Fifth Third Bancorp — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016; comparisons are with the corresponding 2015 periods unless stated otherwise. Fifth Third is a diversified bank headquartered in Cincinnati, with four reportable segments: Commercial Banking, Branch Banking, Consumer Lending, and Wealth and Asset Management. Amounts below are in U.S. dollars; financial statement amounts are generally in millions.
Financial performance and condition
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Total revenue (FTE basis) | $1,507 | $1,448 | $3,052 | $2,931 |
| Net interest income (GAAP) | $902 | $887 | $1,805 | $1,734 |
| Net interest income (FTE) | $908 | $892 | $1,817 | $1,744 |
| Net income attributable to Bancorp | $333 | $315 | $660 | $676 |
| Net income available to common shareholders | $310 | $292 | $622 | $638 |
| Diluted EPS | $0.40 | $0.36 | $0.80 | $0.77 |
| Provision for loan and lease losses | $91 | $79 | $210 | $148 |
| Noninterest expense | $983 | $947 | $1,968 | $1,871 |
- Margins and efficiency: FTE net interest margin was 2.88% in Q2 2016 versus 2.90% a year earlier; first-half margin was 2.89% versus 2.88%. The efficiency ratio was 65.3% for Q2 versus 65.4%, and 64.5% for the first half versus 63.8%.
- Cash flow: For the first half, operating activities provided $702 million, investing activities used $2.264 billion, and financing activities provided $1.381 billion. Cash and due from banks fell $181 million to $2.359 billion. Investing outflows included net loan growth and securities activity; financing inflows included $2.739 billion of long-term debt issuance and $2.472 billion of additional short-term borrowings.
- Balance sheet and funding: Assets were $143.625 billion at June 30, up from $141.048 billion at year-end 2015. Portfolio loans and leases were $93.909 billion, up 1% from year-end; commercial balances grew while consumer balances declined. Deposits were $101.871 billion, down from $103.205 billion. Total borrowings rose to $20.318 billion from $17.468 billion, including $2.450 billion of FHLB advances.
- Credit quality: Net charge-offs were $87 million in Q2 and $183 million for the first half; the annualized charge-off ratio was 0.37% for Q2 and 0.39% for the first half. Nonperforming assets rose to $825 million from $659 million at year-end, and nonperforming portfolio assets were 0.86% of portfolio loans and OREO versus 0.70%. The allowance for loan and lease losses was $1.299 billion, or 1.38% of portfolio loans.
- Capital: Basel III transitional CET1 was 9.94%, Tier 1 risk-based capital 11.03%, total risk-based capital 14.66%, and Tier 1 leverage 9.64%. Management reported ratios above “well-capitalized” guidelines.
- Liquidity: The Modified LCR was 110% at June 30, 2016. Fifth Third reported approximately $36.2 billion of secured borrowing capacity and $8.9 billion of debt or other securities available for issuance under existing authorizations.
Material changes and drivers
- Q2 common income rose 6% and diluted EPS increased to $0.40 from $0.36. First-half common income fell 3%, although diluted EPS increased to $0.80 from $0.77, reflecting fewer average shares outstanding.
- Revenue growth was supported by higher net interest income, corporate banking activity, card and processing revenue, and other noninterest income. Average loans and leases increased 2% year over year in Q2, led by commercial lending and residential mortgages. The December 2015 25-basis-point federal funds rate increase also supported net interest income.
- Mortgage banking net revenue fell $42 million in Q2 and $49 million for the first half, mainly because lower rates increased prepayments and drove MSR valuation pressure. Q2 included a $45 million MSR impairment provision, partly offset by $51 million of gains on related hedging derivatives.
- Credit provision increased, primarily reflecting prolonged commodity-price softness, slow global growth, and a stronger U.S. dollar. Commercial Banking’s first-half provision also reflected criticized commercial loans and energy-related charge-offs. Non-power-producing energy loans classified as criticized were $641 million at June 30, versus $275 million a year earlier; the segment reported $11 million of first-half net charge-offs in oil-field-services lending.
- Noninterest expense rose 4% in Q2 and 5% for the first half. Personnel costs increased, including staffing in risk, compliance, and technology and higher incentive, retirement, and severance costs. First-half FDIC insurance and other taxes also increased.
- Noninterest income included a $50 million negative Visa total-return-swap valuation adjustment in Q2 following a court ruling that vacated approval of the interchange litigation settlement. Branch sales generated gains of $11 million in Q2 and $19 million in the first half. Results also benefited from the absence of substantial 2015 branch-property impairment charges.
Outlook, capital actions, risks, and unusual items
- No specific earnings or revenue forecast is provided in the supplied filing text. The company expects approximately $60 million in annual operating expense savings when its branch consolidation and sales plan is complete. At June 30, it planned to consolidate or sell 27 branches and sell 20 undeveloped parcels; the St. Louis and Pittsburgh branch transactions closed during the first half.
- Following its 2016 CCAR review, the Federal Reserve did not object to potential capital actions for July 2016–June 2017, including a possible increase in the quarterly common dividend to $0.14 in Q4 2016 and up to $660 million of share repurchases, including employee-plan-related repurchases. The quarterly dividend was $0.13 in Q2. Subsequent to quarter-end, Fifth Third announced a $240 million accelerated repurchase transaction, expected to settle by November 2, 2016.
- On July 27, 2016, Vantiv agreed to pay $116 million to terminate and settle certain tax receivable agreement cash flows; Fifth Third expected to recognize a $116 million pretax gain in Q3. The agreement also included options that could result in up to approximately $171 million of additional payments; the filing said Fifth Third expected to recognize a related approximately $163 million pretax gain and receivable in Q3.
- Management identified sensitivity to interest rates, economic conditions, credit quality, funding and liquidity, regulation, litigation, cybersecurity, and reputational risk. The bank’s CRA rating was “Needs to Improve,” which may constrain certain new activities, mergers, and acquisitions; the next examination was expected to begin in Q4 2016. The FDIC assessment changes were estimated to increase annual FDIC insurance expense by approximately $23 million.
- Legal matters include Visa/Mastercard interchange litigation, whose settlement approval was reversed on June 30, 2016, and other pending proceedings. For proceedings where an estimate was possible, the company estimated reasonably possible legal and regulatory losses of up to approximately $43 million in excess of accruals, while noting some matters could not be estimated. Separately, mortgage representation-and-warranty losses were estimated to be reasonably possible up to approximately $27 million above the $21 million reserve.
- Management stated disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether rising nonperforming assets and criticized energy exposures lead to further provisions, charge-offs, or reserve changes.
- How recurring earnings develop after separating underlying revenue and expense trends from Visa swap marks, branch-sale gains, and MSR valuation and hedge effects.
- Whether deposit levels, wholesale funding costs, and the higher borrowing mix affect net interest margin and liquidity.
- Execution and realized savings from the remaining branch and land dispositions, and completion of authorized capital actions.
- Developments in Visa interchange litigation, CRA status, and other legal or regulatory matters, including potential losses beyond recorded reserves.
- Recognition and collection of the expected Vantiv tax receivable agreement gains and any contingent additional settlement payments.