Fifth Third Bancorp — 2009 Third-Quarter 10-Q
Business context and reporting period. Fifth Third Bancorp is a diversified bank headquartered in Cincinnati, operating primarily in the Midwest and Southeast. This unaudited filing covers the quarter and nine months ended September 30, 2009; comparisons are to the corresponding 2008 periods unless noted. The company reported four segments: Commercial Banking, Branch Banking, Consumer Lending, and Investment Advisors. On June 30, 2009, it sold a majority interest in its merchant acquiring and financial-institution processing businesses.
Financial performance and position
- Third-quarter results: Revenue was $1.725 billion on a fully taxable-equivalent (FTE) basis, down 3%. Net interest income was $874 million FTE (reported GAAP net interest income: $869 million), down 18%; noninterest income was $851 million, up 19%. The net loss was $97 million, or $159 million available to common shareholders after $62 million of preferred dividends; diluted loss per share was $0.20.
- Nine-month results: Revenue was $6.621 billion FTE, up 34%; net income was $835 million and income available to common shareholders was $670 million. Diluted earnings per share were $0.91. The comparison was materially affected by the $1.758 billion gain on the processing-business sale.
- Margins and costs: Third-quarter net interest margin was 3.43%, versus 4.24% a year earlier; excluding acquired-loan and deposit discount accretion, management said it was down 2 basis points. The efficiency ratio improved to 50.8% from 54.2%. Noninterest expense fell 9% to $876 million in the quarter, but rose 12% to $2.859 billion for the nine months, including higher FDIC, loan-processing, and unfunded-commitment costs.
- Credit: Third-quarter loan-loss provision was $952 million, versus $941 million; net charge-offs were $756 million, or 3.75% of average loans, versus $463 million and 2.17%. At quarter-end, the allowance for loan and lease losses was $3.681 billion, or 4.69% of loans, versus 2.41% a year earlier. Nonperforming assets, including loans held for sale, were $3.508 billion, compared with $2.451 billion; the reported ratio was approximately 4% excluding held-for-sale loans.
- Balance sheet and funding: Total assets were $110.740 billion, down from $116.294 billion a year earlier. Deposits were $79.358 billion, while total borrowings were $14.269 billion, down from $24.259 billion. Core deposits grew 12% year over year. Regulatory capital ratios at September 30 were 13.23% Tier 1, 17.48% total risk-based, 12.34% Tier 1 leverage, and 7.03% Tier 1 common equity; the company said it exceeded “well-capitalized” guidelines.
- Cash flows: For the first nine months, operating activities provided $2.471 billion, investing activities provided $5.102 billion, and financing activities used $8.182 billion. Cash and due from banks ended the period at $2.130 billion.
Material changes and unusual items
- The processing-business sale generated a $1.758 billion gain in the nine-month results and $562 million in cash proceeds. Fifth Third retained approximately 49% of the business and provides transition services; third-quarter transition-service revenue was $38 million.
- A $244 million third-quarter gain from selling Visa Class B shares contributed to noninterest income. The transaction, related swap, and reversal of the Visa litigation reserve produced a $288 million pretax benefit, or $187 million after tax. The company also released $73 million of Visa litigation reserves in the quarter.
- Mortgage banking revenue rose to $140 million from $45 million in the quarter, as originations more than doubled to $4.6 billion and sales margins improved. Management attributed the increase to lower rates and government homebuyer programs.
- Credit deterioration remained concentrated in real estate and construction, particularly in Michigan and Florida, and was worsened by unemployment and weak economic conditions. The company tightened underwriting, reduced or restructured exposures, and expanded workout efforts. It reported no subprime mortgage originations and no subprime-backed asset-backed securities in its investment portfolio.
- The company raised capital through a $1 billion common-stock offering and exchanged a portion of its Series G preferred stock. It reported that these actions, together with the processing-business sale, put Tier 1 common equity about $650 million above the SCAP assessment requirement. Common dividends remained $0.01 per share; Treasury-program terms restrict increases and share repurchases.
- Operating cash flow, reported earnings, and quarterly revenue include significant loan-loss provisions, securities and Visa gains, the processing-sale gain, and other nonrecurring or market-sensitive items. The filing provides no specific earnings guidance.
Outlook, risks, and contingencies
Management described the economy and credit environment as challenging and identified economic weakness, real-estate conditions, credit quality, interest rates, capital and funding needs, market disruption, regulation, litigation, and reputational risk as factors that could cause results to differ from expectations. No numerical forward guidance was provided. The filing said new accounting rules effective in 2010 were expected to require consolidation of certain previously unconsolidated securitization entities; based on September 30 balances, this could add about $1.6 billion of assets and reduce retained earnings by up to $92 million, with no material capital-ratio effect expected.
Commitments included $42.250 billion to extend credit and $7.691 billion of letters of credit. Other exposures include mortgage reinsurance, mortgage loans sold with recourse, liquidity and credit support for an unconsolidated commercial-loan vehicle, and litigation. The company said it could not assess the outcome of certain patent, securities-class-action, and ERISA matters. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether credit deterioration, charge-offs, delinquencies, and nonperforming assets continue to rise, especially in commercial real estate, construction, and Michigan and Florida portfolios.
- How much of reported revenue and earnings depends on the processing-sale gain, Visa-related benefits, mortgage refinancing activity, and other unusual items.
- Whether net interest margin stabilizes as acquired-loan discount accretion declines and deposit and wholesale-funding costs change.
- The adequacy of the loan-loss allowance and unfunded-commitment reserve relative to future losses; management’s disclosed sensitivities included a possible $197 million allowance increase under a commercial-loan downgrade scenario and $107 million under a 10% increase in estimated consumer and residential loss rates.
- The outcome and balance-sheet effect of the 2010 consolidation of securitization entities, litigation, Visa-related obligations, and other off-balance-sheet commitments.
- Capital, liquidity, dividend restrictions, and the terms and cost of preferred stock and Treasury-program funding.