Fifth Third Bancorp — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; balance-sheet comparisons are generally against December 31, 2016. Fifth Third is a diversified U.S. bank headquartered in Cincinnati, Ohio, with four reported business segments. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Key financial results
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net interest income, GAAP | $970 | $907 | $2,842 | $2,712 |
| Net interest income, FTE | $977 | $913 | $2,861 | $2,730 |
| Total revenue, FTE basis | $2,538 | $1,753 | $5,509 | $4,805 |
| Provision for loan and lease losses | $67 | $80 | $193 | $289 |
| Noninterest expense | $975 | $973 | $2,918 | $2,942 |
| Net income attributable to Bancorp | $1,014 | $516 | $1,685 | $1,170 |
| Net income available to common shareholders | $999 | $501 | $1,633 | $1,118 |
| Diluted EPS | $1.35 | $0.65 | $2.16 | $1.44 |
- Major unusual item: Q3 included a $1.037 billion gain from selling Vantiv, Inc. shares. The transaction drove much of the increase in noninterest income, reported revenue, earnings and the efficiency ratio; the filing does not provide a directly comparable normalized earnings figure.
- Margins and operating efficiency: FTE net interest margin was 3.07% in Q3 and 3.03% year to date, versus 2.88% in both 2016 periods. The FTE efficiency ratio was 38.4% for Q3 and 53.0% year to date, compared with 55.5% and 61.2%; management identifies the Vantiv gain as the primary driver of the improvement.
- Taxes: Effective tax rates were 31.9% for Q3 and 29.2% year to date, versus 25.6% and 25.0% in the comparable 2016 periods. The increase primarily reflected elevated pretax income associated with the Vantiv share sale.
Balance sheet, cash flow, capital and liquidity
- Size and lending: Assets were $142.264 billion at September 30, 2017. Portfolio loans and leases were $91.883 billion, down $215 million from year-end 2016; average loans and leases were down 2% year over year in Q3.
- Funding and debt: Deposits totaled $101.452 billion, down $2.369 billion from year-end. Total borrowings were $19.845 billion, up $1.790 billion; short-term borrowings increased while long-term debt declined. The Bank issued $700 million of five-year senior notes at 2.60% in June. A September auto-loan securitization resulted in approximately $750 million of third-party notes included in long-term debt.
- Cash flows, nine months: Operating activities provided $1.236 billion, versus $1.200 billion in 2016; investing activities provided $906 million, versus $2.207 billion used; financing activities used $2.329 billion, versus $631 million provided. Cash and due from banks ended at $2.205 billion, down $187 million from year-end.
- Liquidity: Modified Liquidity Coverage Ratio was 124%, compared with 115% a year earlier. The filing reports approximately $38.7 billion of available secured borrowing capacity and $17.7 billion available under the Bank’s global bank note program.
- Capital and shareholder returns: CET1 was 10.59%, Tier 1 risk-based capital 11.72%, total risk-based capital 15.16%, and Tier 1 leverage 9.97%. Management said capital ratios exceeded well-capitalized guidelines. The quarterly common dividend was $0.16 per share; the nine-month dividend was $0.44. The company repurchased shares through accelerated share repurchase transactions.
Credit quality and material changes
- Net charge-offs were $68 million in Q3 and $221 million year to date, compared with $107 million and $289 million in 2016. Annualized net charge-offs as a share of average portfolio loans were 0.29% and 0.32%, respectively.
- Nonperforming assets were $575 million, down from $751 million at year-end 2016; nonperforming portfolio assets were 0.60% of portfolio loans and leases plus OREO, versus 0.80%. The allowance for loan and lease losses was $1.205 billion, or 1.31% of portfolio loans and leases.
- Management attributed lower loss provisions to reduced criticized commercial assets, improving economic conditions and stabilized commodity prices. It continued to monitor retail commercial real estate and healthcare exposures; non-power-producing energy exposures had stabilized and showed signs of improvement.
- Average commercial and industrial and auto lending declined, with management citing softer commercial demand, selected commercial loan exits and a strategic focus on improved risk-adjusted auto returns. Commercial construction, residential mortgages and point-of-sale consumer lending grew.
Outlook, risks and contingencies
- The filing provides no specific forward earnings or revenue guidance. Management described economic growth as improving, with moderate U.S. growth expected in 2017, while noting below-target inflation and continued monitoring of selected commercial sectors.
- Interest-rate exposure is significant. The company’s model showed higher net interest income under parallel rate increases and lower income under a 62.5-basis-point decline; results depend on assumptions including deposit repricing and balances. Management cited a modeled 69% rising-rate deposit beta.
- Mortgage servicing rights were moved to fair value accounting from January 1, 2017. Their valuation is sensitive to mortgage rates, prepayment speeds and other assumptions; Q3 mortgage banking revenue also reflected negative servicing-rights valuation changes.
- Hurricane-related estimated losses were included in the allowance at $10 million. Management stated that it was assessing the impact of the 2017 Texas and Florida hurricanes.
- Legal and regulatory matters include the Visa/Mastercard merchant interchange litigation, other lawsuits and governmental inquiries. The company estimated reasonably possible legal and regulatory losses of up to approximately $31 million in excess of accruals where estimable; some matters could not be estimated. Separately, it estimated possible mortgage representation-and-warranty losses up to approximately $11 million above reserves.
- Future accounting changes include the expected January 2020 adoption of the credit-loss standard; management expects the allowance to increase, but the amount was still under evaluation. The company also expected the lease standard to materially increase reported assets and liabilities when adopted.
- Other notable items: the company retained an approximately 8.6% Vantiv Holding interest after the share transaction; a Visa total-return swap generated a $47 million Q3 loss valuation adjustment. On October 30, 2017, the Bank issued $1.1 billion of senior notes, a subsequent event after quarter-end.
Important facts for investors to verify
- How much of reported earnings and the efficiency improvement depends on the one-time Vantiv share-sale gain, and what recurring performance looks like without it.
- Whether loan growth, deposit balances and funding costs stabilize as interest rates and deposit competition change.
- Credit trends in auto, credit card, commercial construction, retail commercial real estate, healthcare and energy portfolios, including allowance adequacy.
- The sensitivity of mortgage servicing rights and Visa-swap valuations to assumptions, interest rates and litigation developments.
- Progress on share repurchases, dividend plans, liquidity capacity and the effect of the October 2017 debt issuance.
- Developments in legal and regulatory matters, hurricane-related credit losses, and the expected impact and timing of new accounting standards.