Fifth Third Bancorp — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. The filing was signed August 8, 2012. Fifth Third is a diversified U.S. bank headquartered in Cincinnati, operating across the Midwest and Southeast, with four reported segments: Commercial Banking, Branch Banking, Consumer Lending and Investment Advisors. Amounts below are in U.S. dollars; financial-statement amounts are generally in millions.
Financial performance and position
| Metric | Q2 2012 | Q2 2011 | First half 2012 | First half 2011 |
|---|---|---|---|---|
| Net interest income, FTE | $899 | $869 | $1,802 | $1,752 |
| Noninterest income | $678 | $656 | $1,448 | $1,240 |
| Total revenue, FTE basis | $1,577 | $1,525 | $3,250 | $2,992 |
| Provision for loan and lease losses | $71 | $113 | $162 | $281 |
| Noninterest expense | $937 | $901 | $1,911 | $1,819 |
| Net income attributable to Bancorp | $385 | $337 | $815 | $602 |
| Net income available to common shareholders | $376 | $328 | $797 | $417 |
| Diluted EPS | $0.40 | $0.35 | $0.85 | $0.46 |
Margins and returns: Net interest margin was 3.56% for Q2 and 3.59% for the first half, down from 3.62% and 3.66%, respectively. The efficiency ratio was 59.4% for Q2 versus 59.1%; first-half ratio improved to 58.8% from 60.8%. Q2 return on assets was 1.32% and return on average common equity was 11.4%.
Balance sheet and funding at June 30: Total assets were $117.5 billion; portfolio loans and leases were $82.4 billion; deposits were $84.3 billion; total borrowings were $14.9 billion, including $9.7 billion of long-term debt. Bancorp shareholders’ equity was $13.8 billion. Transaction deposits were $76.9 billion. The regulatory Tier I risk-based, total risk-based and Tier I leverage ratios were 12.31%, 16.24% and 11.39%, respectively. Tangible common equity was 9.15%, a non-GAAP measure.
Cash flow for the first half: Net cash provided by operating activities was $2.073 billion; investing activities used $2.342 billion and financing activities used $1 million. Cash and due from banks fell $270 million to $2.393 billion. The filing reports cash flows for the six months, not a standalone Q2 cash-flow figure.
Material changes versus comparable periods
- Q2 common net income rose 15% and diluted EPS rose 14%; first-half common net income rose substantially, partly because prior-year preferred dividends included $153 million of Series F discount accretion. First-half net income available to common shareholders increased 91%.
- Q2 net interest income increased 3%, supported by higher average loan balances and lower deposit funding costs, but the yield on interest-earning assets fell and net interest margin contracted. Average loans and leases rose 7% year over year in Q2.
- First-half noninterest income increased 17%, including a $115 million pretax gain from the Vantiv IPO in Q1. Mortgage banking revenue also increased with higher originations and loan-sale gains. Card and processing revenue declined 28% in both Q2 and the first half, primarily reflecting the debit-card interchange fee cap.
- Credit costs eased: net charge-offs were $181 million in Q2 and $401 million in the first half, down 40% in each comparison. The Q2 annualized net charge-off ratio was 0.88%, versus 1.56%; the ALLL ratio fell to 2.45% from 3.35% a year earlier.
- Nonperforming assets, including nonaccrual loans held for sale, declined to $1.679 billion from $2.264 billion a year earlier. OREO declined to $277 million from $449 million.
- Noninterest expense increased 4% in Q2 and 5% in the first half, primarily due to personnel costs. Core deposits grew 6% year over year at period end, while total deposits increased to $84.3 billion from $80.6 billion.
Outlook, management commentary, risks and unusual items
- Outlook: The filing does not provide specific earnings or revenue guidance. Management described credit trends as improved but continued to cite economic, real-estate and market uncertainty. It expected about $8 million of additional net interest income during the remainder of 2012 from acquired-loan and deposit discount accretion, excluding prepayment effects.
- Capital returns: The Federal Reserve did not object to maintaining the $0.08 quarterly common dividend, redeeming up to $1.4 billion of TruPS, and certain Vantiv-related share repurchases. It objected to a dividend increase and broader buybacks. Fifth Third resubmitted its capital plan in June; the filing says it expected a response about 75 days after resubmission. The company completed a roughly $75 million accelerated share repurchase, with additional shares delivered at settlement.
- Subsequent TruPS redemptions: After quarter-end, Fifth Third redeemed $862.5 million of 7.25% TruPS on August 8, funded with available cash; it reported a $9 million extinguishment loss for Q3. It also planned to redeem $575 million on August 15, with an estimated $17 million loss. Pro forma capital ratios after the redemptions were Tier I risk-based 10.95%, total risk-based 14.89% and Tier I leverage 10.14%.
- Vantiv and other one-time or valuation items: The Q1 Vantiv IPO diluted Fifth Third’s interest in Vantiv Holding to about 39% and generated the $115 million pretax gain. Q2 results also included positive Vantiv warrant valuation adjustments. Mortgage servicing rights (MSRs) were exposed to refinancing and rate changes: Q2 included $60 million of temporary MSR impairment, partly offset by $38 million of hedge gains.
- Credit and geographic risk: Management identified continuing stress in Michigan and Florida real estate, homebuilder/developer lending and some non-owner-occupied commercial real estate. It also cautioned that the ALLL methodology may lag changing credit conditions; a 10% downgrade of commercial risk grades was estimated to increase the commercial allowance by about $148 million.
- Legal and contingent matters: A July 2012 memorandum of understanding addressed settlement of the Visa interchange-fee litigation; the Bancorp had about $50 million reserved for the matter at June 30. Management estimated reasonably possible legal losses of up to approximately $49 million above reserves, while noting that some exposures could not be estimated. The SEC was investigating accounting and reporting matters involving certain commercial loans; an enforcement proceeding and adverse consequences were possible. Mortgage-loan representation-and-warranty reserves were $57 million, and unresolved repurchase demand inventory was $97 million.
- Regulation: Proposed Basel III-related U.S. rules were still under evaluation. Management estimated a fully phased-in Tier I common equity ratio of about 9% under its interpretation of the proposal, versus 9.77% under the existing framework. Dodd-Frank’s debit interchange cap was already reducing card revenue; the broader regulatory impact remained uncertain.
- Liquidity: Management cited $32.1 billion of secured borrowing capacity and $19.0 billion available under its bank note program, alongside a $5.6 billion shelf capacity, subject to market access and conditions. The company stated it maintained contingency funding and liquidity stress-testing processes.
Most important facts for investors to verify
- Whether improving credit quality persists and whether the lower $2.016 billion ALLL remains adequate as loan balances grow.
- How much earnings growth is recurring versus attributable to the Vantiv gain, warrant marks, mortgage origination conditions and other valuation effects.
- Whether net interest margin stabilizes as asset yields, deposit costs and loan mix change.
- The effect of TruPS redemptions on capital, liquidity, interest expense and Q3 earnings, including the reported extinguishment losses.
- The Federal Reserve’s response to the resubmitted capital plan and any resulting limits on dividends or repurchases.
- Developments in the SEC commercial-loan investigation, Visa litigation settlement, mortgage repurchase claims and related reserves.
- Exposure to MSR valuation changes and the effectiveness of the economic hedging strategy.