Fifth Third Bancorp — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. Comparisons are with the corresponding 2010 periods unless otherwise indicated. Fifth Third is a Cincinnati-based regional financial services company with four reported business segments and a 49% interest in Vantiv, LLC.
Financial performance and condition
| Metric | Q3 2011 | Nine months 2011 |
|---|---|---|
| Total revenue, FTE basis | $1.567 billion, down 10% | $4.560 billion, down 5% |
| Net interest income, FTE basis | $902 million, down 2% | $2.655 billion, down 2% |
| Net interest margin | 3.65%, versus 3.70% | 3.66%, versus 3.63% |
| Net income attributable to Bancorp | $381 million, versus $238 million | $983 million, versus $420 million |
| Net income available to common shareholders | $373 million; diluted EPS $0.40 | $789 million; diluted EPS $0.86 |
| Provision for loan and lease losses | $87 million, down 81% | $368 million, down 73% |
| Noninterest expense | $946 million, down 3% | $2.765 billion, down 4% |
On a GAAP basis, net interest income was $898 million for Q3 and $2.641 billion for the nine months. Return on assets was 1.34% for Q3 and 1.18% year to date. The efficiency ratio was 60.4% for Q3, versus 56.2%, and 60.6% year to date, versus 60.1%.
Balance sheet and funding at September 30: Total assets were $114.905 billion; portfolio loans and leases were $79.216 billion; deposits were $82.047 billion; and total borrowings were $15.121 billion. Cash and due from banks totaled $2.348 billion. Core deposits reached $78.862 billion, up 4% year over year, while total borrowings rose 15%, largely from higher short-term FHLB borrowing. The filing reports $27.5 billion of borrowing capacity through secured sources and $6.1 billion of remaining public debt shelf capacity.
Cash flow, nine months: Operating activities provided $2.659 billion; investing activities used $4.129 billion; financing activities provided $1.659 billion. Cash and due from banks increased $189 million to $2.348 billion.
Capital: Tier 1 capital was 11.96%, total risk-based capital 16.25%, Tier 1 leverage 11.08%, and Tier 1 common equity 9.33%. The company stated these ratios exceeded well-capitalized guidelines. In January, it raised $1.7 billion in common equity and issued $1.0 billion of 3.625% senior notes due 2016; it then redeemed $3.4 billion of Treasury Series F preferred stock and repurchased the Treasury warrant for $280 million. Common dividends were $0.08 per share in Q3, versus $0.01 a year earlier.
Material changes and drivers
- Common earnings improved substantially as credit costs declined and preferred stock dividends fell in Q3. Nine-month preferred dividends were $194 million and included $153 million of accelerated discount accretion related to the Series F redemption.
- Net charge-offs fell to 1.32% of average loans for Q3 from 4.95%; the nine-month rate was 1.60%, versus 3.41%. Nonperforming assets, excluding nonaccrual loans held for sale, were 2.44% of loans, leases and other assets, down from 2.72% a year earlier.
- Noninterest income declined, primarily reflecting the absence of a $152 million BOLI-related litigation settlement recorded in Q3 2010, along with lower mortgage origination fees and gains on loan sales. Mortgage banking net revenue was $178 million, down 23%.
- Loan yields weakened in the low-rate environment, reducing Q3 net interest margin year over year. Lower deposit costs and a shift toward lower-cost transaction deposits partly offset that pressure.
- Loans and leases increased 3% year over year, led by commercial and industrial, residential mortgage and automobile lending. Commercial construction and commercial real estate exposure continued to run off.
- The allowance for loan and lease losses declined to $2.439 billion from $3.194 billion a year earlier; coverage was 3.08% of loans and leases, versus 4.20%.
Outlook, risks, contingencies and unusual items
- The filing provides no clear quantitative earnings or revenue guidance. Management cited signs of credit improvement, but also described economic conditions as mixed and real estate markets in Michigan and Florida as particularly stressed.
- Management anticipated approximately $5 million of additional net interest income in the remainder of 2011 from accretion and amortization of acquired loan and deposit premiums and discounts, excluding prepayment effects.
- Key risks include interest-rate and margin pressure, economic and real estate weakness, credit deterioration, funding and liquidity access, regulatory changes, and mortgage servicing and prepayment volatility. The company said the ultimate effects of the Dodd-Frank Act were not yet known and could adversely affect performance and growth.
- Mortgage servicing rights were subject to $201 million of temporary impairment in Q3, partly offset by $235 million of gains on economic hedges. The company changed its MSR hedge strategy after quarter-end, leaving about 29% of the September 30 MSR carrying value unhedged under that strategy.
- Two cash flow hedges were terminated in Q3, generating approximately $27 million of expense. The company also recorded $9 million of other-than-temporary impairment on available-for-sale securities during the three and nine months.
- Legal and regulatory matters include an SEC investigation into accounting and reporting for certain commercial loans. Separately, the SEC issued a Wells notice concerning disclosure timing for a trust preferred redemption; the company reported a preliminary staff recommendation for possible enforcement action under Exchange Act Section 13(a) and Regulation FD. The company was cooperating. It estimated reasonably possible legal losses up to $82 million above amounts reserved, while noting that no loss or a greater-than-estimated outcome was possible.
- Other exposures include $52 million of reserves for mortgage representation-and-warranty claims, $828 million of mortgage loans sold with credit recourse, and $46.019 billion of commitments to extend credit. The filing says commitments may expire undrawn and are not equivalent to expected cash outflows.
Investor verification priorities
- Reconcile the improvement in earnings with the sharp decline in provision expense and assess whether credit-cost reductions are sustainable.
- Review nonperforming assets, troubled debt restructurings, delinquency trends, and allowance adequacy—especially commercial real estate and stressed Michigan and Florida exposures.
- Assess net interest margin sensitivity to persistently low rates, deposit repricing, and the increased use of short-term borrowing.
- Examine mortgage banking profitability, MSR impairment and hedge results, and the revised post-quarter hedge strategy.
- Monitor the SEC investigations and other litigation, including potential outcomes beyond recorded reserves, and track mortgage repurchase demands.
- Evaluate capital ratios and funding capacity after the equity raise, preferred redemption, debt issuance, and trust-preferred redemptions; consider the planned phaseout of certain trust preferred securities from Tier 1 capital beginning in 2013.