Fifth Third Bancorp — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013; comparisons are primarily with the corresponding 2012 periods. Fifth Third is a diversified U.S. bank holding company with four reported segments: Commercial Banking, Branch Banking, Consumer Lending and Investment Advisors. It reported $125.7 billion of assets at quarter-end.
Key financial results
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenue (FTE) | $1.619bn | $1.578bn | $5.199bn | $4.828bn |
| Net interest income (FTE) | $898m | $907m | $2.675bn | $2.709bn |
| Net income available to common shareholders | $421m | $354m | $1.415bn | $1.152bn |
| Diluted earnings per share | $0.47 | $0.38 | $1.58 | $1.23 |
| Provision for loan and lease losses | $51m | $65m | $176m | $227m |
| Noninterest expense | $959m | $1.006bn | $2.972bn | $2.918bn |
| Net interest margin (FTE) | 3.31% | 3.56% | 3.35% | 3.58% |
| Efficiency ratio (FTE) | 59.2% | 63.7% | 57.2% | 60.4% |
FTE means fully taxable equivalent. Net interest income in the GAAP income statement was $893 million for Q3 and $2.661 billion for the first nine months of 2013; FTE amounts are used in management’s comparisons.
Balance sheet, funding and capital
- At September 30, total assets were $125.7bn, deposits $94.1bn, total borrowings $11.8bn and total equity $14.7bn. Portfolio loans and leases were $87.2bn, up from $85.8bn at year-end 2012; total loans including held-for-sale loans were $88.6bn.
- Core deposits were $86.6bn, up modestly from year-end, while total deposits rose to $94.1bn from $89.5bn. Total borrowings declined 17% from year-end to $11.8bn.
- Cash and due from banks was $2.9bn. Management reported approximately $36.5bn of secured borrowing capacity and $5.0bn of debt or other securities available for issuance under Board authorizations.
- Regulatory capital ratios included Tier 1 risk-based capital of 11.14%, total risk-based capital of 14.35%, and Tier 1 leverage of 10.58%. The estimated fully phased-in Basel III Tier 1 common ratio was 9.47% assuming the opt-out from AOCI inclusion.
Cash flows and credit quality
- For the first nine months, operating cash flow was $3.827bn, investing cash flow was negative $5.360bn, and financing cash flow was positive $1.979bn. Cash and due from banks increased $446m to $2.887bn. Investing outflows included net purchases of available-for-sale securities and growth in loans.
- Net charge-offs were $109m in Q3 and $353m for the nine months, versus $156m and $557m a year earlier. The Q3 annualized net charge-off ratio declined to 0.49% from 0.75%; the nine-month ratio fell to 0.54% from 0.90%.
- Nonperforming assets, including loans held for sale, were $1.025bn, down from $1.315bn at December 31, 2012; the ratio excluding nonaccrual loans held for sale was 1.16%, versus 1.49% at year-end. The allowance for loan and lease losses was $1.677bn, or 1.92% of portfolio loans, down from $1.854bn and 2.16%.
Material changes and drivers
- Common earnings rose 19% in Q3 and 23% year to date. Growth reflected lower credit costs, reduced Q3 expenses and higher noninterest income, partly offset by weaker net interest income and mortgage banking.
- Net interest margin contracted 25 basis points in Q3 year over year. Lower yields on earning assets, including a 35-basis-point decline, outweighed growth in average loans and lower funding costs. Average loans and leases increased 5% in Q3, led by commercial and industrial lending; average core deposits increased 6%.
- Noninterest income increased 7% in Q3 and 19% year to date. The 2013 periods included $242m of Vantiv share-sale gains in Q2 and $85m in Q3, compared with a $115m Vantiv IPO gain in Q1 2012. These gains make the revenue and earnings comparisons less indicative of recurring performance.
- Q3 mortgage banking net revenue fell $79m to $121m, primarily because mortgage originations and gains on loan sales declined as rates rose and refinancing activity slowed. Improved MSR valuation and hedge results partly offset the decline. Year-to-date mortgage banking revenue was down $14m.
- Q3 noninterest expense declined 5%, mainly due to lower representation-and-warranty provisions and debt-extinguishment costs in the comparison period; nine-month expense rose 2%, with higher legal and regulatory-related costs and FDIC insurance expense among the drivers.
- Commercial Banking, Branch Banking and Investment Advisors reported higher Q3 net income; Consumer Lending net income fell to $15m from $54m, largely reflecting lower mortgage revenue. Year-to-date income rose in all four segments.
Outlook, risks and contingencies
- The filing provides no specific earnings or revenue guidance. Management described modest economic improvement, but noted a softer third-quarter trend and continued economic and political uncertainty.
- Interest-rate exposure remains important: a 200-basis-point rate increase was estimated to raise NII 1.14% over 12 months and 6.14% over months 13–24. The EVE model estimated a 6.25% decline under a 200-basis-point increase. These are modeled sensitivities, not forecasts.
- Management identified real-estate credit stress, particularly in Michigan and Florida. It also noted a $69m potential increase in charge-offs and additional troubled debt restructurings if regulators fully apply OCC guidance concerning certain non-reaffirmed Chapter 7 loans.
- Mortgage representation-and-warranty reserves were $103m; management estimated reasonably possible additional losses of up to approximately $61m beyond the reserve. Legal proceedings could produce aggregate losses of up to approximately $116m above reserves, although management stated that a material adverse effect on consolidated financial position was not expected based on information then available.
- The SEC was discussing a proposed settlement of an investigation into the Bancorp’s accounting for certain commercial loans in 2008. The proposed resolution included findings, a cease-and-desist order and a civil penalty, but required SEC Commissioner approval; the filing provides no penalty amount or assurance of approval.
- Other regulatory risks include possible changes to deposit-advance product rules, debit-card interchange requirements and new liquidity and Basel III capital standards. Management said the financial impact of the deposit-advance developments could not then be estimated.
- Capital actions included a $593m Series H preferred-stock issuance and conversion of Series G preferred shares into approximately 35.5m common shares. The quarterly common dividend was $0.12. The company reported approximately $650m of potential remaining share repurchases under its 2013 CCAR plan, excluding after-tax gains from future Vantiv share sales.
- Vantiv ownership fell to approximately 25%, with a $415m carrying value. The remaining investment, warrants and related valuation changes contribute earnings volatility.
Most important facts for investors to verify
- How much of reported earnings growth is recurring versus attributable to Vantiv gains, MSR valuation changes and lower credit provisions?
- Whether net interest margin stabilizes as asset yields, loan growth and funding costs evolve.
- Whether improving charge-offs and nonperforming assets persist, and whether the allowance remains adequate as the loan portfolio changes.
- The resolution and potential financial impact of the SEC matter, mortgage repurchase claims, other litigation and the Chapter 7 guidance issue.
- How Basel III and proposed liquidity rules affect capital and funding needs, and whether planned dividends and repurchases remain consistent with regulatory approvals and conditions.