outlook, while highlighting inflation, wages, rates, input costs and trade issues.
Important facts for investors to verify
- How much of reported earnings growth reflects recurring banking performance versus the $414 million Worldpay-related gain, $205 million share-sale gain and lower tax rate.
- Whether deposit costs rise faster than asset yields, and how actual deposit retention and pricing compare with the filing’s interest-rate sensitivity assumptions.
- Whether higher charge-offs, particularly in commercial and consumer portfolios, remain consistent with the lower provision and declining allowance ratio.
- Progress and costs of the branch closures and openings, and whether projected growth and efficiency benefits materialize.
- Regulatory and shareholder approvals, final terms, dilution, integration costs and expected benefits of the MB Financial acquisition.
- Changes in unrealized securities losses, capital and liquidity measures, and the company’s capacity to sustain planned dividends and repurchases.
- Developments in Visa-related litigation and other legal matters, and the eventual effects of CECL and lease-accounting adoption.