Fifth Third Bancorp — Q3 2020 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and nine months ended September 30, 2020. Fifth Third is a U.S. regional financial services company with four reported segments: Commercial Banking, Branch Banking, Consumer Lending, and Wealth and Asset Management. It reported $202.0 billion in assets at quarter-end.
Key financial results
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income, GAAP | $1.170 billion | $1.242 billion | $3.600 billion | $3.569 billion |
| Total revenue, FTE | $1.895 billion | $1.986 billion | $5.653 billion | $6.083 billion |
| Provision for (benefit from) credit losses | $(15) million | $134 million | $1.110 billion | $310 million |
| Noninterest expense | $1.161 billion | $1.159 billion | $3.482 billion | $3.499 billion |
| Net income | $581 million | $549 million | $823 million | $1.778 billion |
| Net income available to common shareholders | $562 million | $530 million | $754 million | $1.718 billion |
| Diluted EPS | $0.78 | $0.71 | $1.04 | $2.37 |
Profitability and margins. Q3 return on average assets was 1.14%, return on average common equity was 10.7%, and FTE net interest margin was 2.58%, down from 3.32% a year earlier. The FTE efficiency ratio was 61.3%, versus 58.4%. For the nine months, return on average assets was 0.58%, FTE net interest margin 2.85%, and efficiency ratio 61.6%.
Cash flow. For the first nine months, operating activities provided $2.015 billion, investing activities used $31.593 billion, and financing activities provided $29.296 billion. Cash and due from banks declined $282 million to $2.996 billion. The large investing cash outflow primarily reflected a $29.335 billion increase in other short-term investments.
Balance sheet, funding, and liquidity. Period-end deposits were $156.7 billion, up from $127.1 billion at December 31, 2019; core deposits rose 24% to $153.4 billion. Portfolio loans and leases were $110.7 billion, up 1% from year-end; total loans including held-for-sale were $113.1 billion. Other short-term investments reached $31.3 billion, compared with $2.0 billion at year-end, as deposits grew and commercial credit-line draws were repaid. Total borrowings were $16.6 billion, including $15.1 billion of long-term debt. Management reported more than $100 billion of available liquidity and sufficient liquidity to meet contractual obligations and dividends for 31 months without capital-market access or upstream Bank dividends.
Capital. At September 30, regulatory ratios were 10.14% CET1, 11.64% Tier 1 risk-based, 14.93% total risk-based, and 8.37% Tier 1 leverage. These ratios include the five-year CECL transition benefit; management estimated full phase-in would reduce CET1 by 41 basis points. Tangible common equity to tangible assets, excluding AOCI, was 6.99%.
Material changes versus comparable periods
- Q3 common earnings rose 6% and diluted EPS increased to $0.78, despite lower revenue, largely because credit-loss provision shifted to a $15 million benefit from $134 million of expense in Q3 2019. The benefit reflected improved forecasts and consumer credit, lower period-end loans, and a lower allowance, partly offset by increasing commercial criticized assets and nonperforming loans.
- Nine-month common earnings fell 56%, reflecting $1.110 billion of credit-loss provision versus $310 million in 2019 and lower noninterest income. 2019 included a $562 million gain on the sale of Worldpay shares.
- Lower market rates compressed Q3 FTE net interest income by 6% year over year and reduced FTE net interest margin by 74 basis points. Lower deposit funding costs partly offset lower asset yields; elevated low-yield cash balances also weighed on margin.
- Noninterest income fell 2% in Q3 and 18% for the nine months. Q3 weakness included other income, mortgage servicing, and leasing; nine-month comparison was dominated by the prior-year Worldpay gain. Mortgage origination revenue improved amid refinancing activity, while mortgage servicing asset valuation adjustments remained adverse.
- Credit indicators weakened from year-end: net charge-offs for the first nine months increased to $353 million from $256 million; nonperforming assets increased to $942 million from $687 million; and potential problem commercial loans and leases rose to $3.652 billion from $1.578 billion.
Outlook, risks, contingencies, and unusual items
- COVID-19 and credit outlook: Management said the pandemic and economic uncertainty are expected to adversely affect future operating results, but the extent could not be estimated. Stress-exposed commercial industries included leisure and recreation, retail, healthcare, and travel; the energy loan portfolio was $2.8 billion. The allowance for credit losses was $2.756 billion in total, including $2.574 billion of loan allowance and $182 million for unfunded commitments. Management’s modeled quantitative allowance would increase approximately $1.3 billion if the downside scenario alone were used instead of the weighted scenarios.
- Relief programs and PPP: At September 30, the Bank held about 40,000 PPP loans with a carrying amount of $5.2 billion. Loans with $6.9 billion of amortized cost had received COVID-related payment relief; $1.963 billion remained in active relief. Most initial consumer and commercial relief programs ended during Q3, while residential mortgage forbearance enrollments were expected to continue through December 31, 2020.
- Interest rates and LIBOR: Management expected margin pressure to persist while excess liquidity remained elevated. The filing identifies material LIBOR exposure and an expected transition away from LIBOR by the end of 2021; the full impact remained unclear.
- Capital distributions and funding: The Federal Reserve’s Q3 restrictions on share repurchases and dividends were extended into Q4 2020, with dividends limited by a formula tied to recent income. Fifth Third suspended share repurchases and made no open-market or accelerated repurchases in the first three quarters. The common dividend declared was $0.27 per share for Q3.
- Capital issuance: The Bancorp issued $1.25 billion of senior notes in May; the Bank issued $1.25 billion of senior notes in January. In July, the Bancorp issued Series L preferred stock for approximately $346 million net proceeds.
- Litigation and contingencies: The filing estimates reasonably possible legal and regulatory losses of up to approximately $83 million above accruals, while noting some matters have unestimable ranges. The CFPB account-opening case, related shareholder litigation, and other proceedings remain pending. The Visa-related swap liability was $188 million; management said it was not probable that Visa litigation exposure would exceed the Class B value.
- Other unusual items: CECL adoption on January 1 increased the allowance by approximately $653 million and reduced retained earnings by $472 million. Annual goodwill testing at September 30 found no impairment, though management warned further economic deterioration could lead to future charges. Q3 included $51 million of net securities gains; nine-month other income was also affected by Visa swap losses and lower private-equity income.
- Controls: Management concluded disclosure controls were effective in all material respects and reported no material change in internal control over financial reporting, other than implementation controls related to CECL.
Important facts for investors to verify
- Whether commercial criticized assets, potential problem loans, nonperforming assets, and charge-offs continue to rise, and whether the $2.756 billion credit allowance remains adequate under changing economic forecasts.
- How quickly excess cash and deposit growth normalize, and the resulting effect on net interest margin, net interest income, and deposit costs.
- The performance and forgiveness timing of the $5.2 billion PPP portfolio and the repayment status of loans exiting hardship programs.
- Whether legal proceedings, particularly the CFPB and shareholder matters, produce losses above recorded accruals or affect reputation and business practices.
- Whether capital ratios remain adequate after CECL phase-in and regulatory restrictions, and whether dividend and repurchase limits change.
- How MSR valuations, mortgage refinancing activity, the Visa swap, and the LIBOR transition affect reported earnings and risk.
FTE and tangible-capital figures are non-GAAP measures as identified by the company; comparisons should be considered alongside GAAP results.