Fifth Third Bancorp — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Fifth Third is a diversified bank headquartered in Cincinnati, with $117.5 billion in assets and four reported segments: Commercial Banking, Branch Banking, Consumer Lending and Investment Advisors. Figures below are in U.S. dollars; income-statement comparisons are year over year unless noted.
Financial results and key metrics
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Total revenue, FTE | $1.578 billion | $1.567 billion | $4.828 billion | $4.560 billion |
| Net interest income, FTE | $907 million | $902 million | $2.709 billion | $2.655 billion |
| Net income attributable to Bancorp | $363 million | $381 million | $1.178 billion | $983 million |
| Net income available to common shareholders | $354 million | $373 million | $1.152 billion | $789 million |
| Diluted earnings per share | $0.38 | $0.40 | $1.23 | $0.86 |
| Net interest margin, FTE | 3.56% | 3.65% | 3.58% | 3.66% |
| Efficiency ratio, FTE basis | 63.7% | 60.4% | 60.4% | 60.6% |
| Provision for loan and lease losses | $65 million | $87 million | $227 million | $368 million |
| Net charge-offs | $156 million | $262 million | $557 million | $933 million |
At September 30, total assets were $117.5 billion; portfolio loans and leases were $83.1 billion; deposits were $84.7 billion; and total borrowings were $14.3 billion, including $8.1 billion of long-term debt. The allowance for loan and lease losses was $1.925 billion, or 2.32% of portfolio loans. Shareholders’ equity was $13.7 billion. Regulatory capital ratios were 10.85% Tier I risk-based, 14.76% total risk-based and 10.09% Tier I leverage; management said ratios exceeded well-capitalized guidelines. Tangible common equity was 9.10%, a non-GAAP measure.
For the first nine months, operating cash flow was $2.736 billion, investing cash flow was negative $2.311 billion and financing cash flow was negative $598 million. Cash and due from banks ended the period at $2.490 billion. The filing also reported $31.8 billion of secured borrowing capacity and $5.6 billion available under its public debt shelf, subject to market access and existing authorizations.
Material changes versus comparable periods
- Q3 common earnings fell 5% and diluted EPS declined from $0.40 to $0.38, despite 1% revenue growth. Higher noninterest expense, including $26 million of TruPS extinguishment costs, contributed to the quarterly decline.
- Nine-month common earnings rose 46%, with comparisons affected by $153 million of Series F preferred-stock discount accretion in 2011. 2012 results included a $115 million pretax gain ($75 million after tax) related to the Vantiv IPO.
- Credit measures improved: Q3 net charge-offs fell to 0.75% of average loans from 1.32%; nonperforming assets were $1.489 billion versus $2.141 billion a year earlier. The allowance declined from $2.439 billion to $1.925 billion year over year.
- Average loans grew 6% year over year in Q3, led by commercial and industrial and residential mortgage lending. Core deposits increased 4% on average, while average funding costs fell. Lower asset yields nevertheless compressed net interest margin.
- Noninterest income rose 1% in Q3 and 11% year to date. Mortgage banking and corporate banking gains were partly offset by lower card and processing income, reflecting debit interchange fee caps, and weaker securities gains. Noninterest expense rose 6% in both periods, driven mainly by personnel costs.
- Quarter-end deposits were down 1% from December 2011, while borrowings were up 8%; compared with September 2011, deposits were up 3% and borrowings down 5%.
Outlook, management commentary, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management cited a moderate economic recovery, improving credit trends, continued low interest rates and strong mortgage refinancing as relevant operating conditions.
- Management warned that low interest rates can pressure asset yields and mortgage-servicing-right values; faster prepayments caused $72 million of Q3 temporary MSR impairment, partly offset by $32 million of hedge gains. The filing describes the MSR hedge strategy as non-qualifying and subject to inefficiencies.
- The Federal Reserve did not object to a capital plan permitting a quarterly dividend increase to $0.10 and up to $600 million of share repurchases through Q1 2013. The Bancorp repurchased approximately $350 million of shares in August and had authorization for up to 100 million shares. A further approximately $125 million accelerated repurchase was announced November 6, after quarter-end.
- Fifth Third redeemed $1.4375 billion of 7.25% trust preferred securities in August, recognizing $26 million of extinguishment losses. It also issued $500 million of unsecured senior notes at 3.50%, due 2022. Proposed Basel III rules were estimated to yield a 9.01% fully phased-in Tier I common ratio; this was a preliminary, non-GAAP estimate based on draft rules.
- Mortgage representation-and-warranty reserves increased to $81 million from $55 million at year-end, primarily after receiving additional FHLMC information. The Bancorp reported $74 million of outstanding repurchase demands. It also had $687 million of mortgage loans sold with credit recourse, supported by an $18 million reserve.
- Legal and regulatory matters include an SEC investigation and information requests concerning accounting and reporting for certain commercial loans. The Bancorp estimated reasonably possible legal losses of up to approximately $52 million above reserves, while noting some matters could not be estimated. A proposed Visa interchange litigation settlement was announced October 19, after quarter-end; the Bancorp’s remaining reserve was approximately $50 million, and court approval was not assured.
- Management was evaluating possible effects of OCC guidance on Chapter 7 non-reaffirmed loans. Approximately $150 million of loans could be affected if regulators adopt the guidance, potentially increasing TDRs, nonperforming assets and charge-offs. Key broader risks include economic and real-estate weakness, credit deterioration, interest-rate changes, liquidity and capital requirements, regulation, litigation and operational or reputational events.
Most important facts for investors to verify
- Whether credit improvement continues as the allowance falls, and whether reserve coverage remains adequate given the filing’s cited sensitivities: a 10% downgrade across commercial risk grades could increase the allowance by about $153 million; a 10% increase in estimated residential and consumer loss rates could add about $52 million.
- Whether margin pressure persists: Q3 net interest margin fell 9 basis points year over year, while lower funding costs and loan growth supported net interest income.
- How sustainable mortgage-banking earnings are, including origination volumes, MSR valuation and hedge effectiveness as rates and refinancing activity change.
- The eventual costs and outcomes of mortgage repurchase claims, the Visa settlement and other litigation, and the SEC inquiry into commercial-loan accounting and reporting.
- Actual capital and liquidity effects of share repurchases, TruPS redemptions and final Basel III rules; distinguish the preliminary Basel III estimate from regulatory capital ratios.
- Whether the Q3 expense increase and weaker efficiency ratio reverse, and how recurring earnings compare after excluding the Vantiv IPO gain and other unusual items.