Fifth Third Bancorp — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Fifth Third is a diversified U.S. financial services company headquartered in Cincinnati, with banking operations across ten states and four reported segments: Commercial Banking, Branch Banking, Consumer Lending, and Wealth and Asset Management. Figures below are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial performance and condition
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $1,509 | $1,507 | $2,971 | $3,052 |
| Net interest income, GAAP | $939 | $902 | $1,872 | $1,805 |
| Net interest income, FTE | $945 | $908 | $1,884 | $1,817 |
| Noninterest income | $564 | $599 | $1,087 | $1,235 |
| Provision for loan and lease losses | $52 | $91 | $126 | $210 |
| Noninterest expense | $957 | $983 | $1,943 | $1,968 |
| Net income attributable to Bancorp | $367 | $328 | $672 | $654 |
| Net income available to common shareholders | $344 | $305 | $634 | $616 |
| Diluted EPS | $0.45 | $0.39 | $0.83 | $0.79 |
Margins and returns: FTE net interest margin was 3.01% in Q2, compared with 2.88% a year earlier; the six-month figures were 3.01% and 2.89%. The FTE efficiency ratio was 63.4% for Q2 (65.3% prior year) and 65.4% for the first half (64.5% prior year). Q2 return on average assets was 1.05%, and return on average common equity was 9.0%.
Cash flow, six months: Net cash provided by operating activities was $648 million, versus $702 million in 2016. Investing activities provided $844 million, compared with $2.264 billion used in 2016; financing activities used $1.681 billion, compared with $1.381 billion provided. Cash and due from banks decreased $189 million to $2.203 billion.
Balance sheet and funding at June 30: Total assets were $141.1 billion, down from $142.2 billion at December 31, 2016. Deposits were $101.9 billion, down from $103.8 billion; core deposits were $98.7 billion, versus $101.4 billion. Portfolio loans and leases were $91.4 billion, down from $92.1 billion. Total borrowings were $19.0 billion, up from $18.1 billion, including $5.4 billion of other short-term borrowings and $13.5 billion of long-term debt. The Bancorp issued $700 million of five-year, 2.60% senior notes in June.
Capital and liquidity: Basel III transitional CET1 was 10.63%, Tier 1 risk-based capital 11.76%, total risk-based capital 15.22%, and Tier 1 leverage 10.07%; management said ratios exceeded well-capitalized requirements. Modified LCR was 115%. The Bancorp reported approximately $39.6 billion of available secured borrowing capacity and $8.2 billion of debt or other securities available for issuance under existing Board authorizations.
Material changes and drivers
- Q2 revenue was nearly unchanged year over year; first-half revenue declined 3%, mainly from lower noninterest income. Q2 common net income rose 13% and diluted EPS rose 15% year over year.
- Higher loan yields, increased taxable securities balances, reduced average long-term debt, and Federal Reserve rate increases lifted net interest income and margin. These benefits were partly offset by lower average loan balances and higher deposit and debt funding costs.
- Noninterest income fell 6% in Q2 and 12% in the first half. Mortgage banking revenue declined $20 million in Q2 and $46 million in the first half; corporate banking revenue fell $16 million and $44 million, respectively. The first-half comparison also reflects 2016 Vantiv warrant valuation gains, branch-sale gains, and loan-sale gains that did not recur.
- Credit costs improved: provision expense declined to $52 million in Q2 and $126 million for the half. Net charge-offs were 0.28% of average portfolio loans in Q2 and 0.34% for the half, versus 0.37% and 0.39%. Nonperforming assets were $670 million, down from $751 million at year-end; the nonperforming portfolio asset ratio fell to 0.72% from 0.80%.
- Portfolio mix shifted: average loans were down 2% year over year, including lower commercial and industrial and auto balances; residential mortgage balances grew. The company cited deliberate exits from loans not meeting risk-adjusted return targets and a strategic shift in auto lending.
- Segment results were mixed. First-half Commercial Banking income was $437 million versus $438 million; Branch Banking was $233 million versus $240 million; Consumer Lending had a $17 million loss versus $16 million income; Wealth and Asset Management earned $37 million versus $48 million.
Outlook, risks, contingencies, and unusual items
- Outlook and capital returns: The filing provides no formal company-wide earnings or revenue guidance. Management described economic growth as improving and expected moderate U.S. GDP growth in 2017, while highlighting risks in retail commercial real estate and healthcare. The Federal Reserve did not object to planned capital actions for July 2017–June 2018: quarterly common dividends of $0.16 beginning in Q3 2017 and $0.18 beginning in Q2 2018, and share repurchases of up to $1.161 billion, subject to stated conditions and applicable requirements.
- Subsequent Vantiv transaction: On August 7, 2017, Fifth Third agreed to exchange 19.79 million Vantiv Holding Class B units for Vantiv Class A shares and have Vantiv repurchase those shares at $64.04 each, conditional on Vantiv publishing a firm offer for Worldpay and other terms. Fifth Third expected to record an approximately $1.0 billion pretax gain in Q3 2017. The transaction was not completed as of the filing date.
- Unusual items and accounting: A $31 million operating-lease-asset impairment was recorded in Q1 and reduced corporate banking revenue. Fifth Third adopted fair-value accounting for residential mortgage servicing rights (MSRs) prospectively on January 1, 2017; MSRs were $849 million at June 30, and first-half fair-value changes included a $70 million adjustment. The filing attributes lower mortgage rates and increased modeled prepayments to MSR valuation pressure. A revised estimate of certain bankcard customer refunds benefited first-half net interest income by $12 million.
- Credit and market risks: Management noted continued monitoring of non-power-producing energy, commercial real estate retail and healthcare, consumer auto-credit standards, and legacy real-estate lending. It also cited interest-rate sensitivity: modeled rising-rate NII benefits depend on deposit assumptions, including a 69% weighted-average rising-rate deposit beta; a 25% higher beta made modeled first-year NII decline under the +200 bps scenario.
- Legal and contingent exposures: The company estimated reasonably possible legal and regulatory losses of up to approximately $26 million above accruals, while noting that some matters cannot be estimated and outcomes could affect a particular period materially. Mortgage representation-and-warranty losses were estimated as reasonably possible up to $15 million above the $11 million reserve. Visa interchange litigation remains unresolved; the related Visa swap liability was $98 million, and management said an exposure exceeding the Class B value was not probable at June 30.
- Accounting standards: The expected-credit-loss standard (CECL) is scheduled for adoption in 2020; the Bancorp expects its allowance for credit losses to increase, but the amount was still under evaluation. The company also expected the 2019 lease standard to have a material balance-sheet effect from recognition of operating lease assets and liabilities.
Important facts for investors to verify
- Whether the improvement in credit costs and nonperforming assets persists, particularly in commercial criticized credits, energy, retail commercial real estate, and consumer auto and credit-card portfolios.
- Whether net interest margin gains can continue as loan balances, deposit costs, deposit mix, and interest-rate assumptions change.
- How much of the decline in noninterest income reflects recurring business trends versus prior-year gains and valuation items, and whether mortgage banking revenue stabilizes.
- The completion, conditions, timing, and final accounting impact of the Vantiv/Worldpay-related transaction and expected Q3 gain.
- Capital distributions, including the approved dividend increases and share-repurchase authorization, relative to capital, liquidity, and regulatory constraints.
- Updates to legal and repurchase contingencies, Visa litigation and swap valuation, and the estimated impact of CECL and lease-accounting adoption.
FTE net interest income, margin, and efficiency ratio are non-GAAP measures; GAAP figures are shown where available. The filing’s interim results are not necessarily indicative of full-year results.