Fifth Third Bancorp — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Amounts are U.S. dollars; financial statement amounts are generally in millions unless stated otherwise. Fifth Third is a diversified bank holding company operating across ten states, with four reported segments. It completed its acquisition of MB Financial on March 22, 2019.
Financial results and condition
| Metric | Q2 2019 | Q2 2018 | Change |
|---|---|---|---|
| Total revenue | $1.91 billion | $1.77 billion | +8% |
| Net interest income, GAAP | $1.245 billion | $1.020 billion | +22% |
| Net interest income, FTE | $1.250 billion | $1.024 billion | +22% |
| Noninterest income | $660 million | $743 million | -11% |
| Provision for credit losses | $85 million | $14 million | Higher |
| Noninterest expense | $1.243 billion | $1.001 billion | +24% |
| Net income attributable to Bancorp | $453 million | $602 million | -25% |
| Net income available to common shareholders | $427 million | $579 million | -26% |
| Diluted EPS | $0.57 | $0.82 | -30% |
For the six months ended June 30, revenue was $4.097 billion (+11% year over year), net income attributable to Bancorp was $1.228 billion (-6%), and diluted EPS was $1.66 (-7%). Six-month operating cash flow was $808 million, compared with $1.293 billion; investing cash flow was $(168) million versus $484 million provided; financing cash flow was $(557) million versus $(2.239) billion. Cash and due from banks ended the period at $2.764 billion.
Q2 FTE net interest margin was 3.37%, up from 3.21%; the FTE efficiency ratio was 65.1%, up from 56.7%. The higher expense ratio indicates weaker cost efficiency for the quarter. For the first half, FTE margin was 3.33% versus 3.19%, and the efficiency ratio was 57.1% versus 54.7%.
At June 30, total assets were $168.8 billion, portfolio loans and leases were $109.3 billion, deposits were $125.4 billion, and long-term debt was $15.8 billion. Total borrowings were $16.9 billion, essentially unchanged from year-end 2018. The modified liquidity coverage ratio was 119%. Regulatory capital ratios were CET1 9.57%, Tier 1 risk-based 10.62%, total risk-based 13.53%, and Tier 1 leverage 9.24%; each exceeded the filing’s stated well-capitalized thresholds.
Credit indicators were mixed: Q2 net charge-offs were $78 million, or 0.29% of average portfolio loans, versus $94 million and 0.41% a year earlier. However, nonperforming assets rose to $587 million from $411 million at December 31, 2018, and nonperforming portfolio assets reached 0.51% of portfolio loans and leases and OREO, versus 0.41% at year-end. The allowance for loan and lease losses was $1.115 billion; its ratio to portfolio loans fell to 1.02% from 1.16%, in part because acquired MB Financial loans were recorded at fair value without carrying over an allowance.
Material changes and unusual items
- MB Financial added $13.4 billion of portfolio loans and leases and $14.5 billion of deposits at acquisition. The acquisition was valued at approximately $3.6 billion and generated preliminary goodwill of $1.8 billion. Purchase-accounting fair values remain subject to revision for up to one year after closing.
- Merger-related expenses were $109 million in Q2 and $185 million in the first half, materially contributing to expense growth. The filing also cites acquisition-related staffing and operating costs and increased technology and security investment.
- Common earnings were affected by comparison-period and transaction gains. Fifth Third recorded a $562 million gain from selling its remaining Worldpay shares in Q1 2019; it no longer owns Worldpay equity. In Q2 2018, it had recorded a $205 million Worldpay share-sale gain. First-half 2018 also included a $414 million gain related to Vantiv’s acquisition of Worldpay Group.
- Q2 noninterest income declined mainly because the prior-year quarter included the Worldpay gain. First-half noninterest income rose 7%, partly reflecting the 2019 Worldpay share-sale gain and higher acquisition-related business activity.
- The company repurchased shares through accelerated share repurchase transactions totaling $1.113 billion during the first half. It announced approximately $2 billion of distribution capacity for July 2019–June 2020, including dividends and repurchases, excluding potential repurchases related to remaining after-tax Worldpay gains.
- Available-for-sale securities had net unrealized gains of approximately $1.0 billion at June 30, compared with net unrealized losses of $298 million at year-end 2018. AOCI moved from a loss of $112 million to income of $1.178 billion, substantially reflecting market-value changes in securities and cash-flow hedges.
Outlook, risks and contingencies
- The filing provides no specific earnings, revenue or margin forecast. Management described U.S. economic conditions as generally stable but cited unresolved trade tensions, possible global slowdown, market volatility and potential economic effects.
- Interest-rate sensitivity modeling showed near-neutral first-year and positive second-year NII sensitivity under a 200-basis-point rate increase, but lower NII under a 150-basis-point decline. Results depend on deposit pricing and balance assumptions; management noted that a higher assumed deposit beta could materially change sensitivity.
- Fifth Third expects to adopt CECL on January 1, 2020 and currently expects the allowance to increase, with the amount not yet determined. The impact depends on economic forecasts and portfolio composition and credit quality at adoption.
- The LIBOR transition remains a significant operational and contractual risk. Fifth Third has a transition plan, but timing, replacement benchmarks, contract continuity, systems readiness and market liquidity remain uncertain.
- Legal matters include the payment-card interchange litigation, with final approval of an amended settlement scheduled for November 2019; the Early Access case, in which plaintiffs allege damages exceeding $280 million after an appellate ruling revived a contract claim; and the pending Helton appeal. The filing estimates reasonably possible legal and regulatory losses of up to approximately $28 million above accruals where estimable, while noting some matters cannot be quantified. A separate mortgage representation-and-warranty exposure was estimated at up to $14 million above its reserve.
- The company expects to close 46 acquired Chicago-area branches in Q3 2019, in addition to previously planned branch closures. It also applied to convert its Ohio state-chartered bank to a national bank, subject to regulatory approval.
- Management said disclosure controls were effective. Integration of MB Financial into financial reporting and internal-control processes was ongoing.
Most important facts for investors to verify
- Whether merger integration produces anticipated benefits and cost savings, and how much additional integration expense remains.
- Whether the increase in nonperforming assets and provision for credit losses persists, especially in light of consumer charge-off trends and acquired-loan accounting.
- The eventual CECL allowance and capital impact at adoption in 2020.
- How deposit costs, deposit growth and interest-rate changes affect net interest margin and funding needs.
- Progress and final outcomes in the cited litigation, including the interchange settlement and Early Access claim.
- Completion and fair-value adjustments for the MB Financial purchase accounting, plus execution of planned branch closures and capital distributions.