Fifth Third Bancorp — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Fifth Third is a diversified U.S. bank headquartered in Cincinnati, Ohio, with $141.7 billion in assets and four reportable segments. Unless otherwise noted, financial amounts are in millions.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income, GAAP | $1,043 | $970 | $3,059 | $2,842 |
| Net interest income, FTE | $1,047 | $977 | $3,071 | $2,861 |
| Noninterest income | $563 | $1,561 | $2,215 | $2,648 |
| Total revenue, FTE basis | $1,610 | $2,538 | $5,286 | $5,509 |
| Provision for loan and lease losses | $86 | $67 | $142 | $193 |
| Noninterest expense | $1,008 | $975 | $3,090 | $2,918 |
| Net income attributable to Bancorp | $433 | $1,014 | $1,721 | $1,685 |
| Net income available to common shareholders | $418 | $999 | $1,669 | $1,633 |
| Diluted EPS | $0.61 | $1.35 | $2.38 | $2.16 |
- Q3 net interest margin (FTE) was 3.23%, up from 3.07%; the nine-month margin was 3.20%, up from 3.03%. Higher asset yields and loan balances supported net interest income, while deposit and debt funding costs also rose.
- Q3 return on average assets was 1.21%, return on average common equity 11.2%, and FTE efficiency ratio 62.6%. The efficiency comparison is substantially affected by the unusual prior-year revenue gain.
- Nine-month operating cash flow was $1.927 billion, investing cash flow was negative $901 million, and financing cash flow was negative $1.440 billion. Cash and due from banks ended at $2.100 billion.
Balance sheet, credit and capital
- At September 30, total assets were $141.685 billion; portfolio loans and leases were $93.443 billion; deposits were $104.342 billion; and total borrowings were $17.890 billion. Total borrowings declined 6% from year-end 2017.
- Core deposits were $101.642 billion, up 1% from year-end. Demand deposits declined $3.5 billion, partly offset by growth in interest checking and money market accounts. Average interest-bearing core deposit cost rose to 0.74% in Q3 from 0.39% a year earlier.
- Net charge-offs were 0.30% of average portfolio loans in Q3 and 0.36% for the first nine months, versus 0.29% and 0.32% in the comparable 2017 periods. The allowance for loan and lease losses was $1.091 billion, or 1.17% of portfolio loans, down from $1.196 billion, or 1.30%, at year-end 2017. Nonperforming portfolio assets were 0.48% of loans and leases plus OREO, compared with 0.53% at year-end.
- Basel III ratios were 10.67% CET1, 11.78% Tier 1 risk-based, 14.94% total risk-based, and 10.10% Tier 1 leverage. Modified LCR was 119%.
- Available-for-sale securities had $942 million of gross unrealized losses and fair value of $31.808 billion against amortized cost of $32.707 billion. AOCI was negative $775 million at quarter-end, versus positive $73 million at year-end 2017.
Material changes and unusual items
- Q3 revenue fell 37% and common net income fell 58% year over year, mainly because Q3 2017 included a $1.037 billion gain on Worldpay shares. In 2018, Fifth Third recognized a $414 million Worldpay-related gain in Q1 and a $205 million gain on a Worldpay share sale in Q2; these do not recur in Q3. The company reported a remaining Worldpay Holding investment of $424 million and an approximately 3.3% interest.
- For the first nine months, revenue declined 4% while common net income increased 2%. Net interest income rose 8%; noninterest income declined 16%, reflecting the different timing and size of Worldpay gains and lower mortgage banking revenue. Noninterest expense rose 6%, including higher personnel and technology costs.
- The effective tax rate fell to 15.6% for Q3 and 15.7% for the first nine months, from 31.9% and 29.2%, respectively, primarily reflecting the lower federal corporate tax rate under the Tax Cuts and Jobs Act.
- Fifth Third repurchased approximately $500 million of common stock in Q3. It issued $900 million of Bancorp senior notes and the Bank issued $1.55 billion of senior bank notes during 2018.
Outlook, risks and contingencies
- No specific earnings or revenue guidance is provided in the filing. The company planned over two to three years to close 100–125 branches in mature markets and open 100–125 in higher-growth markets; 31 closures had been identified by quarter-end. It also planned to increase the quarterly dividend to $0.22 in Q4 2018 and $0.24 in Q2 2019, subject to regulatory capital-plan conditions, and had authorization for up to $1.651 billion in share repurchases through June 2019.
- The proposed MB Financial acquisition, valued at approximately $4.7 billion when announced, remained subject to regulatory approval and other closing conditions; closing was expected in Q1 2019. The Federal Reserve was reviewing Fifth Third’s resubmitted capital plan reflecting the proposed combination.
- Management described sensitivity to rates and deposit pricing. The modeled weighted-average rising-rate deposit beta was 70%; estimated NII was near neutral in year one and benefited in year two under a +200 bp ramp, but declined under a -125 bp ramp. The company entered into additional hedges in October to reduce falling-rate exposure.
- Management cited risks including credit deterioration, commercial real estate and retail-sector conditions, rising construction costs and tariffs, deposit competition, interest-rate and mortgage-servicing volatility, cyber and operational risks, regulatory changes, and merger integration and execution. The filing said the company had limited coastal exposure to the 2018 Carolinas hurricane and expected no material net charge-offs from it.
- Legal matters include payment-card interchange litigation, a putative settlement subject to court approval, and other proceedings. The company estimated reasonably possible legal and regulatory losses up to approximately $9 million above accruals where estimable, while noting some possible losses cannot be estimated. It also reported up to approximately $10 million of reasonably possible mortgage representation-and-warranty losses above reserves.
- Adoption of the new lease standard in 2019 was expected to add $400–$500 million of right-of-use assets and lease liabilities. The company expected its 2020 expected-credit-loss standard adoption to increase the allowance, but had not quantified the effect.
Most important facts for investors to verify
- How much of reported earnings and revenue reflects recurring banking operations versus Worldpay gains, valuation changes, and other one-time items.
- Whether net interest margin gains can continue as deposit costs rise, and how actual deposit betas compare with the 70% assumption used in rate-risk modeling.
- Credit performance in unsecured point-of-sale and credit-card lending, commercial criticized assets, and the adequacy of the allowance amid loan growth.
- The effect of unrealized securities losses and rate sensitivity on capital, liquidity, and future earnings.
- Regulatory approval, final terms, capital-plan implications, and expected benefits and costs of the MB Financial transaction.
- Execution and financial effects of branch closures and openings, planned dividends, and authorized repurchases.