Form 10-Q

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 March 31, 2018

Commission File Number 001-33653

 

 

LOGO

(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)

Registrant’s 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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post 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       ☐   (Do not check if a smaller reporting company)    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 685,495,676 shares of the Registrant’s common stock, without par value, outstanding as of April 30, 2018.


LOGO

FINANCIAL CONTENTS

 

Part I. Financial Information

  

Glossary of Abbreviations and Acronyms

     2  

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 2)

  

Selected Financial Data

     3  

Overview

     4  

Non-GAAP Financial Measures

     6  

Recent Accounting Standards

     8  

Critical Accounting Policies

     8  

Statements of Income Analysis

     9  

Balance Sheet Analysis

     15  

Business Segment Review

     20  

Risk Management—Overview

     26  

Credit Risk Management

     27  

Market Risk Management

     40  

Liquidity Risk Management

     44  

Operational Risk Management

     47  

Compliance Risk Management

     47  

Capital Management

     48  

Off-Balance Sheet Arrangements

     50  

Quantitative and Qualitative Disclosures about Market Risk (Item 3)

     51  

Controls and Procedures (Item 4)

     51  

Condensed Consolidated Financial Statements and Notes (Item 1)

  

Balance Sheets (unaudited)

     52  

Statements of Income (unaudited)

     53  

Statements of Comprehensive Income (unaudited)

     54  

Statements of Changes in Equity (unaudited)

     55  

Statements of Cash Flows (unaudited)

     56  

Notes to Condensed Consolidated Financial Statements (unaudited)

     57  

Part II. Other Information

  

Legal Proceedings (Item 1)

     106  

Risk Factors (Item 1A)

     106  

Unregistered Sales of Equity Securities and Use of Proceeds (Item 2)

     106  

Exhibits (Item 6)

     106  

Signature

     107  

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. 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 Third’s 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 Third’s capital plan; (20) regulation of Fifth Third’s derivatives activities; (21) regulatory objections to Fifth Third’s 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 Third’s 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) difficulties in identifying, acquiring or integrating suitable strategic partnerships, investments or acquisitions; (36) potential dilution from future acquisitions; (37) loss of income and/or difficulties encountered in the sale and separation of businesses, investments or other assets; (38) results of Vantiv Holding, LLC, a subsidiary of Worldpay, Inc. or other investments or acquired entities; (39) difficulties from or changes in Fifth Third’s investment in, relationship with, and nature of the operations of Vantiv Holding, LLC, a subsidiary of Worldpay, Inc.; (40) changes in accounting standards or interpretation or declines in the value of Fifth Third’s goodwill or other intangible assets; (41) inaccuracies or other failures from the use of models; (42) effects of critical accounting policies and judgments or the use of inaccurate estimates; (43) weather related events or other natural disasters; and (44) 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 Management’s 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

DFAST: Dodd-Frank Act Stress Test

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: Management’s Discussion and Analysis of Financial Condition and Results of Operations

MSR: Mortgage Servicing Right

N/A: Not Applicable

NII: Net Interest Income

NM: Not Meaningful

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

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


Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 2)

 

The following is Management’s Discussion and Analysis of Financial Condition and Results of Operations of certain significant factors that have affected Fifth Third Bancorp’s (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 Bancorp’s banking subsidiary is referred to as the Bank.

TABLE 1: Selected Financial Data

 

 
                 For the three months        
ended March 31,
    %  
($ in millions, except for per share data)           2018         2017       Change  

Income Statement Data

        

Net interest income (U.S. GAAP)

  $     
996
       
    933             7  

Net interest income (FTE)(a)(b)

       999       939       6  

Noninterest income

       909       523       74  

Total revenue(a)

       1,908       1,462       31  

Provision for loan and lease losses

       23       74       (69

Noninterest expense

       1,046       986       6  

Net income attributable to Bancorp

       704       305       131  

Net income available to common shareholders

         689       290       138  

Common Share Data

        

Earnings per share - basic

  $      0.99       0.38       161  

Earnings per share - diluted

       0.97       0.38       155  

Cash dividends declared per common share

       0.16       0.14       14  

Book value per share

       21.68       20.13       8  

Market value per share

         31.75       25.40       25  

Financial Ratios

        

Return on average assets

       2.02   %      0.88       130  

Return on average common equity

       18.6       7.8       138  

Return on average tangible common equity(b)

       22.4       9.3       141  

Dividend payout ratio

       16.2       36.8       (56

Average total Bancorp shareholders’ equity as a percent of average assets

       11.52       11.72       (2

Tangible common equity as a percent of tangible assets(b)(h)

       9.14       9.15       -  

Net interest margin(a)(b)

       3.18       3.02       5  

Net interest rate spread (a)(b)

       2.88       2.78       4  

Efficiency(a)(b)

         54.8       67.4       (19

Credit Quality

        

Net losses charged-off

  $      81       89       (9

Net losses charged-off as a percent of average portfolio loans and leases

       0.36   %      0.40       (10

ALLL as a percent of portfolio loans and leases

       1.24       1.35       (8

Allowance for credit losses as a percent of portfolio loans and leases(c)

       1.40       1.52       (8

Nonperforming portfolio assets as a percent of portfolio loans and leases and OREO

         0.55       0.79       (30

Average Balances

        

Loans and leases, including held for sale

  $      92,869       92,791       -  

Total securities and other short-term investments

       34,677       33,177       5  

Total assets

       141,565       140,140       1  

Transaction deposits(d)

       97,018       97,018       -  

Core deposits(e)

       100,874       100,845       -  

Wholesale funding(f)

       20,558       19,129       7  

Bancorp shareholders’ equity

         16,313       16,429       (1

Regulatory Capital and Liquidity Ratios

    

CET1 capital(g)

       10.82   %      10.76       1  

Tier I risk-based capital(g)

       11.95       11.90       -  

Total risk-based capital(g)

       15.25       15.45       (1

Tier I leverage

       10.11       10.15       -  

Modified LCR

         113       119       (5
(a)

Amounts presented on an FTE basis. The FTE adjustment for the three months ended March 31, 2018 and 2017 was $3 and $6, 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 Bancorp’s total risk-weighted assets.

(h)

Excludes unrealized gains and losses.

 

3


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

OVERVIEW

Fifth Third Bancorp is a diversified financial services company headquartered in Cincinnati, Ohio. At March 31, 2018, the Bancorp had $141.5 billion in assets and operated 1,153 full-service banking centers and 2,459 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 4.9% interest in Vantiv Holding, LLC. The carrying value of the Bancorp’s investment in Vantiv Holding, LLC was $632 million at March 31, 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 Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2017. Each of these items could have an impact on the Bancorp’s 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 Bancorp’s revenues are dependent on both net interest income and noninterest income. For the three months ended March 31, 2018, net interest income on an FTE basis and noninterest income provided 52% and 48% 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 the three months ended March 31, 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.

Vantiv, Inc. and Vantiv 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 Vantiv Holding, LLC from approximately 8.6% to approximately 4.9%. The Bancorp’s remaining interest in Vantiv Holding, LLC of $632 million continues to be accounted for as an equity method investment given the nature of Vantiv Holding, LLC’s structure as a limited liability company and contractual arrangements between Vantiv Holding, LLC and the Bancorp.

Accelerated Share Repurchase Transactions

During the three months ended March 31, 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 Bancorp’s common stock during the term of the repurchase agreements. For more information on the accelerated share repurchase program, refer to Note 14 of the Notes to Condensed Consolidated Financial Statements. For a summary of the Bancorp’s accelerated share repurchase transactions that were entered into or settled during the three months ended March 31, 2018, refer to Table 2.

 

4


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

TABLE 2: Summary of Accelerated Share Repurchase Transactions    

 

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  

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.

Earnings Summary

The Bancorp’s net income available to common shareholders for the first quarter of 2018 was $689 million, or $0.97 per diluted share, which was net of $15 million in preferred stock dividends. The Bancorp’s net income available to common shareholders for the first quarter of 2017 was $290 million, or $0.38 per diluted share, which was net of $15 million in preferred stock dividends.

Net interest income on an FTE basis (non-GAAP) was $999 million and $939 million for the three months ended March 31, 2018 and 2017, respectively. Net interest income was positively impacted by an increase in yields on average loans and leases of 42 bps and an increase in average taxable securities of $1.3 billion for the three months ended March 31, 2018 compared to the three months ended March 31, 2017. 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 June 2017, December 2017 and March 2018. These positive impacts were partially offset by increases in the rates paid on average interest-bearing core deposits, average long-term debt and average other short-term borrowings for the three months ended March 31, 2018 compared to the three months ended March 31, 2017. Net interest margin on an FTE basis (non-GAAP) was 3.18% and 3.02% for the three months ended March 31, 2018 and 2017, respectively.

Noninterest income increased $386 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to an increase in other noninterest income. Other noninterest income increased $383 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to the gain related to Vantiv, Inc’s acquisition of Worldpay Group plc. and an increase in private equity investment income, partially offset by an increase in the loss on the swap associated with the sale of Visa, Inc. Class B Shares, a reduction in equity method income from the Bancorp’s interest in Vantiv Holding, LLC and an increase in the losses on disposition and impairment of bank premises and equipment.

Noninterest expense increased $60 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to increases in personnel costs, technology and communications expense and other noninterest expense. Personnel costs increased $35 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily driven by increases in base compensation, variable compensation and severance costs, partially offset by a decrease in medical expenses. Technology and communications expense increased $10 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 driven primarily by increased investment in regulatory, compliance and growth initiatives. Other noninterest expense increased $16 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to increases in marketing expense and impairment on affordable housing investments, partially offset by a decrease in professional service fees and an increase in the benefit from the reserve for unfunded commitments.

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 $23 million and $74 million for the three months ended March 31, 2018 and 2017, respectively. Net losses charged-off as a percent of average portfolio loans and leases were 0.36% during the first quarter of 2018 compared to 0.40% during the first quarter of 2017. At March 31, 2018, nonperforming portfolio assets as a percent of portfolio loans and leases and OREO increased to 0.55% 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 Bancorp’s capital ratios exceed the “well-capitalized” guidelines as defined by the PCA requirements of the U.S. banking agencies. As of March 31, 2018, as calculated under the Basel III standardized approach, the CET1 capital ratio was 10.82%, the Tier I risk-based capital ratio was 11.95%, the Total risk-based capital ratio was 15.25% and the Tier I leverage ratio was 10.11%.

 

5


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

NON-GAAP FINANCIAL MEASURES

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    
    March 31,    
 

($ in millions)

       2018            2017      

 

 
Net interest income (U.S. GAAP)     $        996              933   
Add: FTE adjustment              3               
Net interest income on an FTE basis (1)     $        999              939   
Net interest income on an FTE basis (annualized) (2)        4,052              3,808   
Interest income (U.S. GAAP)     $        1,206              1,086   
Add: FTE adjustment        3               

 

 
Interest income on an FTE basis     $        1,209              1,092   
Interest income on an FTE basis (annualized) (3)        4,903              4,429   
Interest expense (annualized) (4)     $        852              621   
Noninterest income (5)        909              523   
Noninterest expense (6)        1,046              986   
Average interest-earning assets (7)        127,546              125,968   
Average interest-bearing liabilities (8)        87,607              84,890   
Ratios:        
Net interest margin on an FTE basis (2) / (7)        3.18  %        3.02   
Net interest spread on an FTE basis (3) / (7) - (4) / (8)        2.88              2.78   

Efficiency ratio on an FTE basis (6) / (1) + (5)

             54.8              67.4   

The following table reconciles the non-GAAP financial measure of income before income taxes on an FTE basis to U.S. GAAP:

TABLE 4: Non-GAAP Financial Measure - Income Before Income Taxes on an FTE Basis    

 

 
             For the three months ended    
    March 31,    
 
($ in millions)        2018            2017      

 

 
Income before income taxes (U.S. GAAP)   $      836              396  
Add: FTE adjustment        3              6  

 

 

Income before income taxes on an FTE basis

  $      839              402  

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.

 

6


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

The following table reconciles the non-GAAP financial measure of return on average tangible common equity to U.S. GAAP for the three months ended:

TABLE 5: Non-GAAP Financial Measures - Return on Average Tangible Common Equity    

($ in millions)    March 31,    
2018        
     March 31,  
2017      
 

Net income available to common shareholders (U.S. GAAP)

   $ 689             290       

Add: Intangible amortization, net of tax

     1             -       

Tangible net income available to common shareholders

   $ 690             290       

Tangible net income available to common shareholders (annualized) (1)

     2,798             1,176       

Average Bancorp’s shareholders’ equity (U.S. GAAP)

   $ 16,313             16,429       

Less:    Average preferred stock

     (1,331)            (1,331)      

Average goodwill

     (2,455)            (2,416)      

Average intangible assets

     (27)            (10)      

Average tangible common equity (2)

   $           12,500             12,672       

Return on average tangible common equity (1) / (2)

     22.4 %        9.3       

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.

The following table reconciles non-GAAP capital ratios to U.S. GAAP:

TABLE 6: Non-GAAP Financial Measures - Capital Ratios    

As of ($ in millions)    March 31,  
2018      
    December 31,    
2017            
 

Total Bancorp Shareholders’ Equity (U.S. GAAP)

   $ 16,184       16,365       

Less:    Preferred stock

     (1,331     (1,331)      

Goodwill

     (2,462     (2,445)      

Intangible assets

     (30     (27)      

AOCI

     389       (73)      

Tangible common equity, excluding unrealized gains / losses (1)

     12,750       12,489       

Add: Preferred stock

     1,331       1,331       

Tangible equity (2)

   $ 14,081       13,820       

Total Assets (U.S. GAAP)

   $ 141,500       142,193       

Less:    Goodwill

     (2,462     (2,445)      

Intangible assets

     (30     (27)      

AOCI, before tax

     492       (92)      

Tangible assets, excluding unrealized gains / losses (3)

   $               139,500       139,629       

Ratios:

    

Tangible equity as a percentage of tangible assets (2) / (3)

     10.09   %      9.90       

Tangible common equity as a percentage of tangible assets (1) / (3)

     9.14       8.94       

 

7


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

RECENT ACCOUNTING STANDARDS

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.

CRITICAL ACCOUNTING POLICIES

The Bancorp’s 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 Bancorp’s financial position, results of operations and cash flows. The Bancorp’s 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 Bancorp’s 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 three months ended March 31, 2018.

 

8


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

STATEMENTS OF INCOME ANALYSIS

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.

Table 7 presents the components of net interest income, net interest margin and net interest rate spread for the three months ended March 31, 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 included in other assets.

Net interest income on an FTE basis (non-GAAP) was $999 million and $939 million for the three months ended March 31, 2018 and March 31, 2017, respectively. Net interest income was positively impacted by an increase in yields on average loans and leases of 42 bps and an increase in average taxable securities of $1.3 billion for the three months ended March 31, 2018 compared to the three months ended March 31, 2017. 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 June 2017, December 2017 and March 2018. These positive impacts were partially offset by increases in the rates paid on average interest-bearing core deposits, average long-term debt and average other short-term borrowings for the three months ended March 31, 2018 compared to the three months ended March 31, 2017. The rates paid on both average interest-bearing core deposits and average long-term debt increased 21 bps and the rates paid on average other short-term borrowings increased 79 bps for the three months ended March 31, 2018 compared to the same period in the prior year.

Net interest rate spread on an FTE basis (non-GAAP) was 2.88% during the three months ended March 31, 2018 compared to 2.78% in the same period in 2017. Yields on average interest-earning assets increased 34 bps, partially offset by a 24 bps increase in the rates paid on average interest-bearing liabilities for the three months ended March 31, 2018 compared to the three months ended March 31, 2017.

Net interest margin on an FTE basis (non-GAAP) was 3.18% for the three months ended March 31, 2018 compared to 3.02% for the three months ended March 31, 2017. The increase from March 31, 2017 was driven primarily by the previously mentioned increase in the net interest rate spread, partially offset by a decrease in average free funding balances. The decrease in average free funding balances was driven by a decrease in average demand deposits of $1.3 billion for the three months ended March 31, 2018 compared to the three months ended March 31, 2017.

Interest income on an FTE basis from loans and leases (non-GAAP) increased $96 million during the three months ended March 31, 2018 compared to the three months ended March 31, 2017. The increase was primarily due to an increase in yields on average commercial and industrial loans, average construction loans, average commercial mortgage loans and average home equity loans. For more information on the Bancorp’s 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 during the three months ended March 31, 2018 compared to the three months ended March 31, 2017 driven by the aforementioned increases in average taxable securities and yields on average taxable securities.

Interest expense on core deposits increased $36 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to an increase in the cost of average interest-bearing core deposits to 52 bps for the three months ended March 31, 2018 from 31 bps for the three months ended March 31, 2017. The increase in the cost of average interest-bearing core deposits was primarily due to an increase in the cost of 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 Bancorp’s deposits.

Interest expense on average wholesale funding increased $21 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to the aforementioned increase in the rates paid on average other short-term borrowings and average long-term debt coupled with an increase in average long-term debt. Refer to the Borrowings subsection of the Balance Sheet Analysis section of MD&A for additional information on the Bancorp’s borrowings. During both the three months ended March 31, 2018 and 2017, average wholesale funding represented 23% of average interest-bearing liabilities. For more information on the Bancorp’s 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.

 

9


Management’s 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

For the three months ended    March 31, 2018     March 31, 2017    

Attribution of Change in

Net Interest Income(a)

($ in millions)    Average
Balance
     Revenue/
Cost
     Average
Yield/
Rate
    Average    
Balance    
     Revenue/
Cost
     Average
Yield/
Rate
    Volume    Yield/Rate    Total

Assets:

                        

Interest-earning assets:

                        

Loans and leases:(b)

                        

  Commercial and industrial loans

   $ 41,799        409        3.96   $ 41,892        359        3.47   $(1)     51        50  

  Commercial mortgage loans

     6,588        68        4.20       6,946        61        3.54     (4)     11        7  

  Commercial construction loans

     4,671        53        4.59       3,987        37        3.77     7      9        16  

  Commercial leases

     3,960        27        2.78       3,904        26        2.70     -      1        1  

Total commercial loans and leases

     57,018        557        3.96       56,729        483        3.45     2      72        74  

  Residential mortgage loans

     16,086        143        3.60       15,800        140        3.57     2      1        3  

  Home equity

     6,889        78        4.62       7,581        74        3.98     (7)     11        4  

  Automobile loans

     9,064        70        3.12       9,786        68        2.81     (5)     7        2  

  Credit card

     2,224        68        12.36       2,141        68        12.92     3      (3)       -  

  Other consumer loans

     1,588        25        6.58       754        12        6.49     13      -        13  

Total consumer loans

     35,851        384        4.35       36,062        362        4.07     6      16        22  

Total loans and leases

   $ 92,869        941        4.11   $ 92,791        845        3.69   $8      88        96  

Securities:

                        

  Taxable

     33,133        263        3.21       31,815        244        3.11     11      8        19  

  Exempt from income taxes(b)

     73        -        1.40       55        1        5.79     -      (1)       (1) 

Other short-term investments

     1,471        5        1.37       1,307        2        0.73     1      2        3  

Total interest-earning assets

   $ 127,546        1,209        3.85   $ 125,968        1,092        3.51   $20      97        117  

  Cash and due from banks

     2,175             2,205                

  Other assets

     13,039             13,220                

  Allowance for loan and lease losses

     (1,195)                         (1,253)                                  

Total assets

   $ 141,565                       $ 140,140                                  

Liabilities and Equity:

                        

Interest-bearing liabilities:

                        

  Interest checking deposits

   $ 28,403        44        0.63   $ 26,760        20        0.31   $1      23        24  

  Savings deposits

     13,546        3        0.07       14,117        2        0.05     -      1        1  

  Money market deposits

     20,750        27        0.53       20,603        16        0.32     -      11        11  

  Foreign office deposits

     494        -        0.13       454        -        0.13     -      -        -  

  Other time deposits

     3,856        12        1.25       3,827        12        1.23     -      -        -  

Total interest-bearing core deposits

     67,049        86        0.52       65,761        50        0.31     1      35        36  

  Certificates $100,000 and over

     2,284        8        1.49       2,579        9        1.35     (2)     1        (1) 

  Other deposits

     379        1        1.44       162        -        0.64     1      -        1  

  Federal funds purchased

     692        2        1.43       639        1        0.70     -      1        1  

  Other short-term borrowings

     2,423        8        1.34       1,893        3        0.55     -      5        5  

  Long-term debt

     14,780        105        2.86       13,856        90        2.65     8      7        15  

Total interest-bearing liabilities

   $ 87,607        210        0.97   $ 84,890        153        0.73   $8      49        57  

Demand deposits

     33,825             35,084                

Other liabilities

     3,800                         3,710                                  

Total liabilities

   $      125,232           $      123,684                

Total equity

   $ 16,333                       $ 16,456                                  

Total liabilities and equity

   $ 141,565                       $ 140,140                                  

Net interest income (FTE)(c)

      $ 999           $ 939        $12      48        60  

Net interest margin (FTE)(c)

           3.18           3.02        

Net interest rate spread (FTE)(c)

           2.88             2.78          

Interest-bearing liabilities to interest-earning assets

 

     68.69                         67.39                
(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 $3 and $6 for the three months ended March 31, 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 Bancorp’s 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 are referred to as charge-offs. 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 $23 million and $74 million for the three months ended March 31, 2018 and 2017, respectively. The decrease in provision expense for the three months ended March 31, 2018 compared to the same period in the prior year was primarily due to a decrease in the level of commercial criticized assets combined with overall improved credit quality. The ALLL decreased $58 million from December 31, 2017 to $1.1 billion at March 31, 2018. At March 31, 2018, the ALLL as a percent of portfolio loans and leases decreased to 1.24%, compared to 1.30% at December 31, 2017.

 

10


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

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 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 increased $386 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017.

The following table presents the components of noninterest income:    

TABLE 8: Components of Noninterest Income    

          For the three months ended
March 31,
        
($ in millions)        2018     2017             % Change  

Service charges on deposits

 

$

    137        138            (1

Wealth and asset management revenue

      113        108            5  

Corporate banking revenue

      88        74            19  

Card and processing revenue

      79        74            7  

Mortgage banking net revenue

      56        52            8  

Other noninterest income

      460        77            497  

Securities losses, net

      (11)       -            NM  

Securities losses, net, non-qualifying hedges on MSRs

        (13)       -            NM  

Total noninterest income

 

$

    909        523            74  

Wealth and asset management revenue

Wealth and asset management revenue increased $5 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017. The increase from the prior year was primarily due to an increase of $5 million in private client service fees driven by an increase in assets under management as a result of strong market performance and the impact of an acquisition in the second quarter of 2017. The Bancorp’s trust and registered investment advisory business had approximately $363 billion and $323 billion in total assets under care as of March 31, 2018 and 2017, respectively, and managed $37 billion and $33 billion in assets for individuals, corporations and not-for-profit organizations as of March 31, 2018 and 2017, respectively.

Corporate banking revenue

Corporate banking revenue increased $14 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017. The increase from the prior year was primarily driven by an increase in lease remarketing fees of $28 million which included the impact of a $31 million impairment charge related to certain operating lease assets that was recognized during the first quarter of 2017. The increase was partially offset by a decrease in business lending fees, syndication fees and letter of credit fees of $6 million, $5 million and $2 million, respectively.

Card and processing revenue

Card and processing revenue increased $5 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily driven by an increase in the number of actively used cards and customer spend volume.

Mortgage banking net revenue

Mortgage banking net revenue increased $4 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017.

The following table presents the components of mortgage banking net revenue:

TABLE 9: Components of Mortgage Banking Net Revenue    

          For the three months ended
March 31,
 
($ in millions)        2018       2017     

Origination fees and gains on loan sales

  $     24       29    

Net mortgage servicing revenue:

     

  Gross mortgage servicing fees

      53       47    

  Net valuation adjustments on MSRs and free-standing derivatives purchased to economically hedge MSRs

        (21     (24)  

Net mortgage servicing revenue

        32       23    

Mortgage banking net revenue

  $     56       52    

Origination fees and gains on loan sales decreased $5 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 due to a decrease in originations and lower margins due to the interest rate environment. Residential mortgage loan originations decreased to $1.6 billion for the three months ended March 31, 2018 from $1.9 billion for the three months ended March 31, 2017.

 

11


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Net mortgage servicing revenue increased $9 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to an increase in gross mortgage servicing fees of $6 million and a decrease in net negative valuation adjustments of $3 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  
March 31,               

($ in millions)        2018   2017

Changes in fair value and settlement of free-standing derivatives
purchased to economically hedge the MSR portfolio

  $   (49)     (1)  

Changes in fair value:

     

   Due to changes in inputs or assumptions

    57       4   

   Other changes in fair value

      (29)     (27)  

Net valuation adjustments on MSR and free-standing derivatives
purchased to economically hedge MSRs

  $   (21)     (24)  

Mortgage rates increased during the three months ended March 31, 2018 which caused modeled prepayment speeds to slow. The fair value of the MSR increased $57 million due to changes to inputs to the valuation model including prepayment speeds and OAS spread assumptions and decreased $29 million due to the passage of time, including the impact of regularly scheduled repayments, paydowns and payoffs during the three months ended March 31, 2018. Mortgage rates also increased during the three months ended March 31, 2017 which caused modeled prepayment speeds to slow. The fair value of the MSR increased $4 million due to changes to inputs to the valuation model including prepayment speeds and OAS spread assumptions and decreased $27 million due to the passage of time, including the impact of regularly scheduled repayments, paydowns and payoffs during the three months ended March 31, 2017.

Further detail on the valuation of MSRs can be found in Note 10 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 11 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 may acquire various securities as a component of its non-qualifying hedging strategy. The Bancorp recognized net losses of $13 million during the three months ended March 31, 2018, recorded in securities losses, net, non-qualifying hedges on MSRs in the Bancorp’s Condensed Consolidated Statements of Income. The Bancorp did not sell any securities related to the non-qualifying hedging strategy during the three months ended March 31, 2017.

The Bancorp’s total residential mortgage loans serviced as of March 31, 2018 and 2017 were $77.2 billion and $71.4 billion, respectively, with $61.0 billion and $55.4 billion, respectively, of residential mortgage loans serviced for others.

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
March 31,

($ in millions)        2018   2017

Gain related to Vantiv, Inc.’s acquisition of Worldpay Group plc.

  $   414     -        

Operating lease income

    23     25       

Private equity investment income

    20     15       

Cardholder fees

    14     14       

BOLI income

    13     12       

Insurance income

    6     1       

Consumer loan and lease fees

    5     5       

Banking center income

    5     5       

Loss on swap associated with the sale of Visa, Inc. Class B Shares

    (39)    (13)      

Net losses on disposition and impairment of bank premises and equipment

    (8)    (1)      

Net losses on loan sales

    (1)    (2)      

Equity method (loss) income from interest in Vantiv Holding, LLC

    (1)    11       

Other, net

      9     5       

Total other noninterest income

  $   460     77       

Other noninterest income increased $383 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to the gain related to Vantiv, Inc.’s acquisition of Worldpay Group plc. and an increase in private equity investment income, partially offset by an increase in the loss on the swap associated with the sale of Visa, Inc. Class B Shares, a reduction in equity method income from the Bancorp’s interest in Vantiv Holding, LLC and an increase in the losses on disposition and impairment of bank premises and equipment.

 

12


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

The Bancorp recognized a $414 million gain related to Vantiv, Inc.’s acquisition of Worldpay Group plc. during the three months ended March 31, 2018. For additional information, refer to Note 17 of the Notes to Condensed Consolidated Financial Statements. Private equity investment income increased $5 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to the recognition of positive net valuation adjustments on certain private equity investments in the first quarter of 2018. For additional information on the valuation of private equity investments, refer to Note 21 of the Notes to Condensed Consolidated Financial Statements.

The Bancorp recognized negative valuation adjustments of $39 million and $13 million related to the Visa total return swap for the three months ended March 31, 2018 and 2017, respectively. The increase from the prior year was primarily attributable to litigation developments during the quarter and an increase in Visa, Inc’s share price. For additional information on the valuation of the swap associated with the sale of Visa, Inc. Class B Shares, refer to Note 21 of the Notes to Condensed Consolidated Financial Statements. Equity method income from the Bancorp’s interest in Vantiv Holding, LLC decreased $12 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 due to a decrease in the Bancorp’s ownership interest in Vantiv Holding, LLC from approximately 17.8% as of March 31, 2017 to approximately 4.9% as of March 31, 2018 and the impact of Worldpay, Inc.’s acquisition and integration costs. Net losses on disposition and impairment of bank premises and equipment increased $7 million compared to the same period in the prior year. The increase was driven by the impact of impairment charges of $8 million during the three months ended March 31, 2018 compared to $3 million during the three months ended March 31, 2017.

Noninterest Expense

Noninterest expense increased $60 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to increases in personnel costs (salaries, wages and incentives plus employee benefits), technology and communications expense and other noninterest expense. The following table presents the components of noninterest expense:

TABLE 12: Components of Noninterest Expense

         

For the three months ended

March 31,

        
($ in millions)        2018         2017          % Change    

Salaries, wages and incentives

  $     447       411       9       

Employee benefits

      110       111       (1)      

Net occupancy expense

      75       78       (4)      

Technology and communications

      68       58       17       

Equipment expense

      31       28       11       

Card and processing expense

      29       30       (3)      

Other noninterest expense

        286       270       6       

Total noninterest expense

  $     1,046       986       6       

Efficiency ratio on an FTE basis(a)

        54.8     67.4          
(a)

This is a non-GAAP measure. For further information, refer to the Non-GAAP Financial Measures section of MD&A.

Personnel costs increased $35 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily driven by increases in base compensation, variable compensation and severance costs, partially offset by a decrease in medical expenses. The increase in base compensation was primarily due to personnel additions in information technology as well as an increase in the Bancorp’s minimum wage as a result of benefits received from the TCJA. Full-time equivalent employees totalled 18,344 at March 31, 2018 compared to 17,763 at March 31, 2017.

Technology and communications expense increased $10 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 driven primarily by increased investment in regulatory, compliance and growth initiatives.

 

13


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

The following table presents the components of other noninterest expense:

TABLE 13: Components of Other Noninterest Expense

            For the three months ended  
March 31,
 
($ in millions)        2018     2017  
Impairment on affordable housing investments   $     48       39  
FDIC insurance and other taxes       32       33  
Marketing       32       19  
Loan and lease       26       22  
Operating lease       21       25  
Losses and adjustments       17       15  
Data processing       14       13  
Professional service fees       13       22  
Travel       13       11  
Postal and courier       9       12  
Recruitment and education       8       8  
Supplies       3       3  
Donations       3       2  
Insurance       3       3  
Benefit from the reserve for unfunded commitments       (10     (2 )   
Other, net         54       45  
Total other noninterest expense   $     286       270  

Other noninterest expense increased $16 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to increases in marketing expense and impairment on affordable housing investments, partially offset by a decrease in professional service fees and an increase in the benefit from the reserve for unfunded commitments.

Marketing expense increased $13 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to an increase in advertising volume related to the brand campaign and promotional offers. Impairment on affordable housing investments increased $9 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily driven by the change in the federal statutory corporate tax rate pursuant to the TCJA. Professional service fees decreased $9 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to a decrease in legal fees and consulting fees. The benefit from the reserve for unfunded commitments was $10 million for the three months ended March 31, 2018 compared to $2 million for the same period in the prior year as a result of a decrease in total unfunded commitments outstanding as of March 31, 2018 combined with overall improved credit quality.

Applicable Income Taxes

The following table presents the Bancorp’s income before income taxes, applicable income tax expense and effective tax rate:

TABLE 14: Applicable Income Taxes

               For the three months ended    
March 31,
 
($ in millions)         2018     2017  

Income before income taxes

   $     836       396      

Applicable income tax expense

       132       91  

Effective tax rate

         15.8     22.9  

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 decrease in the effective tax rate for the three months ended March 31, 2018 compared to the same period in the prior year was 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 Bancorp’s 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 March 31, 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 second quarter of 2018. However, the amount of income tax expense or benefit recognized upon settlement may vary significantly from expectations based on the Bancorp’s stock price and the number of SARs exercised by employees.

 

14


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

BALANCE SHEET ANALYSIS

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)

           March 31, 2018    December 31, 2017  
As of ($ in millions)         Carrying Value      % of Total      Carrying Value      % of Total    

Commercial loans and leases:

             

Commercial and industrial loans

 

$

     41,678      

45

   $ 41,170         45  

Commercial mortgage loans

       6,515      

7

     6,610         7  

Commercial construction loans

       4,766      

5

     4,553         5  

Commercial leases

         3,919       4      4,068         4  

Total commercial loans and leases

         56,878       61      56,401         61  

Consumer loans:

             

Residential mortgage loans

       16,231       18      16,077         17  

Home equity

       6,757       7      7,014         8  

Automobile loans

       9,018       10      9,112         10  

Credit card

       2,188       2      2,299         2  

Other consumer loans

         1,615       2      1,559         2  

Total consumer loans

         35,809       39      36,061         39  

Total loans and leases

 

$

     92,687       100    $                 92,462         100  

Total portfolio loans and leases (excluding loans and leases held for sale)

 

$

     91,970            $                 91,970            

Loans and leases, including loans and leases held for sale, increased $225 million from December 31, 2017. The increase from December 31, 2017 was the result of a $477 million, or 1%, increase in commercial loans and leases, partially offset by a $252 million, or 1%, decrease in consumer loans.

Commercial loans and leases increased from December 31, 2017 primarily due to increases in commercial and industrial loans and commercial construction loans, partially offset by decreases in commercial leases and commercial mortgage loans. Commercial and industrial loans increased $508 million, or 1%, from December 31, 2017 primarily as a result of increased draw levels on existing commitments and a decrease in payoffs. Commercial construction loans increased $213 million, or 5%, from December 31, 2017 primarily due to increases in demand and draw levels on existing commitments. Commercial leases decreased $149 million, or 4%, from December 31, 2017 primarily as a result of a decrease in syndication and participation origination activity. Commercial mortgage loans decreased $95 million, or 1%, from December 31, 2017 primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns.

Consumer loans decreased from December 31, 2017 primarily due to decreases in home equity, credit card and automobile loans, partially offset by increases in residential mortgage loans and other consumer loans. Home equity decreased $257 million, or 4%, from December 31, 2017 as payoffs exceeded new loan production. Credit card decreased $111 million, or 5%, from December 31, 2017 primarily due to seasonal trends from the paydown of year-end balances which were higher due to holiday spending. Automobile loans decreased $94 million, or 1%, from December 31, 2017 as payoffs exceeded new loan production due to a strategic shift focusing on improving risk-adjusted returns. Residential mortgage loans increased $154 million, or 1%, from December 31, 2017 primarily due to the continued retention of certain agency conforming ARMs and certain other fixed-rate loans originated during the three months ended March 31, 2018. Other consumer loans increased $56 million, or 4%, from December 31, 2017 primarily due to growth in point-of-sale loan originations.

TABLE 16: Components of Average Loans and Leases (including loans and leases held for sale)

           March 31, 2018          March 31, 2017  
For the three months ended ($ in millions)         Carrying Value      % of Total            Carrying Value      % of Total    

Commercial loans and leases:

                

Commercial and industrial loans

 

$

     41,799       45    $      41,892         45    

Commercial mortgage loans

       6,588       7         6,946         7    

Commercial construction loans

       4,671       5         3,987         4    

Commercial leases

         3,960       4           3,904         4    

Total commercial loans and leases

         57,018       61           56,729         60    

Consumer loans:

                

Residential mortgage loans

       16,086       18         15,800         18    

Home equity

       6,889       7         7,581         8    

Automobile loans

       9,064       10         9,786         11    

Credit card

       2,224       2         2,141         2    

Other consumer loans

         1,588       2           754         1    

Total consumer loans

         35,851       39           36,062         40    

Total average loans and leases

 

$

     92,869       100    $      92,791         100    

Total average portfolio loans and leases (excluding loans and leases held for sale)

 

$

     92,334            $      92,146            

 

15


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Average loans and leases, including loans and leases held for sale, increased $78 million from March 31, 2017. The increase from March 31, 2017 was the result of a $289 million, or 1%, increase in average commercial loans and leases, partially offset by a $211 million, or 1%, decrease in average consumer loans.

Average commercial loans and leases increased from March 31, 2017 primarily due to an increase in average commercial construction loans, partially offset by a decrease in average commercial mortgage loans. Average commercial construction loans increased $684 million, or 17%, from March 31, 2017 primarily due to increases in demand and draw levels on existing commitments. Average commercial mortgage loans decreased $358 million, or 5%, primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns.

Average consumer loans decreased from March 31, 2017 primarily due to decreases in average automobile loans and average home equity, partially offset by increases in average other consumer loans and average residential mortgage loans. Average automobile loans decreased $722 million, or 7%, from March 31, 2017 as payoffs exceeded new loan production due to a strategic shift focusing on improving risk-adjusted returns. Average home equity decreased $692 million, or 9%, from March 31, 2017 as payoffs exceeded new loan production. Average other consumer loans increased $834 million primarily due to growth in point-of-sale loan originations. Average residential mortgage loans increased $286 million, or 2%, from March 31, 2017 primarily driven by the continued retention of certain agency conforming ARMs and certain other fixed-rate loans.

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 $32.8 billion and $32.7 billion at March 31, 2018 and December 31, 2017, respectively. The taxable investment securities portfolio had an effective duration of 5.2 years at March 31, 2018 compared to 4.7 years at December 31, 2017.

Debt securities are classified as available-for-sale when, in management’s 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 March 31, 2018, the Bancorp’s investment portfolio consisted primarily of AAA-rated available-for-sale debt securities. The Bancorp did not hold any securities classified as below investment grade at March 31, 2018 and an immaterial amount as of December 31, 2017. The Bancorp did not recognize OTTI on its available-for-sale debt and other securities, included in securities gains, net, in the Condensed Consolidated Statements of Income, during the three months ended March 31, 2018 and recognized $10 million during the three months ended March 31, 2017.

The following table summarizes the end of period components of investment securities:

TABLE 17: Components of Investment Securities

As of ($ in millions)         March 31,    
      2018     
    December 31,      
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

    43             43             

Mortgage-backed securities:

   

Agency residential mortgage-backed securities(a)

    15,456             15,281             

Agency commercial mortgage-backed securities

    10,612             10,113             

Non-agency commercial mortgage-backed securities

    3,219             3,247             

Asset-backed securities and other debt securities

    2,190             2,183             

Other securities(b)

    612             612             

Total available-for-sale debt and other securities

  $         32,230             31,577             

Held-to-maturity securities (amortized cost basis):

   

Obligations of states and political subdivisions securities

  $ 21             22             

Asset-backed securities and other debt securities

    2             2             

Total held-to-maturity securities

  $ 23             24             

Trading debt securities (fair value):

   

U.S. Treasury and federal agencies securities

  $ 21             12             

Obligations of states and political subdivisions securities

    52             22             

Agency residential mortgage-backed securities

    364             395             

Asset-backed securities and other debt securities

    134             63             

Total trading debt securities

  $ 571             492             

Total equity securities

  $ 418             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 gains, net in the Condensed Consolidated Statements of Income.

(b)

Other securities consist of FHLB, FRB and DTCC restricted stock holdings of $248, $362 and $2, respectively, at both March 31, 2018 and December 31, 2017, that are carried at cost.

On an amortized cost basis, available-for-sale debt and other securities increased $653 million from December 31, 2017 primarily due to increases in agency commercial mortgage-backed securities and agency residential mortgage-backed securities.

 

16


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

On an amortized cost basis, available-for-sale debt and other securities were 25% of total interest-earning assets at both March 31, 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 March 31, 2018 compared to 6.5 years at December 31, 2017. In addition, at March 31, 2018, the debt securities in the available-for-sale debt and other securities portfolio had a weighted-average yield of 3.15%, compared to 3.18% at December 31, 2017.

Trading debt securities increased $79 million from December 31, 2017 primarily due to an increase in asset-backed securities and other debt 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 $411 million at March 31, 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.

TABLE 18: Characteristics of Available-for-Sale Debt and Other Securities    

As of March 31, 2018 ($ in millions)      Amortized Cost     Fair Value     Weighted-Average
Life (in years)
    Weighted-Average    
Yield    
 

U.S. Treasury and federal agencies securities:

       

 Average life of 1 year or less

  $ -                -             -                3.40 %          

 Average life 1 – 5 years

    98                96             4.8                2.16              

Total

  $ 98                96             4.8                2.16 %          

Obligations of states and political subdivisions securities:(a)

       

 Average life of 1 year or less

    14                14             0.3                1.70              

 Average life 1 – 5 years

    27                28             1.1                5.01              

 Average life 5 – 10 years

    2                2             6.4                -              

Total

  $ 43                44             1.1                3.73 %          

Agency residential mortgage-backed securities:

       

 Average life of 1 year or less

    1                1             0.2                4.48              

 Average life 1 – 5 years

    5,774                5,693             3.8                3.34              

 Average life 5 – 10 years

    8,160                8,037             7.4                3.11              

 Average life greater than 10 years

    1,521                1,477             11.5                3.11              

Total

  $ 15,456                15,208             6.5                3.20 %          

Agency commercial mortgage-backed securities:

       

 Average life of 1 year or less

    208                200             1.0                2.44              

 Average life 1 – 5 years

    2,437                2,414             3.6                3.07              

 Average life 5 – 10 years

    5,783                5,715             7.8                3.05              

 Average life greater than 10 years

    2,184                2,126             11.9                3.10              

Total

  $ 10,612                10,455             7.6                3.05 %          

Non-agency commercial mortgage-backed securities:

       

 Average life of 1 year or less

    -                -             0.5                4.04              

 Average life 1 – 5 years

    134                135             4.1                3.44              

 Average life 5 – 10 years

    3,085                3,055             6.7                3.28              

Total

  $ 3,219                3,190             6.6                3.29 %          

Asset-backed securities and other debt securities:

       

 Average life of 1 year or less

    31                31             0.6                4.23              

 Average life 1 – 5 years

    833                830             3.4                3.53              

 Average life 5 – 10 years

    1,117                1,141             7.1                3.29              

 Average life greater than 10 years

    209                212             10.7                3.25              

Total

  $ 2,190                2,214             5.9                3.39 %          

Other securities

    612                612                        

Total available-for-sale debt and other securities

  $ 32,230                31,819             6.8                3.15 %          
(a)

Taxable-equivalent yield adjustments included in the above table are 0.35%, 1.05%, 0.00% and 0.78% for securities with an average life of 1 year or less, 1-5 years, 5-10 years and in total, respectively.

 

17


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Deposits

The Bancorp’s 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 71% of the Bancorp’s average asset funding base at both March 31, 2018 and December 31, 2017.

The following table presents the end of period components of deposits:

TABLE 19: Components of Deposits

           March 31, 2018      December 31, 2017  
As of ($ in millions)         Balance      % of Total      Balance      % of Total     

Demand

  $      34,066        33          $ 35,276        34        

Interest checking

       29,627        28            27,703        27        

Savings

       13,751        13            13,425        13        

Money market

       21,540        20            20,097        19        

Foreign office

         374               -          484        1        

Transaction deposits

       99,358        94            96,985        94        

Other time

         3,945        4            3,775        4        

Core deposits

       103,303        98            100,760        98        

Certificates $100,000 and over(a)

       2,042        2            2,402        2        

Other

         116               -          -        -          

Total deposits

  $      105,461        100          $     103,162        100        
(a)

Includes $1.0 billion and $1.3 billion of institutional, retail and wholesale certificates $250,000 and over at March 31, 2018 and December 31, 2017, respectively.

Core deposits increased $2.5 billion, or 3%, from December 31, 2017 driven by an increase of $2.4 billion in transaction deposits. Transaction deposits increased from December 31, 2017 primarily due to increases in interest checking deposits, money market deposits and savings deposits, partially offset by a decrease in demand deposits. Interest checking deposits increased $1.9 billion, or 7%, from December 31, 2017 driven primarily by higher balances per account for commercial customers and balance migration from demand deposits accounts. Money market deposits increased $1.4 billion, or 7%, from December 31, 2017 driven primarily by promotional product offerings which drove consumer customer acquisition. Savings deposits increased $326 million, or 2%, from December 31, 2017 primarily due to consumer customer seasonality. Demand deposits decreased $1.2 billion, or 3%, from December 31, 2017 driven primarily by the aforementioned commercial customer balance migration into interest checking deposits, partially offset by higher balances per consumer customer account due to consumer customer seasonality.

The following table presents the components of average deposits for the three months ended:

TABLE 20: Components of Average Deposits

           March 31, 2018           March 31, 2017  
($ in millions)         Balance      % of Total          Balance      % of Total     

Demand

  $      33,825        34           $ 35,084        34        

Interest checking

       28,403        27             26,760        26        

Savings

       13,546        13             14,117        14        

Money market

       20,750        20             20,603        20        

Foreign office

         494        -             454        -         

Transaction deposits

       97,018        94             97,018        94        

Other time

         3,856        4             3,827        4        

Core deposits

       100,874        98             100,845        98        

Certificates $100,000 and over(a)

       2,284        2             2,579        2        

Other

         379        -             162        -         

Total average deposits

  $      103,537        100           $       103,586        100        
(a)

Includes $878 million and $1.3 billion of average institutional, retail and wholesale certificates $250,000 and over for the three months ended March 31, 2018 and 2017, respectively.

On an average basis, core deposits increased $29 million from March 31, 2017 driven by an increase in average other time deposits. Average other time deposits increased $29 million, or 1%, from March 31, 2017 as a result of promotional rate offers facilitated by the rising-rate environment. Average transaction deposits were flat from March 31, 2017. Average interest checking deposits increased $1.6 billion, or 6%, from March 31, 2017, primarily due to an increase in average balances per commercial customer account and balance migration from demand deposit accounts. Average demand deposits decreased $1.3 billion, or 4%, from March 31, 2017 primarily due to commercial customer balance migration into interest checking deposits and a decrease in average balances per commercial customer account.

Average other deposits increased $217 million from March 31, 2017 primarily due to an increase in average Eurodollar trade deposits. Average certificates $100,000 and over decreased $295 million from March 31, 2017 primarily due to the maturity and run-off of commercial certificates of deposit since March 31, 2017.

 

18


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Contractual maturities

The contractual maturities of certificates $100,000 and over as of March 31, 2018 are summarized in the following table:

TABLE 21: Contractual Maturities of Certificates $100,000 and Over

 

($ in millions)

        

Next 3 months

   $ 302   

3-6 months

     289   

6-12 months

     384   

After 12 months

     1,067   

Total certificates $100,000 and over

   $         2,042   

The contractual maturities of other time deposits and certificates $100,000 and over as of March 31, 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

   $ 2,952   

13-24 months

     1,852   

25-36 months

     887   

37-48 months

     243   

49-60 months

     43   

After 60 months

     10   

Total other time deposits and certificates $100,000 and over

   $         5,987   

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 March 31, 2018, average total borrowings as a percent of average interest-bearing liabilities were 20% 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)    March 31, 2018      December 31, 2017    

Federal funds purchased

   $ 178              174              

Other short-term borrowings

     1,335              4,012              

Long-term debt

     14,800              14,904              

Total borrowings

   $                16,313                             19,090              

Total borrowings decreased $2.8 billion, or 15%, from December 31, 2017 primarily due to a decrease in other short-term borrowings. Other short-term borrowings decreased $2.7 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 12 of the Notes to Condensed Consolidated Financial Statements. Long-term debt decreased $104 million from December 31, 2017 primarily driven by the maturity of $600 million of unsecured senior bank notes, $68 million of paydowns on long-term debt associated with automobile loan securitizations and $64 million of fair value adjustments on interest rate swaps related to long-term debt during the three months ended March 31, 2018. These decreases were partially offset by the issuance of $650 million of senior notes. For additional information regarding the senior notes debt issuance, refer to Note 13 of the Notes to Condensed Consolidated Financial Statements.

The following table summarizes components of average borrowings for the three months ended:

TABLE 24: Components of Average Borrowings

($ in millions)

     March 31, 2018        March 31, 2017        

Federal funds purchased

   $ 692              639              

Other short-term borrowings

     2,423              1,893              

Long-term debt

     14,780              13,856              

Total average borrowings

   $                17,895                             16,388              

Total average borrowings increased $1.5 billion, or 9%, compared to March 31, 2017, primarily due to increases in average long-term debt and average other short-term borrowings. Average long-term debt increased $924 million compared to March 31, 2017. The increase was primarily driven by the issuance of $700 million of senior notes and $1.1 billion of unsecured senior fixed-rate bank notes during the second and fourth quarters of 2017, respectively. Average other short-term borrowings increased $530 million compared to March 31, 2017, primarily driven by the increase in FHLB advances. 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 Bancorp’s liquidity management.

 

19


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

BUSINESS SEGMENT REVIEW

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 22 of the Notes to Condensed Consolidated Financial Statements. Results of the Bancorp’s 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 Bancorp’s business segments are not necessarily comparable with similar information for other financial institutions. The Bancorp refines its methodologies from time to time as management’s 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 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 Bancorp’s 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 Third’s 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 Bancorp’s 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 when funding operations by accessing the capital markets as a collective unit.

The results of operations and financial position for the three months ended March 31, 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     
 March  31, 
($ in millions)        2018              2017          

Income Statement Data

      

Commercial Banking

  $   259     217       

Branch Banking

    134     103       

Consumer Lending

    (10)    (3)      

Wealth and Asset Management

       15       

General Corporate and Other

      312     (27)      

Net income

    704     305       

Less: Net income attributable to noncontrolling interests

         -       

Net income attributable to Bancorp

    704     305       

Dividends on preferred stock

      15     15       

Net income available to common shareholders

  $   689     290       

 

20


Management’s 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    
 March 31, 
 
($ in millions)        2018        2017        

Income Statement Data

     

Net interest income (FTE)(a)

  $     422       431      

(Benefit from) provision for loan and lease losses

      (20     6      

Noninterest income:

     

Corporate banking revenue

      86       73      

Service charges on deposits

      71       73      

Other noninterest income

      62       56      

Noninterest expense:

     

Personnel costs

      88       85      

Other noninterest expense

        296       275      

Income before income taxes (FTE)

      277       267      

Applicable income tax expense(a)(b)

        18       50      

Net income

  $     259       217      

Average Balance Sheet Data

     

Commercial loans and leases, including held for sale

  $     53,953       53,733      

Demand deposits

      18,131       19,944      

Interest checking deposits

      10,273       9,245      

Savings and money market deposits

      4,443       6,363      

Other time deposits and certificates $100,000 and over

      611       966      

Foreign office deposits

        492       403      
(a)

Includes FTE adjustments of $3 and $6 for the three months ended March 31, 2018 and 2017, respectively.

(b)

Applicable income tax expense for all periods includes the tax benefit from tax-exempt income and business 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 $259 million for the three months ended March 31, 2018 compared to $217 million for the same period in the prior year. The increase was primarily due to a decrease in the provision for loan and lease losses and an increase in noninterest income partially offset by an increase in noninterest expense and a decrease in net interest income.

Net interest income on an FTE basis decreased $9 million for the three months ended March 31, 2018 compared to the same period in the prior year driven primarily by an increase in FTP charge rates on loans and leases and an increase in the rates paid on core deposits. These decreases in net interest income were partially offset by an increase in yields on average commercial loans and leases and an increase in FTP credits on interest checking deposits due to an increase in FTP credit rates.

Provision for loan and lease losses decreased $26 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to a decrease in net charge-offs on commercial and industrial loans and commercial mortgage loans as well as a decrease in criticized asset levels. Net charge-offs as a percent of average portfolio loans and leases decreased to 14 bps for the three months ended March 31, 2018 compared to 26 bps for the same period in the prior year.

Noninterest income increased $17 million for the three months ended March 31, 2018 compared to the same period in the prior year driven primarily by increases in corporate banking revenue and other noninterest income. Corporate banking revenue increased $13 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily driven by an increase in lease remarketing fees of $28 million which included the impact of a $31 million impairment charge related to certain operating lease assets that was recognized during the first quarter of 2017. The increase was partially offset by a decrease in business lending fees, syndication fees and letter of credit fees of $6 million, $5 million and $2 million, respectively. Other noninterest income increased $6 million for the three months ended March 31, 2018 compared to the same period in the prior year driven by an increase in private equity investment income.

Noninterest expense increased $24 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily driven by an increase other noninterest. Other noninterest expense increased $21 million for the three months ended March 31, 2018 compared to the same period in the prior year due primarily due to increases in corporate overhead allocations, impairment on certain affordable housing investments and equipment expense partially offset by a decrease in operating lease expense.

Average commercial loans and leases increased $220 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to an increase in average commercial construction loans partially offset by decreases in average commercial mortgage loans and average commercial and industrial loans. Average commercial construction loans increased $697 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to increases in demand and draw levels on existing commitments.

 

21


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Average commercial mortgage loans decreased $319 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns. Average commercial and industrial loans decreased $215 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily as a result of deliberate exits from certain loans that did not meet the Bancorp’s risk-adjusted profitability targets and softer loan demand.

Average core deposits decreased $2.6 billion for the three months ended March 31, 2018 compared to the same period in the prior year. The decrease was primarily driven by decreases in average savings and money market deposits and average demand deposits which decreased $1.9 billion and $1.8 billion, respectively, for the three months ended March 31, 2018 compared to the same period in the prior year due to lower average balances per account. These decreases were partially offset by an increase in average interest checking deposits of $1.0 billion for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to an increase of average balances per account.

Branch Banking

Branch Banking provides a full range of deposit and loan products to individuals and small businesses through 1,153 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.

The following table contains selected financial data for the Branch Banking segment:

TABLE 27: Branch Banking

           For the three months ended    
March 31,    
 
($ in millions)         2018          2017  

Income Statement Data

       

Net interest income

  $      466        430      

Provision for loan and lease losses

       44        42      

Noninterest income:

       

Service charges on deposits

       66        65      

Card and processing revenue

       64        59      

Wealth and asset management revenue

       37        36      

Other noninterest income

       17        24      

Noninterest expense:

       

Personnel costs

       136        131      

Net occupancy and equipment expense

       56        60      

Card and processing expense

       29        29      

Other noninterest expense

         216        193      

Income before income taxes

       169        159      

Applicable income tax expense

         35        56      

Net income

  $      134        103      

Average Balance Sheet Data

       

Consumer loans

  $      13,036        13,177      

Commercial loans

       1,873        1,852      

Demand deposits

       14,055        13,601      

Interest checking deposits

       10,315        10,157      

Savings and money market deposits

       28,427        27,156      

Other time deposits and certificates $100,000 and over

         5,031        5,039      

Net income was $134 million for the three months ended March 31, 2018 compared to net income of $103 million for the same period in the prior year. The increase in net income was primarily due to an increase in net interest income partially offset by an increase in noninterest expense.

Net interest income increased $36 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to an increase in FTP credit rates on core deposits as well as an increase in interest income on other consumer loans driven by higher average balances. These benefits were partially offset by an increase in FTP charge rates on loans and leases, an increase in the rates paid on money market deposits and 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 increased $2 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to an increase in net charge-offs on credit card and other consumer loans as well as the impact of the benefit from lower criticized asset levels. Net charge-offs as a percent of average portfolio loans and leases increased to 121 bps for the three months ended March 31, 2018 compared to 109 bps for the same period in the prior year.

Noninterest income was flat for the three months ended March 31, 2018 compared to the same period in the prior year as a decrease in other noninterest income was partially offset by an increase in card and processing revenue. The decrease in other noninterest income was due to the impact of impairment charges on bank premises and equipment of $8 million for the three months ended March 31, 2018. The increase in card and processing revenue for the three months ended March 31, 2018 compared to the same period in the prior year was driven by an increase in the number of actively used cards and customer spend volume.

 

22


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Noninterest expense increased $24 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to an increase in other noninterest expense driven by increases in corporate overhead allocations, marketing expense and loan and lease expense.

Average consumer loans decreased $141 million for the three months ended March 31, 2018 compared to the same period in the prior year. The decrease was primarily driven by decreases in average home equity loans, average residential mortgage loans and average automobile loans of $533 million, $318 million and $180, respectively, for the three months ended March 31, 2018 compared to the same period in the prior year as payoffs exceeded new loan production. These decreases were partially offset by an increase of $890 million in other consumer loans for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to growth in point-of-sale loan originations.

Average core deposits increased $1.9 billion for the three months ended March 31, 2018 compared to the same period in the prior year primarily driven by growth in average savings and money market deposits, average demand deposits and average interest checking deposits of $1.3 billion, $454 million and $158 million, respectively, due to an increase in average balances per customer account and acquisition of new customers.

Consumer Lending

Consumer Lending includes the Bancorp’s 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    
March 31,    
 
($ in millions)         2018        2017    

Income Statement Data

      

Net interest income

  $      59       61        

Provision for loan and lease losses

       12       15        

Noninterest income:

      

Mortgage banking net revenue

       55       51        

Other noninterest income

       (9     4        

Noninterest expense:

      

Personnel costs

       50       48        

Other noninterest expense

         56       58        

Loss before income taxes

       (13     (5)      

Applicable income tax benefit

         (3     (2)      

Net loss

  $      (10     (3)      

Average Balance Sheet Data

      

Residential mortgage loans, including held for sale

  $      11,678       11,161        

Home equity

       261       314        

Automobile loans

         8,702       9,241        

Consumer Lending incurred a net loss of $10 million for the three months ended March 31, 2018 compared to a net loss of $3 million for the same period in the prior year driven by a decrease in noninterest income.

Provision for loan and lease losses decreased $3 million for the three months ended March 31, 2018 compared to the same period in the prior year. Net charge-offs as a percent of average portfolio loans and leases decreased to 24 bps for the three months ended March 31, 2018 compared to 31 bps for the same period in the prior year.

Noninterest income decreased $9 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to a decrease in other noninterest income partially offset by an increase in mortgage banking net revenue. Other noninterest income decreased $13 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to an increase in losses on securities related to non-qualifying hedges on MSRs resulting from increased mortgage rates. Mortgage banking net revenue increased $4 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to an increase of $8 million in net mortgage servicing revenue, partially offset by a decrease of $4 million in mortgage origination fees and gains on loan sales. 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.

Average consumer loans and leases decreased $75 million for the three months ended March 31, 2018 compared to the same period in the prior year as a decrease in average automobile loans was partially offset by an increase in average residential mortgage loans. Average automobile loans decreased $539 million for the three months ended March 31, 2018 compared to the same period in the prior year as payoffs exceeded new loan production due to a strategic shift focusing on improving risk-adjusted returns. Average residential mortgage loans, including held for sale, increased $517 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily driven by the continued retention of certain conforming ARMs and certain other fixed-rate loans.

 

23


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

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    
March 31,    
 
($ in millions)        2018        2017          

Income Statement Data

      

Net interest income

 

$

    43        38        

Provision for loan and lease losses

      16        4        

Noninterest income:

      

Wealth and asset management revenue

      109        105        

Other noninterest income

      7        1        

Noninterest expense:

      

Personnel costs

      54        48        

Other noninterest expense

        77        69        

Income before income taxes

      12        23        

Applicable income tax expense

        3        8        

Net income

  $     9        15        

Average Balance Sheet Data

      

Loans and leases, including held for sale

  $     3,335        3,240        

Core deposits

        9,649        9,045        

Net income was $9 million for the three months ended March 31, 2018 compared to net income of $15 million for the same period in the prior year. The decrease in net income was primarily due to increases in noninterest expense and the provision for loan and lease losses partially offset by increases in net interest income and noninterest income.

Net interest income increased $5 million for the three months ended March 31, 2018 compared to the same period in the prior year due to an increase in FTP credit rates on interest checking 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 $12 million for the three months ended March 31, 2018 compared to the same period in the prior year driven by an increase in net charge-offs on commercial and industrial loans as well as an increase in criticized assets.

Noninterest income increased $10 million for the three months ended March 31, 2018 compared to the same period in the prior year driven by increases in other noninterest income and wealth and asset management revenue. Other noninterest income increased $6 million for the three months ended March 31, 2018 compared to the same period in the prior year driven by an increase in insurance income as a result of acquisitions in the first and fourth quarters of 2017. Wealth and asset management revenue increased $4 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to an increase in private client service fees driven by an increase in assets under management as a result of strong market performance and the impact of an acquisition in the second quarter 2017.

Noninterest expense increased $14 million for the three months ended March 31, 2018 compared to the same period in the prior year driven by increases in both other noninterest expense and personnel costs. Other noninterest expense increased $8 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily driven by an increase in corporate overhead allocations as a result of the aforementioned acquisitions in 2017 as well as increased operational losses. Personnel costs increased $6 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily driven by higher base and incentive compensation as a result of the aforementioned acquisitions in 2017.

Average loans and leases increased $95 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to increases in average residential mortgage loans and average other consumer loans driven by increases in new loan origination activity. This increase was partially offset by a decline in average home equity balances.

Average core deposits increased $604 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to increases in average interest checking deposits and average saving deposits.

 

24


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

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 increased $30 million for the three months ended March 31, 2018 compared to the same period in the prior year. The increase was 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. These positive impacts were partially offset by increases in FTP credit rates on deposits allocated to the business segments and an increase in interest expense on long-term debt.

Provision for loan and lease losses decreased $36 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to a an increase in the benefit from the reduction in the ALLL.

Noninterest income increased $368 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily driven by the recognition of a $414 million gain related to Vantiv, Inc.’s acquisition of Worldpay Group plc. during the three months ended March 31, 2018. This benefit was partially offset by a $39 million negative valuation adjustment related to the Visa total return swap for the three months ended March 31, 2018 compared to a negative valuation adjustment of $13 million for the three months ended March 31, 2017. The increase in noninterest income was also offset by a $12 million decrease in equity method earnings from the Bancorp’s interest in Vantiv Holding, LLC for the three months ended March 31, 2018 compared to the same period primarily due to a decrease in the Bancorp’s ownership percentage in Vantiv Holding, LLC and the impact of Worldpay, Inc’s acquisition and integration costs.

Noninterest expense decreased $2 million for the three months ended March 31, 2018 compared to the same period in the prior year. The decrease was primarily due to increases in corporate overhead allocations from General Corporate and Other to the other business segments and an increase in the benefit from the reserve for unfunded commitments partially offset by increases in personnel and technology and communications expense.

 

25


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

RISK MANAGEMENT – OVERVIEW

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 Bancorp’s strategic and capital planning processes. It is essential that the Bancorp’s business strategies consistently align to its overall risk appetite and capital considerations. Maintaining risks within the Bancorp’s 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 Bancorp’s 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 Bancorp’s 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 Third’s 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 Third’s core values and Code of Business Conduct & Ethics, which may be found on www.53.com, while carrying out their responsibilities. Fifth Third’s 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 Third’s culture.

Below are the Bancorp’s core principles of risk management that are used to ensure the Bancorp is operating in a safe and sound manner:

   

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.

   

Provide transparency and escalate risks and issues as necessary.

   

Ensure Fifth Third’s 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.

   

Avoid risks that cannot be understood, managed and monitored.

   

Act with integrity in all activities.

   

Focus on providing operational excellence by providing reliable, accurate and efficient services to meet customer’s needs.

   

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.

   

Protect the Bancorp’s reputation by thoroughly understanding the consequences of business strategies, products and processes.

   

Conduct business in compliance with all applicable laws, rules and regulations and in alignment with internal policies and procedures.

Fifth Third’s 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 Bancorp’s goal is to ensure that aggregate risks do not exceed its risk capacity, and that risks taken are supportive of the Bancorp’s portfolio diversification and profitability objectives.

Fifth Third’s 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.

 

   

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 Bancorp’s risk appetite is set annually in alignment with the strategic, capital and financial plans, and is reviewed by the Board on an annual basis.

   

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.

   

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.

 

26


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

   

The Bancorp’s 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 Bancorp’s risk appetite and fosters a risk culture to ensure appropriate escalation and transparency of risks.

CREDIT RISK MANAGEMENT

The objective of the Bancorp’s 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 Bancorp’s 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 Bancorp’s 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 Bancorp’s 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 Bancorp’s 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                               
As of March 31, 2018 ($ in millions)           Carrying  
Value  
     Unpaid  
Principal  
Balance  
     Exposure    

Commercial and industrial loans

  $        806        806        1,149  

Commercial mortgage loans

       97        97        97  

Commercial leases

       55        55        55  

Total potential problem portfolio loans and leases

  $        958        958        1,301  
TABLE 31: Potential Problem Portfolio Loans and Leases                               
As of December 31, 2017 ($ in millions)           Carrying  
Value  
     Unpaid  
Principal  
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 borrower’s 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 Bancorp’s ALLL as part of the Bancorp’s adoption of ASU 2016-13 “Measurement of Credit Losses on Financial Instruments,” which will be effective for the Bancorp on January 1, 2020. Scoring systems, various analytical tools and portfolio performance monitoring are used to assess the credit risk in the Bancorp’s homogenous consumer and small business loan portfolios.

 

27


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Overview

Inflationary expectations by market professionals have increased and average hourly earnings growth in the U.S. overall remained strong while the U.S. labor market appears to have continued to shrink, based on publicly-available information. In light of higher inflationary expectations and a strong employment outlook, the FOMC enacted a 25 bp increase in the target rate for Federal Funds target rate and indicated positive outlook on the economy. The Federal Reserve median forecast for change in real GDP was raised to 2.7%.

The TCJA was enacted at a point in the cycle where the economy appeared to be growing, the unemployment rate was low and market professionals believed that it was likely to continue falling and there was increasing confidence in the market that inflation may move to 2% over the medium term.

The Bancorp maintains a focus on commercial real estate exposure. Market data and vacancies remain positive; however credit markets in commercial real estate are becoming more selective around certain asset types and geographies. The Bancorp is also monitoring potential increased risks in the Retail sector as a result changes in distribution models with increasing levels of online purchasing and recent weakness in certain specialty retailers.

Commercial Portfolio

The Bancorp’s credit risk management strategy seeks to minimize concentrations of risk through diversification. The Bancorp has commercial loan concentration limits based on industry, lines of business within the commercial segment, geography and credit product type. The risk within the commercial loan and lease portfolio is managed and monitored through an underwriting process utilizing detailed origination policies, continuous loan level reviews, monitoring of industry concentration and product type limits and continuous portfolio risk management reporting.

The Bancorp provides loans to a variety of customers ranging from large multi-national firms to middle market businesses, sole proprietors and high net worth individuals. The origination policies for commercial and industrial loans outline the risks and underwriting requirements for loans to businesses in various industries. Included in the policies are maturity and amortization terms, collateral and leverage requirements, cash flow coverage measures and hold limits. The Bancorp aligns credit and sales teams with specific industry expertise to better monitor and manage different industry segments of the portfolio.

The origination policies for commercial real estate outline the risks and underwriting requirements for owner and nonowner-occupied and construction lending. Included in the policies are maturity and amortization terms, maximum LTVs, minimum debt service coverage ratios, construction loan monitoring procedures, appraisal requirements, pre-leasing requirements (as applicable), sensitivity and pro-forma analysis requirements and interest rate sensitivity. The Bancorp requires a valuation of real estate collateral, which may include third-party appraisals, be performed at the time of origination and renewal in accordance with regulatory requirements and on an as needed basis when market conditions justify. Although the Bancorp does not back test these collateral value assumptions, the Bancorp maintains an appraisal review department to order and review third-party appraisals in accordance with regulatory requirements. Collateral values on criticized assets with relationships exceeding $1 million are reviewed quarterly to assess the appropriateness of the value ascribed in the assessment of charge-offs and specific reserves.

The Bancorp assesses all real estate and non-real estate collateral securing a loan and considers all cross-collateralized loans in the calculation of the LTV ratio. The following tables provide detail on the most recent LTV ratios for commercial mortgage loans greater than $1 million, excluding impaired commercial mortgage loans individually evaluated. The Bancorp does not typically aggregate the LTV ratios for commercial mortgage loans less than $1 million.

 

TABLE 32: Commercial Mortgage Loans Outstanding by LTV, Loans Greater Than $1 Million
As of March 31, 2018 ($ in millions)          LTV > 100%      LTV 80-100%    LTV < 80%  

Commercial mortgage owner-occupied loans

  $     75           111          2,236      

Commercial mortgage nonowner-occupied loans

    13           152          2,187      

Total

  $     88           263          4,423      
TABLE 33: Commercial Mortgage Loans Outstanding by LTV, Loans Greater Than $1 Million
As of December 31, 2017 ($ in millions)          LTV > 100%    LTV 80-100%    LTV < 80%

Commercial mortgage owner-occupied loans

  $     79           110          2,222      

Commercial mortgage nonowner-occupied loans

    14           169          2,208      

Total

  $     93           279          4,430      

 

28


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

The following table provides detail on commercial loans and leases by industry classification (as defined by the North American Industry Classification System), by loan size and by state, illustrating the diversity and granularity of the Bancorp’s commercial loans and leases as of:

 

TABLE 34: Commercial Loan and Lease Portfolio (excluding loans and leases held for sale)
             March 31, 2018    December 31, 2017
($ in millions)           Outstanding    Exposure    Nonaccrual    Outstanding    Exposure    Nonaccrual  

By Industry:

                   

Manufacturing

  $      10,080         19,224    84      10,044        18,948    74     

Real estate

     7,813         12,387    18      7,713        12,493    25     

Financial services and insurance

     5,725         11,911    1      5,792        11,933    1     

Healthcare

     4,523         6,322    32      4,712        6,486    35     

Business services

     4,102         6,636    34      4,147        6,512    42     

Retail trade

     3,419         7,147    3      3,617        7,950    3     

Accommodation and food

     3,413         5,407    23      3,268        5,321    4     

Communication and information

     3,367         5,538    6      3,322        5,308    -     

Wholesale trade

     3,295         5,413    4      3,017        5,363    6     

Transportation and warehousing

     3,012         4,530    29      3,012        4,621    29     

Construction

     2,447         4,449    3      2,374        4,449    2     

Entertainment and recreation

     1,661         2,909    2      1,624        2,911    7     

Mining

     1,635         3,098    70      1,454        3,001    56     

Utilities

     861         2,264    -      869        2,333    -     

Other services

     713         998    11      714        1,017    16     

Public administration

     420         578    -      370        474    -     

Agribusiness

     312         489    2      304        478    2     

Individuals

     31         63    -      27        57    -     

Other

     -         -    -      15        15    4     

Total

  $      56,829         99,363    322      56,395        99,670    306     

By Loan Size:

                   

Less than $200,000

     1 %    1    4      1        1    5     

$200,000 - $1 million

     3         2    6      3        2    8     

$1 million - $5 million

     7         6    14      7        6    15     

$5 million - $10 million

     6         5    15      6        5    10     

$10 million - $25 million

     21         18    36      21        18    57     

Greater than $25 million

     62         68    25      62        68    5     

Total

           100 %    100    100      100        100    100     

By State:

                   

Ohio

     14 %    15    7      14        15    7     

Florida

     8         7    11      8        8    6     

Michigan

     7         7    9      7        7    13     

Illinois

     7         6    7      7        6    9     

Indiana

     4         4    2      4        4    3     

Georgia

     4         5    -      4        5    2     

North Carolina

     3         3    1      3        3    1     

Tennessee

     3         3    -      3        3    8     

Kentucky

     3         3    -      3        3    1     

Other

     47         47    63      47        46    50     

Total

           100 %    100    100      100        100    100     

The Bancorp’s nonowner-occupied commercial real estate portfolios have been identified by the Bancorp as loans which it believes represent a higher level of risk compared to the rest of the Bancorp’s commercial loan portfolio due to economic or market conditions within the Bancorp’s key lending areas.

 

29


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

The following tables provide an analysis of nonowner-occupied commercial real estate loans by state (excluding loans held for sale):

TABLE 35: Nonowner-Occupied Commercial Real Estate (excluding loans held for sale)(a)    

As of March 31, 2018 ($ in millions)                        

For the three months ended

March 31, 2018

              Outstanding              Exposure     

90 Days  

        Past Due  

         Nonaccrual   Net Charge-Offs

By State:

                 

Ohio

   $                1,609      2,058      -    1  

Florida

   1,011      1,512      -    -  

Illinois

   806      1,000      -    -  

Michigan

   573      740      -    -  

Indiana

   552      800      -    -  

North Carolina

   538      793      -    -  

All other states

   2,661      4,447      -    3  

Total

   $                7,750      11,350      -    4  

(a)   Included in commercial mortgage loans and commercial construction loans in the Loans and Leases subsection of the Balance Sheet Analysis section of MD&A.

TABLE 36: Nonowner-Occupied Commercial Real Estate (excluding loans held for sale)(a)    
As of March 31, 2017 ($ in millions)                         For the three months ended
March 31, 2017
      Outstanding      Exposure     

90 Days

Past Due

   Nonaccrual   Net Charge-Offs

By State:

                 

Ohio

   $                1,516      1,947      -    3  

Florida

   901      1,478      -    1  

Illinois

   692      1,216      -    -  

Michigan

   603      796      -    2  

Indiana

   648      1,071      -    -  

North Carolina

   580      838      -    -  

All other states

   2,658      4,510      -    3  

Total

   $                7,598      11,856      -    9  
(a)

Included in commercial mortgage loans and commercial construction loans in the Loans and Leases subsection of the Balance Sheet Analysis section of MD&A.

 

30


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Consumer Portfolio

Consumer credit risk management utilizes a framework that encompasses consistent processes for identifying, assessing, managing, monitoring and reporting credit risk. These processes are supported by a credit risk governance structure that includes Board oversight, policies, risk limits and risk committees.    

The Bancorp’s consumer portfolio is materially comprised of five categories of loans: residential mortgage loans, home equity loans, automobile loans, credit card and other consumer. The Bancorp has identified certain credit characteristics within these five categories of loans which it believes represent a higher level of risk compared to the rest of the consumer loan portfolio. The Bancorp does not update LTV ratios for the consumer portfolio subsequent to origination except as part of the charge-off process for real estate secured loans. Among consumer portfolios, legacy underwritten residential mortgage and brokered home equity portfolios exhibited the most stress during the past credit crisis. As of March 31, 2018, consumer real estate loans, consisting of residential mortgage loans and home equity loans, originated from 2005 through 2008 represent approximately 14% of the consumer real estate portfolio. These loans accounted for 53% of total consumer real estate secured losses for the three months ended March 31, 2018. Current loss rates in the residential mortgage and home equity portfolios are below pre-crisis levels. In addition to the consumer real estate portfolio, credit risk management continues to closely monitor the automobile portfolio performance. The automobile market has exhibited industry-wide gradual loosening of credit standards such as lower FICOs, longer terms and higher LTVs. Fifth Third has adjusted credit standards focused on improving risk-adjusted returns while maintaining credit risk tolerance. Fifth Third actively manages the automobile portfolio through concentration limits, which mitigates credit risk through limiting the exposure to lower FICO scores, higher advance rates and extended term originations.

Residential mortgage portfolio

The Bancorp manages credit risk in the residential mortgage portfolio through underwriting guidelines that limit exposure to higher LTV ratios and lower FICO scores. Additionally, the portfolio is governed by concentration limits that ensure geographic, product and channel diversification. The Bancorp may also package and sell loans in the portfolio.

The Bancorp does not originate mortgage loans that permit customers to defer principal payments or make payments that are less than the accruing interest. The Bancorp originates both fixed-rate and ARM loans. Within the ARM portfolio, approximately $634 million of ARM loans will have rate resets during the next twelve months. Of these resets, 90% are expected to experience an increase in rate, with an average increase of approximately one percent.

Certain residential mortgage products have contractual features that may increase credit exposure to the Bancorp in the event of a decline in housing values. These types of mortgage products offered by the Bancorp include loans with high LTV ratios, multiple loans on the same collateral that when combined result in a LTV greater than 80% and interest-only loans. The Bancorp has deemed residential mortgage loans with greater than 80% LTV ratios and no mortgage insurance as loans that represent a higher level of risk.

Portfolio residential mortgage loans from 2010 and later vintages represented 91% of the portfolio as of March 31, 2018 and had a weighted-average LTV of 72% and a weighted-average origination FICO of 760.

The following table provides an analysis of the residential mortgage portfolio loans outstanding by LTV at origination as of:

TABLE 37: Residential Mortgage Portfolio Loans by LTV at Origination

          March 31, 2018        December 31, 2017
($ in millions)        Outstanding   Weighted-
Average LTV
         Outstanding   Weighted-
Average LTV
LTV £ 80%   $         11,704           66.4 %     $     11,767             66.4
LTV > 80%, with mortgage insurance(a)       1,926           94.8              1,890             94.8  
LTV > 80%, no mortgage insurance         1,933           94.7                1,934             94.7  

Total

  $         15,563           73.8 %     $     15,591             73.7
(a)

Includes loans with both borrower and lender paid mortgage insurance.

 

31


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

The following tables provide an analysis of the residential mortgage portfolio loans outstanding by state with a greater than 80% LTV ratio and no mortgage insurance:

TABLE 38: Residential Mortgage Portfolio Loans, LTV Greater than 80%, No Mortgage Insurance

As of March 31, 2018 ($ in millions)

                        
For the three months ended
March 31, 2018
 
 
      

    Outstanding    

      
90 Days    
Past Due    
 
 
    

Nonaccrual    

       Net Charge-offs  
By State:            

Ohio

   $         435        3        3        -  

Illinois

     384        1        3        -  

Florida

     285        4        4        -  

Michigan

     222        1        -        -  

Indiana

     140        1        1        -  

North Carolina

     87        -        1        -  

Kentucky

     77        1        -        -  

All other states

     303        2        1        -  

Total

   $ 1,933        13        13        -  
TABLE 39: Residential Mortgage Portfolio Loans, LTV Greater than 80%, No Mortgage Insurance  

As of March 31, 2017 ($ in millions)

                        
For the three months ended
March 31, 2017
 
 
      

    Outstanding

      
90 Days
Past Due
 
 
    

Nonaccrual

       Net Charge-offs  
By State:            

Ohio

   $ 554        2        4        -  

Illinois

     464        -        1        -  

Florida

     338        2        2        1  

Michigan

     271        -        1        -  

Indiana

     159        1        1        -  

North Carolina

     113        -        1        -  

Kentucky

     91        1        -        -  

All other states

     376        -        -        -  

Total

   $ 2,366        6        10        1  

Home equity portfolio

The Bancorp’s home equity portfolio is primarily comprised of home equity lines of credit. Beginning in the first quarter of 2013, the Bancorp’s newly originated home equity lines of credit have a 10-year interest-only draw period followed by a 20-year amortization period. The home equity line of credit previously offered by the Bancorp was a revolving facility with a 20-year term, minimum payments of interest-only and a balloon payment of principal at maturity. Peak maturity years for the balloon home equity lines of credit are 2025 to 2028 and approximately 26% of the balances mature before 2025.

The ALLL provides coverage for probable and estimable losses in the home equity portfolio. The allowance attributable to the portion of the home equity portfolio that has not been restructured in a TDR is calculated on a pooled basis with senior lien and junior lien categories segmented in the determination of the probable credit losses in the home equity portfolio. The modeled loss factor for the home equity portfolio is based on the trailing twelve month historical loss rate for each category, as adjusted for certain prescriptive loss rate factors and certain qualitative adjustment factors to reflect risks associated with current conditions and trends. The prescriptive loss rate factors include adjustments for delinquency trends, LTV trends and refreshed FICO score trends. The qualitative factors include adjustments for changes in policies or procedures in underwriting, monitoring or collections, economic conditions, portfolio mix, lending and risk management personnel, results of internal audit and quality control reviews, collateral values and geographic concentrations. The Bancorp considers home price index trends when determining the collateral value qualitative factor.

The home equity portfolio is managed in two primary groups: loans outstanding with a combined LTV greater than 80% and those loans with a LTV of 80% or less based upon appraisals at origination. For additional information on these loans, refer to Table 41 and Table 42. Of the total $6.8 billion of outstanding home equity loans:

   

88% reside within the Bancorp’s Midwest footprint of Ohio, Michigan, Kentucky, Indiana and Illinois as of March 31, 2018;

   

37% are in senior lien positions and 63% are in junior lien positions at March 31, 2018;

   

82% of non-delinquent borrowers made at least one payment greater than the minimum payment during the three months ended March 31, 2018; and

   

The portfolio had an average refreshed FICO score of 744 at March 31, 2018.

The Bancorp actively manages lines of credit and makes adjustments in lending limits when it believes it is necessary based on FICO score deterioration and property devaluation. The Bancorp does not routinely obtain appraisals on performing loans to update LTV ratios after origination. However, the Bancorp monitors the local housing markets by reviewing various home price indices and incorporates the impact of the changing market conditions in its ongoing credit monitoring processes. For junior lien home equity loans which become 60 days or more past due, the Bancorp tracks the performance of the senior lien loans in which the Bancorp is the servicer and utilizes consumer credit bureau attributes to monitor the status of the senior lien loans that the Bancorp does not service.

 

32


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

If the senior lien loan is found to be 120 days or more past due, the junior lien home equity loan is placed on nonaccrual status unless both loans are well-secured and in the process of collection. Additionally, if the junior lien home equity loan becomes 120 days or more past due and the senior lien loan is also 120 days or more past due, the junior lien home equity loan is assessed for charge-off. Refer to the Analysis of Nonperforming Assets subsection of the Risk Management section of MD&A for more information.

The following table provides an analysis of home equity portfolio loans outstanding disaggregated based upon refreshed FICO score as of:

TABLE 40: Home Equity Portfolio Loans Outstanding by Refreshed FICO Score    

              March 31, 2018               December 31, 2017  
($ in millions)             Outstanding       % of Total                   Outstanding       % of Total
Senior Liens:            
FICO £ 659   $       235             $       246          
FICO 660-719       344                   358            
FICO ³ 720             1,901           28                1,976           28   

Total senior liens

      2,480           37          2,580           37   
Junior Liens:            
FICO £ 659       528                   541            
FICO 660-719       826           12          853           12   
FICO ³ 720             2,923           43                3,040           43   

Total junior liens

            4,277           63                4,434           63   

Total

    $       6,757           100    $       7,014           100 

The Bancorp believes that home equity loans with a greater than 80% combined LTV ratio present a higher level of risk. The following table provides an analysis of the home equity loans outstanding in a senior and junior lien position by LTV at origination:

 
TABLE 41: Home Equity Portfolio Loans Outstanding by LTV at Origination      
      March 31, 2018         December 31, 2017  
($ in millions)             Outstanding      
Weighted-
Average LTV

 
            Outstanding      
Weighted-
Average LTV

 
Senior Liens:            
LTV £ 80%     $       2,173           54.8    $       2,266           54.9 
LTV > 80%             307           88.9                314           88.9   

Total senior liens

      2,480           59.3          2,580           59.3   
Junior Liens:            
LTV £ 80%       2,500           67.4          2,603           67.5   
LTV > 80%             1,777           90.4                1,831           90.4   

Total junior liens

            4,277           78.3                4,434           78.3   

Total

    $       6,757           70.9    $       7,014           70.9 

The following tables provide an analysis of home equity portfolio loans by state with a combined LTV greater than 80%:

TABLE 42: Home Equity Portfolio Loans Outstanding with a LTV Greater than 80%

As of March 31, 2018 ($ in millions)

                                
For the three months ended
March 31, 2018
 
 
      

Outstanding    

      

Exposure    

      
90 Days    
Past Due    
 
 
    

Nonaccrual    

      Net Charge-offs  
By State:              

Ohio

   $ 1,034        1,968        -        8       1  

Michigan

     339        550        -        5       1  

Illinois

     219        349        -        4       1  

Indiana

     148        256        -        3       -  

Kentucky

     136        250        -        2       -  

Florida

     66        95        -        2       -  

All other states

     142        210        -        3       -  

Total

   $ 2,084        3,678        -        27       3  

 

33


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

TABLE 43: Home Equity Portfolio Loans Outstanding with a LTV Greater than 80%    

As of March 31, 2017 ($ in millions)

                                        
For the three months ended
March 31, 2017
 
 
      

    Outstanding      

      

Exposure    

      
90 Days  
Past Due  
 
 
    

Nonaccrual  

       Net Charge-offs  
By State:               

Ohio

   $ 1,026        1,848        -        8        2  

Michigan

     413        643        -        5        -  

Illinois

     253        391        -        3        1  

Indiana

     177        293        -        2        -  

Kentucky

     163        285        -        2        -  

Florida

     78        110        -        2        -  

All other states

     174        248        -        4        -  

Total

   $ 2,284        3,818        -        26        3  

Automobile portfolio

The Bancorp’s automobile portfolio balances have declined since December 31, 2017 as payoffs exceeded new loan production due to a strategic shift focusing on improving risk-adjusted returns. Additionally, the concentration of lower FICO (<690) origination balances remained within targeted credit risk tolerance during the three months ended March 31, 2018. All concentration and guideline changes are monitored monthly to ensure alignment with original credit performance and return projections.

The following table provides an analysis of automobile portfolio loans outstanding disaggregated based upon FICO score as of:

TABLE 44: Automobile Portfolio Loans Outstanding by FICO Score at Origination    

              March 31, 2018           December 31, 2017  
($ in millions)             Outstanding       % of Total           Outstanding       % of Total  
FICO £ 690     $       1,569             17    $     1,563             17 
FICO > 690             7,449             83            7,549             83   

Total

    $       9,018             100    $     9,112             100 

The automobile portfolio is characterized by direct and indirect lending products to consumers. As of March 31, 2018, 44% of the automobile loan portfolio is comprised of loans collateralized by new automobiles. It is a common industry practice to advance on automobile loans an amount in excess of the automobile value due to the inclusion of negative equity trade-in, maintenance/warranty products, taxes, title and other fees paid at closing. The Bancorp monitors its exposure to these higher risk loans.

 

The following table provides an analysis of automobile portfolio loans outstanding by LTV at origination as of:

 

 

 

TABLE 45: Automobile Portfolio Loans Outstanding by LTV at Origination    

 

      March 31, 2018             December 31, 2017  
   

 

 

 

   

 

 

 

($ in millions)             Outstanding      
Weighted-
Average LTV

 
        Outstanding      
Weighted-
Average LTV

 
LTV £ 100%     $       5,702             82.3    $     5,814             82.1 
LTV > 100%             3,316             112.6            3,298             112.4   

Total

    $       9,018             93.8    $     9,112             93.5 

The following table provides an analysis of the Bancorp’s automobile portfolio loans with a LTV at origination greater than 100%:

TABLE 46: Automobile Portfolio Loans Outstanding with a LTV Greater than 100%

As of ($ in millions)

   

    Outstanding

     
90 Days Past
Due and Accruing
 
 
   

Nonaccrual

     
Net Charge-offs for the    
Three Months Ended    
 
 
March 31, 2018   $ 3,316       5       1       8  

March 31, 2017

    3,266       4       2       6  

Credit card portfolio

The credit card portfolio consists of predominately prime accounts with 97% of loan balances existing within the Bancorp’s footprint as of both March 31, 2018 and December 31, 2017. At March 31, 2018 and December 31, 2017, 75% and 76%, respectively, of the outstanding balances were originated through branch-based relationships with the remainder coming from direct mail campaigns and online acquisitions.

 

34


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

The following table provides an analysis of credit card portfolio loans outstanding disaggregated based upon FICO score as of:

TABLE 47: Credit Card Portfolio Loans Outstanding by FICO Score at Origination    

                March 31, 2018                    December 31, 2017      
($ in millions)         

 

Outstanding

        % of Total                  Outstanding         % of Total        

FICO £ 659

        60            3  %                      61             3  %  

FICO 660-719

      574            26               581             25       

FICO ³ 720

            1,554            71                     1,657             72       

Total

                2,188                    100  %                              2,299                     100  %  

Other consumer loans portfolio

The other consumer loans portfolio is comprised of secured and unsecured loans originated through the Bancorp’s branch network as well as point-of-sale loans originated in connection with third-party financial technology companies. Outstanding balances for other consumer loans increased approximately $56 million, or 4%, from December 31, 2017 primarily due to an increase in originations in connection with third-party financial technology companies. Additionally, the Bancorp has approximately $224 million in unfunded commitments associated with loans originated in connection with third-party financial technology companies as of March 31, 2018. Fifth Third closely monitors the credit performance of these point-of-sale loans which is impacted by the credit loss protection coverage provided by the third-party financial technology companies.

The following table provides an analysis of other consumer portfolio loans outstanding by product type at origination as of:

TABLE 48: Other Consumer Portfolio Loans Outstanding by Product Type at Origination    

                March 31, 2018                    December 31, 2017      
($ in millions)         

 

Outstanding

        % of Total                  Outstanding         % of Total        

Unsecured

        434            27  %                      461             30  %  

Other secured

      475            29               482             31       

Point-of-sale

            706            44                     616             39       

Total

                1,615                    100  %                              1,559                     100  %  

Analysis of Nonperforming Assets

Nonperforming assets include nonaccrual loans and leases for which ultimate collectability of the full amount of the principal and/or interest is uncertain; restructured commercial and credit card loans which have not yet met the requirements to be classified as a performing asset; restructured consumer loans which are 90 days past due based on the restructured terms unless the loan is both well-secured and in the process of collection; and certain other assets, including OREO and other repossessed property. A summary of nonperforming assets is included in Table 49. For further information on the Bancorp’s policies related to accounting for delinquent and nonperforming loans and leases, refer to the Nonaccrual Loans and Leases section of Note 1 of the Notes to the Consolidated Financial Statements included in the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2017.

Nonperforming assets were $528 million at March 31, 2018 compared to $495 million at December 31, 2017. At March 31, 2018, $24 million of nonaccrual loans were held for sale, compared to $6 million at December 31, 2017.

Nonperforming portfolio assets as a percent of portfolio loans and leases and OREO were 0.55% as of March 31, 2018 compared to 0.53% as of December 31, 2017. Nonaccrual loans and leases secured by real estate were 26% of nonaccrual loans and leases as of March 31, 2018 compared to 33% as of December 31, 2017.

Commercial portfolio nonaccrual loans and leases were $322 million at March 31, 2018, an increase of $16 million from December 31, 2017. Consumer portfolio nonaccrual loans and leases were $130 million at March 31, 2018, a decrease of $1 million from December 31, 2017. Refer to Table 50 for a rollforward of the nonaccrual loans and leases.

OREO and other repossessed property was $52 million at both March 31, 2018 and December 31, 2017. The Bancorp recognized $3 million and $4 million in losses on the sale or write-down of OREO properties for the three months ended March 31, 2018 and 2017, respectively.

For the three months ended March 31, 2018 and 2017, approximately $8 million and $9 million, respectively, of interest income would have been recognized if the nonaccrual and renegotiated loans and leases on nonaccrual status had been current in accordance with their original terms. Although these values help demonstrate the costs of carrying nonaccrual credits, the Bancorp does not expect to recover the full amount of interest as nonaccrual loans and leases are generally carried below their principal balance.

 

35


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

TABLE 49: Summary of Nonperforming Assets and Delinquent Loans    

As of ($ in millions)          March 31, 2018            December 31, 2017               

Nonaccrual portfolio loans and leases:

      

     Commercial and industrial loans

        155               144                      

     Commercial mortgage loans

      9               12                      

     Commercial leases

      4               -                      

     Residential mortgage loans

      16               17                      

     Home equity

      55               56                      

     Other consumer loans

      1               -                      

Nonaccrual portfolio restructured loans and leases:

      

     Commercial and industrial loans

      144               132                      

     Commercial mortgage loans

      6               14                      

     Commercial leases

      4               4                      

     Residential mortgage loans

      12               13                      

     Home equity

      19               18                      

     Automobile loans

      1               1                      

     Credit card

            26               26                      

Total nonaccrual portfolio loans and leases(b)

      452               437                      

OREO and other repossessed property

            52               52                      

Total nonperforming portfolio assets

      504               489                      

Nonaccrual loans held for sale

      5               5                      

Nonaccrual restructured loans held for sale

            19               1                      

Total nonperforming assets

        528               495                      

Loans and leases 90 days past due and still accruing

      

     Commercial and industrial loans

        7               3                      

     Commercial mortgage loans

      1               -                      

     Residential mortgage loans(a)

      62               57                      

     Automobile loans

      9               10                      

     Credit card

            28               27                      

Total loans and leases 90 days past due and still accruing

        107               97                      

Nonperforming portfolio assets as a percent of portfolio loans and leases and OREO

      0.55   %        0.53                      

ALLL as a percent of nonperforming portfolio assets

            226               245                      
(a)

Information for all periods presented excludes advances made pursuant to servicing agreements for GNMA mortgage pools whose repayments are insured by the FHA or guaranteed by the VA. These advances were $317 as of March 31, 2018 and $290 as of December 31, 2017. The Bancorp recognized losses of $2 for both the three months ended March 31, 2018 and 2017.

(b)

Includes $5 and $3 of nonaccrual government insured commercial loans whose repayments are insured by the SBA at March 31, 2018 and December 31, 2017, respectively, of which $2 and $3 were restructured nonaccrual government insured commercial loans at March 31, 2018 and December 31, 2017, respectively.

The following tables provide a rollforward of portfolio nonaccrual loans and leases, by portfolio segment:

TABLE 50: Rollforward of Portfolio Nonaccrual Loans and Leases    

For the three months ended March 31, 2018 ($ in millions)          Commercial             Residential
 Mortgage 
                Consumer             Total         

Balance, beginning of period

        306          30          101       437    

      Transfers to nonaccrual status

      100          10          33       143    

      Transfers to accrual status

      -          (7        (14     (21  

      Transfers to held for sale

      (24        -          -       (24  

      Loan paydowns/payoffs

      (45        (1        (8     (54  

      Transfers to OREO

      (2        (4        (1     (7  

      Charge-offs

      (35        -          (9     (44  

      Draws/other extensions of credit

      22          -          -       22    

Balance, end of period

        322                28                102       452          

 

TABLE 51: Rollforward of Portfolio Nonaccrual Loans and Leases    

 

       
For the three months ended March 31, 2017 ($ in millions)          Commercial              Residential
 Mortgage 
                Consumer             Total         

      Balance, beginning of period

        523          34          103       660    

      Transfers to nonaccrual status

      128          11          31       170    

      Transfers to accrual status

      -          (5        (14     (19  

      Transfers to held for sale

      (3        -          -       (3  

      Loan paydowns/payoffs

      (80        (2        (8     (90  

      Transfers to OREO

      (2        (2        (2     (6  

      Charge-offs

      (46        (1        (11     (58  

      Draws/other extensions of credit

      3          -          -       3    

Balance, end of period

        523                35                99       657          

 

36


Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Troubled Debt Restructurings

If a borrower is experiencing financial difficulty, the Bancorp may consider, in certain circumstances, modifying the terms of their loan to maximize collection of amounts due. Typically, these modifications reduce the loan interest rate, extend the loan term, reduce the accrued interest or in limited circumstances, reduce the principal balance of the loan. These modifications are classified as TDRs.

At the time of modification, the Bancorp maintains certain consumer loan TDRs (including residential mortgage loans, home equity loans, and other consumer loans) on accrual status, provided there is reasonable assurance of repayment and performance according to the modified terms based upon a current, well-documented credit evaluation. Commercial loans modified as part of a TDR are maintained on accrual status provided there is a sustained payment history of six months or greater prior to the modification in accordance with the modified terms and all remaining contractual payments under the modified terms are reasonably assured of collection. TDRs of commercial loans and credit card loans that do not have a sustained payment history of six months or greater in accordance with the modified terms remain on nonaccrual status until a six-month payment history is sustained.

Consumer restructured loans on accrual status totaled $916 million and $927 million at March 31, 2018 and December 31, 2017, respectively. As of March 31, 2018, the percent of restructured residential mortgage loans, home equity loans and credit card loans that were past due 30 days or more from their modified terms were 25%, 11% and 34%, respectively.

The following tables summarize portfolio TDRs by loan type and delinquency status:

TABLE 52: Accruing and Nonaccruing Portfolio TDRs    

<
            Accruing               
                     30-89 Days          90 Days or             
As of March 31, 2018 ($ in millions)              Current      Past Due          More Past Due             Nonaccruing          Total     

Commercial loans(b)

        249        -                 -                   154            403 

Residential mortgage loans(a)

      500        37                 117                   12            666 

Home equity

      227        10                 -                   19            256 

Automobile loans

      7        -                 -                   1           

Credit card

            15        3                 -                   26            44 

Total

        998        50                 117                   212            1,377 

(a)   Information includes advances made pursuant to servicing agreements for GNMA mortgage pools whose repayments are insured by the FHA or guaranteed by the VA. As of March 31, 2018, these advances represented $302 of current loans, $30 of 30-89 days past due loans and $102 of 90 days or more past due loans.

(b)   Excludes restructured nonaccrual loans held for sale.

 

TABLE 53: Accruing and Nonaccruing Portfolio TDRs    

            Accruing               
                 30-89 Days      90 Days or             
As of December 31, 2017 ($ in millions)              Current      Past Due      More Past Due     Nonaccruing          Total     

Commercial loans(b)

        249