Fifth Third Bancorp — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014; comparisons are with the corresponding 2013 periods unless otherwise noted. Fifth Third is a U.S. regional banking and financial services company headquartered in Cincinnati, Ohio, with four reported segments: Commercial Banking, Branch Banking, Consumer Lending and Investment Advisors.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue, FTE | $1.641 billion | $1.945 billion | $3.103 billion | $3.580 billion |
| Net interest income, FTE | $905 million | $885 million | $1.803 billion | $1.777 billion |
| Net income attributable to Bancorp | $439 million | $591 million | $756 million | $1.013 billion |
| Net income available to common shareholders | $416 million | $582 million | $724 million | $995 million |
| Diluted earnings per share | $0.49 | $0.65 | $0.84 | $1.11 |
| Net interest margin, FTE | 3.15% | 3.33% | 3.18% | 3.38% |
| Efficiency ratio, FTE | 58.2% | 53.2% | 61.4% | 56.2% |
- Revenue and earnings fell substantially, chiefly because mortgage banking revenue declined and the prior-year comparison included larger gains on Vantiv shares. Net interest income rose modestly, but margin contracted.
- Noninterest income fell 31% in Q2 and 28% for the first half. Mortgage banking net revenue fell 67% and 59%, respectively; residential mortgage originations were down 74% and 75%. Other noninterest income also reflected a $125 million Vantiv share-sale gain versus $242 million in Q2 2013.
- Noninterest expense declined 8% in Q2 and 5% for the first half, including lower personnel costs; litigation expense increased. The higher efficiency ratio indicates expenses consumed a greater share of revenue.
- Q2 provision for loan and lease losses was $76 million, versus $64 million; first-half provision was $146 million, versus $126 million. Q2 net charge-offs were $101 million and 0.45% of average loans, versus $112 million and 0.51%. For the first half, the charge-off rate increased to 0.60% from 0.57%, including large commercial credit losses.
Balance sheet, liquidity and capital
- At June 30, total assets were $132.6 billion, up from $130.4 billion at December 31, 2013. Portfolio loans and leases were $90.5 billion; commercial lending growth offset declines in consumer lending.
- Total deposits were $96.0 billion, down from $99.3 billion at year-end; core deposits were $92.3 billion, versus $92.7 billion. Average core deposits were up 9% year over year for Q2, while higher-cost large certificates of deposit ran off.
- Total borrowings rose to $17.3 billion from $11.3 billion at year-end, including increased long-term debt and short-term FHLB funding. Long-term debt was $14.0 billion.
- Six-month cash flows: operating activities provided $965 million, investing activities used $3.184 billion and financing activities provided $2.353 billion. Cash and due from banks ended at $3.312 billion. The filing reports approximately $39.7 billion of secured borrowing capacity available.
- Tier 1 risk-based capital was 10.80%, total risk-based capital 14.30%, and Tier 1 leverage 9.86%; management said ratios exceeded well-capitalized guidelines. The estimated fully phased-in Basel III Tier 1 common ratio was 9.27% assuming the AOCI opt-out.
- Nonperforming assets, including loans held for sale, were $837 million, or 0.92% of portfolio loans, leases and other assets, versus $986 million and 1.10% at December 31. The allowance for loan and lease losses was $1.458 billion, or 1.61% of portfolio loans, versus $1.582 billion and 1.79% at year-end.
Material changes and segment performance
- Commercial and industrial and construction lending grew, supported by stronger demand and targeted origination; mortgage and home-equity balances continued to decline. Average commercial loans and leases increased 7% year over year in Q2, while average consumer loans and leases fell 5%.
- Branch Banking Q2 net income increased to $75 million from $48 million. Commercial Banking was broadly flat at $214 million versus $213 million. Consumer Lending recorded a $15 million loss versus $67 million income, principally reflecting the mortgage downturn. Investment Advisors earned $12 million versus $7 million.
- Net mortgage servicing revenue was affected by changing rates and prepayment assumptions. Q2 included a $32 million temporary MSR impairment, partly offset by $38 million of gains on economic hedges.
- Fifth Third’s Vantiv Holding ownership declined to approximately 23%; the investment’s carrying value was $384 million. The Bancorp recognized a $125 million gain on Vantiv shares sold during Q2.
Outlook, risks and unusual items
- Management described economic growth and employment as improving, but said qualified loan demand remained weaker than desired and low interest rates constrained growth and profitability. The filing provides no specific earnings or revenue guidance.
- In modeled parallel rate increases, net interest income was estimated to rise 1.07% over 12 months and 4.97% over months 13–24 for a 100-basis-point increase; for a 200-basis-point increase, estimates were 1.95% and 8.08%. Falling-rate scenarios were omitted because short-term rates were already low.
- The Federal Reserve did not object to proposed capital actions for April 2014–March 2015, including a possible quarterly common dividend of $0.13 and up to $669 million of share repurchases, subject to conditions and approvals. The Bancorp raised the dividend to $0.13, completed a $150 million accelerated repurchase transaction and issued $297 million net of Series J preferred stock proceeds. A further approximately $225 million accelerated repurchase was announced after quarter-end.
- Fifth Third planned to stop enrolling new customers in its deposit advance product and phase it out for existing customers by year-end 2014; the financial impact was still under evaluation. The Bank also exited its Residential Wholesale Loan Broker business in Q1.
- Regulatory and market risks include Basel III implementation, Dodd-Frank requirements, the Volcker Rule and possible changes to debit interchange rules. The Bancorp disclosed approximately $180 million in private-equity interests and $72 million in related commitments affected by the Volcker Rule, and said it may reduce these positions over time.
- Contingencies include mortgage representation-and-warranty losses reasonably possible up to approximately $52 million beyond reserves, and legal-proceeding losses reasonably possible up to approximately $104 million beyond reserves. The Bancorp was cooperating with DOJ investigations concerning certain FHA-insured loans and possible discriminatory practices in indirect auto lending. It reported a $54 million Visa total-return-swap liability and said it did not consider excess Visa litigation exposure over the related Class B value probable.
- A $17 million impairment charge was recorded for branches and land after the company reconsidered six branches and certain planned banking-center sites. Management identified changing customer preferences and digital banking as risks to branch assets and future distribution costs.
Most important facts for investors to verify
- Whether mortgage origination and servicing revenue stabilize, and how mortgage rates and prepayments affect MSR valuation.
- Whether commercial credit losses remain elevated, particularly after first-half charge-offs, and whether the lower allowance ratio remains adequate.
- Whether core-deposit trends and the higher borrowing mix support liquidity without materially pressuring funding costs.
- Progress on the deposit-advance phase-out, Basel III capital requirements and authorized capital returns, including post-quarter repurchases.
- Developments in mortgage repurchase claims, DOJ investigations, Visa-related exposure and other legal contingencies.