UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2018
Commission File Number 001-33653
(Exact name of Registrant as specified in its charter)
Ohio |
31-0854434 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification Number) |
Fifth Third Center
Cincinnati, Ohio 45263
(Address of principal executive offices)
Registrants telephone number, including area code: (800) 972-3030
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of large accelerated filer, accelerated filer, smaller reporting company and emerging growth company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer |
☒ | Accelerated filer | ☐ | |||
Non-accelerated filer |
☐ | Smaller reporting company | ☐ | |||
Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
There were 655,615,619 shares of the Registrants common stock, without par value, outstanding as of October 31, 2018.
Part I. Financial Information |
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2 | ||||
Managements Discussion and Analysis of Financial Condition and Results of Operations (Item 2) |
3 | |||
3 | ||||
4 | ||||
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10 | ||||
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11 | ||||
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25 | ||||
32 | ||||
33 | ||||
46 | ||||
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53 | ||||
53 | ||||
54 | ||||
56 | ||||
Quantitative and Qualitative Disclosures about Market Risk (Item 3) |
57 | |||
57 | ||||
Condensed Consolidated Financial Statements and Notes (Item 1) |
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58 | ||||
59 | ||||
60 | ||||
61 | ||||
62 | ||||
Notes to Condensed Consolidated Financial Statements (unaudited) |
63 | |||
Part II. Other Information |
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119 | ||||
119 | ||||
Unregistered Sales of Equity Securities and Use of Proceeds (Item 2) |
119 | |||
119 | ||||
120 |
FORWARD-LOOKING STATEMENTS
This report contains statements that we believe are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended, and Rule 3b-6 promulgated thereunder. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. They usually can be identified by the use of forward-looking language such as will likely result, may, are expected to, is anticipated, potential, estimate, forecast, projected, intends to, or may include other similar words or phrases such as believes, plans, trend, objective, continue, remain, or similar expressions, or future or conditional verbs such as will, would, should, could, might, can, or similar verbs. You should not place undue reliance on these statements, as they are subject to risks and uncertainties, including but not limited to the risk factors set forth in the Risk Factors section in Item 1A in our most recent Annual Report on Form 10-K as updated by our Quarterly Reports on Form 10-Q. When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements we may make. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to us. There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements. Factors that might cause such a difference include, but are not limited to: (1) deteriorating credit quality; (2) loan concentration by location or industry of borrowers or collateral; (3) problems encountered by other financial institutions; (4) inadequate sources of funding or liquidity; (5) unfavorable actions of rating agencies; (6) inability to maintain or grow deposits; (7) limitations on the ability to receive dividends from subsidiaries; (8) cyber-security risks; (9) Fifth Thirds ability to secure confidential information and deliver products and services through the use of computer systems and telecommunications networks; (10) failures by third-party service providers; (11) inability to manage strategic initiatives and/or organizational changes; (12) inability to implement technology system enhancements; (13) failure of internal controls and other risk management systems; (14) losses related to fraud, theft or violence; (15) inability to attract and retain skilled personnel; (16) adverse impacts of government regulation; (17) governmental or regulatory changes or other actions; (18) failures to meet applicable capital requirements; (19) regulatory objections to Fifth Thirds capital plan; (20) regulation of Fifth Thirds derivatives activities; (21) regulatory objections to Fifth Thirds resolution plan; (22) deposit insurance premiums; (23) assessments for the orderly liquidation fund; (24) changes in LIBOR; (25) weakness in the national or local economies; (26) global political and economic uncertainty or negative actions; (27) changes in interest rates; (28) changes and trends in capital markets; (29) fluctuation of Fifth Thirds stock price; (30) volatility in mortgage banking revenue; (31) litigation, investigations, and enforcement proceedings by governmental authorities; (32) breaches of contractual covenants, representations and warranties; (33) competition and changes in the financial services industry; (34) changing retail distribution strategies, customer preferences and behavior; (35) risks relating to the potential merger with MB Financial, Inc. and Fifth Thirds ability to realize the anticipated benefits of the merger; (36) difficulties in identifying, acquiring or integrating suitable strategic partnerships, investments or acquisitions; (37) potential dilution from future acquisitions; (38) loss of income and/or difficulties encountered in the sale and separation of businesses, investments or other assets; (39) results of Worldpay Holding, LLC (formerly Vantiv Holding, LLC) a subsidiary of Worldpay, Inc. or other investments or acquired entities; (40) difficulties from or changes in Fifth Thirds investment in, relationship with, and nature of the operations of Worldpay Holding, LLC, a subsidiary of Worldpay, Inc.; (41) changes in accounting standards or interpretation or declines in the value of Fifth Thirds goodwill or other intangible assets; (42) inaccuracies or other failures from the use of models; (43) effects of critical accounting policies and judgments or the use of inaccurate estimates; (44) weather related events or other natural disasters; and (45) the impact of reputational risk created by these or other developments on such matters as business generation and retention, funding and liquidity.
1
Glossary of Abbreviations and Acronyms
Fifth Third Bancorp provides the following list of abbreviations and acronyms as a tool for the reader that are used in Managements Discussion and Analysis of Financial Condition and Results of Operations, the Condensed Consolidated Financial Statements and the Notes to Condensed Consolidated Financial Statements.
ALCO: Asset Liability Management Committee ALLL: Allowance for Loan and Lease Losses AOCI: Accumulated Other Comprehensive Income (Loss) APR: Annual Percentage Rate ARM: Adjustable Rate Mortgage ASF: Available Stable Funding ASU: Accounting Standards Update ATM: Automated Teller Machine BCBS: Basel Committee on Banking Supervision BHC: Bank Holding Company BOLI: Bank Owned Life Insurance BPO: Broker Price Opinion bps: Basis Points CCAR: Comprehensive Capital Analysis and Review CDC: Fifth Third Community Development Corporation CET1: Common Equity Tier 1 CFPB: Consumer Financial Protection Bureau C&I: Commercial and Industrial DCF: Discounted Cash Flow DFA: Dodd-Frank Wall Street Reform & Consumer Protection Act DTCC: Depository Trust & Clearing Corporation ERM: Enterprise Risk Management ERMC: Enterprise Risk Management Committee EVE: Economic Value of Equity FASB: Financial Accounting Standards Board FDIC: Federal Deposit Insurance Corporation FHA: Federal Housing Administration FHLB: Federal Home Loan Bank FHLMC: Federal Home Loan Mortgage Corporation FICO: Fair Isaac Corporation (credit rating) FINRA: Financial Industry Regulatory Authority FNMA: Federal National Mortgage Association FOMC: Federal Open Market Committee FRB: Federal Reserve Bank FTE: Fully Taxable Equivalent FTP: Funds Transfer Pricing FTS: Fifth Third Securities GDP: Gross Domestic Product GNMA: Government National Mortgage Association GSE: United States Government Sponsored Enterprise |
HQLA: High Quality Liquid Assets IPO: Initial Public Offering IRC: Internal Revenue Code IRLC: Interest Rate Lock Commitment ISDA: International Swaps and Derivatives Association, Inc. LCR: Liquidity Coverage Ratio LIBOR: London Interbank Offered Rate LLC: Limited Liability Company LTV: Loan-to-Value MD&A: Managements Discussion and Analysis of Financial Condition MSR: Mortgage Servicing Right N/A: Not Applicable NII: Net Interest Income NM: Not Meaningful NPR: Notice of Proposed Rulemaking NSFR: Net Stable Funding Ratio OAS: Option-Adjusted Spread OCI: Other Comprehensive Income (Loss) OREO: Other Real Estate Owned OTTI: Other-Than-Temporary Impairment PCA: Prompt Corrective Action RCC: Risk Compliance Committee RSF: Required Stable Funding SAR: Stock Appreciation Right SBA: Small Business Administration SCB: Stress Capital Buffer SEC: United States Securities and Exchange Commission SLB: Stress Leverage Buffer TBA: To Be Announced TCJA: Tax Cuts and Jobs Act TDR: Troubled Debt Restructuring TILA: Truth in Lending Act TRA: Tax Receivable Agreement U.S.: United States of America U.S. GAAP: United States Generally Accepted Accounting Principles VA: United States Department of Veteran Affairs VIE: Variable Interest Entity VRDN: Variable Rate Demand Note |
2
Managements Discussion and Analysis of Financial Condition and Results of Operations (Item 2)
The following is Managements Discussion and Analysis of Financial Condition and Results of Operations of certain significant factors that have affected Fifth Third Bancorps (the Bancorp or Fifth Third) financial condition and results of operations during the periods included in the Condensed Consolidated Financial Statements, which are a part of this filing. Reference to the Bancorp incorporates the parent holding company and all consolidated subsidiaries. The Bancorps banking subsidiary is referred to as the Bank.
For the three months | For the nine months | |||||||||||||||||||||||||||||||
ended September 30, | % | ended September 30, | % | |||||||||||||||||||||||||||||
($ in millions, except for per share data) |
2018 | 2017 | Change | 2018 | 2017 | Change | ||||||||||||||||||||||||||
Income Statement Data |
||||||||||||||||||||||||||||||||
Net interest income (U.S. GAAP) |
$ | 1,043 | 970 | 8 | $ | 3,059 | 2,842 | 8 | ||||||||||||||||||||||||
Net interest income (FTE)(a)(b) |
1,047 | 977 | 7 | 3,071 | 2,861 | 7 | ||||||||||||||||||||||||||
Noninterest income |
563 | 1,561 | (64 | ) | 2,215 | 2,648 | (16 | ) | ||||||||||||||||||||||||
Total revenue(a) |
1,610 | 2,538 | (37 | ) | 5,286 | 5,509 | (4 | ) | ||||||||||||||||||||||||
Provision for loan and lease losses |
86 | 67 | 28 | 142 | 193 | (26 | ) | |||||||||||||||||||||||||
Noninterest expense |
1,008 | 975 | 3 | 3,090 | 2,918 | 6 | ||||||||||||||||||||||||||
Net income attributable to Bancorp |
433 | 1,014 | (57 | ) | 1,721 | 1,685 | 2 | |||||||||||||||||||||||||
Net income available to common shareholders |
418 | 999 | (58 | ) | 1,669 | 1,633 | 2 | |||||||||||||||||||||||||
Common Share Data |
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Earnings per share - basic |
$ | 0.62 | 1.37 | (55 | ) | $ | 2.43 | 2.19 | 11 | |||||||||||||||||||||||
Earnings per share - diluted |
0.61 | 1.35 | (55 | ) | 2.38 | 2.16 | 10 | |||||||||||||||||||||||||
Cash dividends declared per common share |
0.18 | 0.16 | 13 | 0.52 | 0.44 | 18 | ||||||||||||||||||||||||||
Book value per share |
21.92 | 21.30 | 3 | 21.92 | 21.30 | 3 | ||||||||||||||||||||||||||
Market value per share |
27.92 | 27.98 | - | 27.92 | 27.98 | - | ||||||||||||||||||||||||||
Financial Ratios |
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Return on average assets |
1.21 | % | 2.85 | (58 | ) | 1.63 | % | 1.60 | 2 | |||||||||||||||||||||||
Return on average common equity |
11.2 | 25.6 | (56 | ) | 15.0 | 14.3 | 5 | |||||||||||||||||||||||||
Return on average tangible common equity(b) |
13.5 | 30.4 | (56 | ) | 18.1 | 17.0 | 6 | |||||||||||||||||||||||||
Dividend payout |
29.0 | 11.7 | 148 | 21.4 | 20.1 | 6 | ||||||||||||||||||||||||||
Average total Bancorp shareholders equity as a percent of average assets |
11.39 | 11.93 | (5 | ) | 11.43 | 11.83 | (3 | ) | ||||||||||||||||||||||||
Tangible common equity as a percent of tangible assets(b)(h) |
9.12 | 8.89 | 3 | 9.12 | 8.89 | 3 | ||||||||||||||||||||||||||
Net interest margin(a)(b) |
3.23 | 3.07 | 5 | 3.20 | 3.03 | 6 | ||||||||||||||||||||||||||
Net interest rate spread (a)(b) |
2.87 | 2.79 | 3 | 2.87 | 2.77 | 4 | ||||||||||||||||||||||||||
Efficiency(a)(b) |
62.6 | 38.4 | 63 | 58.5 | 53.0 | 10 | ||||||||||||||||||||||||||
Credit Quality |
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Net losses charged-off |
$ | 72 | 68 | 6 | $ | 247 | 221 | 12 | ||||||||||||||||||||||||
Net losses charged-off as a percent of average portfolio loans and leases |
0.30 | % | 0.29 | 3 | 0.36 | % | 0.32 | 13 | ||||||||||||||||||||||||
ALLL as a percent of portfolio loans and leases |
1.17 | 1.31 | (11 | ) | 1.17 | 1.31 | (11 | ) | ||||||||||||||||||||||||
Allowance for credit losses as a percent of portfolio loans and leases(c) |
1.31 | 1.48 | (11 | ) | 1.31 | 1.48 | (11 | ) | ||||||||||||||||||||||||
Nonperforming portfolio assets as a percent of portfolio loans and leases and OREO |
0.48 | 0.60 | (20 | ) | 0.48 | 0.60 | (20 | ) | ||||||||||||||||||||||||
Average Balances |
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Loans and leases, including held for sale |
$ | 93,977 | 92,617 | 1 | $ | 93,363 | 92,686 | 1 | ||||||||||||||||||||||||
Securities and other short-term investments |
34,822 | 33,826 | 3 | 34,813 | 33,497 | 4 | ||||||||||||||||||||||||||
Assets |
141,752 | 140,992 | 1 | 141,616 | 140,495 | 1 | ||||||||||||||||||||||||||
Transaction deposits(d) |
97,315 | 94,927 | 3 | 97,303 | 95,916 | 1 | ||||||||||||||||||||||||||
Core deposits(e) |
101,492 | 98,649 | 3 | 101,321 | 99,680 | 2 | ||||||||||||||||||||||||||
Wholesale funding(f) |
20,613 | 21,529 | (4 | ) | 20,546 | 20,450 | - | |||||||||||||||||||||||||
Bancorp shareholders equity |
16,145 | 16,820 | (4 | ) | 16,187 | 16,623 | (3 | ) | ||||||||||||||||||||||||
Regulatory Capital and Liquidity Ratios |
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CET1 capital(g) |
10.67 | % | 10.59 | 1 | 10.67 | % | 10.59 | 1 | ||||||||||||||||||||||||
Tier I risk-based capital(g) |
11.78 | 11.72 | 1 | 11.78 | 11.72 | 1 | ||||||||||||||||||||||||||
Total risk-based capital(g) |
14.94 | 15.16 | (1 | ) | 14.94 | 15.16 | (1 | ) | ||||||||||||||||||||||||
Tier I leverage |
10.10 | 9.97 | 1 | 10.10 | 9.97 | 1 | ||||||||||||||||||||||||||
Modified LCR |
119 | 124 | (4 | ) | 119 | 124 | (4 | ) |
(a) |
Amounts presented on an FTE basis. The FTE adjustment for the three months ended September 30, 2018 and 2017 was $4 and $7, respectively, and for the nine months ended September 30, 2018 and 2017 was $12 and $19, respectively. |
(b) |
These are non-GAAP measures. For further information, refer to the Non-GAAP Financial Measures section of MD&A. |
(c) |
The allowance for credit losses is the sum of the ALLL and the reserve for unfunded commitments. |
(d) |
Includes demand deposits, interest checking deposits, savings deposits, money market deposits and foreign office deposits. |
(e) |
Includes transaction deposits and other time deposits. |
(f) |
Includes certificates $100,000 and over, other deposits, federal funds purchased, other short-term borrowings and long-term debt. |
(g) |
Under the U.S. banking agencies Basel III Final Rule, assets and credit equivalent amounts of off-balance sheet exposures are calculated according to the standardized approach for risk-weighted assets. The resulting values are added together in the Bancorps total risk-weighted assets. |
(h) |
Excludes unrealized gains and losses. |
3
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
Fifth Third Bancorp is a diversified financial services company headquartered in Cincinnati, Ohio. At September 30, 2018, the Bancorp had $141.7 billion in assets and operated 1,152 full-service banking centers and 2,443 Fifth Third branded ATMs in ten states throughout the Midwestern and Southeastern regions of the U.S. The Bancorp reports on four business segments: Commercial Banking, Branch Banking, Consumer Lending and Wealth and Asset Management. The Bancorp also has an approximate 3.3% interest in Worldpay Holding, LLC (formerly Vantiv Holding, LLC). The carrying value of the Bancorps investment in Worldpay Holding, LLC was $424 million at September 30, 2018.
This overview of MD&A highlights selected information in the financial results of the Bancorp and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources and critical accounting policies and estimates, you should carefully read this entire document as well as the Bancorps Annual Report on Form 10-K for the year ended December 31, 2017. Each of these items could have an impact on the Bancorps financial condition, results of operations and cash flows. In addition, refer to the Glossary of Abbreviations and Acronyms in this report for a list of terms included as a tool for the reader of this quarterly report on Form 10-Q. The abbreviations and acronyms identified therein are used throughout this MD&A, as well as the Condensed Consolidated Financial Statements and Notes to Condensed Consolidated Financial Statements.
Net interest income, net interest margin, net interest rate spread and the efficiency ratio are presented in MD&A on an FTE basis. The FTE basis adjusts for the tax-favored status of income from certain loans and securities held by the Bancorp that are not taxable for federal income tax purposes. The Bancorp believes this presentation to be the preferred industry measurement of net interest income as it provides a relevant comparison between taxable and non-taxable amounts. The FTE basis for presenting net interest income is a non-GAAP measure. For further information, refer to the Non-GAAP Financial Measures section of MD&A.
The Bancorps revenues are dependent on both net interest income and noninterest income. For the three months ended September 30, 2018, net interest income on an FTE basis and noninterest income provided 65% and 35% of total revenue, respectively. For the nine months ended September 30, 2018, net interest income on an FTE basis and noninterest income provided 58% and 42% of total revenue, respectively. The Bancorp derives the majority of its revenues within the U.S. from customers domiciled in the U.S. Revenue from foreign countries and external customers domiciled in foreign countries was immaterial to the Condensed Consolidated Financial Statements for both the three and nine months ended September 30, 2018. Changes in interest rates, credit quality, economic trends and the capital markets are primary factors that drive the performance of the Bancorp. As discussed later in the Risk Management section of MD&A, risk identification, measurement, monitoring, control and reporting are important to the management of risk and to the financial performance and capital strength of the Bancorp.
Net interest income is the difference between interest income earned on assets such as loans, leases and securities, and interest expense incurred on liabilities such as deposits, other short-term borrowings and long-term debt. Net interest income is affected by the general level of interest rates, the relative level of short-term and long-term interest rates, changes in interest rates and changes in the amount and composition of interest-earning assets and interest-bearing liabilities. Generally, the rates of interest the Bancorp earns on its assets and pays on its liabilities are established for a period of time. The change in market interest rates over time exposes the Bancorp to interest rate risk through potential adverse changes to net interest income and financial position. The Bancorp manages this risk by continually analyzing and adjusting the composition of its assets and liabilities based on their payment streams and interest rates, the timing of their maturities and their sensitivity to changes in market interest rates. Additionally, in the ordinary course of business, the Bancorp enters into certain derivative transactions as part of its overall strategy to manage its interest rate and prepayment risks. The Bancorp is also exposed to the risk of loss on its loan and lease portfolio, as a result of changing expected cash flows caused by borrower credit events, such as loan defaults and inadequate collateral.
Noninterest income is derived from service charges on deposits, wealth and asset management revenue, corporate banking revenue, card and processing revenue, mortgage banking net revenue, net securities gains or losses and other noninterest income. Noninterest expense includes personnel costs, net occupancy expense, technology and communication costs, equipment expense, card and processing expense and other noninterest expense.
Worldpay, Inc. and Worldpay Holding, LLC Transactions
On January 16, 2018, Vantiv, Inc. completed its previously announced acquisition of Worldpay Group plc. with the resulting combined company named Worldpay, Inc. As a result of this transaction, the Bancorp recognized a gain of $414 million in other noninterest income during the first quarter of 2018 associated with the dilution in its ownership interest in Worldpay Holding, LLC from approximately 8.6% to approximately 4.9%.
On June 27, 2018, the Bancorp completed the sale of 5 million shares of Class A common stock of Worldpay, Inc. (formerly Vantiv, Inc.). The Bancorp had previously received these Class A shares in exchange for Class B Units of Worldpay Holding, LLC. The Bancorp recognized a gain of $205 million related to the sale. As a result of the sale, the Bancorp beneficially owns approximately 3.3% of Worldpays equity through its ownership of approximately 10.3 million Class B Units. At September 30, 2018, the Bancorps remaining interest in Worldpay Holding, LLC of $424 million continues to be accounted for as an equity method investment given the nature of Worldpay Holding, LLCs structure as a limited liability company and contractual arrangements between Worldpay Holding, LLC and the Bancorp.
GS Holdings Transaction
In May 2018, GreenSky, Inc. launched an IPO and issued 38 million shares of Class A common stock for a valuation of $23 per share. In connection with this IPO, the Bancorps investment in GreenSky, LLC, which was comprised of 252,550 membership units, was converted to 2,525,498 units of the newly formed GreenSky Holdings, LLC (GS Holdings), representing a 1.4% interest in GS Holdings. The Bancorps units in GS Holdings are exchangeable on a one-to-one basis for Class A common stock or cash after the initial 180-day lock-up period expires.
4
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
At the time of the IPO, the Bancorp recognized a $16 million gain on its investment in GreenSky, LLC, which was included in other noninterest income in the Condensed Consolidated Statements of Income for the three and six months ended June 30, 2018. At September 30, 2018, the investment in GS Holdings was $45 million, which was included in equity securities in the Condensed Consolidated Balance Sheets.
Accelerated Share Repurchase Transactions
During the nine months ended September 30, 2018, the Bancorp entered into or settled accelerated share repurchase transactions. As part of these transactions, the Bancorp entered into forward contracts in which the final number of shares delivered at settlement was based generally on a discount to the average daily volume weighted-average price of the Bancorps common stock during the term of the repurchase agreements. For more information on the accelerated share repurchase program, refer to Note 15 of the Notes to Condensed Consolidated Financial Statements. For a summary of the Bancorps accelerated share repurchase transactions that were entered into or settled during the nine months ended September 30, 2018, refer to Table 2.
TABLE 2: Summary of Accelerated Share Repurchase Transactions |
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Repurchase Date |
Amount ($ in millions) |
Shares Repurchased on Repurchase Date |
Shares Received from Forward Contract Settlement |
Total Shares Repurchased |
Settlement Date | |||||||||||||||
December 19, 2017 |
$ | 273 | 7,727,273 | 824,367 | 8,551,640 | March 19, 2018 | ||||||||||||||
February 12, 2018 |
318 | 8,691,318 | 1,015,731 | 9,707,049 | March 26, 2018 | |||||||||||||||
May 25, 2018 |
235 | 6,402,244 | 1,172,122 | 7,574,366 | June 15, 2018 |
Open Market Share Repurchase Transactions
Between July 20, 2018 and August 2, 2018, the Bancorp repurchased 16,945,020 shares, or approximately $500 million, of its outstanding common stock through open market repurchase transactions, which settled between July 24, 2018 and August 6, 2018. For more information on the open market share repurchase program, refer to Note 15 of the Notes to Condensed Consolidated Financial Statements.
Senior Notes Offering
On March 14, 2018, the Bancorp issued and sold $650 million of 3.95% senior fixed-rate notes, with a maturity of ten years, due on March 14, 2028. These notes will be redeemable by the Bancorp, in whole or in part, on or after the date that is 30 days prior to the maturity date at a redemption price equal to 100% of the principal amount of the notes to be redeemed plus accrued and unpaid interest thereon to, but excluding, the redemption date.
On June 5, 2018, the Bancorp issued and sold $250 million of senior floating-rate notes, with a maturity of three years, due on June 4, 2021. Interest on the floating-rate notes is 3-month LIBOR plus 47 bps. These notes will be redeemable, in whole or in part, on or after the date that is 30 days prior to the maturity date at a redemption price equal to 100% of the principal amount of the notes to be redeemed plus accrued and unpaid interest thereon to, but excluding, the redemption date.
On July 26, 2018 the Bank issued and sold $1.55 billion in aggregate principal amount of unsecured senior bank notes. The bank notes consisted of $500 million of 3.35% senior fixed-rate notes, with a maturity of three years, due on July 26, 2021; $300 million of senior floating-rate notes at three-month LIBOR plus 44 bps, with a maturity of three years, due on July 26, 2021; and $750 million of 3.95% senior fixed-rate notes, with a maturity of seven years, due July 28, 2025. The Bank entered into interest rate swaps to convert the fixed-rate notes due in 2021 and 2025 to a floating-rate, which resulted in an effective interest rate of one-month LIBOR plus 53 bps and 104 bps, respectively. These bank notes will be redeemable by the Bank, in whole or in part, on or after the date that is 30 days prior to the maturity date at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest up to, but excluding, the redemption date.
2018 Branch Optimization Plan
Customer interactions and service and sales activity in Branch Banking continue to evolve with changing demographics and technology applications. Customers are increasingly utilizing digital tools to interact with their financial institutions in conducting their transactions while still utilizing physical branches for consultations and new product and service initiation. During the past three years, these developments and other business strategies led to a net decrease of 143 in the number of retail branches, or 11% of the Bancorps total branch count, through consolidations and sales.
The Bancorp continues to evaluate its retail network distribution in light of changes in customer behavior while developing new analytical tools that provide enhanced capabilities to optimize the profitability and growth potential of branches. In slower growth mature markets these developments enable the Bancorp to achieve efficiencies through well-executed branch consolidations without materially impacting deposit flows and/or revenue growth while maintaining the service quality standards. While continuing to evaluate such actions, the Bancorp is also focused on achieving higher retail household and deposit growth in other parts of its footprint mainly in markets that exhibit faster economic growth and where the Bancorp has significant opportunities to capture higher market share. To that extent, based on the strategic business evaluation that was performed during the second quarter of 2018, over the next 2-3 years, as part of the 2018 Branch Optimization Plan, the Bancorp plans to close between 100-125 branches in more mature markets and open between 100-125 new branches in higher growth markets where the Bancorp already has an existing retail branch presence. With the existing local presence and familiarity with the customer demographics, and with newly developed analytical tools, the Bancorp expects to achieve higher growth rates as a result of these actions.
5
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
As of September 30, 2018, the Bancorp had identified 31 specific branches for closure under the 2018 Branch Optimization Plan with these closures expected to be completed prior to December 31, 2018. The Bancorp expects to identify the remaining branches to be closed under the 2018 Branch Optimization Plan prior to December 31, 2019. As part of the adoption of the 2018 Branch Optimization Plan, the Bancorp has also elected to sell 21 parcels of land which had previously been held for future branch expansion. For further information about the 2018 Branch Optimization plan, refer to Note 7 of the Notes to Condensed Consolidated Financial Statements.
Legislative and Regulatory Developments
On May 24, 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the Reform Act) was signed into law. Among other regulatory changes, the Reform Act amends various sections of the DFA, most impactful are changes to section 165 of DFA raising the asset thresholds for determining the application of Enhanced Prudential Standards for BHCs deemed systemically important. The Reform Act raised the asset thresholds in two separate timeframes, immediately removing BHCs with consolidated assets below $100 billion from the application of the Enhanced Prudential Standards. BHCs with consolidated assets greater than $100 billion but less than $250 billion, including Fifth Third Bancorp, would continue to be subject to the Enhanced Prudential Standards for 18 months after the date of enactment, unless the Board of Governors of the FRB acts prior to that time period to provide regulatory relief from the Enhanced Prudential Standards or elects to continue to subject these BHCs to some form of Enhanced Prudential Standards. However, the FRB is also authorized to exempt any BHC with assets between $100 billion and $250 billion from any Enhanced Prudential Standards prior to the end of the 18-month period or after.
Regardless of this regulatory outcome, the Reform Act requires the FRB to continue to subject BHCs with consolidated assets between $100 billion to $250 billion to a periodic supervisory stress test and to continue to apply risk committee requirements outlined in the DFA. The Reform Act also provides the FRB the authority to continue to subject BHCs with consolidated assets greater than $100 billion to Enhanced Prudential Standards if the FRB determines that application is warranted and appropriate to address risks to financial stability and promote safety and soundness taking into consideration certain factors including the BHCs capital structure, riskiness, complexity, financial activities (including financial activities of subsidiaries), size, and any other risk-related factors that the FRB deems appropriate.
On October 31, 2018, the federal banking agencies issued two NPRs related to the implementation of the Reform Act. The proposed rules would establish four risk-based categories of institutions and apply tailored capital and liquidity requirements for each respective category. These proposals are subject to modification through the federal rulemaking process in accordance with the Administrative Procedures Act, but based upon Fifth Thirds interpretation of the NPRs, the Bancorp would qualify as a Category IV BHC subject to the least restrictive of the proposed requirements.
The ultimate benefits or consequences of the Reform Act on Fifth Third Bancorp, Fifth Third Bank and their respective subsidiaries and activities will be subject to the final form of these NPRs, and additional rulemakings issued by the FRB and additional federal regulators. Fifth Third cannot predict future changes in the applicable laws, regulations and regulatory agency policies, yet such changes may have a material effect on its business, financial condition or results of operations.
Earnings Summary
The Bancorps net income available to common shareholders for the third quarter of 2018 was $418 million, or $0.61 per diluted share, which was net of $15 million in preferred stock dividends. The Bancorps net income available to common shareholders for the third quarter of 2017 was $999 million, or $1.35 per diluted share, which was net of $15 million in preferred stock dividends. The Bancorps net income available to common shareholders for the nine months ended September 30, 2018 was $1.7 billion, or $2.38 per diluted share, which was net of $52 million in preferred stock dividends. For the nine months ended September 30, 2017, the Bancorps net income available to common shareholders was $1.6 billion, or $2.16 per diluted share, which was net of $52 million in preferred stock dividends.
Net interest income on an FTE basis (non-GAAP) was $1.0 billion and $3.1 billion for the three and nine months ended September 30, 2018, respectively, an increase of $70 million and $210 million compared to the same periods in the prior year. Net interest income was positively impacted by increases in both the yields and amounts of average loans and leases and average taxable securities for the three and nine months ended September 30, 2018 compared to the same periods in the prior year. Additionally, net interest income was positively impacted by the decisions of the FOMC to raise the target range of the federal funds rate 25 bps in December 2017, March 2018, June 2018 and September 2018. These positive impacts were partially offset by increases in the rates paid on average interest-bearing core deposits and average long-term debt for both the three and nine months ended September 30, 2018 compared to the same periods in the prior year. Net interest margin on an FTE basis (non-GAAP) was 3.23% and 3.20% for the three and nine months ended September 30, 2018, respectively, compared to 3.07% and 3.03% for the three and nine months ended September 30, 2017, respectively.
Noninterest income decreased $998 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to decreases in other noninterest income and mortgage banking net revenue. Other noninterest income decreased $990 million during the three months ended September 30, 2018 compared to the three months ended September 30, 2017 primarily due to the gain on sale of Worldpay, Inc. shares recognized during the third quarter of 2017 and a reduction in equity method income from the Bancorps interest in Worldpay Holding, LLC. These reductions were partially offset by a decrease in the loss on the swap associated with the sale of Visa, Inc. Class B Shares and an increase in private equity investment income. Mortgage banking net revenue decreased $14 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to a decrease in origination fees and gains on loan sales driven by a decrease in originations and lower margins due to the interest rate environment.
6
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
Noninterest income decreased $433 million for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 primarily due to decreases in other noninterest income and mortgage banking net revenue. Other noninterest income decreased $443 million during the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to the gain on sale of Worldpay, Inc. shares recognized during the third quarter of 2017, a reduction in equity method income from the Bancorps interest in Worldpay Holding, LLC and an increase in the net losses on disposition and impairment of bank premises and equipment. These reductions were partially offset by the gain related to Vantiv, Inc.s acquisition of Worldpay Group plc., the gain on the sale of Worldpay, Inc. shares recognized during the second quarter of 2018 and increases in private equity investment income and in insurance income. Mortgage banking net revenue decreased $12 million during the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to a decrease in origination fees and gains on loan sales driven by a decrease in originations and lower margins due to the interest rate environment, partially offset by an increase in net mortgage servicing revenue driven by a decrease in net negative valuation adjustments and an increase in gross mortgage servicing fees.
Noninterest expense increased $33 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to increases in personnel costs, technology and communications expense and other noninterest expense. Personnel costs increased $19 million for the three months ended September 30, 2018 compared to the same period in the prior year driven by an increase in base compensation, variable compensation, long-term incentive compensation and severance costs. Technology and communications expense increased $9 million for the three months ended September 30, 2018 compared to the same period in the prior year driven primarily by increased investment in regulatory, compliance and growth initiatives. Other noninterest expense increased $9 million for the three months ended September 30, 2018 compared to the same period in the prior year driven primarily by increased marketing expenses as a result of an increase in advertising volume related to the brand campaign and promotional offers.
Noninterest expense increased $172 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to increases in personnel costs, technology and communications expense and other noninterest expense. Personnel costs increased $120 million for the nine months ended September 30, 2018 compared to the same period in the prior year driven by an increase in base compensation, variable compensation, long-term incentive compensation and severance costs. Technology and communications expense increased $29 million for the nine months ended September 30, 2018 compared to the same period in the prior year driven primarily by increased investment in regulatory, compliance and growth initiatives. Other noninterest expense increased $25 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to increases in marketing expense, the impairment on affordable housing investments, loan and lease expense and donations expense, partially offset by an increase in the benefit for the reserve for unfunded commitments and a decrease in professional service fees.
For more information on net interest income, noninterest income and noninterest expense refer to the Statements of Income Analysis section of MD&A.
Credit Summary
The provision for loan and lease losses was $86 million and $142 million for the three and nine months ended September 30, 2018, respectively, compared to $67 million and $193 million for the comparable periods in 2017. Net losses charged-off as a percent of average portfolio loans and leases increased to 0.30% during the three months ended September 30, 2018 compared to 0.29% during the same period in the prior year and increased to 0.36% for the nine months ended September 30, 2018 compared to 0.32% for the same period in the prior year. At September 30, 2018, nonperforming portfolio assets as a percent of portfolio loans and leases and OREO decreased to 0.48% compared to 0.53% at December 31, 2017. For further discussion on credit quality refer to the Credit Risk Management subsection of the Risk Management section of MD&A.
Capital Summary
The Bancorps capital ratios exceed the well-capitalized guidelines as defined by the PCA requirements of the U.S. banking agencies. As of September 30, 2018, as calculated under the Basel III standardized approach, the CET1 capital ratio was 10.67%, the Tier I risk-based capital ratio was 11.78%, the Total risk-based capital ratio was 14.94% and the Tier I leverage ratio was 10.10%.
7
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
The following are non-GAAP measures which provide useful insight to the reader of the Condensed Consolidated Financial Statements but should be supplemental to primary U.S. GAAP measures and should not be read in isolation or relied upon as a substitute for the primary U.S. GAAP measures.
The FTE basis adjusts for the tax-favored status of income from certain loans and securities held by the Bancorp that are not taxable for federal income tax purposes. The Bancorp believes this presentation to be the preferred industry measurement of net interest income as it provides a relevant comparison between taxable and non-taxable amounts.
The following table reconciles the non-GAAP financial measures of net interest income on an FTE basis, interest income on an FTE basis, net interest margin, net interest rate spread and the efficiency ratio to U.S. GAAP:
TABLE 3: Non-GAAP Financial Measures - Financial Measures and Ratios on an FTE basis |
||||||||||||||||||||||||
For the three months ended | For the nine months ended | |||||||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||||||
($ in millions) |
2018 | 2017 | 2018 | 2017 | ||||||||||||||||||||
Net interest income (U.S. GAAP) |
$ | 1,043 | 970 | 3,059 | 2,842 | |||||||||||||||||||
Add: FTE adjustment |
4 | 7 | 12 | 19 | ||||||||||||||||||||
Net interest income on an FTE basis (1) |
$ | 1,047 | 977 | 3,071 | 2,861 | |||||||||||||||||||
Net interest income on an FTE basis (annualized) (2) |
4,154 | 3,876 | 4,106 | 3,815 | ||||||||||||||||||||
Interest income (U.S. GAAP) |
$ | 1,315 | 1,152 | 3,790 | 3,344 | |||||||||||||||||||
Add: FTE adjustment |
4 | 7 | 12 | 19 | ||||||||||||||||||||
Interest income on an FTE basis |
$ | 1,319 | 1,159 | 3,802 | 3,363 | |||||||||||||||||||
Interest income on an FTE basis (annualized) (3) |
5,233 | 4,598 | 5,083 | 4,496 | ||||||||||||||||||||
Interest expense (annualized) (4) |
$ | 1,079 | 722 | 977 | 671 | |||||||||||||||||||
Noninterest income (5) |
563 | 1,561 | 2,215 | 2,648 | ||||||||||||||||||||
Noninterest expense (6) |
1,008 | 975 | 3,090 | 2,918 | ||||||||||||||||||||
Average interest-earning assets (7) |
128,799 | 126,443 | 128,176 | 126,183 | ||||||||||||||||||||
Average interest-bearing liabilities (8) |
89,772 | 85,328 | 88,875 | 85,181 | ||||||||||||||||||||
Ratios: |
||||||||||||||||||||||||
Net interest margin on an FTE basis (2) / (7) |
3.23 | % | 3.07 | 3.20 | 3.03 | |||||||||||||||||||
Net interest rate spread on an FTE basis ((3) / (7)) - ((4) / (8)) |
2.87 | 2.79 | 2.87 | 2.77 | ||||||||||||||||||||
Efficiency ratio on an FTE basis (6) / ((1) + (5)) |
62.6 | 38.4 | 58.5 | 53.0 |
The Bancorp believes return on average tangible common equity is an important measure for comparative purposes with other financial institutions, but is not defined under U.S. GAAP, and therefore is considered a non-GAAP financial measure. This measure is useful for evaluating the performance of a business as it calculates the return available to common shareholders without the impact of intangible assets and their related amortization.
The following table reconciles the non-GAAP financial measure of return on average tangible common equity to U.S. GAAP:
TABLE 4: Non-GAAP Financial Measures - Return on Average Tangible Common Equity |
||||||||||||||||||||||||
For the three months ended | For the nine months ended | |||||||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||||||
($ in millions) |
2018 | 2017 | 2018 | 2017 | ||||||||||||||||||||
Net income available to common shareholders (U.S. GAAP) |
$ | 418 | 999 | 1,669 | 1,633 | |||||||||||||||||||
Add: Intangible amortization, net of tax |
1 | - | 3 | 1 | ||||||||||||||||||||
Tangible net income available to common shareholders |
$ | 419 | 999 | 1,672 | 1,634 | |||||||||||||||||||
Tangible net income available to common shareholders (annualized) (1) |
1,662 | 3,963 | 2,235 | 2,179 | ||||||||||||||||||||
Average Bancorp shareholders equity (U.S. GAAP) |
$ | 16,145 | 16,820 | 16,187 | 16,623 | |||||||||||||||||||
Less: Average preferred stock |
(1,331 | ) | (1,331 | ) | (1,331 | ) | (1,331) | |||||||||||||||||
Average goodwill |
(2,462 | ) | (2,423 | ) | (2,460 | ) | (2,421) | |||||||||||||||||
Average intangible assets |
(29 | ) | (18 | ) | (28 | ) | (15) | |||||||||||||||||
Average tangible common equity (2) |
$ | 12,323 | 13,048 | 12,368 | 12,856 | |||||||||||||||||||
Return on average tangible common equity (1) / (2) |
13.5 | % | 30.4 | 18.1 | 17.0 |
The Bancorp considers various measures when evaluating capital utilization and adequacy, including the tangible equity ratio and tangible common equity ratio, in addition to capital ratios defined by the U.S. banking agencies. These calculations are intended to complement the capital ratios defined by the U.S. banking agencies for both absolute and comparative purposes. Because U.S. GAAP does not include capital ratio measures, the Bancorp believes there are no comparable U.S. GAAP financial measures to these ratios. These ratios are not formally defined by U.S. GAAP or codified in the federal banking regulations and, therefore, are considered to be non-GAAP financial measures. The Bancorp encourages readers to consider its Condensed Consolidated Financial Statements in their entirety and not to rely on any single financial measure.
8
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
The following table reconciles non-GAAP capital ratios to U.S. GAAP:
TABLE 5: Non-GAAP Financial Measures - Capital Ratios |
||||||||
September 30, | December 31, | |||||||
As of ($ in millions) |
2018 | 2017 | ||||||
Total Bancorp Shareholders Equity (U.S. GAAP) |
$ | 15,830 | 16,365 | |||||
Less: Preferred stock |
(1,331) | (1,331) | ||||||
Goodwill |
(2,462) | (2,445) | ||||||
Intangible assets |
(28) | (27) | ||||||
AOCI |
775 | (73) | ||||||
Tangible common equity, excluding unrealized gains / losses (1) |
12,784 | 12,489 | ||||||
Add: Preferred stock |
1,331 | 1,331 | ||||||
Tangible equity (2) |
$ | 14,115 | 13,820 | |||||
Total Assets (U.S. GAAP) |
$ | 141,685 | 142,193 | |||||
Less: Goodwill |
(2,462) | (2,445) | ||||||
Intangible assets |
(28) | (27) | ||||||
AOCI, before tax |
981 | (92) | ||||||
Tangible assets, excluding unrealized gains / losses (3) |
$ | 140,176 | 139,629 | |||||
Ratios: |
||||||||
Tangible equity as a percentage of tangible assets (2) / (3) |
10.07 % | 9.90 | ||||||
Tangible common equity as a percentage of tangible assets (1) / (3) |
9.12 | 8.94 |
9
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
Note 3 of the Notes to Condensed Consolidated Financial Statements provides a discussion of the significant new accounting standards applicable to the Bancorp and the expected impact of significant accounting standards issued, but not yet required to be adopted.
The Bancorps Condensed Consolidated Financial Statements are prepared in accordance with U.S. GAAP. Certain accounting policies require management to exercise judgment in determining methodologies, economic assumptions and estimates that may materially affect the Bancorps financial position, results of operations and cash flows. The Bancorps critical accounting policies include the accounting for the ALLL, reserve for unfunded commitments, income taxes, valuation of servicing rights, fair value measurements, goodwill and legal contingencies. These accounting policies are discussed in detail in the Critical Accounting Policies section of the Bancorps Annual Report on Form 10-K for the year ended December 31, 2017. There have been no material changes to the valuation techniques or models during the nine months ended September 30, 2018.
10
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
Net Interest Income
Net interest income is the interest earned on loans and leases (including yield-related fees), securities and other short-term investments less the interest paid for core deposits (includes transaction deposits and other time deposits) and wholesale funding (includes certificates $100,000 and over, other deposits, federal funds purchased, other short-term borrowings and long-term debt). The net interest margin is calculated by dividing net interest income by average interest-earning assets. Net interest rate spread is the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities. Net interest margin is typically greater than net interest rate spread due to the interest income earned on those assets that are funded by noninterest-bearing liabilities, or free funding, such as demand deposits or shareholders equity.
Tables 6 and 7 present the components of net interest income, net interest margin and net interest rate spread for the three and nine months ended September 30, 2018 and 2017, as well as the relative impact of changes in the balance sheet and changes in interest rates on net interest income. Nonaccrual loans and leases and loans and leases held for sale have been included in the average loan and lease balances. Average outstanding securities balances are based on amortized cost with any unrealized gains or losses on available-for-sale debt and other securities included in other assets.
Net interest income on an FTE basis (non-GAAP) was $1.0 billion and $3.1 billion for the three and nine months ended September 30, 2018, respectively, an increase of $70 million and $210 million compared to the same periods in the prior year. Net interest income was positively impacted by increases in yields on average loans and leases of 53 bps and 51 bps, respectively, and yields on average taxable securities of 14 bps and 12 bps, respectively, for the three and nine months ended September 30, 2018 compared to the same periods in the prior year. Net interest income was also positively impacted by increases in average loans and leases of $1.4 billion and $677 million, respectively, and average taxable securities of $1.0 billion and $1.2 billion, respectively, for the three and nine months ended September 30, 2018, compared to the same periods in the prior year. Additionally, net interest income was positively impacted by the decisions of the FOMC to raise the target range of the federal funds rate 25 bps in December 2017, March 2018, June 2018 and September 2018. These positive impacts were partially offset by increases in the rates paid on average interest-bearing core deposits and average long-term debt for both the three and nine months ended September 30, 2018 compared to the same periods in the prior year. The rates paid on average interest-bearing core deposits increased 35 bps and 29 bps, respectively, for the three and nine months ended September 30, 2018 compared to the same periods in the prior year. The rates paid on average long-term debt increased 27 bps for both the three and nine months ended September 30, 2018 compared to the same periods in the prior year.
Net interest rate spread on an FTE basis (non-GAAP) was 2.87% during both the three and nine months ended September 30, 2018 compared to 2.79% and 2.77%, respectively, in the same periods in the prior year. Yields on average interest-earning assets increased 43 bps and 41 bps for the three and nine months ended September 30, 2018, respectively, partially offset by a 35 bps and 31 bps increase in rates paid on average interest-bearing liabilities for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year.
Net interest margin on an FTE basis (non-GAAP) was 3.23% and 3.20% for the three and nine months ended September 30, 2018, respectively, compared to 3.07% and 3.03% for the three and nine months ended September 30, 2017, respectively. The increase for both periods was driven primarily by the previously mentioned increases in the net interest rate spread partially offset by decreases in average free funding balances. The decreases in average free funding balances for both periods were driven by decreases in average demand deposits of $2.5 billion and $2.0 billion for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year.
Interest income on an FTE basis from loans and leases (non-GAAP) increased $139 million and $373 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increases were primarily due to the aforementioned increases in yields on average loans and leases, as well as increases in the volume of average other consumer loans. For more information on the Bancorps loan and lease portfolio, refer to the Loans and Leases subsection of the Balance Sheet Analysis section of MD&A. Interest income from investment securities and other short-term investments increased $21 million and $66 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily as a result of the aforementioned increases in average taxable securities and yields on average taxable securities.
Interest expense on core deposits increased $67 million and $158 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increases were primarily due to increases in the cost of average interest-bearing core deposits to 74 bps and 64 bps for the three and nine months ended September 30, 2018, respectively, from 39 bps and 35 bps for the three and nine months ended September 30, 2017, respectively. The increases in the cost of average interest-bearing core deposits for both periods were primarily due to increases in the rates paid on average interest checking deposits and average money market deposits. Refer to the Deposits subsection of the Balance Sheet Analysis section of MD&A for additional information on the Bancorps deposits.
Interest expense on average wholesale funding increased $23 million and $71 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to the aforementioned increases in the rates paid on average long-term debt coupled with increases in average long-term debt. Refer to the Borrowings subsection of the Balance Sheet Analysis section of MD&A for additional information on the Bancorps borrowings. During both the three and nine months ended September 30, 2018, average wholesale funding represented 23% of average interest-bearing liabilities compared to 25% and 24% during the three and nine months ended September 30, 2017, respectively. For more information on the Bancorps interest rate risk management, including estimated earnings sensitivity to changes in market interest rates, see the Market Risk Management subsection of the Risk Management section of MD&A.
11
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
TABLE 6: Condensed Average Balance Sheets and Analysis of Net Interest Income on an FTE Basis |
||||||||||||||||||||||||||||||||||||
Attribution of Change in | ||||||||||||||||||||||||||||||||||||
For the three months ended |
September 30, 2018 | September 30, 2017 | Net Interest Income(a) | |||||||||||||||||||||||||||||||||
Average | Average | |||||||||||||||||||||||||||||||||||
Average | Revenue/ | Yield/ | Average | Revenue/ | Yield/ | |||||||||||||||||||||||||||||||
($ in millions) |
Balance | Cost | Rate | Balance | Cost | Rate | Volume | Yield/Rate | Total | |||||||||||||||||||||||||||
Assets: |
||||||||||||||||||||||||||||||||||||
Interest-earning assets: |
||||||||||||||||||||||||||||||||||||
Loans and leases:(b) |
||||||||||||||||||||||||||||||||||||
Commercial and industrial loans |
$ | 42,614 | 463 | 4.32 | % | $ | 41,314 | 391 | 3.75 | % | $ | 12 | 60 | 72 | ||||||||||||||||||||||
Commercial mortgage loans |
6,664 | 77 | 4.57 | 6,814 | 66 | 3.85 | (1 | ) | 12 | 11 | ||||||||||||||||||||||||||
Commercial construction loans |
4,870 | 63 | 5.14 | 4,533 | 48 | 4.23 | 4 | 11 | 15 | |||||||||||||||||||||||||||
Commercial leases |
3,746 | 27 | 2.85 | 4,079 | 28 | 2.70 | (2 | ) | 1 | (1 | ) | |||||||||||||||||||||||||
Total commercial loans and leases |
57,894 | 630 | 4.32 | 56,740 | 533 | 3.72 | 13 | 84 | 97 | |||||||||||||||||||||||||||
Residential mortgage loans |
16,226 | 146 | 3.58 | 16,206 | 142 | 3.48 | - | 4 | 4 | |||||||||||||||||||||||||||
Home equity |
6,529 | 83 | 5.03 | 7,207 | 80 | 4.39 | (8 | ) | 11 | 3 | ||||||||||||||||||||||||||
Automobile loans |
8,969 | 78 | 3.47 | 9,267 | 69 | 2.96 | (3 | ) | 12 | 9 | ||||||||||||||||||||||||||
Credit card |
2,299 | 71 | 12.17 | 2,140 | 63 | 11.63 | 5 | 3 | 8 | |||||||||||||||||||||||||||
Other consumer loans |
2,060 | 36 | 6.98 | 1,057 | 18 | 6.89 | 18 | - | 18 | |||||||||||||||||||||||||||
Total consumer loans |
36,083 | 414 | 4.56 | 35,877 | 372 | 4.12 | 12 | 30 | 42 | |||||||||||||||||||||||||||
Total loans and leases |
$ | 93,977 | 1,044 | 4.41 | % | $ | 92,617 | 905 | 3.88 | % | $ | 25 | 114 | 139 | ||||||||||||||||||||||
Securities: |
||||||||||||||||||||||||||||||||||||
Taxable |
33,301 | 268 | 3.20 | 32,289 | 249 | 3.06 | 8 | 11 | 19 | |||||||||||||||||||||||||||
Exempt from income taxes(b) |
69 | 1 | 4.35 | 65 | 1 | 5.33 | - | - | - | |||||||||||||||||||||||||||
Other short-term investments |
1,452 | 6 | 1.74 | 1,472 | 4 | 1.16 | - | 2 | 2 | |||||||||||||||||||||||||||
Total interest-earning assets |
$ | 128,799 | 1,319 | 4.07 | % | $ | 126,443 | 1,159 | 3.64 | % | $ | 33 | 127 | 160 | ||||||||||||||||||||||
Cash and due from banks |
2,193 | 2,227 | ||||||||||||||||||||||||||||||||||
Other assets |
11,837 | 13,532 | ||||||||||||||||||||||||||||||||||
Allowance for loan and lease losses |
(1,077) | (1,210) | ||||||||||||||||||||||||||||||||||
Total assets |
$ | 141,752 | $ | 140,992 | ||||||||||||||||||||||||||||||||
Liabilities and Equity: |
||||||||||||||||||||||||||||||||||||
Interest-bearing liabilities: |
||||||||||||||||||||||||||||||||||||
Interest checking deposits |
$ | 29,681 | 66 | 0.88 | % | $ | 25,765 | 29 | 0.44 | % | $ | 5 | 32 | 37 | ||||||||||||||||||||||
Savings deposits |
13,231 | 4 | 0.11 | 13,889 | 2 | 0.06 | - | 2 | 2 | |||||||||||||||||||||||||||
Money market deposits |
21,753 | 44 | 0.80 | 20,028 | 19 | 0.39 | 2 | 23 | 25 | |||||||||||||||||||||||||||
Foreign office deposits |
317 | - | 0.33 | 395 | - | 0.21 | - | - | - | |||||||||||||||||||||||||||
Other time deposits |
4,177 | 15 | 1.48 | 3,722 | 12 | 1.23 | - | 3 | 3 | |||||||||||||||||||||||||||
Total interest-bearing core deposits |
69,159 | 129 | 0.74 | 63,799 | 62 | 0.39 | 7 | 60 | 67 | |||||||||||||||||||||||||||
Certificates $100,000 and over |
2,596 | 12 | 1.85 | 2,625 | 9 | 1.38 | - | 3 | 3 | |||||||||||||||||||||||||||
Other deposits |
578 | 3 | 1.95 | 560 | 2 | 1.16 | - | 1 | 1 | |||||||||||||||||||||||||||
Federal funds purchased |
1,987 | 10 | 1.96 | 675 | 2 | 1.16 | 6 | 2 | 8 | |||||||||||||||||||||||||||
Other short-term borrowings |
1,018 | 6 | 2.22 | 4,212 | 12 | 1.09 | (13 | ) | 7 | (6 | ) | |||||||||||||||||||||||||
Long-term debt |
14,434 | 112 | 3.09 | 13,457 | 95 | 2.82 | 7 | 10 | 17 | |||||||||||||||||||||||||||
Total interest-bearing liabilities |
$ | 89,772 | 272 | 1.20 | % | $ | 85,328 | 182 | 0.85 | % | $ | 7 | 83 | 90 | ||||||||||||||||||||||
Demand deposits |
32,333 | 34,850 | ||||||||||||||||||||||||||||||||||
Other liabilities |
3,482 | 3,973 | ||||||||||||||||||||||||||||||||||
Total liabilities |
$ | 125,587 | $ | 124,151 | ||||||||||||||||||||||||||||||||
Total equity |
$ | 16,165 | $ | 16,841 | ||||||||||||||||||||||||||||||||
Total liabilities and equity |
$ | 141,752 | $ | 140,992 | ||||||||||||||||||||||||||||||||
Net interest income (FTE)(c) |
$ | 1,047 | $ | 977 | $ | 26 | 44 | 70 | ||||||||||||||||||||||||||||
Net interest margin (FTE)(c) |
3.23 | % | 3.07 | % | ||||||||||||||||||||||||||||||||
Net interest rate spread (FTE)(c) |
2.87 | 2.79 | ||||||||||||||||||||||||||||||||||
Interest-bearing liabilities to interest-earning assets |
|
69.70 | 67.48 |
(a) |
Changes in interest not solely due to volume or yield/rate are allocated in proportion to the absolute dollar amount of change in volume and yield/rate. |
(b) |
The FTE adjustments included in the above table were $4 and $7 for the three months ended September 30, 2018 and 2017, respectively. |
(c) |
Net interest income (FTE), net interest margin (FTE) and net interest rate spread (FTE) are non-GAAP measures. For further information, refer to the Non-GAAP Financial Measures section of MD&A. |
12
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
TABLE 7: Condensed Average Balance Sheets and Analysis of Net Interest Income on an FTE Basis |
||||||||||||||||||||||||||||||||||||
Attribution of Change in | ||||||||||||||||||||||||||||||||||||
For the nine months ended |
September 30, 2018 | September 30, 2017 | Net Interest Income(a) | |||||||||||||||||||||||||||||||||
Average | Average | |||||||||||||||||||||||||||||||||||
Average | Revenue/ | Yield/ | Average | Revenue/ | Yield/ | |||||||||||||||||||||||||||||||
($ in millions) |
Balance | Cost | Rate | Balance | Cost | Rate | Volume | Yield/Rate | Total | |||||||||||||||||||||||||||
Assets: |
||||||||||||||||||||||||||||||||||||
Interest-earning assets: |
||||||||||||||||||||||||||||||||||||
Loans and leases:(b) |
||||||||||||||||||||||||||||||||||||
Commercial and industrial loans |
$ | 42,249 | 1,321 | 4.18 | % | $ | 41,619 | 1,123 | 3.61 | % | $ | 17 | 181 | 198 | ||||||||||||||||||||||
Commercial mortgage loans |
6,591 | 217 | 4.40 | 6,873 | 189 | 3.68 | (8 | ) | 36 | 28 | ||||||||||||||||||||||||||
Commercial construction loans |
4,762 | 175 | 4.90 | 4,277 | 128 | 4.01 | 17 | 30 | 47 | |||||||||||||||||||||||||||
Commercial leases |
3,850 | 81 | 2.82 | 4,008 | 81 | 2.71 | (3 | ) | 3 | - | ||||||||||||||||||||||||||
Total commercial loans and leases |
57,452 | 1,794 | 4.17 | 56,777 | 1,521 | 3.58 | 23 | 250 | 273 | |||||||||||||||||||||||||||
Residential mortgage loans |
16,176 | 433 | 3.58 | 16,011 | 423 | 3.53 | 4 | 6 | 10 | |||||||||||||||||||||||||||
Home equity |
6,695 | 242 | 4.83 | 7,389 | 232 | 4.19 | (23 | ) | 33 | 10 | ||||||||||||||||||||||||||
Automobile loans |
9,000 | 221 | 3.29 | 9,486 | 204 | 2.88 | (11 | ) | 28 | 17 | ||||||||||||||||||||||||||
Credit card |
2,248 | 205 | 12.16 | 2,121 | 188 | 11.84 | 12 | 5 | 17 | |||||||||||||||||||||||||||
Other consumer loans |
1,792 | 91 | 6.79 | 902 | 45 | 6.70 | 45 | 1 | 46 | |||||||||||||||||||||||||||
Total consumer loans |
35,911 | 1,192 | 4.44 | 35,909 | 1,092 | 4.06 | 27 | 73 | 100 | |||||||||||||||||||||||||||
Total loans and leases |
$ | 93,363 | 2,986 | 4.28 | % | $ | 92,686 | 2,613 | 3.77 | % | $ | 50 | 323 | 373 | ||||||||||||||||||||||
Securities: |
||||||||||||||||||||||||||||||||||||
Taxable |
33,272 | 797 | 3.20 | 32,067 | 738 | 3.08 | 28 | 31 | 59 | |||||||||||||||||||||||||||
Exempt from income taxes(b) |
75 | 2 | 3.28 | 63 | 2 | 5.38 | 1 | (1) | - | |||||||||||||||||||||||||||
Other short-term investments |
1,466 | 17 | 1.58 | 1,367 | 10 | 0.97 | - | 7 | 7 | |||||||||||||||||||||||||||
Total interest-earning assets |
$ | 128,176 | 3,802 | 3.97 | % | $ | 126,183 | 3,363 | 3.56 | % | $ | 79 | 360 | 439 | ||||||||||||||||||||||
Cash and due from banks |
2,182 | 2,202 | ||||||||||||||||||||||||||||||||||
Other assets |
12,394 | 13,343 | ||||||||||||||||||||||||||||||||||
Allowance for loan and lease losses |
(1,136) | (1,233) | ||||||||||||||||||||||||||||||||||
Total assets |
$ | 141,616 | $ | 140,495 | ||||||||||||||||||||||||||||||||
Liabilities and Equity: |
||||||||||||||||||||||||||||||||||||
Interest-bearing liabilities: |
||||||||||||||||||||||||||||||||||||
Interest checking deposits |
$ | 28,938 | 165 | 0.76 | % | $ | 26,176 | 73 | 0.38 | % | $ | 9 | 83 | 92 | ||||||||||||||||||||||
Savings deposits |
13,463 | 9 | 0.09 | 14,081 | 6 | 0.06 | (1 | ) | 4 | 3 | ||||||||||||||||||||||||||
Money market deposits |
21,517 | 110 | 0.68 | 20,301 | 53 | 0.35 | 3 | 54 | 57 | |||||||||||||||||||||||||||
Foreign office deposits |
393 | 1 | 0.28 | 409 | 1 | 0.17 | - | - | - | |||||||||||||||||||||||||||
Other time deposits |
4,018 | 41 | 1.36 | 3,764 | 35 | 1.23 | 2 | 4 | 6 | |||||||||||||||||||||||||||
Total interest-bearing core deposits |
68,329 | 326 | 0.64 | 64,731 | 168 | 0.35 | 13 | 145 | 158 | |||||||||||||||||||||||||||
Certificates $100,000 and over |
2,346 | 28 | 1.58 | 2,609 | 27 | 1.36 | (3 | ) | 4 | 1 | ||||||||||||||||||||||||||
Other deposits |
385 | 5 | 1.76 | 330 | 2 | 1.03 | 1 | 2 | 3 | |||||||||||||||||||||||||||
Federal funds purchased |
1,258 | 17 | 1.80 | 542 | 4 | 0.94 | 8 | 5 | 13 | |||||||||||||||||||||||||||
Other short-term borrowings |
1,959 | 25 | 1.70 | 3,441 | 24 | 0.92 | (13 | ) | 14 | 1 | ||||||||||||||||||||||||||
Long-term debt |
14,598 | 330 | 3.02 | 13,528 | 277 | 2.75 | 24 | 29 | 53 | |||||||||||||||||||||||||||
Total interest-bearing liabilities |
$ | 88,875 | 731 | 1.10 | % | $ | 85,181 | 502 | 0.79 | % | $ | 30 | 199 | 229 | ||||||||||||||||||||||
Demand deposits |
32,992 | 34,949 | ||||||||||||||||||||||||||||||||||
Other liabilities |
3,541 | 3,717 | ||||||||||||||||||||||||||||||||||
Total liabilities |
$ | 125,408 | $ | 123,847 | ||||||||||||||||||||||||||||||||
Total equity |
$ | 16,208 | $ | 16,648 | ||||||||||||||||||||||||||||||||
Total liabilities and equity |
$ | 141,616 | $ | 140,495 | ||||||||||||||||||||||||||||||||
Net interest income (FTE)(c) |
$ | 3,071 | $ | 2,861 | $ | 49 | 161 | 210 | ||||||||||||||||||||||||||||
Net interest margin (FTE)(c) |
3.20 | % | 3.03 | % | ||||||||||||||||||||||||||||||||
Net interest rate spread (FTE)(c) |
2.87 | 2.77 | ||||||||||||||||||||||||||||||||||
Interest-bearing liabilities to interest-earning assets |
|
69.34 | 67.51 |
(a) |
Changes in interest not solely due to volume or yield/rate are allocated in proportion to the absolute dollar amount of change in volume and yield/rate. |
(b) |
The FTE adjustments included in the above table were $12 and $19 for the nine months ended September 30, 2018 and 2017, respectively. |
(c) |
Net interest income (FTE), net interest margin (FTE) and net interest rate spread (FTE) are non-GAAP measures. For further information, refer to the Non-GAAP Financial Measures section of MD&A. |
Provision for Loan and Lease Losses
The Bancorp provides as an expense an amount for probable loan and lease losses within the loan and lease portfolio that is based on factors previously discussed in the Critical Accounting Policies section of the Bancorps Annual Report on Form 10-K for the year ended December 31, 2017. The provision is recorded to bring the ALLL to a level deemed appropriate by the Bancorp to cover losses inherent in the portfolio. Actual credit losses on loans and leases are charged against the ALLL. The amount of loans and leases actually removed from the Condensed Consolidated Balance Sheets is referred to as a charge-off. Net charge-offs include current period charge-offs less recoveries on previously charged-off loans and leases.
The provision for loan and lease losses was $86 million and $142 million for the three and nine months ended September 30, 2018, respectively, compared to $67 million and $193 million during the same periods in the prior year. The increase in provision expense for the three months ended September 30, 2018 was primarily due to an increase in outstanding commercial loan balances and an increase in consumer reserve rates for certain products. The decrease in provision expense for the nine months ended September 30, 2018 was primarily due to a decrease in the level of commercial criticized assets combined with overall improved credit quality.
13
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
The ALLL decreased $105 million from December 31, 2017 to $1.1 billion at September 30, 2018. At September 30, 2018, the ALLL as a percent of portfolio loans and leases decreased to 1.17% compared to 1.30% at December 31, 2017.
Refer to the Credit Risk Management subsection of the Risk Management section of MD&A as well as Note 6 of the Notes to Condensed Consolidated Financial Statements for more detailed information on the provision for loan and lease losses, including an analysis of loan and lease portfolio composition, nonperforming assets, net charge-offs and other factors considered by the Bancorp in assessing the credit quality of the loan and lease portfolio and the ALLL.
Noninterest Income
Noninterest income decreased $998 million and $433 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year.
The following table presents the components of noninterest income:
TABLE 8: Components of Noninterest Income |
||||||||||||||||||||||||||||
For the three months ended | For the nine months ended | |||||||||||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||||||||||
($ in millions) |
2018 | 2017 | % Change | 2018 | 2017 | % Change | ||||||||||||||||||||||
Service charges on deposits |
$ |
139 | 138 | 1 | $ |
414 | 415 | - | ||||||||||||||||||||
Wealth and asset management revenue |
114 | 102 | 12 | 335 | 313 | 7 | ||||||||||||||||||||||
Corporate banking revenue |
100 | 101 | (1) | 308 | 276 | 12 | ||||||||||||||||||||||
Card and processing revenue |
82 | 79 | 4 | 245 | 232 | 6 | ||||||||||||||||||||||
Mortgage banking net revenue |
49 | 63 | (22) | 158 | 170 | (7) | ||||||||||||||||||||||
Other noninterest income |
86 | 1,076 | (92) | 794 | 1,237 | (36) | ||||||||||||||||||||||
Securities (losses) gains, net |
(6 | ) | - | NM | (21 | ) | 1 | NM | ||||||||||||||||||||
Securities (losses) gains, net - non-qualifying hedges on MSRs |
(1 | ) | 2 | NM | (18 | ) | 4 | NM | ||||||||||||||||||||
Total noninterest income |
$ |
563 | 1,561 | (64) | $ |
2,215 | 2,648 | (16) |
Wealth and asset management revenue
Wealth and asset management revenue increased $12 million and $22 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase for both the three and nine months ended September 30, 2018 compared to the same periods in the prior year was primarily due to increases of $6 million and $13 million, respectively, in private client service fees and increases of $4 million and $7 million, respectively, in brokerage fees. These increases were driven by an increase in assets under management as a result of strong market performance and increased asset production. The Bancorps trust and registered investment advisory businesses had approximately $376 billion and $348 billion in total assets under care at September 30, 2018 and 2017, respectively, and managed $38 billion and $36 billion in assets for individuals, corporations and not-for-profit organizations at September 30, 2018 and 2017, respectively.
Corporate banking revenue
Corporate banking revenue decreased $1 million for the three months ended September 30, 2018 and increased $32 million for the nine months ended September 30, 2018 compared to the same periods in the prior year. The decrease for the three months ended September 30, 2018 compared to the same period in the prior year was primarily driven by decreases in institutional sales and letter of credit fees of $4 million and $1 million, respectively. These decreases were partially offset by an increase in foreign exchange fees of $4 million. The increase for the nine months ended September 30, 2018 compared to the same period in the prior year was primarily driven by increases in lease remarketing fees, foreign exchange fees and contract revenue from commercial customer derivatives of $26 million, $9 million and $8 million, respectively. The increase in lease remarketing fees for the nine months ended September 30, 2018 included the impact of a $31 million impairment charge related to certain operating lease assets that was recognized during the first quarter of 2017. These benefits were partially offset by decreases of $6 million in both business lending fees and letter of credit fees.
Card and processing revenue
Card and processing revenue increased $3 million and $13 million for the three and nine months ended September 30, 2018 compared to the same periods in the prior year. The increases for both the three and nine months ended September 30, 2018 compared to the same periods in the prior year were primarily driven by increases in the number of actively used cards and customer spend volume.
Mortgage banking net revenue
Mortgage banking net revenue decreased $14 million and $12 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year.
14
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
The following table presents the components of mortgage banking net revenue:
TABLE 9: Components of Mortgage Banking Net Revenue |
||||||||||||||||||
For the three months ended | For the nine months ended | |||||||||||||||||
September 30, | September 30, | |||||||||||||||||
($ in millions) |
2018 | 2017 | 2018 | 2017 | ||||||||||||||
Origination fees and gains on loan sales |
$ | 25 | 40 | 77 | 106 | |||||||||||||
Net mortgage servicing revenue: |
||||||||||||||||||
Gross mortgage servicing fees |
56 | 56 | 162 | 152 | ||||||||||||||
Net valuation adjustments on MSRs and free-standing derivatives purchased to economically hedge MSRs |
(32 | ) | (33 | ) | (81 | ) | (88 | ) | ||||||||||
Net mortgage servicing revenue |
24 | 23 | 81 | 64 | ||||||||||||||
Total mortgage banking net revenue |
$ | 49 | 63 | 158 | 170 |
Origination fees and gains on loan sales decreased $15 million and $29 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year driven by a decrease in originations and lower margins due to the interest rate environment. Residential mortgage loan originations decreased to $1.9 billion and $5.5 billion during the three and nine months ended September 30, 2018, respectively, compared to $2.1 billion and $6.3 billion during the same periods in the prior year.
Net mortgage servicing revenue increased $1 million and $17 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increases for the three and nine months ended September 30, 2018 compared to the same periods in the prior year included decreases in net negative valuation adjustments of $1 million and $7 million, respectively. The increase for the nine months ended September 30, 2018 also included an increase in gross mortgage servicing fees of $10 million. Refer to Table 10 for the components of net valuation adjustments on the MSR portfolio and the impact of the non-qualifying hedging strategy:
TABLE 10: Components of Net Valuation Adjustments on MSRs |
||||||||||||||||||
For the three months ended | For the nine months ended | |||||||||||||||||
September 30, | September 30, | |||||||||||||||||
($ in millions) |
2018 | 2017 | 2018 | 2017 | ||||||||||||||
Changes in fair value and settlement of free-standing derivatives purchased to economically hedge the MSR portfolio |
$ | (24 | ) | 1 | (89 | ) | 16 | |||||||||||
Changes in fair value: |
||||||||||||||||||
Due to changes in inputs or assumptions |
25 | (2 | ) | 103 | (15 | ) | ||||||||||||
Other changes in fair value |
(33 | ) | (32 | ) | (95 | ) | (89 | ) | ||||||||||
Net valuation adjustments on MSR and free-standing derivatives purchased to economically hedge MSRs |
$ | (32 | ) | (33 | ) | (81 | ) | (88 | ) |
Mortgage rates increased during both the three and nine months ended September 30, 2018 which caused modeled prepayment speeds to slow. The fair value of the MSR increased $25 million and $103 million, respectively, due to changes to inputs to the valuation model including prepayment speeds and OAS spread assumptions and decreased $33 million and $95 million, respectively, due to the passage of time, including the impact of regularly scheduled repayments, paydowns and payoffs for the three and nine months ended September 30, 2018.
Mortgage rates decreased during both the three and nine months ended September 30, 2017 which caused modeled prepayments speeds to increase, which led to fair value adjustments on servicing rights. The fair value of the MSR decreased $2 million and $15 million, respectively, due to changes to inputs to the valuation model including prepayment speeds and OAS spread assumptions and decreased $32 million and $89 million, respectively, due to the passage of time, including the impact of regularly scheduled repayments, paydowns and payoffs for the three and nine months ended September 30, 2017.
Further detail on the valuation of MSRs can be found in Note 11 of the Notes to Condensed Consolidated Financial Statements. The Bancorp maintains a non-qualifying hedging strategy to manage a portion of the risk associated with changes in the valuation of the MSR portfolio. Refer to Note 12 of the Notes to Condensed Consolidated Financial Statements for more information on the free-standing derivatives used to economically hedge the MSR portfolio.
In addition to the derivative positions used to economically hedge the MSR portfolio, the Bancorp acquires various securities as a component of its non-qualifying hedging strategy. The Bancorp recognized net losses of $1 million and $18 million during the three and nine months ended September 30, 2018, respectively, and net gains of $2 million and $4 million during the three and nine months ended September 30, 2017, respectively, recorded in securities (losses) gains, net - non-qualifying hedges on MSRs in the Bancorps Condensed Consolidated Statements of Income.
The Bancorps total residential mortgage loans serviced at September 30, 2018 and 2017 were $80.1 billion and $77.1 billion, respectively, with $64.0 billion and $60.8 billion, respectively, of residential mortgage loans serviced for others.
15
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
Other noninterest income
The following table presents the components of other noninterest income:
TABLE 11: Components of Other Noninterest Income |
||||||||||||||||||
For the three months ended | For the nine months ended | |||||||||||||||||
September 30, | September 30, | |||||||||||||||||
($ in millions) |
2018 | 2017 | 2018 | 2017 | ||||||||||||||
Gain related to Vantiv, Inc.s acquisition of Worldpay Group plc. |
$ | - | - | 414 | - | |||||||||||||
Gain on sale of Worldpay, Inc. shares |
- | 1,037 | 205 | 1,037 | ||||||||||||||
Operating lease income |
20 | 23 | 65 | 73 | ||||||||||||||
Private equity investment income |
26 | 2 | 61 | 29 | ||||||||||||||
BOLI income |
15 | 13 | 41 | 38 | ||||||||||||||
Cardholder fees |
14 | 14 | 41 | 41 | ||||||||||||||
Consumer loan and lease fees |
6 | 6 | 17 | 17 | ||||||||||||||
Insurance income |
5 | 2 | 16 | 5 | ||||||||||||||
Banking center income |
5 | 5 | 16 | 15 | ||||||||||||||
Net gains (losses) on loan sales |
3 | - | 2 | (2) | ||||||||||||||
Equity method income from interest in Worldpay Holding, LLC |
2 | 13 | 1 | 37 | ||||||||||||||
Loss on swap associated with the sale of Visa, Inc. Class B Shares |
(17 | ) | (47) | (66) | (69) | |||||||||||||
Net (losses) gains on disposition and impairment of bank premises and equipment |
4 | (1) | (37) | (3) | ||||||||||||||
Other, net |
3 | 9 | 18 | 19 | ||||||||||||||
Total other noninterest income |
$ | 86 | 1,076 | 794 | 1,237 |
Other noninterest income decreased $990 million during the three months ended September 30, 2018 compared to the same period in the prior year primarily due to the gain on sale of Worldpay, Inc. shares recognized during the third quarter of 2017 and a reduction in equity method income from the Bancorps interest in Worldpay Holding, LLC. These reductions were partially offset by a decrease in the loss on the swap associated with the sale of Visa, Inc. Class B Shares and an increase in private equity investment income.
The Bancorp recognized a $1.0 billion gain on the sale of Worldpay, Inc. shares during the three months ended September 30, 2017. Equity method income from the Bancorps interest in Worldpay Holding, LLC decreased $11 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to a decrease in the Bancorps ownership percentage in Worldpay Holding, LLC from approximately 8.6% as of September 30, 2017 to approximately 3.3% as of September 30, 2018 and the impact of a reduction in Worldpay Holding, LLC net income for the three months ended September 30, 2018 compared to the same period in the prior year. During the three months ended September 30, 2018, the Bancorp recognized negative valuation adjustments of $17 million related to the Visa total return swap compared to negative valuation adjustments of $47 million during the three months ended September 30, 2017. The decrease from the prior period was attributable to litigation developments during the third quarter of 2017. For additional information on the valuation of the swap associated with the sale of Visa, Inc. Class B Shares, refer to Note 16, Note 17 and Note 22 of the Notes to Condensed Consolidated Financial Statements. Private equity investment income increased $24 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to valuation adjustments on certain private equity investments.
Other noninterest income decreased $443 million during the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to the gain on sale of Worldpay, Inc. shares recognized during the third quarter of 2017, a reduction in equity method income from the Bancorps interest in Worldpay Holding, LLC and an increase in the net losses on disposition and impairment of bank premises and equipment. These reductions were partially offset by the gain related to Vantiv, Inc.s acquisition of Worldpay Group plc., the gain on sale of Worldpay, Inc. shares recognized during the second quarter of 2018 and increases in private equity investment income and in insurance income.
The Bancorp recognized a $205 million gain on the sale of Worldpay, Inc. shares during the nine months ended September 30, 2018 compared to a $1.0 billion gain on the sale of Worldpay, Inc. shares during the nine months ended September 30, 2017. The Bancorp also recognized a $414 million gain related to Vantiv, Inc.s acquisition of Worldpay Group plc. during the nine months ended September 30, 2018. For more information, refer to Note 18 of the Notes to Condensed Consolidated Financial Statements. Equity method income from the Bancorps interest in Worldpay Holding, LLC decreased $36 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to the decrease in the Bancorps ownership percentage in Worldpay Holding, LLC and the impact of Worldpay, Inc.s acquisition and integration costs on its earnings. Net losses on disposition and impairment of bank premises and equipment for the nine months ended September 30, 2018 included the impact of branch impairment charges of $33 million. For more information, refer to Note 7 of the Notes to Condensed Consolidated Financial Statements. Private equity investment income increased $32 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to valuation adjustments on certain private equity investments. Insurance income increased $11 million for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 as a result of acquisitions in 2017.
Noninterest Expense
Noninterest expense increased $33 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to increases in personnel costs (salaries, wages and incentives plus employee benefits), technology and communications expense and other noninterest expense. Noninterest expense increased $172 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to increases in personnel costs, technology and communications expense and other noninterest expense.
16
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
The following table presents the components of noninterest expense:
TABLE 12: Components of Noninterest Expense |
||||||||||||||||||||||||||||||
For the three months ended | For the nine months ended | |||||||||||||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||||||||||||
($ in millions) |
2018 | 2017 |
% Change | 2018 | 2017 | % Change | ||||||||||||||||||||||||
Salaries, wages and incentives |
$ |
421 | 407 | 3 | $ | 1,339 | 1,215 | 10 | ||||||||||||||||||||||
Employee benefits |
82 | 77 | 6 | 270 | 274 | (1) | ||||||||||||||||||||||||
Net occupancy expense |
70 | 74 | (5) | 219 | 221 | (1) | ||||||||||||||||||||||||
Technology and communications |
71 | 62 | 15 | 206 | 177 | 16 | ||||||||||||||||||||||||
Equipment expense |
31 | 30 | 3 | 92 | 88 | 5 | ||||||||||||||||||||||||
Card and processing expense |
31 | 32 | (3) | 91 | 95 | (4) | ||||||||||||||||||||||||
Other noninterest expense |
302 | 293 | 3 | 873 | 848 | 3 | ||||||||||||||||||||||||
Total noninterest expense |
$ |
1,008 | 975 | 3 | $ | 3,090 | 2,918 | 6 | ||||||||||||||||||||||
Efficiency ratio on an FTE basis(a) |
62.6 | % | 38.4 | 58.5 | % | 53.0 |
(a) |
This is a non-GAAP measure. For further information, refer to the Non-GAAP Financial Measures section of MD&A. |
Personnel costs increased $19 million and $120 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year driven by an increase in base compensation, variable compensation, long-term incentive compensation and severance costs. The increase in base compensation was primarily due to personnel additions in information technology as well as an increase in the Bancorps minimum wage as a result of benefits received from the TCJA. Full-time equivalent employees totaled 17,512 at September 30, 2018 compared to 17,797 at September 30, 2017.
Technology and communications expense increased $9 million and $29 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year driven primarily by increased investment in regulatory, compliance and growth initiatives.
The following table presents the components of other noninterest expense:
TABLE 13: Components of Other Noninterest Expense |
||||||||||||||||||||||||
For the three months ended | For the nine months ended | |||||||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||||||
($ in millions) |
2018 | 2017 | 2018 | 2017 | ||||||||||||||||||||
Impairment on affordable housing investments |
$ | 39 | 41 | 134 | 119 | |||||||||||||||||||
Marketing |
43 | 37 | 105 | 86 | ||||||||||||||||||||
FDIC insurance and other taxes |
33 | 33 | 99 | 98 | ||||||||||||||||||||
Loan and lease |
29 | 26 | 84 | 72 | ||||||||||||||||||||
Operating lease |
19 | 20 | 59 | 67 | ||||||||||||||||||||
Losses and adjustments |
18 | 20 | 51 | 46 | ||||||||||||||||||||
Professional service fees |
15 | 17 | 45 | 61 | ||||||||||||||||||||
Data processing |
14 | 14 | 42 | 43 | ||||||||||||||||||||
Travel |
13 | 12 | 39 | 35 | ||||||||||||||||||||
Postal and courier |
8 | 10 | 26 | 33 | ||||||||||||||||||||
Recruitment and education |
8 | 9 | 24 | 26 | ||||||||||||||||||||
Donations |
3 | 4 | 19 | 10 | ||||||||||||||||||||
Supplies |
3 | 3 | 10 | 10 | ||||||||||||||||||||
Insurance |
4 | 3 | 10 | 9 | ||||||||||||||||||||
Benefit from the reserve for unfunded commitments |
(2 | ) | (5 | ) | (32 | ) | (4) | |||||||||||||||||
Other, net |
55 | 49 | 158 | 137 | ||||||||||||||||||||
Total other noninterest expense |
$ | 302 | 293 | 873 | 848 |
Other noninterest expense increased $9 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to an increase in marketing expense. Marketing expense increased $6 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to an increase in advertising volume related to the brand campaign and promotional offers during the three months ended September 30, 2018. Other noninterest expense for the three months ended September 30, 2018 included a $2 million decrease in impairment on affordable housing investments as compared to the prior year period primarily due to a decrease in the number of investments, partially offset by the impact of the change in the federal statutory corporate tax rate pursuant to the TCJA.
Other noninterest expense increased $25 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to increases in marketing expense, the impairment on affordable housing investments, loan and lease expense and donations expense, partially offset by an increase in the benefit for the reserve for unfunded commitments and a decrease in professional service fees. Marketing expense increased $19 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to promotional offers during the nine months ended September 30, 2018. Impairment on affordable housing investments increased $15 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily driven by the change in the federal statutory corporate tax rate pursuant to the TCJA. Loan and lease expense increased $12 million for the nine months ended September 30, 2018 compared to the same period in the prior year driven by an increase in loan servicing expenses on point-of-sale loans as a result of growth in point-of-sale originations.
17
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
Donations expense increased $9 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to a contribution to the Fifth Third Foundation. The benefit from the reserve for unfunded commitments was $32 million for the nine months ended September 30, 2018 compared to a benefit from the reserve for unfunded commitments of $4 million for the same period in the prior year as a result of overall improved credit quality. Professional service fees decreased $16 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to decreases in legal fees and consulting fees.
Applicable Income Taxes
The following table presents the Bancorps income before income taxes, applicable income tax expense and effective tax rate:
TABLE 14: Applicable Income Taxes |
||||||||||||||||||
For the three months ended | For the nine months ended | |||||||||||||||||
September 30, | September 30, | |||||||||||||||||
($ in millions) |
2018 | 2017 | 2018 | 2017 | ||||||||||||||
Income before income taxes |
$ | 512 | 1,489 | 2,042 | 2,379 | |||||||||||||
Applicable income tax expense |
79 | 475 | 321 | 694 | ||||||||||||||
Effective tax rate |
15.6 | % | 31.9 | 15.7 | 29.2 |
Applicable income tax expense for all periods includes the benefit from tax-exempt income, tax-advantaged investments, and tax credits, partially offset by the effect of certain nondeductible expenses. The tax credits are associated with the Low-Income Housing Tax Credit program established under Section 42 of the IRC, the New Markets Tax Credit program established under Section 45D of the IRC, the Rehabilitation Investment Tax Credit program established under Section 47 of the IRC, and the Qualified Zone Academy Bond program established under Section 1397E of the IRC.
The decreases in the effective tax rates for the three and nine months ended September 30, 2018 compared to the same periods in the prior year were primarily related to the reduction in the federal statutory corporate tax rate partially offset by changes to previously deductible items associated with the enactment of the TCJA.
For stock-based awards, U.S. GAAP requires that the tax consequences for the difference between the expense recognized for financial reporting and the Bancorps actual tax deduction for the stock-based awards be recognized through income tax expense in the interim periods in which they occur. The Bancorp cannot predict its stock price or whether and when its employees will exercise stock-based awards in the future. Based on its stock price at September 30, 2018, the Bancorp estimates that it may be necessary to recognize $12 million of additional income tax benefit over the next twelve months related to the settlement of stock-based awards primarily in the first half of 2019. However, the amount of income tax expense or benefit recognized upon settlement may vary significantly from expectations based on the Bancorps stock price and the number of SARs exercised by employees.
18
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
Loans and Leases
The Bancorp classifies its commercial loans and leases based upon primary purpose and consumer loans based upon product or collateral. Table 15 summarizes end of period loans and leases, including loans and leases held for sale and Table 16 summarizes average total loans and leases, including loans and leases held for sale.
TABLE 15: Components of Total Loans and Leases (including loans and leases held for sale) |
||||||||||||||||||
September 30, 2018 | December 31, 2017 | |||||||||||||||||
As of ($ in millions) |
Carrying Value | % of Total | Carrying Value | % of Total | ||||||||||||||
Commercial loans and leases: |
||||||||||||||||||
Commercial and industrial loans |
$ | 42,725 | 46 | $ | 41,170 | 45 | ||||||||||||
Commercial mortgage loans |
6,701 | 7 | 6,610 | 7 | ||||||||||||||
Commercial construction loans |
4,892 | 5 | 4,553 | 5 | ||||||||||||||
Commercial leases |
3,697 | 4 | 4,068 | 4 | ||||||||||||||
Total commercial loans and leases |
58,015 | 62 | 56,401 | 61 | ||||||||||||||
Consumer loans: |
||||||||||||||||||
Residential mortgage loans |
16,148 | 17 | 16,077 | 17 | ||||||||||||||
Home equity |
6,485 | 7 | 7,014 | 8 | ||||||||||||||
Automobile loans |
9,002 | 10 | 9,112 | 10 | ||||||||||||||
Credit card |
2,325 | 2 | 2,299 | 2 | ||||||||||||||
Other consumer loans |
2,131 | 2 | 1,559 | 2 | ||||||||||||||
Total consumer loans |
36,091 | 38 | 36,061 | 39 | ||||||||||||||
Total loans and leases |
$ | 94,106 | 100 | $ | 92,462 | 100 | ||||||||||||
Total portfolio loans and leases (excluding loans and leases held for sale) |
$ | 93,443 | $ | 91,970 |
Loans and leases, including loans and leases held for sale, increased $1.6 billion from December 31, 2017. The increase from December 31, 2017 was the result of a $1.6 billion increase in commercial loans and leases as well as a $30 million increase in consumer loans.
Commercial loans and leases increased from December 31, 2017 due to increases in commercial and industrial loans, commercial construction loans and commercial mortgage loans, partially offset by a decrease in commercial leases. Commercial and industrial loans increased $1.6 billion, or 4%, from December 31, 2017 primarily as a result of an increase in new loan originations as well as a decrease in payoffs during the nine months ended September 30, 2018. Commercial construction loans increased $339 million, or 7%, from December 31, 2017 primarily due to increases in draw levels on existing commitments as a result of seasonal trends. Commercial mortgage loans increased $91 million, or 1%, from December 31, 2017 primarily due to an increase in new loan originations and continued success in permanent financing from the Bancorps commercial construction loan portfolio. Commercial leases decreased $371 million, or 9%, from December 31, 2017 primarily as a result of a planned reduction in indirect non-relationship based lease originations.
Consumer loans increased from December 31, 2017 due to increases in other consumer loans, credit card and residential mortgage loans, partially offset by decreases in home equity and automobile loans. Other consumer loans increased $572 million, or 37%, from December 31, 2017 primarily due to growth in point-of-sale loan originations. Residential mortgage loans increased $71 million from December 31, 2017 primarily due to the continued retention of certain agency conforming ARMs and certain other fixed-rate loans originated during the nine months ended September 30, 2018. Credit card increased $26 million, or 1%, from December 31, 2017 primarily due to an increase in balance active customers. Home equity decreased $529 million, or 8%, from December 31, 2017 as payoffs exceeded new loan production. Automobile loans decreased $110 million, or 1%, from December 31, 2017 as payoffs exceeded new loan production due to a strategic shift focusing on improving risk-adjusted returns.
TABLE 16: Components of Average Loans and Leases (including loans and leases held for sale) |
||||||||||||||||||
September 30, 2018 | September 30, 2017 | |||||||||||||||||
For the three months ended ($ in millions) |
Carrying Value | % of Total | Carrying Value | % of Total | ||||||||||||||
Commercial loans and leases: |
||||||||||||||||||
Commercial and industrial loans |
$ | 42,614 | 46 | $ | 41,314 | 45 | ||||||||||||
Commercial mortgage loans |
6,664 | 7 | 6,814 | 7 | ||||||||||||||
Commercial construction loans |
4,870 | 5 | 4,533 | 5 | ||||||||||||||
Commercial leases |
3,746 | 4 | 4,079 | 4 | ||||||||||||||
Total commercial loans and leases |
57,894 | 62 | 56,740 | 61 | ||||||||||||||
Consumer loans: |
||||||||||||||||||
Residential mortgage loans |
16,226 | 17 | 16,206 | 18 | ||||||||||||||
Home equity |
6,529 | 7 | 7,207 | 8 | ||||||||||||||
Automobile loans |
8,969 | 10 | 9,267 | 10 | ||||||||||||||
Credit card |
2,299 | 2 | 2,140 | 2 | ||||||||||||||
Other consumer loans |
2,060 | 2 | 1,057 | 1 | ||||||||||||||
Total consumer loans |
36,083 | 38 | 35,877 | 39 | ||||||||||||||
Total average loans and leases |
$ | 93,977 | 100 | $ | 92,617 | 100 | ||||||||||||
Total average portfolio loans and leases (excluding loans and leases held for sale) |
$ | 93,192 | $ | 91,906 |
19
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
Average loans and leases, including loans and leases held for sale, increased $1.4 billion from September 30, 2017. The increase from September 30, 2017 was the result of a $1.2 billion, or 2%, increase in average commercial loans and leases as well as a $206 million, or 1%, increase in average consumer loans.
Average commercial loans and leases increased from September 30, 2017 due to increases in average commercial and industrial and average commercial construction loans, partially offset by decreases in average commercial mortgage loans and average commercial leases. Average commercial and industrial loans increased $1.3 billion, or 3%, from September 30, 2017 primarily as a result of an increase in new loan originations as well as a decrease in payoffs. Average commercial construction loans increased $337 million, or 7%, from September 30, 2017 primarily due to increases in draw levels on existing commitments. Average commercial leases decreased $333 million, or 8%, from September 30, 2017 primarily as a result of a planned reduction in indirect non-relationship based lease originations. Average commercial mortgage loans decreased $150 million, or 2%, from September 30, 2017 primarily due to an increase in paydowns and lower new loan origination activity in the fourth quarter of 2017 and the first quarter of 2018 driven by increased competition.
Average consumer loans increased from September 30, 2017 due to increases in average other consumer loans, credit card and residential mortgage loans, partially offset by decreases in average home equity and automobile loans. Average other consumer loans increased $1.0 billion, or 95%, from September 30, 2017 primarily due to growth in point-of-sale loan originations. Average credit card increased $159 million, or 7%, from September 30, 2017 primarily due to both an increase in balance active customers and an increase in card usage resulting in an increase in the average balance per active customer. Average residential mortgage loans increased $20 million from September 30, 2017 primarily driven by the continued retention of certain agency conforming ARMs and certain other fixed-rate loans. Average home equity decreased $678 million, or 9%, from September 30, 2017 as payoffs exceeded new loan production. Average automobile loans decreased $298 million, or 3%, from September 30, 2017 as payoffs exceeded new loan production due to a strategic shift focusing on improving risk-adjusted returns.
Investment Securities
The Bancorp uses investment securities as a means of managing interest rate risk, providing both collateral for pledging purposes and liquidity for satisfying regulatory requirements. Total investment securities were $32.6 billion and $32.7 billion at September 30, 2018 and December 31, 2017, respectively. The taxable investment securities portfolio had an effective duration of 5.2 years at September 30, 2018 compared to 4.7 years at December 31, 2017.
Debt securities are classified as available-for-sale when, in managements judgment, they may be sold in response to, or in anticipation of, changes in market conditions. Securities that management has the intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. Debt securities are classified as trading when bought and held principally for the purpose of selling them in the near term. At September 30, 2018, the Bancorps investment portfolio consisted primarily of AAA-rated available-for-sale and other debt securities. The Bancorp held an immaterial amount in below investment grade available-for-sale and other debt securities at both September 30, 2018 and December 31, 2017. For both the three and nine months ended September 30, 2018 the Bancorp did not recognize OTTI on any of its available-for-sale debt and other securities. For the three and nine months ended September 30, 2017 the Bancorp recognized $4 million and $28 million, respectively, of OTTI on its available-for-sale debt and other securities, included in securities (losses) gains, net, in the Condensed Consolidated Statements of Income.
20
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
The following table summarizes the end of period components of investment securities:
TABLE 17: Components of Investment Securities |
||||||||
September 30, | December 31, | |||||||
As of ($ in millions) |
2018 | 2017 | ||||||
Available-for-sale debt and other securities (amortized cost basis): |
||||||||
U.S. Treasury and federal agencies securities |
$ | 98 | 98 | |||||
Obligations of states and political subdivisions securities |
2 | 43 | ||||||
Mortgage-backed securities: |
||||||||
Agency residential mortgage-backed securities(a) |
16,447 | 15,281 | ||||||
Agency commercial mortgage-backed securities |
10,405 | 10,113 | ||||||
Non-agency commercial mortgage-backed securities |
3,169 | 3,247 | ||||||
Asset-backed securities and other debt securities |
2,035 | 2,183 | ||||||
Other securities(b) |
551 | 612 | ||||||
Total available-for-sale debt and other securities |
$ | 32,707 | 31,577 | |||||
Held-to-maturity securities (amortized cost basis): |
||||||||
Obligations of states and political subdivisions securities |
$ | 16 | 22 | |||||
Asset-backed securities and other debt securities |
2 | 2 | ||||||
Total held-to-maturity securities |
$ | 18 | 24 | |||||
Trading debt securities (fair value): |
||||||||
U.S. Treasury and federal agencies securities |
$ | 20 | 12 | |||||
Obligations of states and political subdivisions securities |
69 | 22 | ||||||
Agency residential mortgage-backed securities |
63 | 395 | ||||||
Asset-backed securities and other debt securities |
117 | 63 | ||||||
Total trading debt securities |
$ | 269 | 492 | |||||
Total equity securities |
$ | 500 | 439 |
(a) |
Includes interest-only mortgage-backed securities of $34 as of December 31, 2017 recorded at fair value with fair value changes recorded in securities (losses) gains, net in the Condensed Consolidated Statements of Income. |
(b) |
Other securities consist of FHLB, FRB and DTCC restricted stock holdings of $184, $365 and $2, respectively, at September 30, 2018 and $248, $362, and $2, respectively, at December 31, 2017, that are carried at cost. |
On an amortized cost basis, available-for-sale debt and other securities increased $1.1 billion from December 31, 2017 primarily due to increases in agency residential mortgage-backed securities and agency commercial mortgage-backed securities, partially offset by a decrease in asset-backed securities and other debt securities.
On an amortized cost basis, available-for-sale debt and other securities were 25% of total interest-earning assets at both September 30, 2018 and December 31, 2017. The estimated weighted-average life of the debt securities in the available-for-sale debt and other securities portfolio was 6.8 years at September 30, 2018 compared to 6.5 years at December 31, 2017. In addition, at September 30, 2018, the debt securities in the available-for-sale debt and other securities portfolio had a weighted-average yield of 3.21%, compared to 3.18% at December 31, 2017.
Trading debt securities decreased $223 million from December 31, 2017 primarily due to a decrease in agency residential mortgage-backed securities.
Information presented in Table 18 is on a weighted-average life basis, anticipating future prepayments. Yield information is presented on an FTE basis and is computed using amortized cost balances. Maturity and yield calculations for the total available-for-sale debt and other securities portfolio exclude other securities that have no stated yield or maturity. Total net unrealized losses on the available-for-sale debt and other securities portfolio were $899 million at September 30, 2018 compared to net unrealized gains of $174 million at December 31, 2017. The fair value of investment securities is impacted by interest rates, credit spreads, market volatility and liquidity conditions. The fair value of investment securities generally decreases when interest rates increase or when credit spreads expand.
21
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
TABLE 18: Characteristics of Available-for-Sale Debt and Other Securities |
||||||||||||||||
Weighted-Average | Weighted-Average | |||||||||||||||
As of September 30, 2018 ($ in millions) |
Amortized Cost | Fair Value | Life (in years) | Yield | ||||||||||||
U.S. Treasury and federal agencies securities: |
||||||||||||||||
Average life of 1 year or less |
$ | - | - | 0.2 | 3.04 % | |||||||||||
Average life 1 5 years |
98 | 95 | 4.3 | 2.12 | ||||||||||||
Total |
$ | 98 | 95 | 4.3 | 2.12 % | |||||||||||
Obligations of states and political subdivisions securities:(a) |
||||||||||||||||
Average life of 1 year or less |
- | - | 0.3 | 5.90 | ||||||||||||
Average life 1 5 years |
- | - | 2.4 | 5.90 | ||||||||||||
Average life 5 10 years |
2 | 2 | 6.0 | - | ||||||||||||
Total |
$ | 2 | 2 | 5.6 | 0.54 % | |||||||||||
Agency residential mortgage-backed securities: |
||||||||||||||||
Average life of 1 year or less |
- | - | 0.4 | 10.07 | ||||||||||||
Average life 1 5 years |
5,932 | 5,821 | 4.4 | 3.41 | ||||||||||||
Average life 5 10 years |
9,367 | 9,066 | 7.4 | 3.17 | ||||||||||||
Average life greater than 10 years |
1,148 | 1,086 | 11.0 | 3.09 | ||||||||||||
Total |
$ | 16,447 | 15,973 | 6.6 | 3.25 % | |||||||||||
Agency commercial mortgage-backed securities: |
||||||||||||||||
Average life 1 5 years |
2,219 | 2,142 | 3.5 | 2.92 | ||||||||||||
Average life 5 10 years |
6,024 | 5,855 | 7.5 | 3.10 | ||||||||||||
Average life greater than 10 years |
2,162 | 2,049 | 11.7 | 3.09 | ||||||||||||
Total |
$ | 10,405 | 10,046 | 7.5 | 3.06 % | |||||||||||
Non-agency commercial mortgage-backed securities: |
||||||||||||||||
Average life of 1 year or less |
- | - | 0.3 | 4.53 | ||||||||||||
Average life 1 5 years |
699 | 692 | 4.6 | 3.23 | ||||||||||||
Average life 5 10 years |
2,470 | 2,405 | 6.6 | 3.23 | ||||||||||||
Total |
$ | 3,169 | 3,097 | 6.2 | 3.23 % | |||||||||||
Asset-backed securities and other debt securities: |
||||||||||||||||
Average life of 1 year or less |
36 | 35 | 0.4 | 2.59 | ||||||||||||
Average life 1 5 years |
1,104 | 1,105 | 3.7 | 3.87 | ||||||||||||
Average life 5 10 years |
698 | 705 | 6.7 | 3.62 | ||||||||||||
Average life greater than 10 years |
197 | 199 | 10.4 | 3.66 | ||||||||||||
Total |
$ | 2,035 | 2,044 | 5.3 | 3.74 % | |||||||||||
Other securities |
551 | 551 | ||||||||||||||
Total available-for-sale debt and other securities |
$ | 32,707 | 31,808 | 6.8 | 3.21 % |
(a) |
Taxable-equivalent yield adjustments included in the above table are 0.00%, 0.48%, 0.00% and 0.03% for securities with an average life of 1 year or less, 1-5 years, 5-10 years and in total, respectively. |
22
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
Deposits
The Bancorps deposit balances represent an important source of funding and revenue growth opportunity. The Bancorp continues to focus on core deposit growth in its retail and commercial franchises by improving customer satisfaction, building full relationships and offering competitive rates. Average core deposits represented 72% and 71% of the Bancorps average asset funding base at September 30, 2018 and December 31, 2017, respectively.
The following table presents the end of period components of deposits:
TABLE 19: Components of Deposits |
||||||||||||||||||
September 30, 2018 | December 31, 2017 | |||||||||||||||||
As of ($ in millions) |
Balance | % of Total | Balance | % of Total | ||||||||||||||
Demand |
$ | 31,803 | 31 | $ | 35,276 | 34 | ||||||||||||
Interest checking |
30,288 | 29 | 27,703 | 27 | ||||||||||||||
Savings |
13,027 | 12 | 13,425 | 13 | ||||||||||||||
Money market |
21,977 | 21 | 20,097 | 19 | ||||||||||||||
Foreign office |
298 | - | 484 | 1 | ||||||||||||||
Total transaction deposits |
97,393 | 93 | 96,985 | 94 | ||||||||||||||
Other time |
4,249 | 4 | 3,775 | 4 | ||||||||||||||
Total core deposits |
101,642 | 97 | 100,760 | 98 | ||||||||||||||
Certificates $100,000 and over(a) |
2,700 | 3 | 2,402 | 2 | ||||||||||||||
Total deposits |
$ | 104,342 | 100 | $ | 103,162 | 100 |
(a) |
Includes $1.5 billion and $1.3 billion of institutional, retail and wholesale certificates $250,000 and over at September 30, 2018 and December 31, 2017, respectively. |
Core deposits increased $882 million, or 1%, from December 31, 2017 driven by an increase of $474 million in other time deposits and an increase of $408 million in transaction deposits. Other time deposits increased from December 31, 2017 primarily due to promotional rate offers facilitated by the rising-rate environment. Transaction deposits increased from December 31, 2017 primarily due to increases in interest checking deposits and money market deposits, partially offset by a decrease in demand deposits. Interest checking deposits increased $2.6 billion, or 9%, from December 31, 2017 driven primarily by balance migration from demand deposit accounts and higher balances per commercial customer account. Money market deposits increased $1.9 billion, or 9%, from December 31, 2017 primarily as a result of promotional rate offers facilitated by the rising-rate environment, growth in the Fifth Third Preferred Banking program and direct mail marketing which drove consumer customer acquisition. Demand deposits decreased $3.5 billion, or 10%, from December 31, 2017 primarily as a result of the aforementioned commercial customer balance migration into interest checking deposits and lower balances per commercial customer account due to commercial customer seasonality.
Certificates $100,000 and over increased $298 million from December 31, 2017 primarily due to an increase in retail brokered certificates of deposit since December 31, 2017.
The following table presents the components of average deposits for the three months ended:
TABLE 20: Components of Average Deposits |
||||||||||||||||||
September 30, 2018 | September 30, 2017 | |||||||||||||||||
($ in millions) |
Balance | % of Total | Balance | % of Total | ||||||||||||||
Demand |
$ | 32,333 | 31 | $ | 34,850 | 33 | ||||||||||||
Interest checking |
29,681 | 28 | 25,765 | 25 | ||||||||||||||
Savings |
13,231 | 13 | 13,889 | 14 | ||||||||||||||
Money market |
21,753 | 21 | 20,028 | 20 | ||||||||||||||
Foreign office |
317 | - | 395 | - | ||||||||||||||
Total transaction deposits |
97,315 | 93 | 94,927 | 92 | ||||||||||||||
Other time |
4,177 | 4 | 3,722 | 4 | ||||||||||||||
Total core deposits |
101,492 | 97 | 98,649 | 96 | ||||||||||||||
Certificates $100,000 and over(a) |
2,596 | 2 | 2,625 | 3 | ||||||||||||||
Other deposits |
578 | 1 | 560 | 1 | ||||||||||||||
Total average deposits |
$ | 104,666 | 100 | $ | 101,834 | 100 |
(a) |
Includes $1.4 billion and $1.5 billion of average institutional, retail and wholesale certificates $250,000 and over for the three months ended September 30, 2018 and 2017, respectively. |
On an average basis, core deposits increased $2.8 billion, or 3%, from September 30, 2017 primarily due to an increase of $2.4 billion in average transaction deposits and an increase of $455 million in average other time deposits. Average other time deposits increased from September 30, 2017 primarily as a result of promotional offers facilitated by the rising-rate environment. The increase in average transaction deposits was driven by increases in average interest checking deposits and average money market deposits, partially offset by a decrease in average demand deposits. Average interest checking deposits increased $3.9 billion, or 15%, from September 30, 2017, primarily due to balance migration from demand deposit accounts and an increase in average balances per commercial customer account. Average money market deposits increased $1.7 billion, or 9%, from September 30, 2017 primarily as a result of promotional rate offers facilitated by the rising-rate environment, growth in the Fifth Third Preferred Banking program and direct mail marketing which drove consumer customer acquisition. Average demand deposits decreased $2.5 billion, or 7%, from September 30, 2017 primarily due to commercial customer balance migration into interest checking deposits and a decrease in average balances per commercial customer account.
23
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
Contractual maturities
The contractual maturities of certificates $100,000 and over as of September 30, 2018 are summarized in the following table:
TABLE 21: Contractual Maturities of Certificates $100,000 and Over |
||||
($ in millions) |
||||
Next 3 months |
$ | 708 | ||
3-6 months |
547 | |||
6-12 months |
588 | |||
After 12 months |
857 | |||
Total certificates $100,000 and over |
$ | 2,700 |
The contractual maturities of other time deposits and certificates $100,000 and over as of September 30, 2018 are summarized in the following table:
TABLE 22: Contractual Maturities of Other Time Deposits and Certificates $100,000 and Over |
||||
($ in millions) |
||||
Next 12 months |
$ | 3,728 | ||
13-24 months |
2,304 | |||
25-36 months |
759 | |||
37-48 months |
126 | |||
49-60 months |
24 | |||
After 60 months |
8 | |||
Total other time deposits and certificates $100,000 and over |
$ | 6,949 |
Borrowings
The Bancorp accesses a variety of short-term and long-term funding sources. Borrowings with original maturities of one year or less are classified as short-term and include federal funds purchased and other short-term borrowings. As of September 30, 2018, average total borrowings as a percent of average interest-bearing liabilities were 19% compared to 21% at December 31, 2017.
The following table summarizes the end of period components of borrowings:
TABLE 23: Components of Borrowings |
||||||
As of ($ in millions) |
September 30, 2018 | December 31, 2017 | ||||
Federal funds purchased |
$ | 2,316 | 174 | |||
Other short-term borrowings |
1,114 | 4,012 | ||||
Long-term debt |
14,460 | 14,904 | ||||
Total borrowings |
$ | 17,890 | 19,090 |
Total borrowings decreased $1.2 billion, or 6%, from December 31, 2017 due to decreases in other short-term borrowings and long-term debt partially offset by an increase in federal funds purchased. Other short-term borrowings decreased $2.9 billion from December 31, 2017 driven by a decrease in FHLB advances. The level of other short-term borrowings can fluctuate significantly from period to period depending on funding needs and which sources are used to satisfy those needs. For further information on the components of other short-term borrowings, refer to Note 13 of the Notes to Condensed Consolidated Financial Statements. Long-term debt decreased $444 million from December 31, 2017 primarily driven by the maturity of $1.9 billion of unsecured senior bank notes and $500 million of unsecured subordinated debt, $379 million of paydowns on long-term debt associated with automobile loan securitizations and $117 million of fair value adjustments associated with interest rate swaps hedging long-term debt during the nine months ended September 30, 2018. These decreases were partially offset by the issuance of $1.9 billion of unsecured fixed-rate senior notes and $550 million of unsecured floating-rate senior notes since December 31, 2017. For additional information regarding long-term debt issuances, refer to Note 14 of the Notes to Condensed Consolidated Financial Statements. Federal funds purchased increased $2.1 billion from December 31, 2017 due to a reallocation of other short-term borrowings.
The following table summarizes components of average borrowings for the three months ended:
TABLE 24: Components of Average Borrowings |
||||||
($ in millions) |
September 30, 2018 | September 30, 2017 | ||||
Federal funds purchased |
$ | 1,987 | 675 | |||
Other short-term borrowings |
1,018 | 4,212 | ||||
Long-term debt |
14,434 | 13,457 | ||||
Total average borrowings |
$ | 17,439 | 18,344 |
Total average borrowings decreased $905 million, or 5%, compared to September 30, 2017, due to decreases in average other short-term borrowings partially offset by increases in average federal funds purchased and average long-term debt. Average other short-term borrowings decreased $3.2 billion compared to September 30, 2017, primarily driven by the decrease in FHLB advances. Average long-term debt increased $977 million compared to September 30, 2017. The increase was primarily driven by the issuance of $2.7 billion of unsecured fixed-rate senior bank notes and $850 million of unsecured floating-rate senior bank notes since September 30, 2017 partially offset by the maturity of $1.9 billion in unsecured senior bank notes since September 30, 2017 and $500 million of unsecured subordinated debt during the second quarter of 2018. Average federal funds purchased increased $1.3 billion due to a reallocation of other short-term borrowings. Information on the average rates paid on borrowings is discussed in the Net Interest Income subsection of the Statements of Income Analysis section of MD&A. In addition, refer to the Liquidity Risk Management subsection of the Risk Management section of MD&A for a discussion on the role of borrowings in the Bancorps liquidity management.
24
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
The Bancorp reports on four business segments: Commercial Banking, Branch Banking, Consumer Lending and Wealth and Asset Management. Additional information on each business segment is included in Note 23 of the Notes to Condensed Consolidated Financial Statements. Results of the Bancorps business segments are presented based on its management structure and management accounting practices. The structure and accounting practices are specific to the Bancorp; therefore, the financial results of the Bancorps business segments are not necessarily comparable with similar information for other financial institutions. The Bancorp refines its methodologies from time to time as managements accounting practices and businesses change.
The Bancorp manages interest rate risk centrally at the corporate level. By employing an FTP methodology, the business segments are insulated from most benchmark interest rate volatility, enabling them to focus on serving customers through the origination of loans and acceptance of deposits. The FTP methodology assigns charge rates and credit rates to classes of assets and liabilities, respectively, based on the estimated amount and timing of the cash flows for each transaction. Assigning the FTP rate based on matching the duration of cash flows allocates interest income and interest expense to each business segment so its resulting net interest income is insulated from future changes in benchmark interest rates. The Bancorps FTP methodology also allocates the contribution to net interest income of the asset-generating and deposit-providing businesses on a duration-adjusted basis to better attribute the driver of the performance. As the asset and liability durations are not perfectly matched, the residual impact of the FTP methodology is captured in General Corporate and Other. The charge and credit rates are determined using the FTP rate curve, which is based on an estimate of Fifth Thirds marginal borrowing cost in the wholesale funding markets. The FTP curve is constructed using the U.S. swap curve, brokered CD pricing and unsecured debt pricing.
The Bancorp adjusts the FTP charge and credit rates as dictated by changes in interest rates for various interest-earning assets and interest-bearing liabilities and by the review of behavioral assumptions, such as prepayment rates on interest-earning assets and the estimated durations for indeterminate-lived deposits. Key assumptions, including the credit rates provided for deposit accounts, are reviewed annually. Credit rates for deposit products and charge rates for loan products may be reset more frequently in response to changes in market conditions. The credit rates for several deposit products were reset January 1, 2018 to reflect the current market rates and updated market assumptions. These rates were generally higher than those in place during 2017, thus net interest income for deposit-providing business segments was positively impacted during 2018. FTP charge rates on assets were affected by the prevailing level of interest rates and by the duration and repricing characteristics of the portfolio. As overall market rates increased, the FTP charge increased for asset-generating business segments during 2018.
The Bancorps methodology for allocating provision for loan and lease losses expense to the business segments includes charges or benefits associated with changes in criticized commercial loan levels in addition to actual net charge-offs experienced by the loans and leases owned by each business segment. Provision for loan and lease losses expense attributable to loan and lease growth and changes in ALLL factors is captured in General Corporate and Other. The financial results of the business segments include allocations for shared services and headquarters expenses. Additionally, the business segments form synergies by taking advantage of cross-sell opportunities and funding operations by accessing the capital markets as a collective unit.
The results of operations and financial position for the three and nine months ended September 30, 2017 were adjusted to reflect changes in internal expense allocation methodologies.
The following table summarizes net income (loss) by business segment:
TABLE 25: Net Income (Loss) by Business Segment |
||||||||||||||||||||
For the three months ended | For the nine months ended | |||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||
($ in millions) |
2018 | 2017 | 2018 | 2017 | ||||||||||||||||
Income Statement Data |
||||||||||||||||||||
Commercial Banking |
$ |
298 | 244 | 843 | 698 | |||||||||||||||
Branch Banking |
207 | 124 | 490 | 338 | ||||||||||||||||
Consumer Lending |
- | 12 | (13 | ) | 11 | |||||||||||||||
Wealth and Asset Management |
25 | 19 | 70 | 52 | ||||||||||||||||
General Corporate and Other |
(97 | ) | 615 | 331 | 586 | |||||||||||||||
Net income |
$ |
433 | 1,014 | 1,721 | 1,685 |
25
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
Commercial Banking
Commercial Banking offers credit intermediation, cash management and financial services to large and middle-market businesses and government and professional customers. In addition to the traditional lending and depository offerings, Commercial Banking products and services include global cash management, foreign exchange and international trade finance, derivatives and capital markets services, asset-based lending, real estate finance, public finance, commercial leasing and syndicated finance.
The following table contains selected financial data for the Commercial Banking segment:
TABLE 26: Commercial Banking |
||||||||||||||||||||||||
For the three months ended | For the nine months ended | |||||||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||||||
($ in millions) |
2018 | 2017 | 2018 | 2017 | ||||||||||||||||||||
Income Statement Data |
||||||||||||||||||||||||
Net interest income (FTE)(a) |
$ | 431 | 429 | 1,285 | 1,280 | |||||||||||||||||||
(Benefit from) provision for loan and lease losses |
(11 | ) | (3) | (41 | ) | 25 | ||||||||||||||||||
Noninterest income: |
||||||||||||||||||||||||
Corporate banking revenue |
100 | 100 | 304 | 272 | ||||||||||||||||||||
Service charges on deposits |
68 | 71 | 207 | 217 | ||||||||||||||||||||
Other noninterest income |
67 | 45 | 170 | 156 | ||||||||||||||||||||
Noninterest expense: |
||||||||||||||||||||||||
Personnel costs |
79 | 71 | 250 | 225 | ||||||||||||||||||||
Other noninterest expense |
266 | 270 | 839 | 806 | ||||||||||||||||||||
Income before income taxes (FTE) |
332 | 307 | 918 | 869 | ||||||||||||||||||||
Applicable income tax expense(a)(b) |
34 | 63 | 75 | 171 | ||||||||||||||||||||
Net income |
$ | 298 | 244 | 843 | 698 | |||||||||||||||||||
Average Balance Sheet Data |
||||||||||||||||||||||||
Commercial loans and leases, including held for sale |
$ | 54,685 | 53,722 | 54,305 | 53,708 | |||||||||||||||||||
Demand deposits |
16,198 | 19,292 | 16,967 | 19,466 | ||||||||||||||||||||
Interest checking deposits |
12,511 | 8,680 | 11,303 | 8,912 | ||||||||||||||||||||
Savings and money market deposits |
3,691 | 4,972 | 4,263 | 5,615 | ||||||||||||||||||||
Other time deposits and certificates $100,000 and over |
268 | 903 | 401 | 931 | ||||||||||||||||||||
Foreign office deposits |
316 | 391 | 392 | 391 |
(a) |
Includes FTE adjustments of $4 and $7 for the three months ended September 30, 2018 and 2017, respectively, and $12 and $19 for the nine months ended September 30, 2018 and 2017, respectively. |
(b) |
Applicable income tax expense for all periods includes the tax benefit from tax-exempt income, tax-advantaged investments and tax credits, partially offset by the effect of certain nondeductible expenses. Refer to the Applicable Income Taxes subsection of the Statements of Income Analysis section of MD&A for additional information. |
Net income was $298 million for the three months ended September 30, 2018 compared to net income of $244 million for the three months ended September 30, 2017. Net income was $843 million for the nine months ended September 30, 2018 compared to net income of $698 million for the nine months ended September 30, 2017. The increase for both periods was driven by decreases in the provision for loan and lease losses and increases in noninterest income and net interest income on an FTE basis partially offset by increases in noninterest expense.
Net interest income on an FTE basis increased $2 million and $5 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily driven by increases in yields on average commercial loans and leases and increases in FTP credits on interest checking deposits. These increases were partially offset by increases in FTP charge rates on loans and leases and increases in the rates paid on core deposits.
Provision for loan and lease losses decreased $8 million and $66 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The decrease for the three months ended September 30, 2018 compared to the same period in the prior year was primarily driven by a decrease in net charge-offs. The decrease for the nine months ended September 30, 2018 compared to the same period in the prior year was primarily driven by a decrease in criticized asset levels partially offset by an increase in net charge-offs. Net charge-offs as a percent of average portfolio loans and leases decreased to 12 bps and increased to 20 bps for the three and nine months ended September 30, 2018, respectively, compared to 19 bps for both periods in the prior year.
Noninterest income increased $19 million and $36 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase for both the three and nine months ended September 30, 2018 was driven by an increase in other noninterest income partially offset by a decrease in service charges on deposits. Additionally, the increase for the nine months ended September 30, 2018 included the impact of an increase in corporate banking revenue. Other noninterest income increased $22 million and $14 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to an increase in private equity investment income. Service charges on deposits decreased $3 million and $10 million for three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. Corporate banking revenue increased $32 million for the nine months ended September 30, 2018 compared to the same period in the prior year driven by increases in lease remarketing fees, foreign exchange fees, institutional sales revenue and contract revenue from commercial customer derivatives partially offset by decreases in business lending fees and letter of credit fees. The increase in lease remarketing fees for the nine months ended September 30, 2018 included the impact of a $31 million impairment charge related to certain operating lease assets that was recognized during the first quarter of 2017.
26
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
Noninterest expense increased $4 million and $58 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase for the three months ended September 30, 2018 was due to an increase in personnel costs partially offset by a decrease in other noninterest expense. Personnel costs increased $8 million for the three months ended September 30, 2018 compared to the same period in the prior year due to increased base compensation. Other noninterest expense decreased $4 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to decreases in consulting expense, impairment on affordable housing investments and OREO expense partially offset by increases in corporate overhead allocations. The increase for the nine months ended September 30, 2018 was a result of increases in both other noninterest expense and personnel costs. Other noninterest expense increased $33 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to increases in corporate overhead allocations and impairment on affordable housing investments partially offset by a decrease in consulting expense. Personnel costs increased $25 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to increased base compensation and incentive compensation.
Average commercial loans and leases increased $963 million and $597 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in average commercial and industrial loans and average commercial construction loans partially offset by decreases in average commercial leases and average commercial mortgage loans. Average commercial and industrial loans increased $1.1 billion and $522 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year as a result of an increase in new loan originations as well as a decrease in payoffs. Average commercial construction loans increased $310 million and $474 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in draw levels on existing commitments. Average commercial leases decreased $335 million and $159 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily as a result of a planned reduction in indirect non-relationship based lease originations. Average commercial mortgage loans decreased $146 million and $240 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year due to an increase in paydowns and lower new loan origination activity driven by increased competition.
Average core deposits decreased $620 million and $1.5 billion for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The decreases for the three and nine months ended September 30, 2018 were driven by decreases in average demand deposits of $3.1 billion and $2.5 billion, respectively, and average savings and money market deposits of $1.3 billion and $1.4 billion, respectively, compared to the same periods in the prior year primarily due to lower average balances per account. These decreases were partially offset by increases in average interest checking deposits of $3.8 billion and $2.4 billion for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to balance migration from demand deposit accounts and increases in average balances per account.
Branch Banking
Branch Banking provides a full range of deposit and loan products to individuals and small businesses through 1,152 full-service banking centers. Branch Banking offers depository and loan products, such as checking and savings accounts, home equity loans and lines of credit, credit cards and loans for automobiles and other personal financing needs, as well as products designed to meet the specific needs of small businesses, including cash management services.
27
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
The following table contains selected financial data for the Branch Banking segment:
TABLE 27: Branch Banking |
||||||||||||||||||||
For the three months ended | For the nine months ended | |||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||
($ in millions) |
2018 | 2017 | 2018 | 2017 | ||||||||||||||||
Income Statement Data |
||||||||||||||||||||
Net interest income |
$ | 525 | 453 | 1,490 | 1,320 | |||||||||||||||
Provision for loan and lease losses |
34 | 35 | 124 | 115 | ||||||||||||||||
Noninterest income: |
||||||||||||||||||||
Service charges on deposits |
71 | 67 | 205 | 196 | ||||||||||||||||
Card and processing revenue |
67 | 64 | 199 | 185 | ||||||||||||||||
Wealth and asset management revenue |
38 | 35 | 113 | 106 | ||||||||||||||||
Other noninterest income |
28 | 25 | 41 | 76 | ||||||||||||||||
Noninterest expense: |
||||||||||||||||||||
Personnel costs |
131 | 126 | 404 | 387 | ||||||||||||||||
Net occupancy and equipment expense |
56 | 56 | 168 | 172 | ||||||||||||||||
Card and processing expense |
30 | 31 | 89 | 93 | ||||||||||||||||
Other noninterest expense |
216 | 206 | 642 | 595 | ||||||||||||||||
Income before income taxes |
262 | 190 | 621 | 521 | ||||||||||||||||
Applicable income tax expense |
55 | 66 | 131 | 183 | ||||||||||||||||
Net income |
$ | 207 | 124 | 490 | 338 | |||||||||||||||
Average Balance Sheet Data |
||||||||||||||||||||
Consumer loans |
$ | 13,069 | 12,905 | 12,992 | 13,013 | |||||||||||||||
Commercial loans |
1,972 | 1,915 | 1,919 | 1,928 | ||||||||||||||||
Demand deposits |
14,403 | 13,875 | 14,310 | 13,839 | ||||||||||||||||
Interest checking deposits |
10,065 | 10,228 | 10,232 | 10,231 | ||||||||||||||||
Savings and money market deposits |
29,786 | 27,671 | 29,260 | 27,539 | ||||||||||||||||
Other time deposits and certificates $100,000 and over |
5,443 | 4,903 | 5,238 | 4,962 |
Net income was $207 million for the three months ended September 30, 2018 compared to net income of $124 million for the three months ended September 30, 2017. Net income was $490 million for the nine months ended September 30, 2018 compared to $338 million for the nine months ended September 30, 2017. The increase for both periods was driven by increases in net interest income partially offset by increases in noninterest expense.
Net interest income increased $72 million and $170 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase in net interest income for both periods was primarily due to increases in FTP credit rates on core deposits as well as increases in interest income on other consumer loans driven by higher average balances. These benefits were partially offset by increases in FTP charge rates on loans and leases and increases in the rates paid on savings and money market deposits. Additionally, for the nine months ended September 30, 2018, the increase in net interest income was partially offset by the impact of a $12 million benefit in the first quarter of 2017 related to a revised estimate of refunds to be offered to certain bankcard customers.
Provision for loan and lease losses decreased $1 million and increased $9 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase for the nine months ended September 30, 2018 was primarily due to increases in net charge-offs on other consumer loans and credit card. Net charge-offs as a percent of average portfolio loans and leases increased to 99 bps and 111 bps for the three and nine months ended September 30, 2018, respectively, compared to 96 bps and 103 bps for the three and nine months ended September 30, 2017, respectively.
Noninterest income increased $13 million and decreased $5 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase for the three months ended September 30, 2018 compared to the same period in the prior year was primarily due to increases in service charges on deposits, card and processing revenue, wealth and asset management revenue and other noninterest income of $4 million, $3 million, $3 million and $3 million, respectively. The decrease for the nine months ended September 30, 2018 compared to the same period in the prior year was primarily due to a decrease in other noninterest income partially offset by increases in card and processing revenue, service charges on deposits and wealth and asset management revenue. Other noninterest income decreased $35 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to the impact of impairment on bank premises and equipment. Card and processing revenue increased $14 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily driven by increases in the number of actively used cards and customer spend volume. Service charges on deposits increased $9 million for the nine months ended September 30, 2018 compared to the same period in the prior year. Wealth and asset management revenue increased $7 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily driven by an increase in brokerage fees and private client service fees.
Noninterest expense increased $14 million and $56 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in other noninterest expense and personnel costs. Other noninterest expense increased $10 million and $47 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in corporate overhead allocations and loan and lease expense. Personnel costs increased $5 million and $17 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to higher base compensation.
28
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
Average consumer loans increased $164 million and decreased $21 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The change for both the three and nine months ended September 30, 2018 compared to the same periods in the prior year was impacted by increases in average other consumer loans of $1.1 billion and $993 million, respectively, primarily due to growth in point-of-sale loan originations and decreases in both average home equity loans of $536 million and $542 million, respectively, and average residential mortgage loans of $305 million and $314 million, respectively, as payoffs exceeded new loan production.
Average core deposits increased $2.9 billion and $2.4 billion for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase for both periods was primarily driven by growth in average savings and money market deposits of $2.1 billion and $1.7 billion and growth in average demand deposits of $528 million and $471 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in average balances per customer account and the acquisition of new customers.
Consumer Lending
Consumer Lending includes the Bancorps residential mortgage, home equity, automobile and other indirect lending activities. Lending activities include the origination, retention and servicing of residential mortgage and home equity loans or lines of credit, sales and securitizations of those loans, pools of loans or lines of credit and all associated hedging activities. Indirect lending activities include extending loans to consumers through correspondent lenders and automobile dealers.
The following table contains selected financial data for the Consumer Lending segment:
TABLE 28: Consumer Lending |
||||||||||||||||||
For the three months ended | For the nine months ended | |||||||||||||||||
September 30, | September 30, | |||||||||||||||||
($ in millions) |
2018 | 2017 | 2018 | 2017 | ||||||||||||||
Income Statement Data |
||||||||||||||||||
Net interest income |
$ | 60 | 59 | 178 | 179 | |||||||||||||
Provision for loan and lease losses |
10 | 8 | 30 | 30 | ||||||||||||||
Noninterest income: |
||||||||||||||||||
Mortgage banking net revenue |
48 | 61 | 153 | 164 | ||||||||||||||
Other noninterest income |
2 | 7 | (7 | ) | 18 | |||||||||||||
Noninterest expense: |
||||||||||||||||||
Personnel costs |
46 | 46 | 148 | 142 | ||||||||||||||
Other noninterest expense |
54 | 55 | 162 | 171 | ||||||||||||||
(Loss) income before income taxes |
- | 18 | (16 | ) | 18 | |||||||||||||
Applicable income tax (benefit) expense |
- | 6 | (3 | ) | 7 | |||||||||||||
Net (loss) income |
$ | - | 12 | (13 | ) | 11 | ||||||||||||
Average Balance Sheet Data |
||||||||||||||||||
Residential mortgage loans, including held for sale |
$ | 11,896 | 11,672 | 11,805 | 11,422 | |||||||||||||
Home equity |
237 | 285 | 249 | 299 | ||||||||||||||
Automobile loans |
8,668 | 8,826 | 8,669 | 8,995 |
Consumer Lending reported an immaterial amount of net income for the three months ended September 30, 2018 compared to net income of $12 million for the three months ended September 30, 2017. Consumer Lending incurred a net loss of $13 million for the nine months ended September 30, 2018 compared to net income of $11 million for the nine months ended September 30, 2017. The decrease for both periods was driven by decreases in noninterest income partially offset by decreases in the noninterest expense.
Provision for loan and lease losses increased $2 million and was flat for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. Net charge-offs as a percent of average portfolio loans and leases were 20 bps for both the three and nine months ended September 30, 2018 compared to 15 bps and 20 bps for the same periods in the prior year, respectively.
Noninterest income decreased $18 million and $36 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year due to decreases in both mortgage banking net revenue and other noninterest income. Mortgage banking net revenue decreased $13 million and $11 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to decreases in origination fees and gains on loan sales partially offset by increases in net mortgage servicing revenue. Refer to the Noninterest Income subsection of the Statements of Income Analysis section of the MD&A for additional information on the fluctuations in mortgage banking net revenue. Other noninterest income decreased $5 million and $25 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in losses on securities related to non-qualifying hedges on MSRs resulting from increased interest rates.
Noninterest expense decreased $1 million and $3 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in prior year. Other noninterest expense decreased $9 million for the nine months ended September 30, 2018 compared to the same period in prior year primarily due to decreases in operational losses and loan and lease expense. Personnel costs increased $6 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to an increase in base compensation.
29
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
Average consumer loans increased $18 million and $7 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. Average residential mortgage loans increased $224 million and $383 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily driven by the continued retention of certain agency conforming ARMs and certain other fixed-rate loans. Average automobile loans decreased $158 million and $326 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year as payoffs exceeded new loan production due to a strategic shift focusing on improving risk-adjusted returns.
Wealth and Asset Management
Wealth and Asset Management provides a full range of investment alternatives for individuals, companies and not-for-profit organizations. Wealth and Asset Management is made up of five main businesses: FTS; ClearArc Capital, Inc.; Fifth Third Insurance Agency, Inc.; Fifth Third Private Bank; and Fifth Third Institutional Services. FTS offers full service retail brokerage services to individual clients and broker-dealer services to the institutional marketplace. ClearArc Capital, Inc. provides asset management services. Fifth Third Insurance Agency, Inc. assists clients with their financial and risk management needs. Fifth Third Private Bank offers holistic strategies to affluent clients in wealth planning, investing, insurance and wealth protection. Fifth Third Institutional Services provides advisory services for institutional clients including states and municipalities.
The following table contains selected financial data for the Wealth and Asset Management segment:
TABLE 29: Wealth and Asset Management |
||||||||||||||||||||
For the three months ended | For the nine months ended | |||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||
($ in millions) |
2018 | 2017 | 2018 | 2017 | ||||||||||||||||
Income Statement Data |
||||||||||||||||||||
Net interest income |
$ | 46 | 38 | 134 | 114 | |||||||||||||||
Provision for (benefit from) loan and lease losses |
3 | (1) | 8 | 2 | ||||||||||||||||
Noninterest income: |
||||||||||||||||||||
Wealth and asset management revenue |
110 | 99 | 324 | 304 | ||||||||||||||||
Other noninterest income |
5 | 2 | 20 | 8 | ||||||||||||||||
Noninterest expense: |
||||||||||||||||||||
Personnel costs |
50 | 42 | 154 | 136 | ||||||||||||||||
Other noninterest expense |
76 | 69 | 227 | 209 | ||||||||||||||||
Income before income taxes |
32 | 29 | 89 | 79 | ||||||||||||||||
Applicable income tax expense |
7 | 10 | 19 | 27 | ||||||||||||||||
Net income |
$ | 25 | 19 | 70 | 52 | |||||||||||||||
Average Balance Sheet Data |
||||||||||||||||||||
Loans and leases, including held for sale |
$ | 3,449 | 3,265 | 3,410 | 3,257 | |||||||||||||||
Core deposits |
9,029 | 8,543 | 9,266 | 8,721 |
Net income was $25 million for the three months ended September 30, 2018 compared to net income of $19 million for the three months ended September 30, 2017. Net income was $70 million for the nine months ended September 30, 2018 compared to $52 million for the nine months ended September 30, 2017. The increases for both periods were driven primarily by increases in noninterest income and net interest income partially offset by increases in noninterest expense and provision for loan and lease losses.
Net interest income increased $8 million and $20 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in FTP credit rates on interest checking deposits and savings and money market deposits as well as increases in yields on average loans and leases. These positive impacts were partially offset by increases in the rates paid on interest checking deposits as well as an increase in FTP charge rates on loans and leases.
Provision for loan and lease losses increased $4 million and $6 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year driven by an increase in net charge-offs partially offset by the impact of the benefit of lower criticized assets.
Noninterest income increased $14 million and $32 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year driven by increases in wealth and asset management revenue and other noninterest income. Wealth and asset management revenue increased $11 million and $20 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in private client service fees and brokerage fees driven by an increase in assets under management as a result of strong market performance and increased asset production. Other noninterest income increased $3 million and $12 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year due to increases in insurance income as a result of acquisitions in 2017.
Noninterest expense increased $15 million and $36 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year as a result of increases in personnel costs and other noninterest expense. Personnel costs increased $8 million and $18 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year driven by increases in base compensation and incentive compensation driven by the aforementioned acquisitions in 2017. Other noninterest expense increased $7 million and $18 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily driven by increases in corporate overhead allocations.
30
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
Average loans and leases increased $184 million and $153 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year driven by increases in average commercial and industrial loans and average residential mortgage loans due to increases in new loan origination activity. These increases were partially offset by a decline in average home equity balances.
Average core deposits increased $486 million and $545 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in average interest checking deposits and average savings and money market deposits.
General Corporate and Other
General Corporate and Other includes the unallocated portion of the investment securities portfolio, securities gains and losses, certain non-core deposit funding, unassigned equity, unallocated provision for loan and lease losses expense or a benefit from the reduction of the ALLL, the payment of preferred stock dividends and certain support activities and other items not attributed to the business segments.
Net interest income decreased $13 million for the three months ended September 30, 2018 compared to the same period in the prior year driven by increases in FTP credit rates on deposits allocated to the business segments and increases in interest expense on long-term debt and federal funds purchased as well as the impact of interest rate contracts hedging commercial and industrial loans. The decrease for the three months ended September 30, 2018 was partially offset by an increase in the benefit related to the FTP charges on loans and leases as well as an increase in interest income on taxable securities. Net interest income increased $16 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily driven by an increase in the benefit related to the FTP charges on loans and leases as well as an increase in interest income on taxable securities. The increase for the nine months ended September 30, 2018 was partially offset by increases in FTP credit rates on deposits allocated to the business segments, the impact of interest rate contracts hedging commercial and industrial loans as well as an increase in interest expense on long-term debt and federal funds purchased.
The provision for loan and lease losses increased $22 million and was flat for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase for the three months ended September 30, 2018 compared to the same period in the prior year was primarily due to a decrease in the allocation of provision expense to the business segments driven by a decrease in commercial criticized assets.
Noninterest income decreased $1 billion and $455 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year driven by the recognition of a $1.0 billion gain on the sale of Worldpay, Inc. shares during the third quarter of 2017. The decrease for nine months ended September 30, 2018 was partially offset by the recognition of a $205 million gain on the sale of Worldpay, Inc. shares during the second quarter of 2018 and a $414 million gain related to Vantiv, Inc.s acquisition of Worldpay Group plc. during the first quarter of 2018. Both periods were impacted by negative valuation adjustments related to the Visa total return swap which were $17 million and $66 million for the three and nine months ended September 30, 2018, respectively, compared with $47 million and $69 million for the same periods in the prior year. Additionally, equity method earnings from the Bancorps interest in Worldpay Holding, LLC decreased $11 million and $36 million compared to the three and nine months ended September 30, 2017, respectively, primarily due to a decrease in the Bancorps ownership percentage in Worldpay Holding, LLC and the impact of Worldpay, Inc.s acquisition and integration costs on its earnings.
Noninterest expense increased $4 million and $30 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase for both periods was primarily due to increases in technology and communications expense and personnel costs partially offset by increases in corporate overhead allocations from General Corporate and Other to the other business segments. Additionally, the nine months ended September 30, 2018 included an increase of $10 million in donations expense compared to the same period in the prior year as a result of a contribution to the Fifth Third Foundation in the second quarter of 2018 partially offset by an increased benefit from the reserve for unfunded commitments for the same period.
31
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
Risk management is critical for effectively serving customers financial needs while protecting the Bancorp and achieving strategic goals. It is also essential to reducing the volatility of earnings and safeguarding our brand and reputation. Further, risk management is integral to the Bancorps strategic and capital planning processes. It is essential that the Bancorps business strategies consistently align to its overall risk appetite and capital considerations. Maintaining risks within the Bancorps risk appetite requires that risks are understood by all employees across the enterprise, and appropriate risk mitigants and controls are in place to limit risk to within the risk appetite. To achieve this, the Bancorp implements a framework for managing risk that encompasses business as usual activities and the utilization of a risk process for identifying, assessing, managing, monitoring and reporting risks.
Fifth Third uses a structure consisting of three lines of defense in order to clarify the roles and responsibilities for effective risk management.
The risk taking functions within the lines of business comprise the first line of defense. The first line of defense originates risk through normal business as usual activities; therefore, it is essential that they monitor, assess and manage the risks being taken, implement controls necessary to mitigate those risks and take responsibility for managing their business within the Bancorps risk appetite.
Control functions, such as the Risk Management organization, are the second line of defense and are responsible for providing challenge, oversight and governance of activities performed by the first line.
The Audit division is the third line of defense and provides an independent assessment of the Bancorps internal control structure and related systems and processes. The Credit Risk Review division provides an independent assessment of credit risk, which includes evaluating the sufficiency of underwriting, documentation and approval processes for consumer and commercial credits, the accuracy of risk grades assigned to commercial credit exposure, nonaccrual status, specific reserves and monitoring for charge-offs.
Fifth Thirds core values and culture provide a foundation for supporting sound risk management practices by setting expectations for appropriate conduct and accountability across the organization.
All employees are expected to conduct themselves in alignment with Fifth Thirds core values and Code of Business Conduct & Ethics, which may be found on www.53.com, while carrying out their responsibilities. Fifth Thirds Corporate Responsibility and Reputation Committee provides oversight of business conduct policies, programs and strategies and monitors reporting of potential misconduct, trends or themes across the enterprise. Prudent risk management is a responsibility that is expected from all employees across the first, second and third lines of defense and is a foundational element of Fifth Thirds culture.
Below are the Bancorps core principles of risk management that are used to ensure the Bancorp is operating in a safe and sound manner:
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Understand the risks taken as a necessary part of business; however, the Bancorp ensures risks taken are in alignment with its strategy and risk appetite. |
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Provide transparency and escalate risks and issues as necessary. |
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Ensure Fifth Thirds products and services are designed, delivered and maintained to provide value and benefit to its customers and to Fifth Third, and that potential opportunities remain aligned to the core customer base. |
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Avoid risks that cannot be understood, managed and monitored. |
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Act with integrity in all activities. |
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Focus on providing operational excellence by providing reliable, accurate and efficient services to meet customers needs. |
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Maintain a strong financial position to ensure that the Bancorp meets its strategic objectives through all economic cycles and is able to access the capital markets at all times, even under stressed conditions. |
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Protect the Bancorps reputation by thoroughly understanding the consequences of business strategies, products and processes. |
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Conduct business in compliance with all applicable laws, rules and regulations and in alignment with internal policies and procedures. |
Fifth Thirds success is dependent on effective risk management and understanding and controlling the risks taken in order to deliver sustainable returns for employees and shareholders. The Bancorps goal is to ensure that aggregate risks do not exceed its risk capacity, and that risks taken are supportive of the Bancorps portfolio diversification and profitability objectives.
Fifth Thirds Risk Management Framework states its risk appetite and the linkage to strategic and capital planning, defines and sets the tolerance for each of the eight risk types, explains the process used to manage risk across the enterprise and sets forth its risk governance structure.
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The Board of Directors (the Board) and executive management define the risk appetite, which is considered in the development of business strategies, and forms the basis for enterprise risk management. The Bancorps risk appetite is set annually in alignment with the strategic, capital and financial plans, and is reviewed by the Board on an annual basis. |
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The Risk Management Process provides a consistent and integrated approach for managing risks and ensuring appropriate risk mitigants and controls are in place, and risks and issues are appropriately escalated. Five components are utilized for effective risk management; identifying, assessing, managing, monitoring and reporting risks. |
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The Board and executive management have identified eight risk types for monitoring the overall risk of the Bancorp; Credit Risk, Market Risk, Liquidity Risk, Operational Risk, Regulatory Compliance Risk, Legal Risk, Reputation Risk and Strategic Risk, and have also qualitatively established a risk tolerance, which is defined as the maximum amount of risk the Bancorp is willing to take for each of the eight risk types. These risk types are assessed on an ongoing basis and reported to the board each quarter, or more frequently, if necessary. In addition, each business and operational function (first line of defense) is accountable for proactively identifying and managing risk using its risk management process. Risk tolerances and risk limits are also established, where appropriate, in order to ensure that businesses and operational functions across the enterprise are able to monitor and manage risks at a more granular level, while ensuring that aggregate risks across the enterprise do not exceed the overall risk appetite. |
32
Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)
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The Bancorps risk governance structure includes management committees operating under delegation from, and providing information directly or indirectly to, the Board. The Bancorp Board delegates certain responsibilities to Board sub-committees, including the RCC as outlined in each respective Committee Charter, which may be found on www.53.com. The ERMC, which reports to the RCC, comprises senior management from across the Bancorp and reviews and approves risk management frameworks and policies, oversees the management of all risk types to ensure that aggregated risks remain within the Bancorps risk appetite and fosters a risk culture to ensure appropriate escalation and transparency of risks. |
The objective of the Bancorps credit risk management strategy is to quantify and manage credit risk on an aggregate portfolio basis, as well as to limit the risk of loss resulting from the failure of a borrower or counterparty to honor its financial or contractual obligations to the Bancorp. The Bancorps credit risk management strategy is based on three core principles: conservatism, diversification and monitoring. The Bancorp believes that effective credit risk management begins with conservative lending practices which are described below. These practices include the use of intentional risk-based limits for single name exposures and counterparty selection criteria designed to reduce or eliminate exposure to borrowers who have higher than average default risk and defined weaknesses in financial performance. The Bancorp carefully designed and monitors underwriting, documentation and collection standards. The Bancorps credit risk management strategy also emphasizes diversification on a geographic, industry and customer level as well as ongoing portfolio monitoring and timely management reviews of large credit exposures and credits experiencing deterioration of credit quality. Credit officers with the authority to extend credit are delegated specific authority amounts, the utilization of which is closely monitored. Underwriting activities are centrally managed, and ERM manages the policy and the authority delegation process directly. The Credit Risk Review function provides independent and objective assessments of the quality of underwriting and documentation, the accuracy of risk grades and the charge-off, nonaccrual and reserve analysis process. The Bancorps credit review process and overall assessment of the adequacy of the allowance for credit losses is based on quarterly assessments of the probable estimated losses inherent in the loan and lease portfolio. The Bancorp uses these assessments to promptly identify potential problem loans or leases within the portfolio, maintain an adequate allowance for credit losses and take any necessary charge-offs. The Bancorp defines potential problem loans and leases as those rated substandard that do not meet the definition of a nonaccrual loan or a restructured loan. Refer to Note 6 of the Notes to Condensed Consolidated Financial Statements for further information on the Bancorps credit grade categories, which are derived from standard regulatory rating definitions. In addition, stress testing is performed on various commercial and consumer portfolios using the CCAR model and for certain portfolios, such as real estate and leveraged lending, the stress testing is performed by Credit department personnel at the individual loan level during credit underwriting.
The following tables provide a summary of potential problem portfolio loans and leases:
TABLE 30: Potential Problem Portfolio Loans and Leases |
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Unpaid | ||||||||||||
Carrying | Principal | |||||||||||
As of September 30, 2018 ($ in millions) |
Value | Balance | Exposure | |||||||||
Commercial and industrial loans |
$ | 558 | 558 | 801 | ||||||||
Commercial mortgage loans |
111 | 112 | 111 | |||||||||
Commercial leases |
60 | 60 | 60 | |||||||||
Total potential problem portfolio loans and leases |
$ | 729 | 730 | 972 | ||||||||
TABLE 31: Potential Problem Portfolio Loans and Leases |
||||||||||||
Unpaid | ||||||||||||
Carrying | Principal | |||||||||||
As of December 31, 2017 ($ in millions) |
Value | Balance | Exposure | |||||||||
Commercial and industrial loans |
$ | 911 | 912 | 1,370 | ||||||||
Commercial mortgage loans |
138 | 138 | 138 | |||||||||
Commercial leases |
70 | 70 | 70 | |||||||||
Total potential problem portfolio loans and leases |
$ | 1,119 | 1,120 | 1,578 |
In addition to the individual review of larger commercial loans that exhibit probable or observed credit weaknesses, the commercial credit review process includes the use of two risk grading systems. The risk grading system currently utilized for allowance for credit loss analysis purposes encompasses ten categories. The Bancorp also maintains a dual risk rating system for credit approval and pricing, portfolio monitoring and capital allocation that includes a through-the-cycle rating philosophy for assessing a borrowers creditworthiness. A through-the-cycle rating philosophy uses a grading scale that assigns ratings based on average default rates through an entire business cycle for borrowers with similar financial performance. The dual risk rating system includes thirteen probabilities of default grade categories and an additional eleven grade categories for estimating losses given an event of default. The probability of default and loss given default evaluations are not separated in the ten-category risk rating system. The Bancorp has completed significant validation and testing of the dual risk rating system as a commercial credit risk management tool. The Bancorp is assessing the necessary modifications to the dual risk rating system outputs to develop a U.S. GAAP compliant ALLL model and will evaluate the use of modified dual risk ratings for purposes of determining the Bancorps ALLL as part of the Bancorps adoption of ASU 2016-13 Measurement of Cr