Fifth Third Bancorp — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010. Financial statements are unaudited. Fifth Third is a diversified bank headquartered in Cincinnati, Ohio, with about $112 billion in assets at quarter-end. Unless noted, dollar amounts below are in millions.
Financial performance and condition
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net interest income, FTE | $887 | $836 | $1,788 | $1,617 |
| Noninterest income | $620 | $2,583 | $1,247 | $3,280 |
| Provision for loan and lease losses | $325 | $1,041 | $915 | $1,814 |
| Noninterest expense | $935 | $1,021 | $1,891 | $1,984 |
| Net income | $192 | $882 | $182 | $932 |
| Net income available to common shareholders | $130 | $856 | $57 | $829 |
| Diluted earnings per share | $0.16 | $1.15 | $0.07 | $1.18 |
- Margins and expenses: Net interest margin was 3.57% for Q2 and 3.60% for the first half, up from 3.26% and 3.16%. The Q2 efficiency ratio was 62.1%; the prior-year comparison was unusually low at 29.9% because it included the processing-business sale gain. Excluding that gain, Q2 2009’s ratio was 61.7%.
- Credit: Net charge-offs were $434 million in Q2 and $1.016 billion in the first half. Annualized net charge-offs were 2.26% and 2.64% of average loans, respectively. The allowance for loan and lease losses was $3.693 billion, or 4.85% of portfolio loans. Nonperforming assets were $3.136 billion including nonaccrual loans held for sale; the reported ratio excluding those held-for-sale loans was 3.87%.
- Balance sheet and funding: Total assets were $112.025 billion; portfolio loans and leases were $76.232 billion, deposits $82.115 billion, total borrowings $12.785 billion, and shareholders’ equity $13.701 billion. Loans including held-for-sale balances were $78.382 billion, down 8% from June 2009. Deposits were up 2% year over year, while borrowings were down 26%.
- Capital: Tier 1 capital was 13.66%, total risk-based capital 18.00%, Tier 1 leverage 12.24%, and Tier 1 common equity 7.17%. The filing states the regulatory capital ratios exceeded “well-capitalized” guidelines.
- Cash flows, first half: Operating activities provided $1.244 billion and investing activities provided $2.025 billion; financing activities used $3.371 billion. Cash and due from banks decreased $102 million to $2.216 billion.
Material changes versus comparable periods
- Net interest income improved as funding shifted toward lower-cost core deposits and wholesale funding declined. Average loans contracted, partly offsetting the benefit; average core deposits rose 12% year over year in Q2.
- Reported noninterest income fell sharply because Q2 2009 included a $1.764 billion gain from the sale of a majority interest in the merchant-acquiring and financial-institutions processing businesses. The sale also reduced subsequent card and processing revenue and expenses. Q2 2010 included $13 million of Transition Service Agreement revenue and matching operating expense.
- Provision expense and net charge-offs declined substantially year over year, and management described credit trends as showing signs of moderation. However, nonperforming assets were higher than a year earlier as a percentage of loans and other assets, and other real estate owned rose to $439 million from $253 million.
- Common earnings were also affected by preferred dividends: $62 million in Q2 and $125 million in the first half of 2010. The comparable 2009 amounts were $26 million and $103 million.
- Effective January 1, 2010, revised VIE accounting brought certain securitization entities onto the balance sheet. Initial adoption added about $1.3 billion in assets and reduced retained earnings by $77 million; management said regulatory capital ratios were not materially affected.
Outlook, risks, contingencies and unusual items
- The filing provides no specific earnings or financial guidance. Management cited weak economic conditions, unemployment, housing-market weakness—particularly in Michigan and Florida—and continued credit stress, while noting signs of moderation. It suspended homebuilder and new non-owner-occupied commercial real estate lending and tightened underwriting standards.
- Key disclosed risks include deterioration in credit quality, interest-rate and margin changes, funding and liquidity access, capital requirements, regulatory or legislative changes, litigation, competition, and operational and reputational risks. The filing’s forward-looking statements are subject to these and other uncertainties.
- Mortgage-related exposures warrant attention: the reserve for representations and warranties on residential loans sold to third parties increased to $65 million from $37 million at year-end; related first-half expense was $45 million. The company also reported $176 million of private mortgage-insurance reinsurance exposure, with a $58 million reserve.
- Legal matters include Visa interchange-fee litigation, patent litigation, and consolidated securities and ERISA cases; the filing says the outcomes of certain cases cannot currently be assessed. In Q2, Visa funded an additional $500 million to its litigation escrow, prompting a $20 million payment by Fifth Third under its related swap.
- Fifth Third opted out of the FDIC Transaction Account Guarantee program effective July 1, 2010. The filing discusses potential deposit-service-charge pressure from Regulation E, effective for new accounts July 1 and existing accounts August 15, 2010.
- Subsequent event: On August 3, 2010, Fifth Third reached a settlement concerning a bank-owned life insurance policy and related litigation. It expected to record an approximately $125 million pretax benefit, net of expenses, in Q3 2010.
- Common dividends were $0.01 per share in Q2. TARP-related restrictions limit common dividends and stock repurchases; the filing also notes that certain executive compensation deductions remain limited while the company participates in TARP.
Important facts for investors to verify
- How much of the lower credit provision reflects durable portfolio improvement, and whether nonperforming assets and foreclosed-property balances continue to decline.
- Whether net interest margin gains can persist amid shrinking loan balances, low rates, and changing deposit costs.
- The ongoing effect of the processing-business sale on recurring revenue, costs, and the remaining Transition Service Agreement.
- The adequacy of credit and mortgage-related reserves, including representation-and-warranty claims, PMI reinsurance, and real-estate exposures concentrated in Florida and Michigan.
- The timing, conditions, and actual Q3 accounting impact of the approximately $125 million BOLI settlement benefit; this is an expected, nonrecurring item.
- Liquidity and capital access after the TAG opt-out, the effect of the credit-rating downgrade by DBRS, and the terms and duration of TARP-related restrictions.
- Cash-flow and earnings comparability: 2009 results include the processing-sale gain, while 2010 balance-sheet figures reflect VIE consolidation and are not fully comparable without adjustment.