Fifth Third Bancorp — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015; comparisons are with the corresponding 2014 periods unless otherwise noted. Fifth Third is a Cincinnati-based regional financial services company operating across the Midwest and Southeast, with Commercial Banking, Branch Banking, Consumer Lending and Investment Advisors segments. Amounts are in U.S. dollars; financial-statement amounts are generally in millions unless noted.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net interest income, FTE | $892m | $905m | $1,744m | $1,803m |
| Noninterest income | $556m | $736m | $1,187m | $1,300m |
| Total revenue, FTE | $1,448m | $1,641m | $2,931m | $3,103m |
| Provision for loan and lease losses | $79m | $76m | $148m | $146m |
| Noninterest expense | $947m | $954m | $1,871m | $1,903m |
| Net income attributable to Bancorp | $315m | $439m | $676m | $756m |
| Net income available to common shareholders | $292m | $416m | $638m | $724m |
| Diluted EPS | $0.36 | $0.49 | $0.77 | $0.84 |
| Net interest margin, FTE | 2.90% | 3.15% | 2.88% | 3.18% |
| Efficiency ratio, FTE | 65.4% | 58.2% | 63.8% | 61.4% |
- Balance sheet at June 30: Assets were $141.7bn, portfolio loans and leases $92.7bn, deposits $103.0bn, and total borrowings $17.8bn, including $13.5bn of long-term debt. Core deposits were $100.2bn. Shareholders’ equity was $15.6bn.
- Cash flow, six months: Operating activities provided $950m; investing activities used $3.1bn; financing activities provided $1.9bn. Cash and due from banks decreased $306m to $2.8bn.
- Credit and capital: Net charge-offs were $86m in Q2 and $177m for the half; annualized charge-off rates were 0.37% and 0.39%, respectively. Nonperforming assets were $627m, or 0.67% of portfolio loans, leases and other assets including OREO (excluding nonaccrual loans held for sale). ALLL was $1.293bn, or 1.39% of portfolio loans and leases. Basel III transitional CET1, Tier 1 risk-based, total risk-based and Tier 1 leverage ratios were 9.42%, 10.51%, 13.69% and 9.44%.
- Liquidity: Estimated Modified Liquidity Coverage Ratio was 108% at quarter-end; the requirement was scheduled to take effect January 1, 2016. The company reported approximately $36.5bn of secured borrowing capacity and $19.6bn available under its bank note program.
Material changes and significant items
- Q2 common income fell 30% and diluted EPS fell from $0.49 to $0.36. FTE net interest income declined 1% in Q2 and 3% for the half; margin fell 25 basis points in Q2 and 30 basis points for the half. Management cited lower asset yields, changes to the deposit advance product and higher average long-term debt. Loan growth and higher average taxable securities partly offset these pressures.
- Noninterest income fell 24% in Q2. The comparison was affected by the $125m Vantiv share-sale gain recorded in Q2 2014; Q2 2015 also included $98m of branch/land impairment and lower Vantiv warrant valuation gains. Six-month noninterest income included $102m of branch/land impairment. Mortgage banking revenue improved, partly from MSR valuation recoveries as mortgage rates rose. The first half also included a $37m gain on sale of certain restructured residential mortgage loans.
- Noninterest expense declined modestly, but the efficiency ratio worsened as revenue contracted. Personnel costs increased, while other expense declined, notably from lower legal settlements and reserve expense.
- Portfolio loans and leases rose $2.4bn from year-end, largely from commercial lending; commercial and industrial and construction lending grew, while consumer loans declined slightly. Nonperforming assets and charge-offs improved from prior comparisons, though potential problem commercial loans increased to $1.654bn from $1.330bn at year-end.
- The Board authorized a plan to consolidate and/or sell 105 operating branches and sell 31 undeveloped parcels. Assets held for sale included $561m of deposits and $409m of assets at June 30; recorded branch and land impairments were significant.
- Capital actions included accelerated share repurchases. The Federal Reserve did not object to potential capital distributions through June 2016, including repurchases up to $765m and a potential quarterly dividend increase to $0.14 in 2016. The declared Q2 dividend was $0.13 per common share.
Outlook, commentary and risks
- Management described its U.S. economic outlook as reasonably positive for growth and employment during the remainder of 2015, while noting weaker-than-desired qualified loan demand and a low-rate environment that constrained growth and profitability.
- Changes to the deposit advance product for existing customers were expected to reduce 2015 net interest income by approximately $95m. The company had stopped enrolling new customers and continued servicing existing customers pending further regulatory guidance.
- Interest-rate sensitivity modeling estimated that a 100-basis-point parallel increase would raise FTE net interest income by 0.89% over 12 months and 4.23% over months 13–24; a 200-basis-point increase was estimated to raise it 1.63% and 6.65%, respectively. Results depend on assumptions, including deposit runoff and deposit-rate beta, and are not forecasts.
- Credit risks include stressed older-vintage consumer real estate loans and a $1.7bn non-power-producing energy portfolio exposed to lower oil prices, with migration into criticized classifications. Management also noted heightened stress in residential mortgage and brokered home equity portfolios.
- Legal and regulatory matters include Visa interchange litigation and ongoing government investigations, including matters related to certain government-insured/GSE loans and indirect auto lending. The company estimated reasonably possible legal and regulatory losses of up to approximately $60m above accruals where estimable; some matters could not be estimated. Separately, it estimated potential mortgage representation-and-warranty losses up to approximately $32m above the $32m reserve.
- Other risks include interest-rate and market movements, mortgage servicing-right valuations, regulatory capital and liquidity requirements, cyber threats, and execution of the branch plan. The filing disclosed that the bank subsidiary’s CRA examination could result in a “Needs to Improve” rating; the regulator had not made a final determination.
- Subsequent events: On July 27, 2015, Fifth Third issued $1.1bn of five-year, 2.875% senior notes. It also entered into a $150m accelerated repurchase transaction, with shares purchased August 3.
Most important facts for investors to verify
- How much of the earnings decline reflects recurring margin and revenue pressure versus the prior-year Vantiv gain and 2015 branch, land and lease impairments?
- Whether deposit growth and commercial loan growth can offset ongoing margin compression and the expected $95m deposit-advance impact.
- Whether credit quality continues to improve, particularly in older consumer real estate vintages, criticized energy exposures and the growing potential-problem commercial loan balance.
- The final costs, timing, proceeds and customer/deposit effects of the 105-branch and 31-parcel disposition plan.
- Updates to capital distributions, liquidity compliance, the CRA examination and legal or regulatory exposure, including the Visa, mortgage and indirect-auto matters.