FIFTH THIRD BANCORP quarterly report, Q2 FY2011

Fifth Third Bancorp — Q2 2011 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2011. Fifth Third is a diversified regional financial-services company headquartered in Cincinnati, with four reported segments: Commercial Banking, Branch Banking, Consumer Lending and Investment Advisors. It reported $110.8 billion in assets at quarter-end. Comparisons below are primarily with the corresponding 2010 period unless noted.

Financial performance and condition

Metric	Q2 2011	Six months 2011
Net income attributable to Bancorp	$337 million	$602 million
Net income available to common shareholders	$328 million	$417 million
Diluted earnings per share	$0.35	$0.46
Net interest income, FTE basis	$869 million	$1.752 billion
Noninterest income	$656 million	$1.240 billion
Provision for loan and lease losses	$113 million	$281 million
Noninterest expense	$901 million	$1.819 billion

The GAAP statements report net interest income of $864 million for Q2 and $1.743 billion for the first half; FTE adjustments account for the difference. Q2 return on assets was 1.22%, net interest margin was 3.62% FTE, and the efficiency ratio was 59.1% FTE.

• Credit: Q2 net charge-offs were $304 million, or 1.56% of average loans and leases; the first-half figures were $671 million and 1.74%. Nonperforming assets, including nonaccrual loans held for sale, were $2.264 billion at June 30, versus $3.136 billion a year earlier. The allowance for loan and lease losses was $2.614 billion, or 3.35% of portfolio loans.
• Balance sheet and funding: Total assets were $110.8 billion; portfolio loans and leases were $78.0 billion. Deposits totaled $80.6 billion, including $77.0 billion of core deposits. Borrowings totaled $13.3 billion, including $10.2 billion of long-term debt. Cash and due from banks were $2.4 billion; available-for-sale securities had a fair value of $15.5 billion.
• Capital: Regulatory ratios were 11.93% Tier I capital, 16.03% total risk-based capital, 11.03% Tier I leverage and 9.20% Tier I common equity. Management said capital ratios exceeded “well-capitalized” guidelines. The common equity offering and preferred-stock redemption materially changed the capital mix.
• Cash flow, first half: Operating activities provided $2.894 billion; investing activities used $1.291 billion; financing activities used $1.382 billion. Cash and due from banks increased $221 million to $2.380 billion.

Changes versus comparable periods

• Q2 common net income rose from $130 million to $328 million; first-half common net income rose from $57 million to $417 million. Lower credit-loss provisions were a major contributor. First-half 2011 preferred dividends included $153 million of accelerated discount accretion related to the Series F preferred-stock redemption.
• Q2 FTE net interest income declined 2%, while net interest margin increased to 3.62% from 3.57%. Lower loan yields and reduced average interest-earning assets pressured revenue; lower funding costs and a shift toward lower-cost deposits partly offset that pressure.
• Q2 noninterest income increased 6%, led by mortgage banking and investment advisory revenue. Mortgage banking benefited from MSR and hedge valuation gains, while origination fees and gains on loan sales declined. Deposit service charges fell 16%, primarily following Regulation E and overdraft-policy changes.
• Noninterest expense declined 4% in Q2 and the first half, mainly from lower FDIC-related costs, commitment provisions and certain mortgage representation-and-warranty costs. Personnel expense increased.
• Average core deposits increased 2% year over year, with customers shifting from time deposits to transaction accounts. Total deposits at quarter-end were down from December 2010 and June 2010, largely reflecting runoff in time deposits.
• Portfolio loans and leases were up 1% from June 2010: consumer balances grew, while commercial balances declined slightly. Commercial and construction real estate lending continued to run off under tighter underwriting and lending restrictions.

Outlook, risks and unusual items

• The filing provides no specific earnings or revenue guidance. Management described credit trends as moderating and the economy as showing signs of stabilization, but highlighted continuing economic, unemployment and housing-market weakness, especially in Michigan and Florida.
• Interest-rate risk remains important. The company estimated that a parallel 100-basis-point increase would raise FTE net interest income 0.20% over 12 months and 3.27% over months 13–24; a 200-basis-point increase was estimated at 0.42% and 6.09%, respectively. These are model estimates, not forecasts.
• Management said the ultimate effects of the Dodd-Frank Act were not yet known and could adversely affect performance and growth. The phase-out of qualifying trust preferred securities from Tier I capital is scheduled to begin in 2013.
• On August 1, 2011, the SEC staff issued a Wells notice concerning disclosure and notification timing for the June redemption of Fifth Third Capital Trust VII securities. The staff indicated a preliminary intent to recommend an enforcement action alleging violations of Exchange Act Section 13(a) and Regulation FD. The company said it would respond and that a Wells notice is not a formal finding. The company anticipated compensation payments of up to approximately $1.5 million to certain purchasers of the securities.
• The SEC was also seeking information concerning accounting and reporting involving certain commercial loans. The filing says this could lead to an enforcement proceeding; the outcome and potential impact are not clear.
• Other material matters include Visa interchange-fee litigation and securities-related litigation; management said some cases remained unresolved and their ultimate effects could not be assessed. The company reported that a shareholder derivative complaint was expected to be dismissed following the court’s August 3, 2011 decision.
• Notable capital actions: Fifth Third raised $1.7 billion in common equity in January, issued $1.0 billion of 3.625% senior notes due 2016, redeemed $3.4 billion of Treasury-held Series F preferred stock in February, repurchased the Treasury warrant for $280 million in March, and redeemed $452 million of trust preferred securities in June. The quarterly common dividend was $0.06 per share.

Important facts for investors to verify

• How much of the earnings improvement reflects sustainable operating performance versus lower provisions, MSR/hedge valuation effects, capital actions and unusual preferred-stock accretion?
• Whether credit improvement persists, particularly in commercial real estate, Michigan and Florida, and whether the lower $2.614 billion allowance remains adequate as loan losses and nonperforming assets evolve.
• The composition and cost of funding: deposit trends, increased short-term FHLB borrowings, total borrowings, and the effect of low rates on net interest income.
• The status and potential financial, regulatory and disclosure consequences of the SEC investigations and Wells notice, as well as mortgage repurchase, Visa and other litigation exposures.
• Whether capital and liquidity remain resilient under stress, including the effect of trust-preferred phase-out and future regulatory requirements. Review the full notes and contingent-commitment disclosures; reported cash flows and modeled rate sensitivities are not substitutes for those details.