FIFTH THIRD BANCORP annual report, FY2017

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Fifth Third Bancorp — 2017 Form 10-K

Reporting period: Year ended December 31, 2017; fourth-quarter results are also summarized. Fifth Third Bancorp is a U.S. regional financial services company operating across the Midwest and Southeast through Commercial Banking, Branch Banking, Consumer Lending, and Wealth and Asset Management. The filing was signed February 28, 2018.

Financial performance and position

  • Revenue: Total revenue on a fully taxable equivalent (FTE, non-GAAP) basis was $7.048 billion, up from $6.336 billion in 2016. FTE net interest income was $3.824 billion, compared with $3.640 billion; GAAP net interest income was $3.798 billion. Noninterest income was $3.224 billion, up $528 million.
  • Earnings: Net income attributable to Fifth Third was $2.194 billion, versus $1.564 billion in 2016. Net income available to common shareholders was $2.119 billion, or $2.83 diluted EPS, compared with $1.489 billion, or $1.93. The 2017 results included a $1.037 billion Vantiv share-sale gain and a $220 million tax benefit from deferred-tax remeasurement.
  • Margins and returns: FTE net interest margin rose to 3.03% from 2.88%; the FTE net interest rate spread increased to 2.76% from 2.66%. The efficiency ratio improved to 56.6% from 61.6%. Return on average assets was 1.56% versus 1.10%; return on average common equity was 13.9% versus 9.8%.
  • Expenses and credit costs: Noninterest expense increased to $3.990 billion from $3.903 billion. Provision for loan and lease losses declined to $261 million from $343 million. Net charge-offs were $298 million, or 0.32% of average portfolio loans and leases, versus $362 million, or 0.39%.
  • Assets, loans and deposits: Year-end assets were $142.193 billion, little changed from $142.177 billion. Portfolio loans and leases were $91.970 billion, down from $92.098 billion; total deposits were $103.162 billion, down from $103.821 billion. Average loans declined, while average core deposits increased to $99.823 billion from $99.381 billion.
  • Credit quality: Nonperforming assets fell to $495 million from $751 million, and nonperforming portfolio assets were 0.53% of portfolio loans and leases and OREO, versus 0.80%. The allowance for loan and lease losses was $1.196 billion, or 1.30% of portfolio loans, compared with $1.253 billion, or 1.36%.
  • Cash flow: Net cash provided by operating activities was $1.494 billion, down from $2.114 billion. Investing activities provided $414 million, compared with $2.887 billion used in 2016; financing activities used $1.786 billion, versus $625 million provided. Cash and due from banks ended the year at $2.514 billion.
  • Debt and liquidity: Total borrowings were $19.090 billion, up from $18.055 billion; long-term debt was $14.904 billion. The Bancorp issued $700 million of senior notes and the Bank issued $1.1 billion of senior bank notes during 2017. The modified Liquidity Coverage Ratio was 129%; management reported $40.8 billion of available secured borrowing capacity.
  • Capital and shareholder returns: Bancorp CET1 was 10.61%, Tier 1 risk-based capital 11.74%, total risk-based capital 15.16%, and Tier 1 leverage 10.01%; the company stated it exceeded well-capitalized guidelines. Common dividends declared were $0.60 per share, up from $0.53. The Bancorp repurchased 58.5 million shares under its public program during 2017.

Material changes versus 2016

  • Net income rose substantially, but the increase was driven in large part by the $1.037 billion Vantiv share-sale gain and the $220 million TCJA-related deferred-tax benefit; these are not recurring operating trends.
  • Net interest income and margin improved with higher asset yields and federal funds rate increases. Higher deposit and wholesale funding costs partly offset those benefits, and average loans declined $1.6 billion.
  • Credit indicators improved overall: provision, charge-offs, nonperforming assets, and commercial criticized assets declined. However, consumer charge-offs were broadly stable and auto and home-equity balances continued to run off.
  • Mortgage banking net revenue decreased to $224 million from $285 million, including a $120 million net negative valuation adjustment on mortgage servicing rights (MSRs) and related hedges. The company adopted fair-value measurement for residential MSRs effective January 1, 2017.
  • Affordable-housing investment impairment increased to $222 million from $168 million, including $68 million recognized in fourth-quarter 2017 related primarily to the TCJA.

Outlook, management commentary and risks

  • Strategy: The three-year NorthStar plan targets, by the end of 2019, annualized return on average tangible common equity of 14%–16%, return on average assets of 1.35%–1.45%, and an efficiency ratio below 60%, alongside customer growth and risk and operational excellence.
  • Tax outlook: The company expects its effective tax rate to decrease significantly beginning in 2018 following the federal corporate rate reduction from 35% to 21%. The filing does not provide a specific 2018 earnings or tax-rate forecast.
  • Vantiv/Worldpay: Fifth Third retained an approximately 8.6% Vantiv Holding interest at year-end. Following Worldpay’s January 16, 2018 acquisition of Worldpay Group plc, the Bancorp expected an approximately $415 million gain in first-quarter 2018 from dilution of its interest to about 4.9%.
  • Fourth quarter: Common net income was $486 million, or $0.67 diluted EPS, versus $999 million in the third quarter and $372 million in fourth-quarter 2016. Sequential results reflected the absence of the third-quarter Vantiv gain, higher expenses, and a $27 million leveraged-lease tax remeasurement charge to interest income.
  • Interest-rate and funding risks: Management’s model showed net interest income benefiting from rising-rate scenarios and declining under a 75-basis-point rate decrease. Results depend on deposit behavior, repricing assumptions, loan and securities prepayments, and market rates. The filing also warns that LIBOR reforms could affect instruments tied to LIBOR.
  • Credit, market and operating risks: Management highlighted potential deterioration in credit quality, commercial real estate and retail-sector weakness, auto-credit standards, interest-rate and mortgage-servicing volatility, cybersecurity, third-party providers, regulatory changes, and liquidity or deposit pressures. The allowance model is judgmental; management estimated that a one-category downgrade affecting 10% of commercial loans could increase the commercial allowance by about $157 million.
  • Contingencies: The Bancorp estimated reasonably possible legal and regulatory losses of up to approximately $31 million in excess of accruals, while noting some matters could not be estimated. The Visa total-return swap liability was $137 million at year-end. The filing identifies significant pending litigation, including a trust-beneficiary claim seeking more than $800 million; outcomes and timing are uncertain.
  • Accounting outlook: Fifth Third expects adoption of the current expected credit loss standard (CECL) on January 1, 2020 to increase the allowance, but the amount was not yet determined. It expects the 2019 lease standard to materially increase balance-sheet assets and liabilities for operating leases.

Important facts for investors to verify

  • How much of 2017 earnings growth remains after excluding the Vantiv gain, TCJA deferred-tax benefit, and other unusual items.
  • Whether core earnings, net interest margin, deposit costs, and loan demand support the NorthStar targets and 2018 outlook.
  • MSR fair-value assumptions and sensitivity, mortgage banking performance, and the sustainability of its economic hedges.
  • Credit trends by portfolio, especially commercial exposures, retail-sector risk, auto lending, and older-vintage home-equity and mortgage loans; also assess the eventual CECL allowance impact.
  • Capital plans, buybacks and dividends relative to regulatory approval, liquidity needs, and debt maturities; review the Visa litigation exposure and other legal contingencies.
  • The expected Worldpay-related gain and the value, restrictions, and future disposition of Fifth Third’s remaining investment.

FTE figures and tangible-equity returns are non-GAAP measures. The filing cautions that forward-looking statements are subject to risks and uncertainties.