FIFTH THIRD BANCORP quarterly report, Q3 FY2012

Fifth Third Bancorp — Q3 2012 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2012. Fifth Third is a diversified bank headquartered in Cincinnati, with $117.5 billion in assets and four reported segments: Commercial Banking, Branch Banking, Consumer Lending and Investment Advisors. Figures below are in U.S. dollars; income-statement comparisons are year over year unless noted.

Financial results and key metrics

MetricQ3 2012Q3 2011Nine months 2012Nine months 2011
Total revenue, FTE$1.578 billion$1.567 billion$4.828 billion$4.560 billion
Net interest income, FTE$907 million$902 million$2.709 billion$2.655 billion
Net income attributable to Bancorp$363 million$381 million$1.178 billion$983 million
Net income available to common shareholders$354 million$373 million$1.152 billion$789 million
Diluted earnings per share$0.38$0.40$1.23$0.86
Net interest margin, FTE3.56%3.65%3.58%3.66%
Efficiency ratio, FTE basis63.7%60.4%60.4%60.6%
Provision for loan and lease losses$65 million$87 million$227 million$368 million
Net charge-offs$156 million$262 million$557 million$933 million

At September 30, total assets were $117.5 billion; portfolio loans and leases were $83.1 billion; deposits were $84.7 billion; and total borrowings were $14.3 billion, including $8.1 billion of long-term debt. The allowance for loan and lease losses was $1.925 billion, or 2.32% of portfolio loans. Shareholders’ equity was $13.7 billion. Regulatory capital ratios were 10.85% Tier I risk-based, 14.76% total risk-based and 10.09% Tier I leverage; management said ratios exceeded well-capitalized guidelines. Tangible common equity was 9.10%, a non-GAAP measure.

For the first nine months, operating cash flow was $2.736 billion, investing cash flow was negative $2.311 billion and financing cash flow was negative $598 million. Cash and due from banks ended the period at $2.490 billion. The filing also reported $31.8 billion of secured borrowing capacity and $5.6 billion available under its public debt shelf, subject to market access and existing authorizations.

Material changes versus comparable periods

  • Q3 common earnings fell 5% and diluted EPS declined from $0.40 to $0.38, despite 1% revenue growth. Higher noninterest expense, including $26 million of TruPS extinguishment costs, contributed to the quarterly decline.
  • Nine-month common earnings rose 46%, with comparisons affected by $153 million of Series F preferred-stock discount accretion in 2011. 2012 results included a $115 million pretax gain ($75 million after tax) related to the Vantiv IPO.
  • Credit measures improved: Q3 net charge-offs fell to 0.75% of average loans from 1.32%; nonperforming assets were $1.489 billion versus $2.141 billion a year earlier. The allowance declined from $2.439 billion to $1.925 billion year over year.
  • Average loans grew 6% year over year in Q3, led by commercial and industrial and residential mortgage lending. Core deposits increased 4% on average, while average funding costs fell. Lower asset yields nevertheless compressed net interest margin.
  • Noninterest income rose 1% in Q3 and 11% year to date. Mortgage banking and corporate banking gains were partly offset by lower card and processing income, reflecting debit interchange fee caps, and weaker securities gains. Noninterest expense rose 6% in both periods, driven mainly by personnel costs.
  • Quarter-end deposits were down 1% from December 2011, while borrowings were up 8%; compared with September 2011, deposits were up 3% and borrowings down 5%.

Outlook, management commentary, risks and unusual items

  • The filing provides no specific earnings or revenue guidance. Management cited a moderate economic recovery, improving credit trends, continued low interest rates and strong mortgage refinancing as relevant operating conditions.
  • Management warned that low interest rates can pressure asset yields and mortgage-servicing-right values; faster prepayments caused $72 million of Q3 temporary MSR impairment, partly offset by $32 million of hedge gains. The filing describes the MSR hedge strategy as non-qualifying and subject to inefficiencies.
  • The Federal Reserve did not object to a capital plan permitting a quarterly dividend increase to $0.10 and up to $600 million of share repurchases through Q1 2013. The Bancorp repurchased approximately $350 million of shares in August and had authorization for up to 100 million shares. A further approximately $125 million accelerated repurchase was announced November 6, after quarter-end.
  • Fifth Third redeemed $1.4375 billion of 7.25% trust preferred securities in August, recognizing $26 million of extinguishment losses. It also issued $500 million of unsecured senior notes at 3.50%, due 2022. Proposed Basel III rules were estimated to yield a 9.01% fully phased-in Tier I common ratio; this was a preliminary, non-GAAP estimate based on draft rules.
  • Mortgage representation-and-warranty reserves increased to $81 million from $55 million at year-end, primarily after receiving additional FHLMC information. The Bancorp reported $74 million of outstanding repurchase demands. It also had $687 million of mortgage loans sold with credit recourse, supported by an $18 million reserve.
  • Legal and regulatory matters include an SEC investigation and information requests concerning accounting and reporting for certain commercial loans. The Bancorp estimated reasonably possible legal losses of up to approximately $52 million above reserves, while noting some matters could not be estimated. A proposed Visa interchange litigation settlement was announced October 19, after quarter-end; the Bancorp’s remaining reserve was approximately $50 million, and court approval was not assured.
  • Management was evaluating possible effects of OCC guidance on Chapter 7 non-reaffirmed loans. Approximately $150 million of loans could be affected if regulators adopt the guidance, potentially increasing TDRs, nonperforming assets and charge-offs. Key broader risks include economic and real-estate weakness, credit deterioration, interest-rate changes, liquidity and capital requirements, regulation, litigation and operational or reputational events.

Most important facts for investors to verify

  • Whether credit improvement continues as the allowance falls, and whether reserve coverage remains adequate given the filing’s cited sensitivities: a 10% downgrade across commercial risk grades could increase the allowance by about $153 million; a 10% increase in estimated residential and consumer loss rates could add about $52 million.
  • Whether margin pressure persists: Q3 net interest margin fell 9 basis points year over year, while lower funding costs and loan growth supported net interest income.
  • How sustainable mortgage-banking earnings are, including origination volumes, MSR valuation and hedge effectiveness as rates and refinancing activity change.
  • The eventual costs and outcomes of mortgage repurchase claims, the Visa settlement and other litigation, and the SEC inquiry into commercial-loan accounting and reporting.
  • Actual capital and liquidity effects of share repurchases, TruPS redemptions and final Basel III rules; distinguish the preliminary Basel III estimate from regulatory capital ratios.
  • Whether the Q3 expense increase and weaker efficiency ratio reverse, and how recurring earnings compare after excluding the Vantiv IPO gain and other unusual items.