Fifth Third Bancorp — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. Comparisons below are with Q1 2016 for income and cash flow, and with December 31, 2016 for period-end balance-sheet measures. Amounts are in U.S. dollars; financial statement amounts are generally in millions.
Business context
Fifth Third is a Cincinnati-based diversified financial services company operating primarily in the Midwest and Southeast. It reported four segments: Commercial Banking, Branch Banking, Consumer Lending, and Wealth and Asset Management. At quarter-end, it had $140.2 billion in assets, 1,155 full-service banking centers, and an approximately 18% interest in Vantiv Holding, carried at $430 million.
Financial and operating metrics
| Metric | Q1 2017 | Comparable period | Change |
|---|---|---|---|
| Net interest income, GAAP | $933 million | $903 million | Up 3% |
| Net interest income, FTE | $939 million | $909 million | Up 3% |
| Noninterest income | $523 million | $637 million | Down 18% |
| Total revenue, FTE basis | $1.462 billion | $1.546 billion | Down 5% |
| Provision for loan and lease losses | $74 million | $119 million | Down 38% |
| Noninterest expense | $986 million | $986 million | Flat |
| Net income attributable to Bancorp | $305 million | $326 million | Down 6% |
| Net income available to common shareholders | $290 million | $311 million | Down 7% |
| Diluted EPS | $0.38 | $0.40 | Down 5% |
| Net interest margin, FTE | 3.02% | 2.91% | Up 11 bps |
| Efficiency ratio, FTE | 67.4% | 63.8% | Higher by 3.6 percentage points |
The decline in common earnings reflected lower noninterest income and continued flat expenses, partly offset by higher net interest income and a smaller credit-loss provision. The effective tax rate was 22.9%, versus 25.1% in Q1 2016. Return on average assets was 0.88% versus 0.93%; return on average common equity was 7.8% versus 8.3%.
Balance sheet, credit, capital, and liquidity
- Assets and loans: Total assets were $140.2 billion, down from $142.2 billion at year-end. Period-end portfolio loans and leases were $91.6 billion, down $470 million from year-end; average loans were down 1% year over year. C&I and auto balances contracted, while residential mortgage and commercial construction balances grew.
- Deposits and funding: Total deposits were $104.2 billion, up $335 million from year-end; core deposits were $101.8 billion. Total borrowings were $15.8 billion, down $2.2 billion from year-end, mainly reflecting lower short-term FHLB funding and debt repayments. Wholesale funding averaged 23% of interest-bearing liabilities, versus 26% a year earlier.
- Credit: Net charge-offs were $89 million, or 0.40% of average portfolio loans, versus $96 million and 0.42% in Q1 2016. Nonperforming assets were $730 million, down from $751 million at year-end; nonperforming portfolio assets were 0.79% of loans and leases plus OREO, versus 0.80%. The allowance for loan and lease losses was $1.238 billion, or 1.35% of portfolio loans, versus $1.253 billion and 1.36% at year-end.
- Capital: Basel III transitional CET1 was 10.76%, Tier 1 risk-based capital 11.90%, total risk-based capital 15.45%, and Tier 1 leverage 10.15%. The company stated that it exceeded applicable well-capitalized and capital-conservation-buffer thresholds. Fully phased-in CET1 was 10.66%.
- Liquidity: Modified LCR was 119%. The company reported approximately $44.1 billion of secured borrowing capacity and $17.1 billion available under the Bank’s global bank note program. Cash and due from banks were $2.205 billion at quarter-end.
- Cash flows: Operating activities provided $536 million and investing activities provided $1.307 billion; financing activities used $2.030 billion. Cash and due from banks declined $187 million to $2.205 billion. Financing cash use included $1.520 billion of net repayments of other short-term borrowings, $714 million of long-term debt repayments, and common and preferred dividends.
Material changes and unusual items
- FTE net interest income rose as asset yields improved, including the effect of Federal Reserve rate increases, higher taxable securities balances, and lower average long-term debt. The increase was partly offset by lower average loan balances and higher funding costs. A revised estimate of bankcard customer refunds contributed a $12 million interest-income benefit.
- Noninterest income fell $114 million year over year. Q1 2016 included a $47 million positive Vantiv warrant valuation adjustment and an $8 million gain on the sale of St. Louis branches. Q1 2017 also included a $13 million negative Visa total-return-swap valuation adjustment.
- Mortgage banking revenue declined $26 million year over year, including lower origination gains and servicing revenue. Effective January 1, 2017, the company prospectively adopted fair-value accounting for all existing classes of residential mortgage servicing rights (MSRs); fair-value changes are now recognized in earnings. The quarter included a $23 million MSR fair-value adjustment and a $1 million net loss on related derivatives.
- A $31 million impairment of operating lease assets reduced corporate banking revenue. The filing also reports $20 million of net losses on operating lease equipment disposition and impairment in the cash-flow reconciliation; investors should verify the presentation and relationship of these amounts in the notes.
- Consumer Lending reported a $12 million net loss, compared with $8 million of income a year earlier, principally because of lower mortgage banking revenue and higher credit provision.
- Q1 2017 operating cash flow included $1.627 billion of proceeds from sales of loans held for sale and $1.483 billion of net originations. Loan sales and securitizations totaled $1.6 billion, versus $1.3 billion in Q1 2016.
- On April 26, 2017, after quarter-end, the Bancorp entered into an approximately $342 million accelerated share repurchase transaction, with payment scheduled for May 1 and settlement expected by July 26, 2017. The Q1 also included settlement of a prior accelerated repurchase transaction and receipt of 1.044 million shares in February.
Outlook, risks, and contingencies
The filing provides no specific earnings or revenue guidance. Management described the U.S. economy as improving, with moderate growth expected in 2017, steady labor-market gains, stronger manufacturing activity, and rising housing prices; it also noted more selective commercial real estate credit markets. Results remain sensitive to interest rates, loan demand, deposit pricing and runoff, credit quality, capital markets, and economic conditions. In the company’s modeled rising-rate scenarios, net interest income increased, but estimates depend on deposit runoff and repricing assumptions; modeled EVE declined 5.45% under an immediate 200-basis-point shock.
- Management identified non-power-producing energy and nonowner-occupied commercial real estate as relatively higher-risk portfolios. Energy exposure was $1.295 billion outstanding, including $430 million criticized, with $197 million nonaccrual; management reported stabilization and some improvement. Consumer charge-off rates rose year over year, particularly for auto, credit card, and other consumer loans.
- Commercial loan allowance sensitivity was approximately $183 million higher if 10% of commercial loans in each risk category were downgraded by one category. A 10% increase in estimated residential mortgage and consumer loss rates would add approximately $30 million to the allowance; these are sensitivities, not forecasts.
- Legal proceedings include Visa/Mastercard interchange litigation, which returned to the trial court after an appellate reversal of the settlement, and other disclosed matters. The company estimated reasonably possible legal and regulatory losses up to approximately $18 million above accruals, while noting that some ranges cannot be estimated. It also estimated possible mortgage representation-and-warranty losses up to approximately $22 million above the $12 million reserve.
- The proposed modified NSFR could affect future funding practices if adopted. The company also expects the 2020 expected-credit-loss standard (CECL) to increase the allowance at adoption, with the amount still under evaluation. It expects the 2019 lease standard to have a material balance-sheet effect from recognition of operating lease assets and liabilities.
- Disclosure controls were reported effective at quarter-end; management stated that controls introduced to remediate prior deficiencies concerning employee benefit plan registration and prospectus delivery were effective.
Most important facts for investors to verify
- Whether net interest margin gains can offset continued loan contraction and higher deposit and borrowing costs.
- How much of the decline in noninterest income reflects prior-year gains versus recurring weakness, including lease remarketing and mortgage banking.
- Credit trends in auto, card, legacy home-equity, energy, and criticized commercial exposures, and the adequacy of the allowance as CECL approaches.
- The earnings volatility and key assumptions of the newly adopted fair-value MSR method and its non-qualifying hedges.
- Liquidity and capital effects of the $342 million post-quarter share repurchase, planned capital distributions, and potential funding-rule changes.
- Developments in major litigation and the adequacy of recorded reserves relative to the disclosed possible excess losses.