Fifth Third Bancorp — Q2 2009 Form 10-Q
Business context and reporting period
Fifth Third Bancorp is a Cincinnati-based regional financial services company with five reported segments: Commercial Banking, Branch Banking, Consumer Lending, Processing Solutions and Investment Advisors. This unaudited report covers the quarter and six months ended June 30, 2009, with comparisons to 2008. The Bancorp reported $116.0 billion in assets at quarter-end.
Financial performance and condition
- Q2 earnings and revenue: Net income was $882 million, versus a $202 million net loss a year earlier; net income available to common shareholders was $856 million and diluted EPS was $1.15. Total revenue was $3.419 billion, including a $1.764 billion gain on the Processing Business Sale. Excluding that sale, management reported a $173 million net loss for the quarter.
- Six-month results: Net income was $932 million and net income available to common shareholders was $829 million, compared with $84 million in net income in the first half of 2008. Total revenue was $4.897 billion, including the processing-sale gain.
- Interest income and margins: Q2 net interest income was $831 million under GAAP ($836 million FTE); net interest margin was 3.26%, versus 3.04% in Q2 2008. The prior-year quarter included an approximately $130 million leveraged-lease charge; excluding that item, management said Q2 2009 net interest income fell about $38 million year over year and margin declined 31 basis points. Six-month FTE net interest income was $1.617 billion versus $1.570 billion.
- Credit costs and asset quality: Q2 loan-loss provision was $1.041 billion, up 45%; net charge-offs were $626 million, or 3.08% of average loans and leases, versus 1.66%. The allowance for loan and lease losses was $3.485 billion, or 4.28% of loans, compared with 1.85% a year earlier. Nonperforming assets including loans held for sale were $3.192 billion; the reported ratio excluding nonaccrual loans held for sale was 3.48%, versus 2.26% a year earlier.
- Expenses and efficiency: Q2 noninterest expense increased 19% to $1.021 billion, including a $55 million special FDIC assessment. The reported efficiency ratio was 29.9%, but 61.7% excluding the processing-sale gain, versus 58.6% in Q2 2008.
- Balance sheet, funding and liquidity: At June 30, total deposits were $80.820 billion, portfolio loans and leases were $81.429 billion, and total borrowings were $17.339 billion, down from $23.121 billion a year earlier. Core deposits were $69.628 billion, up 6% year over year. Cash and due from banks totaled $2.899 billion. The Bancorp reported $21.9 billion of secured borrowing capacity and $17.7 billion available under its bank-note program; availability from capital markets remained subject to conditions.
- Cash flows: For the first six months, operating activities provided $627 million, investing activities provided $3.043 billion, and financing activities used $3.510 billion. Cash and due from banks increased $160 million to $2.899 billion.
- Capital: Tier 1 capital was 12.90%, total risk-based capital 16.96%, Tier 1 leverage 12.17%, and Tier 1 common equity 6.94%. Tangible common equity was 6.55% under the company’s non-GAAP calculation. Management said the ratios exceeded well-capitalized guidelines.
Material changes versus the prior comparable period
- The June 30 sale of approximately 51% of the merchant acquiring and financial-institution processing businesses generated a $1.8 billion pretax gain ($1.1 billion after tax). Fifth Third retained approximately 49%, received a $1.25 billion note and warrants, and began accounting for its retained interest under the equity method.
- Capital actions included a $1 billion common-stock offering (approximately 158 million shares at an average $6.33) and an exchange of 63% of Series G preferred shares for approximately 60 million common shares and $230 million cash. These actions, together with the sale, strengthened capital; management said the Bancorp exceeded its SCAP Tier 1 common-equity requirement by approximately $650 million.
- Credit deterioration drove higher provisions, charge-offs and nonperforming assets. Commercial construction and other commercial real-estate exposures contracted, while consumer mortgage and other consumer lending balances increased. Management cited particular stress in Michigan and Florida.
- Mortgage banking net revenue rose to $147 million from $86 million, with mortgage originations more than doubling to $7.2 billion. Investment advisory revenue declined 21%, to $73 million.
- Net interest margin comparisons are affected by the $130 million leveraged-lease charge in Q2 2008. The Bancorp settled its leveraged-lease tax dispute with the IRS in Q1 2009; the settlement reduced first-half 2009 tax expense by $55 million.
Outlook, commentary, risks and unusual items
- The filing provides no specific numerical earnings or revenue guidance. Management emphasized continued economic weakness, credit deterioration and market disruption.
- Key risks include further deterioration in credit quality and real-estate values, especially in Michigan and Florida; unemployment and borrower stress; funding and liquidity access; interest-rate and margin changes; and regulatory, competitive, operational and reputational risks.
- The Bancorp disclosed $44.993 billion of commitments to extend credit and $7.933 billion of letters of credit. The off-balance-sheet commercial-loan QSPE had $1.2 billion of loans; Fifth Third held about 83% of its commercial paper and had a $2.4 billion liquidity asset-purchase agreement. Management expects the Bancorp to consolidate the QSPE upon adoption of new accounting standards on January 1, 2010; the QSPE had $1.3 billion of assets at June 30.
- Contingencies include mortgage credit recourse, private mortgage-insurance reinsurance exposure of $182 million (with a $30 million reserve), and pending litigation, including Visa-related antitrust claims and securities and ERISA class actions. Management said certain litigation outcomes could not be assessed; the TJX-related claims against the Bancorp had been dismissed.
- Subsequent to quarter-end, Visa-related transactions were expected to provide an approximately $206 million after-tax benefit in Q3 2009, including the sale of Visa Class B shares and additional escrow funding. The filing’s detailed note identifies a $288 million pretax benefit from the share sale and swap and a separate $29 million reduction in noninterest expense.
- Other unusual items included the $55 million special FDIC assessment, the $35 million benefit to common shareholders from the Series G exchange, and a $15 million facility impairment charge. The Bancorp stated it did not originate subprime mortgage loans and held no subprime-backed ABS in its securities portfolio.
Most important facts for investors to verify
- How much of reported earnings and revenue depended on the one-time processing-sale gain, and how the retained processing investment performs under equity-method accounting.
- Whether provisions, charge-offs and nonperforming assets stabilize or worsen, particularly for commercial real estate, construction, residential mortgages and home equity loans in Michigan and Florida.
- Whether capital and liquidity remain adequate after the equity issuance, preferred-stock exchange, sale proceeds and subsequent Visa transactions; also monitor dividend restrictions tied to Treasury preferred stock.
- The effects of the January 2010 QSPE consolidation and the Bancorp’s related liquidity, credit and balance-sheet exposure.
- Progress and potential financial impact of the disclosed litigation and mortgage-reinsurance exposures, and whether the anticipated Q3 Visa benefit was ultimately recognized as described.