Fifth Third Bancorp — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Fifth Third is a diversified U.S. bank headquartered in Cincinnati, Ohio, with four reported segments: Commercial Banking, Branch Banking, Consumer Lending, and Wealth and Asset Management. Amounts below are in U.S. dollars; financial statement amounts are generally in millions.
Key financial results
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net interest income, GAAP | $1,200 | $1,245 | $2,429 | $2,327 |
| Net interest income, FTE | $1,203 | $1,250 | $2,436 | $2,336 |
| Total revenue, FTE | $1,853 | $1,910 | $3,757 | $4,097 |
| Provision for credit losses | $485 | $85 | $1,125 | $175 |
| Noninterest expense | $1,121 | $1,243 | $2,321 | $2,341 |
| Net income | $195 | $453 | $243 | $1,228 |
| Net income available to common shareholders | $163 | $427 | $193 | $1,187 |
| Diluted EPS | $0.23 | $0.57 | $0.27 | $1.66 |
Q2 FTE revenue declined 3% year over year and net income available to common shareholders fell 62%. For the first half, revenue declined 8% and common net income fell 84%; 2019 included a $562 million gain on sale of Worldpay shares. Q2 return on average assets was 0.40% and return on average common equity was 3.2%.
Margins, credit, balance sheet and liquidity
- Margins: FTE net interest margin was 2.75% in Q2, down from 3.37%; first-half margin was 2.99%, versus 3.33%. Lower market rates reduced asset yields, partly offset by lower deposit and funding costs. Management expected elevated excess cash to keep margins subdued.
- Credit: Net charge-offs were $130 million in Q2, or 0.44% of average portfolio loans, versus $78 million and 0.29% a year earlier. The allowance for loan and lease losses was $2.696 billion; the total allowance for credit losses, including unfunded commitments, was $2.872 billion. Total ACL equaled 2.50% of portfolio loans. Nonperforming assets were $749 million, or 0.65% of portfolio loans and leases plus OREO, compared with $687 million and 0.62% at year-end 2019.
- Assets and funding: Total assets were $202.9 billion, up from $169.4 billion at year-end 2019. Portfolio loans were $115.1 billion; deposits were $156.9 billion, up from $127.1 billion. Other short-term investments rose to $28.2 billion from $2.0 billion, reflecting deposit growth and repayment of commercial credit-line draws. Total borrowings were $17.9 billion, including $16.3 billion of long-term debt.
- Liquidity: Management reported more than $100 billion of available liquidity and said the Bancorp could meet contractual obligations and preferred and common dividends for 30 months without accessing capital markets or receiving upstream Bank dividends. The Bank had approximately $48.1 billion of available secured borrowing capacity.
- Cash flows, first half: Operating activities provided $1.952 billion; investing activities used $32.691 billion; financing activities provided $30.682 billion. Cash and due from banks declined $57 million to $3.221 billion. These flows reflect substantial growth in short-term investments and deposits.
- Capital: At June 30, CET1 was 9.72%, Tier 1 risk-based capital 10.96%, total risk-based capital 14.24%, and Tier 1 leverage 8.16%. Regulatory ratios include the five-year CECL transition. The FRB had given an indicative 2.5% stress capital buffer, with the final buffer then expected by August 31, 2020.
Material changes and notable items
- Fifth Third adopted CECL on January 1, 2020. Adoption increased the allowance by approximately $653 million and reduced retained earnings by $472 million. Subsequent pandemic-related deterioration drove further credit provisioning.
- Commercial and industrial lending grew, including $5.2 billion of PPP loans on the balance sheet at quarter-end; the Bancorp reported originating about 37,000 PPP loans totaling $5.5 billion. Commercial criticized assets and potential problem loans increased, with potential problem loans and leases rising to $3.157 billion from $1.578 billion at year-end.
- Mortgage banking revenue increased to $99 million in Q2 from $63 million, supported by higher originations and loan-sale gains. The MSR balance fell to $676 million from $993 million at year-end, largely due to valuation effects from lower rates and higher prepayment expectations; hedging gains partly offset these effects.
- Noninterest expense declined 10% in Q2, including lower MB Financial integration costs and pandemic-related reductions in marketing and travel. Merger-related expense was $9 million, versus $109 million in Q2 2019.
- Senior fixed-rate notes totaling $2.5 billion were issued in the first half: $1.25 billion by the Bank in January and $1.25 billion by the Bancorp in May. Long-term debt was $16.3 billion at June 30.
- Common dividends declared were $0.27 per share for Q2. Share repurchases were suspended; the FRB required large banks to suspend repurchases in Q3 and cap dividends at the Q2 amount, subject to an earnings-based formula.
Outlook, risks and contingencies
- Management said the pandemic and related economic disruption would adversely affect future results, while the scale and duration of the impact remained uncertain. The CECL baseline assumed a slow, U-shaped recovery, unemployment above 8% through the second half of 2020, and full recovery not until 2024; a more adverse W-shaped scenario assumed unemployment peaking at 12% in the first half of 2021. Applying the downside scenario alone would increase modeled quantitative ACL by approximately $1.5 billion, before any additional qualitative adjustments.
- Management expected service-charge revenue to increase in the low double digits in Q3 versus Q2, and card and processing revenue to rise in the low-to-mid single digits. No full-year earnings or revenue guidance is provided in the supplied filing text.
- Potential pressure points include pandemic-related borrower stress, energy exposure, heavily affected commercial sectors, low interest rates, deposit growth and excess liquidity, mortgage prepayments and MSR valuations, and the transition away from LIBOR. The Bancorp estimated pandemic hardship programs could reduce loan cash flows by $75–$100 million over the next 12 months and require $200–$300 million of mortgage servicer advances over six months.
- COVID-19 payment relief covered more than 150,000 customers; at June 30, portfolio loans and leases enrolled in deferral or forbearance programs totaled $6.710 billion. PPP guarantees and forgiveness processes were subject to regulatory and operational uncertainty.
- Legal matters include the CFPB lawsuit concerning alleged unauthorized accounts, shareholder litigation, and Visa/Mastercard interchange litigation. The filing estimated reasonably possible legal and regulatory losses up to approximately $86 million above accruals, while noting some matters could not be estimated. Mortgage representation-and-warranty losses could be up to approximately $9 million above the $7 million reserve.
- Goodwill was $4.261 billion. Management’s pandemic-related qualitative reviews found no indication of impairment at June 30, but warned that further economic deterioration could lead to future impairment charges.
Investor verification priorities
- Track credit migration, criticized and potential problem commercial loans, charge-offs, deferrals and the adequacy of the $2.872 billion total ACL against changing economic forecasts.
- Verify the effect of PPP balances, fee recognition, forgiveness, and SBA guarantee procedures on loan yields, credit risk and future revenue.
- Monitor net interest margin, excess cash balances, deposit costs, rate sensitivity and management’s stated outlook for the remainder of 2020.
- Confirm final regulatory capital-buffer requirements, dividend restrictions, and the impact of CECL transition treatment on reported capital ratios.
- Follow legal proceedings and whether losses exceed recorded reserves, particularly the CFPB and shareholder cases and the Visa-related swap exposure.
- Review subsequent-period MSR valuations, mortgage refinancing activity, hardship-program performance and liquidity needs.