Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2018

Commission File Number 001-33653

 

 

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Large accelerated filer

     Accelerated filer  

Non-accelerated filer

     Smaller reporting company  
     Emerging growth company  

If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ☐  No  ☒

There were 655,615,619 shares of the Registrant’s common stock, without par value, outstanding as of October 31, 2018.


Table of Contents

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)

     3  

Selected Financial Data

     3  

Overview

     4  

Non-GAAP Financial Measures

     8  

Recent Accounting Standards

     10  

Critical Accounting Policies

     10  

Statements of Income Analysis

     11  

Balance Sheet Analysis

     19  

Business Segment Review

     25  

Risk Management—Overview

     32  

Credit Risk Management

     33  

Market Risk Management

     46  

Liquidity Risk Management

     50  

Operational Risk Management

     53  

Compliance Risk Management

     53  

Capital Management

     54  

Off-Balance Sheet Arrangements

     56  

Quantitative and Qualitative Disclosures about Market Risk (Item 3)

     57  

Controls and Procedures (Item 4)

     57  

Condensed Consolidated Financial Statements and Notes (Item 1)

  

Balance Sheets (unaudited)

     58  

Statements of Income (unaudited)

     59  

Statements of Comprehensive Income (unaudited)

     60  

Statements of Changes in Equity (unaudited)

     61  

Statements of Cash Flows (unaudited)

     62  

Notes to Condensed Consolidated Financial Statements (unaudited)

     63  

Part II. Other Information

  

Legal Proceedings (Item 1)

     119  

Risk Factors (Item 1A)

     119  

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

     119  

Exhibits (Item 6)

     119  

Signatures

     120  

FORWARD-LOOKING STATEMENTS

This report contains statements that we believe are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended, and Rule 3b-6 promulgated thereunder. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. They usually can be identified by the use of forward-looking language such as “will likely result,” “may,” “are expected to,” “is anticipated,” “potential,” “estimate,” “forecast,” “projected,” “intends to,” or may include other similar words or phrases such as “believes,” “plans,” “trend,” “objective,” “continue,” “remain,” or similar expressions, or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” or similar verbs. You should not place undue reliance on these statements, as they are subject to risks and uncertainties, including but not limited to the risk factors set forth in the Risk Factors section in Item 1A in our most recent Annual Report on Form 10-K as updated by our Quarterly Reports on Form 10-Q. When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements we may make. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to us. There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements. Factors that might cause such a difference include, but are not limited to: (1) deteriorating credit quality; (2) loan concentration by location or industry of borrowers or collateral; (3) problems encountered by other financial institutions; (4) inadequate sources of funding or liquidity; (5) unfavorable actions of rating agencies; (6) inability to maintain or grow deposits; (7) limitations on the ability to receive dividends from subsidiaries; (8) cyber-security risks; (9) Fifth 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) risks relating to the potential merger with MB Financial, Inc. and Fifth Third’s ability to realize the anticipated benefits of the merger; (36) difficulties in identifying, acquiring or integrating suitable strategic partnerships, investments or acquisitions; (37) potential dilution from future acquisitions; (38) loss of income and/or difficulties encountered in the sale and separation of businesses, investments or other assets; (39) results of Worldpay Holding, LLC (formerly Vantiv Holding, LLC) a subsidiary of Worldpay, Inc. or other investments or acquired entities; (40) difficulties from or changes in Fifth Third’s investment in, relationship with, and nature of the operations of Worldpay Holding, LLC, a subsidiary of Worldpay, Inc.; (41) changes in accounting standards or interpretation or declines in the value of Fifth Third’s goodwill or other intangible assets; (42) inaccuracies or other failures from the use of models; (43) effects of critical accounting policies and judgments or the use of inaccurate estimates; (44) weather related events or other natural disasters; and (45) the impact of reputational risk created by these or other developments on such matters as business generation and retention, funding and liquidity.

 

1


Table of Contents

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

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

NPR: Notice of Proposed Rulemaking

NSFR: Net Stable Funding Ratio

OAS: Option-Adjusted Spread

OCI: Other Comprehensive Income (Loss)

OREO: Other Real Estate Owned

OTTI: Other-Than-Temporary Impairment

PCA: Prompt Corrective Action

RCC: Risk Compliance Committee

RSF: Required Stable Funding

SAR: Stock Appreciation Right

SBA: Small Business Administration

SCB: Stress Capital Buffer

SEC: United States Securities and Exchange Commission

SLB: Stress Leverage Buffer

TBA: To Be Announced

TCJA: Tax Cuts and Jobs Act

TDR: Troubled Debt Restructuring

TILA: Truth in Lending Act

TRA: Tax Receivable Agreement

U.S.: United States of America

U.S. GAAP: United States Generally Accepted Accounting Principles

VA: United States Department of Veteran Affairs

VIE: Variable Interest Entity

VRDN: Variable Rate Demand Note

 

2


Table of Contents

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                   For the nine months         
           ended September 30,      %            ended September 30,      %  

($ in millions, except for per share data)

          2018     2017      Change             2018     2017      Change  

Income Statement Data

                   

Net interest income (U.S. GAAP)

  $          1,043       970        8     $          3,059       2,842        8  

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

       1,047       977        7          3,071       2,861        7  

Noninterest income

       563       1,561        (64        2,215       2,648        (16

Total revenue(a)

       1,610       2,538        (37        5,286       5,509        (4

Provision for loan and lease losses

       86       67        28          142       193        (26

Noninterest expense

       1,008       975        3          3,090       2,918        6  

Net income attributable to Bancorp

       433       1,014        (57        1,721       1,685        2  

Net income available to common shareholders

             418       999        (58              1,669       1,633        2  

Common Share Data

                   

Earnings per share - basic

  $          0.62       1.37        (55   $          2.43       2.19        11  

Earnings per share - diluted

       0.61       1.35        (55        2.38       2.16        10  

Cash dividends declared per common share

       0.18       0.16        13          0.52       0.44        18  

Book value per share

       21.92       21.30        3          21.92       21.30        3  

Market value per share

             27.92       27.98        -                27.92       27.98        -  

Financial Ratios

                   

Return on average assets

       1.21  %      2.85        (58        1.63  %      1.60        2  

Return on average common equity

       11.2       25.6        (56        15.0       14.3        5  

Return on average tangible common equity(b)

       13.5       30.4        (56        18.1       17.0        6  

Dividend payout

       29.0       11.7        148          21.4       20.1        6  

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

       11.39       11.93        (5        11.43       11.83        (3

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

       9.12       8.89        3          9.12       8.89        3  

Net interest margin(a)(b)

       3.23       3.07        5          3.20       3.03        6  

Net interest rate spread (a)(b)

       2.87       2.79        3          2.87       2.77        4  

Efficiency(a)(b)

             62.6       38.4        63                58.5       53.0        10  

Credit Quality

                   

Net losses charged-off

  $          72       68        6     $          247       221        12  

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

       0.30  %      0.29        3          0.36  %      0.32        13  

ALLL as a percent of portfolio loans and leases

       1.17       1.31        (11        1.17       1.31        (11

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

       1.31       1.48        (11        1.31       1.48        (11

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

             0.48       0.60        (20              0.48       0.60        (20

Average Balances

                   

Loans and leases, including held for sale

  $          93,977       92,617        1     $          93,363       92,686        1  

Securities and other short-term investments

       34,822       33,826        3          34,813       33,497        4  

Assets

       141,752       140,992        1          141,616       140,495        1  

Transaction deposits(d)

       97,315       94,927        3          97,303       95,916        1  

Core deposits(e)

       101,492       98,649        3          101,321       99,680        2  

Wholesale funding(f)

       20,613       21,529        (4        20,546       20,450        -  

Bancorp shareholders’ equity

             16,145       16,820        (4              16,187       16,623        (3

Regulatory Capital and Liquidity Ratios

       

CET1 capital(g)

       10.67  %      10.59        1          10.67  %      10.59        1  

Tier I risk-based capital(g)

       11.78       11.72        1          11.78       11.72        1  

Total risk-based capital(g)

       14.94       15.16        (1        14.94       15.16        (1

Tier I leverage

       10.10       9.97        1          10.10       9.97        1  

Modified LCR

             119       124        (4              119       124        (4

(a)

Amounts presented on an FTE basis. The FTE adjustment for the three months ended September 30, 2018 and 2017 was $4 and $7, respectively, and for the nine months ended September 30, 2018 and 2017 was $12 and $19, respectively.

(b)

These are non-GAAP measures. For further information, refer to the Non-GAAP Financial Measures section of MD&A.

(c)

The allowance for credit losses is the sum of the ALLL and the reserve for unfunded commitments.

(d)

Includes demand deposits, interest checking deposits, savings deposits, money market deposits and foreign office deposits.

(e)

Includes transaction deposits and other time deposits.

(f)

Includes certificates $100,000 and over, other deposits, federal funds purchased, other short-term borrowings and long-term debt.

(g)

Under the U.S. banking agencies’ Basel III Final Rule, assets and credit equivalent amounts of off-balance sheet exposures are calculated according to the standardized approach for risk-weighted assets. The resulting values are added together in the Bancorp’s total risk-weighted assets.

(h)

Excludes unrealized gains and losses.

 

3


Table of Contents

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 September 30, 2018, the Bancorp had $141.7 billion in assets and operated 1,152 full-service banking centers and 2,443 Fifth Third branded ATMs in ten states throughout the Midwestern and Southeastern regions of the U.S. The Bancorp reports on four business segments: Commercial Banking, Branch Banking, Consumer Lending and Wealth and Asset Management. The Bancorp also has an approximate 3.3% interest in Worldpay Holding, LLC (formerly Vantiv Holding, LLC). The carrying value of the Bancorp’s investment in Worldpay Holding, LLC was $424 million at September 30, 2018.

This overview of MD&A highlights selected information in the financial results of the Bancorp and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources and critical accounting policies and estimates, you should carefully read this entire document as well as the 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 September 30, 2018, net interest income on an FTE basis and noninterest income provided 65% and 35% of total revenue, respectively. For the nine months ended September 30, 2018, net interest income on an FTE basis and noninterest income provided 58% and 42% of total revenue, respectively. The Bancorp derives the majority of its revenues within the U.S. from customers domiciled in the U.S. Revenue from foreign countries and external customers domiciled in foreign countries was immaterial to the Condensed Consolidated Financial Statements for both the three and nine months ended September 30, 2018. Changes in interest rates, credit quality, economic trends and the capital markets are primary factors that drive the performance of the Bancorp. As discussed later in the Risk Management section of MD&A, risk identification, measurement, monitoring, control and reporting are important to the management of risk and to the financial performance and capital strength of the Bancorp.

Net interest income is the difference between interest income earned on assets such as loans, leases and securities, and interest expense incurred on liabilities such as deposits, other short-term borrowings and long-term debt. Net interest income is affected by the general level of interest rates, the relative level of short-term and long-term interest rates, changes in interest rates and changes in the amount and composition of interest-earning assets and interest-bearing liabilities. Generally, the rates of interest the Bancorp earns on its assets and pays on its liabilities are established for a period of time. The change in market interest rates over time exposes the Bancorp to interest rate risk through potential adverse changes to net interest income and financial position. The Bancorp manages this risk by continually analyzing and adjusting the composition of its assets and liabilities based on their payment streams and interest rates, the timing of their maturities and their sensitivity to changes in market interest rates. Additionally, in the ordinary course of business, the Bancorp enters into certain derivative transactions as part of its overall strategy to manage its interest rate and prepayment risks. The Bancorp is also exposed to the risk of loss on its loan and lease portfolio, as a result of changing expected cash flows caused by borrower credit events, such as loan defaults and inadequate collateral.

Noninterest income is derived from service charges on deposits, wealth and asset management revenue, corporate banking revenue, card and processing revenue, mortgage banking net revenue, net securities gains or losses and other noninterest income. Noninterest expense includes personnel costs, net occupancy expense, technology and communication costs, equipment expense, card and processing expense and other noninterest expense.

Worldpay, Inc. and Worldpay Holding, LLC Transactions

On January 16, 2018, Vantiv, Inc. completed its previously announced acquisition of Worldpay Group plc. with the resulting combined company named Worldpay, Inc. As a result of this transaction, the Bancorp recognized a gain of $414 million in other noninterest income during the first quarter of 2018 associated with the dilution in its ownership interest in Worldpay Holding, LLC from approximately 8.6% to approximately 4.9%.

On June 27, 2018, the Bancorp completed the sale of 5 million shares of Class A common stock of Worldpay, Inc. (formerly Vantiv, Inc.). The Bancorp had previously received these Class A shares in exchange for Class B Units of Worldpay Holding, LLC. The Bancorp recognized a gain of $205 million related to the sale. As a result of the sale, the Bancorp beneficially owns approximately 3.3% of Worldpay’s equity through its ownership of approximately 10.3 million Class B Units. At September 30, 2018, the Bancorp’s remaining interest in Worldpay Holding, LLC of $424 million continues to be accounted for as an equity method investment given the nature of Worldpay Holding, LLC’s structure as a limited liability company and contractual arrangements between Worldpay Holding, LLC and the Bancorp.

GS Holdings Transaction

In May 2018, GreenSky, Inc. launched an IPO and issued 38 million shares of Class A common stock for a valuation of $23 per share. In connection with this IPO, the Bancorp’s investment in GreenSky, LLC, which was comprised of 252,550 membership units, was converted to 2,525,498 units of the newly formed GreenSky Holdings, LLC (“GS Holdings”), representing a 1.4% interest in GS Holdings. The Bancorp’s units in GS Holdings are exchangeable on a one-to-one basis for Class A common stock or cash after the initial 180-day lock-up period expires.

 

4


Table of Contents

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

 

 

At the time of the IPO, the Bancorp recognized a $16 million gain on its investment in GreenSky, LLC, which was included in other noninterest income in the Condensed Consolidated Statements of Income for the three and six months ended June 30, 2018. At September 30, 2018, the investment in GS Holdings was $45 million, which was included in equity securities in the Condensed Consolidated Balance Sheets.

Accelerated Share Repurchase Transactions

During the nine months ended September 30, 2018, the Bancorp entered into or settled accelerated share repurchase transactions. As part of these transactions, the Bancorp entered into forward contracts in which the final number of shares delivered at settlement was based generally on a discount to the average daily volume weighted-average price of the Bancorp’s common stock during the term of the repurchase agreements. For more information on the accelerated share repurchase program, refer to Note 15 of the Notes to Condensed Consolidated Financial Statements. For a summary of the Bancorp’s accelerated share repurchase transactions that were entered into or settled during the nine months ended September 30, 2018, refer to Table 2.

 

TABLE 2: Summary of Accelerated Share Repurchase Transactions

                 

Repurchase Date

  

Amount    

    ($ in millions)    

    Shares Repurchased on
Repurchase Date
    Shares Received from
Forward Contract
Settlement
     Total Shares    
Repurchased    
     Settlement Date          

December 19, 2017

   $ 273       7,727,273       824,367        8,551,640        March 19, 2018  

February 12, 2018

     318       8,691,318       1,015,731        9,707,049        March 26, 2018  

May 25, 2018

     235       6,402,244       1,172,122        7,574,366        June 15, 2018  

Open Market Share Repurchase Transactions

Between July 20, 2018 and August 2, 2018, the Bancorp repurchased 16,945,020 shares, or approximately $500 million, of its outstanding common stock through open market repurchase transactions, which settled between July 24, 2018 and August 6, 2018. For more information on the open market share repurchase program, refer to Note 15 of the Notes to Condensed Consolidated Financial Statements.

Senior Notes Offering

On March 14, 2018, the Bancorp issued and sold $650 million of 3.95% senior fixed-rate notes, with a maturity of ten years, due on March 14, 2028. These notes will be redeemable by the Bancorp, in whole or in part, on or after the date that is 30 days prior to the maturity date at a redemption price equal to 100% of the principal amount of the notes to be redeemed plus accrued and unpaid interest thereon to, but excluding, the redemption date.

On June 5, 2018, the Bancorp issued and sold $250 million of senior floating-rate notes, with a maturity of three years, due on June 4, 2021. Interest on the floating-rate notes is 3-month LIBOR plus 47 bps. These notes will be redeemable, in whole or in part, on or after the date that is 30 days prior to the maturity date at a redemption price equal to 100% of the principal amount of the notes to be redeemed plus accrued and unpaid interest thereon to, but excluding, the redemption date.

On July 26, 2018 the Bank issued and sold $1.55 billion in aggregate principal amount of unsecured senior bank notes. The bank notes consisted of $500 million of 3.35% senior fixed-rate notes, with a maturity of three years, due on July 26, 2021; $300 million of senior floating-rate notes at three-month LIBOR plus 44 bps, with a maturity of three years, due on July 26, 2021; and $750 million of 3.95% senior fixed-rate notes, with a maturity of seven years, due July 28, 2025. The Bank entered into interest rate swaps to convert the fixed-rate notes due in 2021 and 2025 to a floating-rate, which resulted in an effective interest rate of one-month LIBOR plus 53 bps and 104 bps, respectively. These bank notes will be redeemable by the Bank, in whole or in part, on or after the date that is 30 days prior to the maturity date at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest up to, but excluding, the redemption date.

2018 Branch Optimization Plan

Customer interactions and service and sales activity in Branch Banking continue to evolve with changing demographics and technology applications. Customers are increasingly utilizing digital tools to interact with their financial institutions in conducting their transactions while still utilizing physical branches for consultations and new product and service initiation. During the past three years, these developments and other business strategies led to a net decrease of 143 in the number of retail branches, or 11% of the Bancorp’s total branch count, through consolidations and sales.

The Bancorp continues to evaluate its retail network distribution in light of changes in customer behavior while developing new analytical tools that provide enhanced capabilities to optimize the profitability and growth potential of branches. In slower growth mature markets these developments enable the Bancorp to achieve efficiencies through well-executed branch consolidations without materially impacting deposit flows and/or revenue growth while maintaining the service quality standards. While continuing to evaluate such actions, the Bancorp is also focused on achieving higher retail household and deposit growth in other parts of its footprint – mainly in markets that exhibit faster economic growth and where the Bancorp has significant opportunities to capture higher market share. To that extent, based on the strategic business evaluation that was performed during the second quarter of 2018, over the next 2-3 years, as part of the 2018 Branch Optimization Plan, the Bancorp plans to close between 100-125 branches in more mature markets and open between 100-125 new branches in higher growth markets where the Bancorp already has an existing retail branch presence. With the existing local presence and familiarity with the customer demographics, and with newly developed analytical tools, the Bancorp expects to achieve higher growth rates as a result of these actions.

 

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

 

 

As of September 30, 2018, the Bancorp had identified 31 specific branches for closure under the 2018 Branch Optimization Plan with these closures expected to be completed prior to December 31, 2018. The Bancorp expects to identify the remaining branches to be closed under the 2018 Branch Optimization Plan prior to December 31, 2019. As part of the adoption of the 2018 Branch Optimization Plan, the Bancorp has also elected to sell 21 parcels of land which had previously been held for future branch expansion. For further information about the 2018 Branch Optimization plan, refer to Note 7 of the Notes to Condensed Consolidated Financial Statements.

Legislative and Regulatory Developments

On May 24, 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Reform Act”) was signed into law. Among other regulatory changes, the Reform Act amends various sections of the DFA, most impactful are changes to section 165 of DFA raising the asset thresholds for determining the application of Enhanced Prudential Standards for BHCs deemed systemically important. The Reform Act raised the asset thresholds in two separate timeframes, immediately removing BHCs with consolidated assets below $100 billion from the application of the Enhanced Prudential Standards. BHCs with consolidated assets greater than $100 billion but less than $250 billion, including Fifth Third Bancorp, would continue to be subject to the Enhanced Prudential Standards for 18 months after the date of enactment, unless the Board of Governors of the FRB acts prior to that time period to provide regulatory relief from the Enhanced Prudential Standards or elects to continue to subject these BHCs to some form of Enhanced Prudential Standards. However, the FRB is also authorized to exempt any BHC with assets between $100 billion and $250 billion from any Enhanced Prudential Standards prior to the end of the 18-month period or after.

Regardless of this regulatory outcome, the Reform Act requires the FRB to continue to subject BHCs with consolidated assets between $100 billion to $250 billion to a periodic supervisory stress test and to continue to apply risk committee requirements outlined in the DFA. The Reform Act also provides the FRB the authority to continue to subject BHCs with consolidated assets greater than $100 billion to Enhanced Prudential Standards if the FRB determines that application is warranted and appropriate to address risks to financial stability and promote safety and soundness taking into consideration certain factors including the BHC’s capital structure, riskiness, complexity, financial activities (including financial activities of subsidiaries), size, and any other risk-related factors that the FRB deems appropriate.

On October 31, 2018, the federal banking agencies issued two NPRs related to the implementation of the Reform Act. The proposed rules would establish four risk-based categories of institutions and apply tailored capital and liquidity requirements for each respective category. These proposals are subject to modification through the federal rulemaking process in accordance with the Administrative Procedures Act, but based upon Fifth Third’s interpretation of the NPRs, the Bancorp would qualify as a Category IV BHC subject to the least restrictive of the proposed requirements.

The ultimate benefits or consequences of the Reform Act on Fifth Third Bancorp, Fifth Third Bank and their respective subsidiaries and activities will be subject to the final form of these NPRs, and additional rulemakings issued by the FRB and additional federal regulators. Fifth Third cannot predict future changes in the applicable laws, regulations and regulatory agency policies, yet such changes may have a material effect on its business, financial condition or results of operations.

Earnings Summary

The Bancorp’s net income available to common shareholders for the third quarter of 2018 was $418 million, or $0.61 per diluted share, which was net of $15 million in preferred stock dividends. The Bancorp’s net income available to common shareholders for the third quarter of 2017 was $999 million, or $1.35 per diluted share, which was net of $15 million in preferred stock dividends. The Bancorp’s net income available to common shareholders for the nine months ended September 30, 2018 was $1.7 billion, or $2.38 per diluted share, which was net of $52 million in preferred stock dividends. For the nine months ended September 30, 2017, the Bancorp’s net income available to common shareholders was $1.6 billion, or $2.16 per diluted share, which was net of $52 million in preferred stock dividends.

Net interest income on an FTE basis (non-GAAP) was $1.0 billion and $3.1 billion for the three and nine months ended September 30, 2018, respectively, an increase of $70 million and $210 million compared to the same periods in the prior year. Net interest income was positively impacted by increases in both the yields and amounts of average loans and leases and average taxable securities for the three and nine months ended September 30, 2018 compared to the same periods in the prior year. Additionally, net interest income was positively impacted by the decisions of the FOMC to raise the target range of the federal funds rate 25 bps in December 2017, March 2018, June 2018 and September 2018. These positive impacts were partially offset by increases in the rates paid on average interest-bearing core deposits and average long-term debt for both the three and nine months ended September 30, 2018 compared to the same periods in the prior year. Net interest margin on an FTE basis (non-GAAP) was 3.23% and 3.20% for the three and nine months ended September 30, 2018, respectively, compared to 3.07% and 3.03% for the three and nine months ended September 30, 2017, respectively.

Noninterest income decreased $998 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to decreases in other noninterest income and mortgage banking net revenue. Other noninterest income decreased $990 million during the three months ended September 30, 2018 compared to the three months ended September 30, 2017 primarily due to the gain on sale of Worldpay, Inc. shares recognized during the third quarter of 2017 and a reduction in equity method income from the Bancorp’s interest in Worldpay Holding, LLC. These reductions were partially offset by a decrease in the loss on the swap associated with the sale of Visa, Inc. Class B Shares and an increase in private equity investment income. Mortgage banking net revenue decreased $14 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to a decrease in origination fees and gains on loan sales driven by a decrease in originations and lower margins due to the interest rate environment.

 

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Noninterest income decreased $433 million for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 primarily due to decreases in other noninterest income and mortgage banking net revenue. Other noninterest income decreased $443 million during the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to the gain on sale of Worldpay, Inc. shares recognized during the third quarter of 2017, a reduction in equity method income from the Bancorp’s interest in Worldpay Holding, LLC and an increase in the net losses on disposition and impairment of bank premises and equipment. These reductions were partially offset by the gain related to Vantiv, Inc.’s acquisition of Worldpay Group plc., the gain on the sale of Worldpay, Inc. shares recognized during the second quarter of 2018 and increases in private equity investment income and in insurance income. Mortgage banking net revenue decreased $12 million during the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to a decrease in origination fees and gains on loan sales driven by a decrease in originations and lower margins due to the interest rate environment, partially offset by an increase in net mortgage servicing revenue driven by a decrease in net negative valuation adjustments and an increase in gross mortgage servicing fees.

Noninterest expense increased $33 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to increases in personnel costs, technology and communications expense and other noninterest expense. Personnel costs increased $19 million for the three months ended September 30, 2018 compared to the same period in the prior year driven by an increase in base compensation, variable compensation, long-term incentive compensation and severance costs. Technology and communications expense increased $9 million for the three months ended September 30, 2018 compared to the same period in the prior year driven primarily by increased investment in regulatory, compliance and growth initiatives. Other noninterest expense increased $9 million for the three months ended September 30, 2018 compared to the same period in the prior year driven primarily by increased marketing expenses as a result of an increase in advertising volume related to the brand campaign and promotional offers.

Noninterest expense increased $172 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to increases in personnel costs, technology and communications expense and other noninterest expense. Personnel costs increased $120 million for the nine months ended September 30, 2018 compared to the same period in the prior year driven by an increase in base compensation, variable compensation, long-term incentive compensation and severance costs. Technology and communications expense increased $29 million for the nine months ended September 30, 2018 compared to the same period in the prior year driven primarily by increased investment in regulatory, compliance and growth initiatives. Other noninterest expense increased $25 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to increases in marketing expense, the impairment on affordable housing investments, loan and lease expense and donations expense, partially offset by an increase in the benefit for the reserve for unfunded commitments and a decrease in professional service fees.

For more information on net interest income, noninterest income and noninterest expense refer to the Statements of Income Analysis section of MD&A.

Credit Summary

The provision for loan and lease losses was $86 million and $142 million for the three and nine months ended September 30, 2018, respectively, compared to $67 million and $193 million for the comparable periods in 2017. Net losses charged-off as a percent of average portfolio loans and leases increased to 0.30% during the three months ended September 30, 2018 compared to 0.29% during the same period in the prior year and increased to 0.36% for the nine months ended September 30, 2018 compared to 0.32% for the same period in the prior year. At September 30, 2018, nonperforming portfolio assets as a percent of portfolio loans and leases and OREO decreased to 0.48% compared to 0.53% at December 31, 2017. For further discussion on credit quality refer to the Credit Risk Management subsection of the Risk Management section of MD&A.

Capital Summary

The Bancorp’s capital ratios exceed the “well-capitalized” guidelines as defined by the PCA requirements of the U.S. banking agencies. As of September 30, 2018, as calculated under the Basel III standardized approach, the CET1 capital ratio was 10.67%, the Tier I risk-based capital ratio was 11.78%, the Total risk-based capital ratio was 14.94% and the Tier I leverage ratio was 10.10%.

 

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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             For the nine months ended      
            September 30,             September 30,      

($ in millions)

           2018     2017              2018      2017  

Net interest income (U.S. GAAP)

   $          1,043       970           3,059        2,842      

Add: FTE adjustment

              4       7                 12        19      

Net interest income on an FTE basis (1)

   $          1,047       977           3,071        2,861      

Net interest income on an FTE basis (annualized) (2)

        4,154       3,876           4,106        3,815      

Interest income (U.S. GAAP)

   $          1,315       1,152           3,790        3,344      

Add: FTE adjustment

              4       7                 12        19      

Interest income on an FTE basis

   $          1,319       1,159           3,802        3,363      

Interest income on an FTE basis (annualized) (3)

        5,233       4,598           5,083        4,496      

Interest expense (annualized) (4)

   $          1,079       722           977        671      

Noninterest income (5)

        563       1,561           2,215        2,648      

Noninterest expense (6)

        1,008       975           3,090        2,918      

Average interest-earning assets (7)

        128,799       126,443           128,176        126,183      

Average interest-bearing liabilities (8)

        89,772       85,328           88,875        85,181      

Ratios:

                

Net interest margin on an FTE basis (2) / (7)

        3.23  %      3.07           3.20        3.03      

Net interest rate spread on an FTE basis ((3) / (7)) - ((4) / (8))

        2.87       2.79           2.87        2.77      

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

              62.6       38.4                 58.5        53.0      

The Bancorp believes return on average tangible common equity is an important measure for comparative purposes with other financial institutions, but is not defined under U.S. GAAP, and therefore is considered a non-GAAP financial measure. This measure is useful for evaluating the performance of a business as it calculates the return available to common shareholders without the impact of intangible assets and their related amortization.

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

 

TABLE 4: Non-GAAP Financial Measures - Return on Average Tangible Common Equity

 
            For the three months ended            For the nine months ended      
            September 30,            September 30,      

($ in millions)

           2018     2017             2018     2017

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

   $          418       999          1,669       1,633      

Add: Intangible amortization, net of tax

              1       -                3       1      

Tangible net income available to common shareholders

   $          419       999          1,672       1,634      

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

        1,662       3,963          2,235       2,179      

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

   $          16,145       16,820          16,187       16,623      

Less: Average preferred stock

        (1,331     (1,331        (1,331     (1,331)     

 Average goodwill

        (2,462     (2,423        (2,460     (2,421)     

 Average intangible assets

              (29     (18              (28     (15)     

Average tangible common equity (2)

   $          12,323       13,048          12,368       12,856      

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

              13.5  %      30.4                18.1       17.0      

The Bancorp considers various measures when evaluating capital utilization and adequacy, including the tangible equity ratio and tangible common equity ratio, in addition to capital ratios defined by the U.S. banking agencies. These calculations are intended to complement the capital ratios defined by the U.S. banking agencies for both absolute and comparative purposes. Because U.S. GAAP does not include capital ratio measures, the Bancorp believes there are no comparable U.S. GAAP financial measures to these ratios. These ratios are not formally defined by U.S. GAAP or codified in the federal banking regulations and, therefore, are considered to be non-GAAP financial measures. The Bancorp encourages readers to consider its Condensed Consolidated Financial Statements in their entirety and not to rely on any single financial measure.

 

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

 

TABLE 5: Non-GAAP Financial Measures - Capital Ratios

               
      September 30,      December 31,    

As of ($ in millions)

    2018      2017    

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

   $ 15,830               16,365      

Less:  Preferred stock

     (1,331)              (1,331)     

 Goodwill

     (2,462)              (2,445)     

 Intangible assets

     (28)              (27)     

 AOCI

     775               (73)     

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

     12,784               12,489      

Add:   Preferred stock

     1,331               1,331      

Tangible equity (2)

   $ 14,115               13,820      

Total Assets (U.S. GAAP)

   $                 141,685               142,193      

Less:  Goodwill

     (2,462)              (2,445)     

 Intangible assets

     (28)              (27)     

 AOCI, before tax

     981               (92)     

Tangible assets, excluding unrealized gains / losses (3)

   $ 140,176               139,629      

Ratios:

     

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

     10.07 %          9.90      

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

     9.12               8.94      

 

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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 nine months ended September 30, 2018.

 

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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.

Tables 6 and 7 present the components of net interest income, net interest margin and net interest rate spread for the three and nine months ended September 30, 2018 and 2017, as well as the relative impact of changes in the balance sheet and changes in interest rates on net interest income. Nonaccrual loans and leases and loans and leases held for sale have been included in the average loan and lease balances. Average outstanding securities balances are based on amortized cost with any unrealized gains or losses on available-for-sale debt and other securities included in other assets.

Net interest income on an FTE basis (non-GAAP) was $1.0 billion and $3.1 billion for the three and nine months ended September 30, 2018, respectively, an increase of $70 million and $210 million compared to the same periods in the prior year. Net interest income was positively impacted by increases in yields on average loans and leases of 53 bps and 51 bps, respectively, and yields on average taxable securities of 14 bps and 12 bps, respectively, for the three and nine months ended September 30, 2018 compared to the same periods in the prior year. Net interest income was also positively impacted by increases in average loans and leases of $1.4 billion and $677 million, respectively, and average taxable securities of $1.0 billion and $1.2 billion, respectively, for the three and nine months ended September 30, 2018, compared to the same periods in the prior year. Additionally, net interest income was positively impacted by the decisions of the FOMC to raise the target range of the federal funds rate 25 bps in December 2017, March 2018, June 2018 and September 2018. These positive impacts were partially offset by increases in the rates paid on average interest-bearing core deposits and average long-term debt for both the three and nine months ended September 30, 2018 compared to the same periods in the prior year. The rates paid on average interest-bearing core deposits increased 35 bps and 29 bps, respectively, for the three and nine months ended September 30, 2018 compared to the same periods in the prior year. The rates paid on average long-term debt increased 27 bps for both the three and nine months ended September 30, 2018 compared to the same periods in the prior year.

Net interest rate spread on an FTE basis (non-GAAP) was 2.87% during both the three and nine months ended September 30, 2018 compared to 2.79% and 2.77%, respectively, in the same periods in the prior year. Yields on average interest-earning assets increased 43 bps and 41 bps for the three and nine months ended September 30, 2018, respectively, partially offset by a 35 bps and 31 bps increase in rates paid on average interest-bearing liabilities for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year.

Net interest margin on an FTE basis (non-GAAP) was 3.23% and 3.20% for the three and nine months ended September 30, 2018, respectively, compared to 3.07% and 3.03% for the three and nine months ended September 30, 2017, respectively. The increase for both periods was driven primarily by the previously mentioned increases in the net interest rate spread partially offset by decreases in average free funding balances. The decreases in average free funding balances for both periods were driven by decreases in average demand deposits of $2.5 billion and $2.0 billion for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year.

Interest income on an FTE basis from loans and leases (non-GAAP) increased $139 million and $373 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increases were primarily due to the aforementioned increases in yields on average loans and leases, as well as increases in the volume of average other consumer loans. For more information on the 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 and $66 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily as a result of the aforementioned increases in average taxable securities and yields on average taxable securities.

Interest expense on core deposits increased $67 million and $158 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increases were primarily due to increases in the cost of average interest-bearing core deposits to 74 bps and 64 bps for the three and nine months ended September 30, 2018, respectively, from 39 bps and 35 bps for the three and nine months ended September 30, 2017, respectively. The increases in the cost of average interest-bearing core deposits for both periods were primarily due to increases in the rates paid on average interest checking deposits and average money market deposits. Refer to the Deposits subsection of the Balance Sheet Analysis section of MD&A for additional information on the Bancorp’s deposits.

Interest expense on average wholesale funding increased $23 million and $71 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to the aforementioned increases in the rates paid on average long-term debt coupled with increases in average long-term debt. Refer to the Borrowings subsection of the Balance Sheet Analysis section of MD&A for additional information on the Bancorp’s borrowings. During both the three and nine months ended September 30, 2018, average wholesale funding represented 23% of average interest-bearing liabilities compared to 25% and 24% during the three and nine months ended September 30, 2017, respectively. For more information on the 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.

 

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TABLE 6: Condensed Average Balance Sheets and Analysis of Net Interest Income on an FTE Basis

 
                                             Attribution of Change in  

For the three months ended

   September 30, 2018     September 30, 2017     Net Interest Income(a)  
                   Average                   Average                     
     Average      Revenue/      Yield/     Average      Revenue/      Yield/                     

($ in millions)

   Balance      Cost      Rate     Balance      Cost      Rate     Volume     Yield/Rate      Total  

Assets:

                       

Interest-earning assets:

                       

Loans and leases:(b)

                       

Commercial and industrial loans

   $ 42,614        463        4.32   $ 41,314        391        3.75   $ 12       60            72  

Commercial mortgage loans

     6,664        77        4.57       6,814        66        3.85       (1     12            11  

Commercial construction loans

     4,870        63        5.14       4,533        48        4.23       4       11            15  

Commercial leases

     3,746        27        2.85       4,079        28        2.70       (2     1            (1

Total commercial loans and leases

     57,894        630        4.32       56,740        533        3.72       13       84            97  

Residential mortgage loans

     16,226        146        3.58       16,206        142        3.48       -       4            4  

Home equity

     6,529        83        5.03       7,207        80        4.39       (8     11            3  

Automobile loans

     8,969        78        3.47       9,267        69        2.96       (3     12            9  

Credit card

     2,299        71        12.17       2,140        63        11.63       5       3            8  

Other consumer loans

     2,060        36        6.98       1,057        18        6.89       18       -            18  

Total consumer loans

     36,083        414        4.56       35,877        372        4.12       12       30            42  

Total loans and leases

   $ 93,977        1,044        4.41   $ 92,617        905        3.88   $ 25       114            139  

Securities:

                       

Taxable

     33,301        268        3.20       32,289        249        3.06       8       11            19  

Exempt from income taxes(b)

     69        1        4.35       65        1        5.33       -       -            -  

Other short-term investments

     1,452        6        1.74       1,472        4        1.16       -       2            2  

Total interest-earning assets

   $ 128,799        1,319        4.07   $ 126,443        1,159        3.64   $           33       127            160  

Cash and due from banks

     2,193             2,227               

Other assets

     11,837             13,532               

Allowance for loan and lease losses

     (1,077)                         (1,210)                                             

Total assets

   $      141,752                       $      140,992                                             

Liabilities and Equity:

                       

Interest-bearing liabilities:

                       

Interest checking deposits

   $ 29,681        66        0.88   $ 25,765        29        0.44   $ 5       32            37  

Savings deposits

     13,231        4        0.11       13,889        2        0.06       -       2            2  

Money market deposits

     21,753        44        0.80       20,028        19        0.39       2       23            25  

Foreign office deposits

     317        -        0.33       395        -        0.21       -       -            -  

Other time deposits

     4,177        15        1.48       3,722        12        1.23       -       3            3  

Total interest-bearing core deposits

     69,159        129        0.74       63,799        62        0.39       7       60            67  

Certificates $100,000 and over

     2,596        12        1.85       2,625        9        1.38       -       3            3  

Other deposits

     578        3        1.95       560        2        1.16       -       1            1  

Federal funds purchased

     1,987        10        1.96       675        2        1.16       6       2            8  

Other short-term borrowings

     1,018        6        2.22       4,212        12        1.09       (13     7            (6

Long-term debt

     14,434        112        3.09       13,457        95        2.82       7       10            17  

Total interest-bearing liabilities

   $ 89,772        272        1.20   $ 85,328        182        0.85   $ 7       83            90  

Demand deposits

     32,333             34,850               

Other liabilities

     3,482                         3,973                                             

Total liabilities

   $ 125,587           $ 124,151               

Total equity

   $ 16,165                       $ 16,841                                             

Total liabilities and equity

   $ 141,752                       $ 140,992                                             

Net interest income (FTE)(c)

      $ 1,047           $ 977        $ 26       44            70  

Net interest margin (FTE)(c)

           3.23           3.07       

Net interest rate spread (FTE)(c)

           2.87             2.79         

Interest-bearing liabilities to interest-earning assets

 

              69.70                         67.48                           

(a)

Changes in interest not solely due to volume or yield/rate are allocated in proportion to the absolute dollar amount of change in volume and yield/rate.

(b)

The FTE adjustments included in the above table were $4 and $7 for the three months ended September 30, 2018 and 2017, respectively.

(c)

Net interest income (FTE), net interest margin (FTE) and net interest rate spread (FTE) are non-GAAP measures. For further information, refer to the Non-GAAP Financial Measures section of MD&A.

 

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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

 
                                             Attribution of Change in  

For the nine months ended

   September 30, 2018     September 30, 2017     Net Interest Income(a)  
                   Average                   Average                     
     Average      Revenue/      Yield/     Average      Revenue/      Yield/                     

($ in millions)

   Balance      Cost      Rate     Balance      Cost      Rate     Volume     Yield/Rate      Total  

Assets:

                       

Interest-earning assets:

                       

Loans and leases:(b)

                       

Commercial and industrial loans

   $ 42,249        1,321        4.18   $ 41,619        1,123        3.61   $ 17       181            198  

Commercial mortgage loans

     6,591        217        4.40       6,873        189        3.68       (8     36            28  

Commercial construction loans

     4,762        175        4.90       4,277        128        4.01       17       30            47  

Commercial leases

     3,850        81        2.82       4,008        81        2.71       (3     3            -  

Total commercial loans and leases

     57,452        1,794        4.17       56,777        1,521        3.58       23       250            273  

Residential mortgage loans

     16,176        433        3.58       16,011        423        3.53       4       6            10  

Home equity

     6,695        242        4.83       7,389        232        4.19       (23     33            10  

Automobile loans

     9,000        221        3.29       9,486        204        2.88       (11     28            17  

Credit card

     2,248        205        12.16       2,121        188        11.84       12       5            17  

Other consumer loans

     1,792        91        6.79       902        45        6.70       45       1            46  

Total consumer loans

     35,911        1,192        4.44       35,909        1,092        4.06       27       73            100  

Total loans and leases

   $ 93,363        2,986        4.28   $ 92,686        2,613        3.77   $ 50       323            373  

Securities:

                       

Taxable

     33,272        797        3.20       32,067        738        3.08       28       31            59  

Exempt from income taxes(b)

     75        2        3.28       63        2        5.38       1       (1)           -  

Other short-term investments

     1,466        17        1.58       1,367        10        0.97       -       7            7  

Total interest-earning assets

   $ 128,176        3,802        3.97   $ 126,183        3,363        3.56   $           79       360            439  

Cash and due from banks

     2,182             2,202               

Other assets

     12,394             13,343               

Allowance for loan and lease losses

     (1,136)                         (1,233)                                             

Total assets

   $      141,616                       $      140,495                                             

Liabilities and Equity:

                       

Interest-bearing liabilities:

                       

Interest checking deposits

   $ 28,938        165        0.76   $ 26,176        73        0.38   $ 9       83            92  

Savings deposits

     13,463        9        0.09       14,081        6        0.06       (1     4            3  

Money market deposits

     21,517        110        0.68       20,301        53        0.35       3       54            57  

Foreign office deposits

     393        1        0.28       409        1        0.17       -       -            -  

Other time deposits

     4,018        41        1.36       3,764        35        1.23       2       4            6  

Total interest-bearing core deposits

     68,329        326        0.64       64,731        168        0.35       13       145            158  

Certificates $100,000 and over

     2,346        28        1.58       2,609        27        1.36       (3     4            1  

Other deposits

     385        5        1.76       330        2        1.03       1       2            3  

Federal funds purchased

     1,258        17        1.80       542        4        0.94       8       5            13  

Other short-term borrowings

     1,959        25        1.70       3,441        24        0.92       (13     14            1  

Long-term debt

     14,598        330        3.02       13,528        277        2.75       24       29            53  

Total interest-bearing liabilities

   $ 88,875        731        1.10   $ 85,181        502        0.79   $ 30       199            229  

Demand deposits

     32,992             34,949               

Other liabilities

     3,541                         3,717                                             

Total liabilities

   $ 125,408           $ 123,847               

Total equity

   $ 16,208                       $ 16,648                                             

Total liabilities and equity

   $ 141,616                       $ 140,495                                             

Net interest income (FTE)(c)

      $ 3,071           $ 2,861        $ 49       161            210  

Net interest margin (FTE)(c)

           3.20           3.03       

Net interest rate spread (FTE)(c)

           2.87             2.77         

Interest-bearing liabilities to interest-earning assets

 

              69.34                         67.51                           

(a)

Changes in interest not solely due to volume or yield/rate are allocated in proportion to the absolute dollar amount of change in volume and yield/rate.

(b)

The FTE adjustments included in the above table were $12 and $19 for the nine months ended September 30, 2018 and 2017, respectively.

(c)

Net interest income (FTE), net interest margin (FTE) and net interest rate spread (FTE) are non-GAAP measures. For further information, refer to the Non-GAAP Financial Measures section of MD&A.

Provision for Loan and Lease Losses

The Bancorp provides as an expense an amount for probable loan and lease losses within the loan and lease portfolio that is based on factors previously discussed in the Critical Accounting Policies section of the 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 is referred to as a charge-off. Net charge-offs include current period charge-offs less recoveries on previously charged-off loans and leases.

The provision for loan and lease losses was $86 million and $142 million for the three and nine months ended September 30, 2018, respectively, compared to $67 million and $193 million during the same periods in the prior year. The increase in provision expense for the three months ended September 30, 2018 was primarily due to an increase in outstanding commercial loan balances and an increase in consumer reserve rates for certain products. The decrease in provision expense for the nine months ended September 30, 2018 was primarily due to a decrease in the level of commercial criticized assets combined with overall improved credit quality.

 

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

 

 

The ALLL decreased $105 million from December 31, 2017 to $1.1 billion at September 30, 2018. At September 30, 2018, the ALLL as a percent of portfolio loans and leases decreased to 1.17% compared to 1.30% at December 31, 2017.

Refer to the Credit Risk Management subsection of the Risk Management section of MD&A as well as Note 6 of the Notes to Condensed Consolidated Financial Statements for more detailed information on the provision for loan and lease losses, including an analysis of loan and lease portfolio composition, nonperforming assets, net charge-offs and other factors considered by the Bancorp in assessing the credit quality of the loan and lease portfolio and the ALLL.

Noninterest Income

Noninterest income decreased $998 million and $433 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year.

The following table presents the components of noninterest income:

 

TABLE 8: Components of Noninterest Income

                                                     
          For the three months ended                    For the nine months ended           
        September 30,                September 30,         

($ in millions)

       2018     2017      % Change          2018     2017      % Change  

Service charges on deposits

 

$

    139       138              1      

$

    414       415              -    

Wealth and asset management revenue

      114       102              12           335       313              7    

Corporate banking revenue

      100       101              (1)          308       276              12    

Card and processing revenue

      82       79              4           245       232              6    

Mortgage banking net revenue

      49       63              (22)          158       170              (7)   

Other noninterest income

      86       1,076              (92)          794       1,237              (36)   

Securities (losses) gains, net

      (6     -              NM          (21     1              NM   

Securities (losses) gains, net - non-qualifying hedges on MSRs

        (1     2              NM            (18     4              NM   

Total noninterest income

 

$

    563       1,561              (64)     

$

    2,215       2,648              (16)   

Wealth and asset management revenue

Wealth and asset management revenue increased $12 million and $22 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase for both the three and nine months ended September 30, 2018 compared to the same periods in the prior year was primarily due to increases of $6 million and $13 million, respectively, in private client service fees and increases of $4 million and $7 million, respectively, in brokerage fees. These increases were driven by an increase in assets under management as a result of strong market performance and increased asset production. The Bancorp’s trust and registered investment advisory businesses had approximately $376 billion and $348 billion in total assets under care at September 30, 2018 and 2017, respectively, and managed $38 billion and $36 billion in assets for individuals, corporations and not-for-profit organizations at September 30, 2018 and 2017, respectively.

Corporate banking revenue

Corporate banking revenue decreased $1 million for the three months ended September 30, 2018 and increased $32 million for the nine months ended September 30, 2018 compared to the same periods in the prior year. The decrease for the three months ended September 30, 2018 compared to the same period in the prior year was primarily driven by decreases in institutional sales and letter of credit fees of $4 million and $1 million, respectively. These decreases were partially offset by an increase in foreign exchange fees of $4 million. The increase for the nine months ended September 30, 2018 compared to the same period in the prior year was primarily driven by increases in lease remarketing fees, foreign exchange fees and contract revenue from commercial customer derivatives of $26 million, $9 million and $8 million, respectively. The increase in lease remarketing fees for the nine months ended September 30, 2018 included the impact of a $31 million impairment charge related to certain operating lease assets that was recognized during the first quarter of 2017. These benefits were partially offset by decreases of $6 million in both business lending fees and letter of credit fees.

Card and processing revenue

Card and processing revenue increased $3 million and $13 million for the three and nine months ended September 30, 2018 compared to the same periods in the prior year. The increases for both the three and nine months ended September 30, 2018 compared to the same periods in the prior year were primarily driven by increases in the number of actively used cards and customer spend volume.

Mortgage banking net revenue

Mortgage banking net revenue decreased $14 million and $12 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year.

 

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

 

 

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

 

TABLE 9: Components of Mortgage Banking Net Revenue

                                
        For the three months ended     For the nine months ended  
        September 30,     September 30,  

($ in millions)

       2018     2017     2018     2017  

Origination fees and gains on loan sales

  $     25       40       77       106  

Net mortgage servicing revenue:

         

Gross mortgage servicing fees

      56       56       162       152  

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

        (32     (33     (81     (88

Net mortgage servicing revenue

        24       23       81       64  

Total mortgage banking net revenue

  $     49       63       158       170  

Origination fees and gains on loan sales decreased $15 million and $29 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year driven by a decrease in originations and lower margins due to the interest rate environment. Residential mortgage loan originations decreased to $1.9 billion and $5.5 billion during the three and nine months ended September 30, 2018, respectively, compared to $2.1 billion and $6.3 billion during the same periods in the prior year.

Net mortgage servicing revenue increased $1 million and $17 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increases for the three and nine months ended September 30, 2018 compared to the same periods in the prior year included decreases in net negative valuation adjustments of $1 million and $7 million, respectively. The increase for the nine months ended September 30, 2018 also included an increase in gross mortgage servicing fees of $10 million. Refer to Table 10 for the components of net valuation adjustments on the MSR portfolio and the impact of the non-qualifying hedging strategy:

 

TABLE 10: Components of Net Valuation Adjustments on MSRs

 
        For the three months ended     For the nine months ended  
        September 30,     September 30,  

($ in millions)

       2018     2017     2018     2017  

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

  $     (24     1       (89     16  

Changes in fair value:

         

Due to changes in inputs or assumptions

      25       (2     103       (15

Other changes in fair value

        (33     (32     (95     (89

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

  $     (32     (33     (81     (88

Mortgage rates increased during both the three and nine months ended September 30, 2018 which caused modeled prepayment speeds to slow. The fair value of the MSR increased $25 million and $103 million, respectively, due to changes to inputs to the valuation model including prepayment speeds and OAS spread assumptions and decreased $33 million and $95 million, respectively, due to the passage of time, including the impact of regularly scheduled repayments, paydowns and payoffs for the three and nine months ended September 30, 2018.

Mortgage rates decreased during both the three and nine months ended September 30, 2017 which caused modeled prepayments speeds to increase, which led to fair value adjustments on servicing rights. The fair value of the MSR decreased $2 million and $15 million, respectively, due to changes to inputs to the valuation model including prepayment speeds and OAS spread assumptions and decreased $32 million and $89 million, respectively, due to the passage of time, including the impact of regularly scheduled repayments, paydowns and payoffs for the three and nine months ended September 30, 2017.

Further detail on the valuation of MSRs can be found in Note 11 of the Notes to Condensed Consolidated Financial Statements. The Bancorp maintains a non-qualifying hedging strategy to manage a portion of the risk associated with changes in the valuation of the MSR portfolio. Refer to Note 12 of the Notes to Condensed Consolidated Financial Statements for more information on the free-standing derivatives used to economically hedge the MSR portfolio.

In addition to the derivative positions used to economically hedge the MSR portfolio, the Bancorp acquires various securities as a component of its non-qualifying hedging strategy. The Bancorp recognized net losses of $1 million and $18 million during the three and nine months ended September 30, 2018, respectively, and net gains of $2 million and $4 million during the three and nine months ended September 30, 2017, respectively, recorded in securities (losses) gains, net - non-qualifying hedges on MSRs in the Bancorp’s Condensed Consolidated Statements of Income.

The Bancorp’s total residential mortgage loans serviced at September 30, 2018 and 2017 were $80.1 billion and $77.1 billion, respectively, with $64.0 billion and $60.8 billion, respectively, of residential mortgage loans serviced for others.

 

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

 

 

Other noninterest income    

The following table presents the components of other noninterest income:    

 

TABLE 11: Components of Other Noninterest Income

                                  
        For the three months ended      For the nine months ended  
        September 30,      September 30,  

($ in millions)

       2018     2017      2018      2017  

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

  $     -       -               414           -        

Gain on sale of Worldpay, Inc. shares

      -       1,037               205           1,037        

Operating lease income

      20       23               65           73        

Private equity investment income

      26       2               61           29        

BOLI income

      15       13               41           38        

Cardholder fees

      14       14               41           41        

Consumer loan and lease fees

      6       6               17           17        

Insurance income

      5       2               16           5        

Banking center income

      5       5               16           15        

Net gains (losses) on loan sales

      3       -               2           (2)       

Equity method income from interest in Worldpay Holding, LLC

      2       13               1           37        

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

      (17     (47)              (66)          (69)       

Net (losses) gains on disposition and impairment of bank premises and equipment

      4       (1)              (37)          (3)       

Other, net

        3       9               18           19        

Total other noninterest income

  $     86       1,076               794           1,237        

Other noninterest income decreased $990 million during the three months ended September 30, 2018 compared to the same period in the prior year primarily due to the gain on sale of Worldpay, Inc. shares recognized during the third quarter of 2017 and a reduction in equity method income from the Bancorp’s interest in Worldpay Holding, LLC. These reductions were partially offset by a decrease in the loss on the swap associated with the sale of Visa, Inc. Class B Shares and an increase in private equity investment income.

The Bancorp recognized a $1.0 billion gain on the sale of Worldpay, Inc. shares during the three months ended September 30, 2017. Equity method income from the Bancorp’s interest in Worldpay Holding, LLC decreased $11 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to a decrease in the Bancorp’s ownership percentage in Worldpay Holding, LLC from approximately 8.6% as of September 30, 2017 to approximately 3.3% as of September 30, 2018 and the impact of a reduction in Worldpay Holding, LLC net income for the three months ended September 30, 2018 compared to the same period in the prior year. During the three months ended September 30, 2018, the Bancorp recognized negative valuation adjustments of $17 million related to the Visa total return swap compared to negative valuation adjustments of $47 million during the three months ended September 30, 2017. The decrease from the prior period was attributable to litigation developments during the third quarter of 2017. For additional information on the valuation of the swap associated with the sale of Visa, Inc. Class B Shares, refer to Note 16, Note 17 and Note 22 of the Notes to Condensed Consolidated Financial Statements. Private equity investment income increased $24 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to valuation adjustments on certain private equity investments.

Other noninterest income decreased $443 million during the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to the gain on sale of Worldpay, Inc. shares recognized during the third quarter of 2017, a reduction in equity method income from the Bancorp’s interest in Worldpay Holding, LLC and an increase in the net losses on disposition and impairment of bank premises and equipment. These reductions were partially offset by the gain related to Vantiv, Inc.’s acquisition of Worldpay Group plc., the gain on sale of Worldpay, Inc. shares recognized during the second quarter of 2018 and increases in private equity investment income and in insurance income.

The Bancorp recognized a $205 million gain on the sale of Worldpay, Inc. shares during the nine months ended September 30, 2018 compared to a $1.0 billion gain on the sale of Worldpay, Inc. shares during the nine months ended September 30, 2017. The Bancorp also recognized a $414 million gain related to Vantiv, Inc.’s acquisition of Worldpay Group plc. during the nine months ended September 30, 2018. For more information, refer to Note 18 of the Notes to Condensed Consolidated Financial Statements. Equity method income from the Bancorp’s interest in Worldpay Holding, LLC decreased $36 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to the decrease in the Bancorp’s ownership percentage in Worldpay Holding, LLC and the impact of Worldpay, Inc.’s acquisition and integration costs on its earnings. Net losses on disposition and impairment of bank premises and equipment for the nine months ended September 30, 2018 included the impact of branch impairment charges of $33 million. For more information, refer to Note 7 of the Notes to Condensed Consolidated Financial Statements. Private equity investment income increased $32 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to valuation adjustments on certain private equity investments. Insurance income increased $11 million for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 as a result of acquisitions in 2017.

Noninterest Expense

Noninterest expense increased $33 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to increases in personnel costs (salaries, wages and incentives plus employee benefits), technology and communications expense and other noninterest expense. Noninterest expense increased $172 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to increases in personnel costs, technology and communications expense and other noninterest expense.

 

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

 

 

The following table presents the components of noninterest expense:

 

TABLE 12: Components of Noninterest Expense

                                    
        For the three months ended                 For the nine months ended        
        September 30,                 September 30,        

($ in millions)

       2018        

2017

    % Change            2018         2017        % Change  

Salaries, wages and incentives

 

$

    421       407       3       $       1,339       1,215       10     

Employee benefits

      82       77       6         270       274       (1)    

Net occupancy expense

      70       74       (5)         219       221       (1)    

Technology and communications

      71       62       15           206       177       16     

Equipment expense

      31       30       3         92       88       5     

Card and processing expense

      31       32       (3)         91       95       (4)    

Other noninterest expense

        302       293       3               873       848       3     

Total noninterest expense

 

$

    1,008       975       3       $       3,090       2,918       6     

Efficiency ratio on an FTE basis(a)

        62.6     38.4                       58.5     53.0          

(a)

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

Personnel costs increased $19 million and $120 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year driven by an increase in base compensation, variable compensation, long-term incentive compensation and severance costs. The increase in base compensation was primarily due to personnel additions in information technology as well as an increase in the Bancorp’s minimum wage as a result of benefits received from the TCJA. Full-time equivalent employees totaled 17,512 at September 30, 2018 compared to 17,797 at September 30, 2017.

Technology and communications expense increased $9 million and $29 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year driven primarily by increased investment in regulatory, compliance and growth initiatives.

The following table presents the components of other noninterest expense:

 

TABLE 13: Components of Other Noninterest Expense

                                         
          For the three months ended     For the nine months ended  
          September 30,     September 30,  

($ in millions)

         2018     2017            2018     2017  

Impairment on affordable housing investments

  $         39       41         134       119     

Marketing

      43       37         105       86     

FDIC insurance and other taxes

      33       33         99       98     

Loan and lease

      29       26         84       72     

Operating lease

      19       20         59       67     

Losses and adjustments

      18       20         51       46     

Professional service fees

      15       17         45       61     

Data processing

      14       14         42       43     

Travel

      13       12         39       35     

Postal and courier

      8       10         26       33     

Recruitment and education

      8       9         24       26     

Donations

      3       4         19       10     

Supplies

      3       3         10       10     

Insurance

      4       3         10       9     

Benefit from the reserve for unfunded commitments

      (2     (5       (32     (4)    

Other, net

            55       49               158       137     

Total other noninterest expense

  $         302       293               873       848     

Other noninterest expense increased $9 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to an increase in marketing expense. Marketing expense increased $6 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to an increase in advertising volume related to the brand campaign and promotional offers during the three months ended September 30, 2018. Other noninterest expense for the three months ended September 30, 2018 included a $2 million decrease in impairment on affordable housing investments as compared to the prior year period primarily due to a decrease in the number of investments, partially offset by the impact of the change in the federal statutory corporate tax rate pursuant to the TCJA.

Other noninterest expense increased $25 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to increases in marketing expense, the impairment on affordable housing investments, loan and lease expense and donations expense, partially offset by an increase in the benefit for the reserve for unfunded commitments and a decrease in professional service fees. Marketing expense increased $19 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to promotional offers during the nine months ended September 30, 2018. Impairment on affordable housing investments increased $15 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily driven by the change in the federal statutory corporate tax rate pursuant to the TCJA. Loan and lease expense increased $12 million for the nine months ended September 30, 2018 compared to the same period in the prior year driven by an increase in loan servicing expenses on point-of-sale loans as a result of growth in point-of-sale originations.

 

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

 

 

Donations expense increased $9 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to a contribution to the Fifth Third Foundation. The benefit from the reserve for unfunded commitments was $32 million for the nine months ended September 30, 2018 compared to a benefit from the reserve for unfunded commitments of $4 million for the same period in the prior year as a result of overall improved credit quality. Professional service fees decreased $16 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to decreases in legal fees and consulting fees.

Applicable Income Taxes

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

 

TABLE 14: Applicable Income Taxes

                                      
         For the three months ended          For the nine months ended  
          September 30,          September 30,  

($ in millions)

         2018       2017                2018     2017      

Income before income taxes

   $     512     1,489           2,042      2,379   

Applicable income tax expense

       79       475              321      694      

Effective tax rate

         15.6    31.9                  15.7      29.2      

Applicable income tax expense for all periods includes the benefit from tax-exempt income, tax-advantaged investments, and tax credits, partially offset by the effect of certain nondeductible expenses. The tax credits are associated with the Low-Income Housing Tax Credit program established under Section 42 of the IRC, the New Markets Tax Credit program established under Section 45D of the IRC, the Rehabilitation Investment Tax Credit program established under Section 47 of the IRC, and the Qualified Zone Academy Bond program established under Section 1397E of the IRC.

The decreases in the effective tax rates for the three and nine months ended September 30, 2018 compared to the same periods in the prior year were primarily related to the reduction in the federal statutory corporate tax rate partially offset by changes to previously deductible items associated with the enactment of the TCJA.

For stock-based awards, U.S. GAAP requires that the tax consequences for the difference between the expense recognized for financial reporting and the 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 September 30, 2018, the Bancorp estimates that it may be necessary to recognize $12 million of additional income tax benefit over the next twelve months related to the settlement of stock-based awards primarily in the first half of 2019. However, the amount of income tax expense or benefit recognized upon settlement may vary significantly from expectations based on the Bancorp’s stock price and the number of SARs exercised by employees.

 

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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)

 
                  September 30, 2018                        December 31, 2017          

As of ($ in millions)

         Carrying Value      % of Total            Carrying Value      % of Total  

Commercial loans and leases:

                

Commercial and industrial loans

   $      42,725        46        $ 41,170        45  

Commercial mortgage loans

        6,701        7          6,610        7  

Commercial construction loans

        4,892        5          4,553        5  

Commercial leases

          3,697        4          4,068        4  

Total commercial loans and leases

          58,015        62          56,401        61  

Consumer loans:

                

Residential mortgage loans

        16,148        17          16,077        17  

Home equity

        6,485        7          7,014        8  

Automobile loans

        9,002        10          9,112        10  

Credit card

        2,325        2          2,299        2  

Other consumer loans

          2,131        2          1,559        2  

Total consumer loans

          36,091        38          36,061        39  

Total loans and leases

   $      94,106        100        $ 92,462        100  

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

   $      93,443                 $ 91,970           

Loans and leases, including loans and leases held for sale, increased $1.6 billion from December 31, 2017. The increase from December 31, 2017 was the result of a $1.6 billion increase in commercial loans and leases as well as a $30 million increase in consumer loans.

Commercial loans and leases increased from December 31, 2017 due to increases in commercial and industrial loans, commercial construction loans and commercial mortgage loans, partially offset by a decrease in commercial leases. Commercial and industrial loans increased $1.6 billion, or 4%, from December 31, 2017 primarily as a result of an increase in new loan originations as well as a decrease in payoffs during the nine months ended September 30, 2018. Commercial construction loans increased $339 million, or 7%, from December 31, 2017 primarily due to increases in draw levels on existing commitments as a result of seasonal trends. Commercial mortgage loans increased $91 million, or 1%, from December 31, 2017 primarily due to an increase in new loan originations and continued success in permanent financing from the Bancorp’s commercial construction loan portfolio. Commercial leases decreased $371 million, or 9%, from December 31, 2017 primarily as a result of a planned reduction in indirect non-relationship based lease originations.

Consumer loans increased from December 31, 2017 due to increases in other consumer loans, credit card and residential mortgage loans, partially offset by decreases in home equity and automobile loans. Other consumer loans increased $572 million, or 37%, from December 31, 2017 primarily due to growth in point-of-sale loan originations. Residential mortgage loans increased $71 million from December 31, 2017 primarily due to the continued retention of certain agency conforming ARMs and certain other fixed-rate loans originated during the nine months ended September 30, 2018. Credit card increased $26 million, or 1%, from December 31, 2017 primarily due to an increase in balance active customers. Home equity decreased $529 million, or 8%, from December 31, 2017 as payoffs exceeded new loan production. Automobile loans decreased $110 million, or 1%, from December 31, 2017 as payoffs exceeded new loan production due to a strategic shift focusing on improving risk-adjusted returns.

 

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

 
                  September 30, 2018                        September 30, 2017          

For the three months ended ($ in millions)

         Carrying Value      % of Total            Carrying Value      % of Total  

Commercial loans and leases:

                

Commercial and industrial loans

   $      42,614          46        $ 41,314          45  

Commercial mortgage loans

        6,664          7          6,814          7  

Commercial construction loans

        4,870          5          4,533          5  

Commercial leases

          3,746          4          4,079          4  

Total commercial loans and leases

          57,894          62          56,740          61  

Consumer loans:

                

Residential mortgage loans

        16,226          17          16,206          18  

Home equity

        6,529          7          7,207          8  

Automobile loans

        8,969          10          9,267          10  

Credit card

        2,299          2          2,140          2  

Other consumer loans

          2,060          2          1,057          1  

Total consumer loans

          36,083          38          35,877          39  

Total average loans and leases

   $      93,977          100        $ 92,617          100  

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

   $      93,192                   $ 91,906             

 

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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 $1.4 billion from September 30, 2017. The increase from September 30, 2017 was the result of a $1.2 billion, or 2%, increase in average commercial loans and leases as well as a $206 million, or 1%, increase in average consumer loans.

Average commercial loans and leases increased from September 30, 2017 due to increases in average commercial and industrial and average commercial construction loans, partially offset by decreases in average commercial mortgage loans and average commercial leases. Average commercial and industrial loans increased $1.3 billion, or 3%, from September 30, 2017 primarily as a result of an increase in new loan originations as well as a decrease in payoffs. Average commercial construction loans increased $337 million, or 7%, from September 30, 2017 primarily due to increases in draw levels on existing commitments. Average commercial leases decreased $333 million, or 8%, from September 30, 2017 primarily as a result of a planned reduction in indirect non-relationship based lease originations. Average commercial mortgage loans decreased $150 million, or 2%, from September 30, 2017 primarily due to an increase in paydowns and lower new loan origination activity in the fourth quarter of 2017 and the first quarter of 2018 driven by increased competition.

Average consumer loans increased from September 30, 2017 due to increases in average other consumer loans, credit card and residential mortgage loans, partially offset by decreases in average home equity and automobile loans. Average other consumer loans increased $1.0 billion, or 95%, from September 30, 2017 primarily due to growth in point-of-sale loan originations. Average credit card increased $159 million, or 7%, from September 30, 2017 primarily due to both an increase in balance active customers and an increase in card usage resulting in an increase in the average balance per active customer. Average residential mortgage loans increased $20 million from September 30, 2017 primarily driven by the continued retention of certain agency conforming ARMs and certain other fixed-rate loans. Average home equity decreased $678 million, or 9%, from September 30, 2017 as payoffs exceeded new loan production. Average automobile loans decreased $298 million, or 3%, from September 30, 2017 as payoffs exceeded new loan production due to a strategic shift focusing on improving risk-adjusted returns.

Investment Securities

The Bancorp uses investment securities as a means of managing interest rate risk, providing both collateral for pledging purposes and liquidity for satisfying regulatory requirements. Total investment securities were $32.6 billion and $32.7 billion at September 30, 2018 and December 31, 2017, respectively. The taxable investment securities portfolio had an effective duration of 5.2 years at September 30, 2018 compared to 4.7 years at December 31, 2017.

Debt securities are classified as available-for-sale when, in 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 September 30, 2018, the Bancorp’s investment portfolio consisted primarily of AAA-rated available-for-sale and other debt securities. The Bancorp held an immaterial amount in below investment grade available-for-sale and other debt securities at both September 30, 2018 and December 31, 2017. For both the three and nine months ended September 30, 2018 the Bancorp did not recognize OTTI on any of its available-for-sale debt and other securities. For the three and nine months ended September 30, 2017 the Bancorp recognized $4 million and $28 million, respectively, of OTTI on its available-for-sale debt and other securities, included in securities (losses) gains, net, in the Condensed Consolidated Statements of Income.

 

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

 

 

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

 

TABLE 17: Components of Investment Securities

               
     September 30,      December 31,  

As of ($ in millions)

   2018      2017  

Available-for-sale debt and other securities (amortized cost basis):

     

U.S. Treasury and federal agencies securities

   $ 98                   98          

Obligations of states and political subdivisions securities

     2                   43          

Mortgage-backed securities:

     

Agency residential mortgage-backed securities(a)

     16,447                   15,281          

Agency commercial mortgage-backed securities

     10,405                   10,113          

Non-agency commercial mortgage-backed securities

     3,169                   3,247          

Asset-backed securities and other debt securities

     2,035                   2,183          

Other securities(b)

     551                   612          

Total available-for-sale debt and other securities

   $             32,707                   31,577          

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

     

Obligations of states and political subdivisions securities

   $ 16                   22          

Asset-backed securities and other debt securities

     2                   2          

Total held-to-maturity securities

   $ 18                   24          

Trading debt securities (fair value):

     

U.S. Treasury and federal agencies securities

   $ 20                   12          

Obligations of states and political subdivisions securities

     69                   22          

Agency residential mortgage-backed securities

     63                   395          

Asset-backed securities and other debt securities

     117                   63          

Total trading debt securities

   $ 269                   492          

Total equity securities

   $ 500                   439          

(a)

Includes interest-only mortgage-backed securities of $34 as of December 31, 2017 recorded at fair value with fair value changes recorded in securities (losses) gains, net in the Condensed Consolidated Statements of Income.

(b)

Other securities consist of FHLB, FRB and DTCC restricted stock holdings of $184, $365 and $2, respectively, at September 30, 2018 and $248, $362, and $2, respectively, at December 31, 2017, that are carried at cost.

On an amortized cost basis, available-for-sale debt and other securities increased $1.1 billion from December 31, 2017 primarily due to increases in agency residential mortgage-backed securities and agency commercial mortgage-backed securities, partially offset by a decrease in asset-backed securities and other debt securities.

On an amortized cost basis, available-for-sale debt and other securities were 25% of total interest-earning assets at both September 30, 2018 and December 31, 2017. The estimated weighted-average life of the debt securities in the available-for-sale debt and other securities portfolio was 6.8 years at September 30, 2018 compared to 6.5 years at December 31, 2017. In addition, at September 30, 2018, the debt securities in the available-for-sale debt and other securities portfolio had a weighted-average yield of 3.21%, compared to 3.18% at December 31, 2017.

Trading debt securities decreased $223 million from December 31, 2017 primarily due to a decrease in agency residential mortgage-backed securities.

Information presented in Table 18 is on a weighted-average life basis, anticipating future prepayments. Yield information is presented on an FTE basis and is computed using amortized cost balances. Maturity and yield calculations for the total available-for-sale debt and other securities portfolio exclude other securities that have no stated yield or maturity. Total net unrealized losses on the available-for-sale debt and other securities portfolio were $899 million at September 30, 2018 compared to net unrealized gains of $174 million at December 31, 2017. The fair value of investment securities is impacted by interest rates, credit spreads, market volatility and liquidity conditions. The fair value of investment securities generally decreases when interest rates increase or when credit spreads expand.

 

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

 

 

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

 
                   Weighted-Average      Weighted-Average  

As of September 30, 2018 ($ in millions)

   Amortized Cost      Fair Value      Life (in years)      Yield  

U.S. Treasury and federal agencies securities:

           

Average life of 1 year or less

   $ -                    -            0.2                 3.04 %        

Average life 1 – 5 years

     98                    95            4.3                 2.12            

Total

   $ 98                    95            4.3                 2.12 %        

Obligations of states and political subdivisions securities:(a)

           

Average life of 1 year or less

     -                    -            0.3                 5.90            

Average life 1 – 5 years

     -                    -            2.4                 5.90            

Average life 5 – 10 years

     2                    2            6.0                 -             

Total

   $ 2                    2            5.6                 0.54 %        

Agency residential mortgage-backed securities:

           

Average life of 1 year or less

     -                    -            0.4                 10.07            

Average life 1 – 5 years

     5,932                    5,821            4.4                 3.41            

Average life 5 – 10 years

     9,367                    9,066            7.4                 3.17            

Average life greater than 10 years

     1,148                    1,086            11.0                 3.09            

Total

   $ 16,447                    15,973            6.6                 3.25 %        

Agency commercial mortgage-backed securities:

           

Average life 1 – 5 years

     2,219                    2,142            3.5                 2.92            

Average life 5 – 10 years

     6,024                    5,855            7.5                 3.10            

Average life greater than 10 years

     2,162                    2,049            11.7                 3.09            

Total

   $ 10,405                    10,046            7.5                 3.06 %        

Non-agency commercial mortgage-backed securities:

           

Average life of 1 year or less

     -                    -            0.3                 4.53            

Average life 1 – 5 years

     699                    692            4.6                 3.23            

Average life 5 – 10 years

     2,470                    2,405            6.6                 3.23            

Total

   $ 3,169                    3,097            6.2                 3.23 %        

Asset-backed securities and other debt securities:

           

Average life of 1 year or less

     36                    35            0.4                 2.59            

Average life 1 – 5 years

     1,104                    1,105            3.7                 3.87            

Average life 5 – 10 years

     698                    705            6.7                 3.62            

Average life greater than 10 years

     197                    199            10.4                 3.66            

Total

   $ 2,035                    2,044            5.3                 3.74 %        

Other securities

     551                    551                        

Total available-for-sale debt and other securities

   $         32,707                    31,808            6.8                 3.21 %        

(a)

Taxable-equivalent yield adjustments included in the above table are 0.00%, 0.48%, 0.00% and 0.03% for securities with an average life of 1 year or less, 1-5 years, 5-10 years and in total, respectively.

 

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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 72% and 71% of the Bancorp’s average asset funding base at September 30, 2018 and December 31, 2017, respectively.

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

 

TABLE 19: Components of Deposits

                                   
        September 30, 2018      December 31, 2017  

As of ($ in millions)

       Balance      % of Total      Balance        % of Total    

Demand

  $     31,803        31         $ 35,276        34      

Interest checking

      30,288        29           27,703        27      

Savings

      13,027        12           13,425        13      

Money market

      21,977        21           20,097        19      

Foreign office

        298        -            484        1      

Total transaction deposits

      97,393        93           96,985        94      

Other time

        4,249        4           3,775        4      

Total core deposits

      101,642        97           100,760        98      

Certificates $100,000 and over(a)

        2,700        3           2,402        2      

Total deposits

  $     104,342        100         $     103,162        100      

(a)

Includes $1.5 billion and $1.3 billion of institutional, retail and wholesale certificates $250,000 and over at September 30, 2018 and December 31, 2017, respectively.

Core deposits increased $882 million, or 1%, from December 31, 2017 driven by an increase of $474 million in other time deposits and an increase of $408 million in transaction deposits. Other time deposits increased from December 31, 2017 primarily due to promotional rate offers facilitated by the rising-rate environment. Transaction deposits increased from December 31, 2017 primarily due to increases in interest checking deposits and money market deposits, partially offset by a decrease in demand deposits. Interest checking deposits increased $2.6 billion, or 9%, from December 31, 2017 driven primarily by balance migration from demand deposit accounts and higher balances per commercial customer account. Money market deposits increased $1.9 billion, or 9%, from December 31, 2017 primarily as a result of promotional rate offers facilitated by the rising-rate environment, growth in the Fifth Third Preferred Banking program and direct mail marketing which drove consumer customer acquisition. Demand deposits decreased $3.5 billion, or 10%, from December 31, 2017 primarily as a result of the aforementioned commercial customer balance migration into interest checking deposits and lower balances per commercial customer account due to commercial customer seasonality.

Certificates $100,000 and over increased $298 million from December 31, 2017 primarily due to an increase in retail brokered certificates of deposit since December 31, 2017.

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

 

TABLE 20: Components of Average Deposits

                                   
        September 30, 2018      September 30, 2017  

($ in millions)

       Balance      % of Total      Balance         % of Total    

Demand

  $     32,333        31          $ 34,850        33       

Interest checking

      29,681        28            25,765        25       

Savings

      13,231        13            13,889        14       

Money market

      21,753        21            20,028        20       

Foreign office

        317        -             395        -        

Total transaction deposits

      97,315        93            94,927        92       

Other time

        4,177        4            3,722        4       

Total core deposits

      101,492        97            98,649        96       

Certificates $100,000 and over(a)

      2,596        2            2,625        3       

Other deposits

        578        1            560        1       

Total average deposits

  $     104,666        100          $     101,834        100       

(a)

Includes $1.4 billion and $1.5 billion of average institutional, retail and wholesale certificates $250,000 and over for the three months ended September 30, 2018 and 2017, respectively.

On an average basis, core deposits increased $2.8 billion, or 3%, from September 30, 2017 primarily due to an increase of $2.4 billion in average transaction deposits and an increase of $455 million in average other time deposits. Average other time deposits increased from September 30, 2017 primarily as a result of promotional offers facilitated by the rising-rate environment. The increase in average transaction deposits was driven by increases in average interest checking deposits and average money market deposits, partially offset by a decrease in average demand deposits. Average interest checking deposits increased $3.9 billion, or 15%, from September 30, 2017, primarily due to balance migration from demand deposit accounts and an increase in average balances per commercial customer account. Average money market deposits increased $1.7 billion, or 9%, from September 30, 2017 primarily as a result of promotional rate offers facilitated by the rising-rate environment, growth in the Fifth Third Preferred Banking program and direct mail marketing which drove consumer customer acquisition. Average demand deposits decreased $2.5 billion, or 7%, from September 30, 2017 primarily due to commercial customer balance migration into interest checking deposits and a decrease in average balances per commercial customer account.

 

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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 September 30, 2018 are summarized in the following table:

 

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

       

($ in millions)

       

Next 3 months

   $ 708   

3-6 months

     547   

6-12 months

     588   

After 12 months

     857   

Total certificates $100,000 and over

   $       2,700   

The contractual maturities of other time deposits and certificates $100,000 and over as of September 30, 2018 are summarized in the following table:

 

TABLE 22: Contractual Maturities of Other Time Deposits and Certificates $100,000 and Over

       

($ in millions)

       

Next 12 months

   $       3,728   

13-24 months

     2,304   

25-36 months

     759   

37-48 months

     126   

49-60 months

     24   

After 60 months

      

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

   $ 6,949   

Borrowings

The Bancorp accesses a variety of short-term and long-term funding sources. Borrowings with original maturities of one year or less are classified as short-term and include federal funds purchased and other short-term borrowings. As of September 30, 2018, average total borrowings as a percent of average interest-bearing liabilities were 19% compared to 21% at December 31, 2017.

The following table summarizes the end of period components of borrowings:

 

TABLE 23: Components of Borrowings

            

As of ($ in millions)

     September 30, 2018         December 31, 2017    

Federal funds purchased

   $ 2,316                   174               

Other short-term borrowings

     1,114                   4,012               

Long-term debt

     14,460                   14,904               

Total borrowings

   $   17,890                   19,090               

Total borrowings decreased $1.2 billion, or 6%, from December 31, 2017 due to decreases in other short-term borrowings and long-term debt partially offset by an increase in federal funds purchased. Other short-term borrowings decreased $2.9 billion from December 31, 2017 driven by a decrease in FHLB advances. The level of other short-term borrowings can fluctuate significantly from period to period depending on funding needs and which sources are used to satisfy those needs. For further information on the components of other short-term borrowings, refer to Note 13 of the Notes to Condensed Consolidated Financial Statements. Long-term debt decreased $444 million from December 31, 2017 primarily driven by the maturity of $1.9 billion of unsecured senior bank notes and $500 million of unsecured subordinated debt, $379 million of paydowns on long-term debt associated with automobile loan securitizations and $117 million of fair value adjustments associated with interest rate swaps hedging long-term debt during the nine months ended September 30, 2018. These decreases were partially offset by the issuance of $1.9 billion of unsecured fixed-rate senior notes and $550 million of unsecured floating-rate senior notes since December 31, 2017. For additional information regarding long-term debt issuances, refer to Note 14 of the Notes to Condensed Consolidated Financial Statements. Federal funds purchased increased $2.1 billion from December 31, 2017 due to a reallocation of other short-term borrowings.

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

 

TABLE 24: Components of Average Borrowings

            

($ in millions)

     September 30, 2018         September 30, 2017    

Federal funds purchased

   $ 1,987                   675               

Other short-term borrowings

     1,018                   4,212               

Long-term debt

     14,434                   13,457               

Total average borrowings

   $   17,439                   18,344               

Total average borrowings decreased $905 million, or 5%, compared to September 30, 2017, due to decreases in average other short-term borrowings partially offset by increases in average federal funds purchased and average long-term debt. Average other short-term borrowings decreased $3.2 billion compared to September 30, 2017, primarily driven by the decrease in FHLB advances. Average long-term debt increased $977 million compared to September 30, 2017. The increase was primarily driven by the issuance of $2.7 billion of unsecured fixed-rate senior bank notes and $850 million of unsecured floating-rate senior bank notes since September 30, 2017 partially offset by the maturity of $1.9 billion in unsecured senior bank notes since September 30, 2017 and $500 million of unsecured subordinated debt during the second quarter of 2018. Average federal funds purchased increased $1.3 billion due to a reallocation of other short-term borrowings. Information on the average rates paid on borrowings is discussed in the Net Interest Income subsection of the Statements of Income Analysis section of MD&A. In addition, refer to the Liquidity Risk Management subsection of the Risk Management section of MD&A for a discussion on the role of borrowings in the Bancorp’s liquidity management.

 

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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 23 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 the cash flows for each transaction. Assigning the FTP rate based on matching the duration of cash flows allocates interest income and interest expense to each business segment so its resulting net interest income is insulated from future changes in benchmark interest rates. The 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 funding operations by accessing the capital markets as a collective unit.

The results of operations and financial position for the three and nine months ended September 30, 2017 were adjusted to reflect changes in internal expense allocation methodologies.

The following table summarizes net income (loss) by business segment:

 

TABLE 25: Net Income (Loss) by Business Segment

                                      
             For the three months ended                 For the nine months ended      
         September 30,         September 30,  

($ in millions)

        2018     2017          2018     2017  

Income Statement Data

            

Commercial Banking

 

$

     298       244               843       698        

Branch Banking

       207       124               490       338        

Consumer Lending

       -       12               (13     11        

Wealth and Asset Management

       25       19               70       52        

General Corporate and Other

         (97     615                 331       586        

Net income

 

$

     433       1,014                 1,721       1,685        

 

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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             For the nine months ended  
           September 30,             September 30,  

($ in millions)

          2018     2017              2018     2017  

Income Statement Data

              

Net interest income (FTE)(a)

  $          431       429               1,285       1,280    

(Benefit from) provision for loan and lease losses

       (11     (3)              (41     25    

Noninterest income:

              

Corporate banking revenue

       100       100               304       272    

Service charges on deposits

       68       71               207       217    

Other noninterest income

       67       45               170       156    

Noninterest expense:

              

Personnel costs

       79       71               250       225    

Other noninterest expense

             266       270                     839       806    

Income before income taxes (FTE)

       332       307               918       869    

Applicable income tax expense(a)(b)

             34       63                     75       171    

Net income

  $          298       244                     843       698    

Average Balance Sheet Data

              

Commercial loans and leases, including held for sale

  $          54,685       53,722               54,305       53,708    

Demand deposits

       16,198       19,292               16,967       19,466    

Interest checking deposits

       12,511       8,680               11,303       8,912    

Savings and money market deposits

       3,691       4,972               4,263       5,615    

Other time deposits and certificates $100,000 and over

       268       903               401       931    

Foreign office deposits

             316       391                     392       391    

(a)

Includes FTE adjustments of $4 and $7 for the three months ended September 30, 2018 and 2017, respectively, and $12 and $19 for the nine months ended September 30, 2018 and 2017, respectively.

(b)

Applicable income tax expense for all periods includes the tax benefit from tax-exempt income, tax-advantaged investments and tax credits, partially offset by the effect of certain nondeductible expenses. Refer to the Applicable Income Taxes subsection of the Statements of Income Analysis section of MD&A for additional information.

Net income was $298 million for the three months ended September 30, 2018 compared to net income of $244 million for the three months ended September 30, 2017. Net income was $843 million for the nine months ended September 30, 2018 compared to net income of $698 million for the nine months ended September 30, 2017. The increase for both periods was driven by decreases in the provision for loan and lease losses and increases in noninterest income and net interest income on an FTE basis partially offset by increases in noninterest expense.

Net interest income on an FTE basis increased $2 million and $5 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily driven by increases in yields on average commercial loans and leases and increases in FTP credits on interest checking deposits. These increases were partially offset by increases in FTP charge rates on loans and leases and increases in the rates paid on core deposits.

Provision for loan and lease losses decreased $8 million and $66 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The decrease for the three months ended September 30, 2018 compared to the same period in the prior year was primarily driven by a decrease in net charge-offs. The decrease for the nine months ended September 30, 2018 compared to the same period in the prior year was primarily driven by a decrease in criticized asset levels partially offset by an increase in net charge-offs. Net charge-offs as a percent of average portfolio loans and leases decreased to 12 bps and increased to 20 bps for the three and nine months ended September 30, 2018, respectively, compared to 19 bps for both periods in the prior year.

Noninterest income increased $19 million and $36 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase for both the three and nine months ended September 30, 2018 was driven by an increase in other noninterest income partially offset by a decrease in service charges on deposits. Additionally, the increase for the nine months ended September 30, 2018 included the impact of an increase in corporate banking revenue. Other noninterest income increased $22 million and $14 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to an increase in private equity investment income. Service charges on deposits decreased $3 million and $10 million for three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. Corporate banking revenue increased $32 million for the nine months ended September 30, 2018 compared to the same period in the prior year driven by increases in lease remarketing fees, foreign exchange fees, institutional sales revenue and contract revenue from commercial customer derivatives partially offset by decreases in business lending fees and letter of credit fees. The increase in lease remarketing fees for the nine months ended September 30, 2018 included the impact of a $31 million impairment charge related to certain operating lease assets that was recognized during the first quarter of 2017.

 

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

 

 

Noninterest expense increased $4 million and $58 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase for the three months ended September 30, 2018 was due to an increase in personnel costs partially offset by a decrease in other noninterest expense. Personnel costs increased $8 million for the three months ended September 30, 2018 compared to the same period in the prior year due to increased base compensation. Other noninterest expense decreased $4 million for the three months ended September 30, 2018 compared to the same period in the prior year primarily due to decreases in consulting expense, impairment on affordable housing investments and OREO expense partially offset by increases in corporate overhead allocations. The increase for the nine months ended September 30, 2018 was a result of increases in both other noninterest expense and personnel costs. Other noninterest expense increased $33 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to increases in corporate overhead allocations and impairment on affordable housing investments partially offset by a decrease in consulting expense. Personnel costs increased $25 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to increased base compensation and incentive compensation.

Average commercial loans and leases increased $963 million and $597 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in average commercial and industrial loans and average commercial construction loans partially offset by decreases in average commercial leases and average commercial mortgage loans. Average commercial and industrial loans increased $1.1 billion and $522 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year as a result of an increase in new loan originations as well as a decrease in payoffs. Average commercial construction loans increased $310 million and $474 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in draw levels on existing commitments. Average commercial leases decreased $335 million and $159 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily as a result of a planned reduction in indirect non-relationship based lease originations. Average commercial mortgage loans decreased $146 million and $240 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year due to an increase in paydowns and lower new loan origination activity driven by increased competition.

Average core deposits decreased $620 million and $1.5 billion for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The decreases for the three and nine months ended September 30, 2018 were driven by decreases in average demand deposits of $3.1 billion and $2.5 billion, respectively, and average savings and money market deposits of $1.3 billion and $1.4 billion, respectively, compared to the same periods in the prior year primarily due to lower average balances per account. These decreases were partially offset by increases in average interest checking deposits of $3.8 billion and $2.4 billion for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to balance migration from demand deposit accounts and increases in average balances per account.

Branch Banking

Branch Banking provides a full range of deposit and loan products to individuals and small businesses through 1,152 full-service banking centers. Branch Banking offers depository and loan products, such as checking and savings accounts, home equity loans and lines of credit, credit cards and loans for automobiles and other personal financing needs, as well as products designed to meet the specific needs of small businesses, including cash management services.

 

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

 

 

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

 

TABLE 27: Branch Banking

                                         
         For the three months ended          For the nine months ended  
         September 30,          September 30,  

($ in millions)

        2018      2017           2018      2017  

Income Statement Data

               

Net interest income

  $      525            453              1,490        1,320    

Provision for loan and lease losses

       34            35              124        115    

Noninterest income:

                      

Service charges on deposits

       71            67              205        196    

Card and processing revenue

       67            64              199        185    

Wealth and asset management revenue

       38            35              113        106    

Other noninterest income

       28            25              41        76    

Noninterest expense:

               

Personnel costs

       131            126              404        387    

Net occupancy and equipment expense

       56            56              168        172    

Card and processing expense

       30            31              89        93    

Other noninterest expense

         216            206                642        595    

Income before income taxes

       262            190              621        521    

Applicable income tax expense

         55            66                131        183    

Net income

  $      207            124                490        338    

Average Balance Sheet Data

               

Consumer loans

  $      13,069            12,905              12,992        13,013    

Commercial loans

       1,972            1,915              1,919        1,928    

Demand deposits

       14,403            13,875              14,310        13,839    

Interest checking deposits

       10,065            10,228              10,232        10,231    

Savings and money market deposits

       29,786            27,671              29,260        27,539    

Other time deposits and certificates $100,000 and over

         5,443            4,903                5,238        4,962    

Net income was $207 million for the three months ended September 30, 2018 compared to net income of $124 million for the three months ended September 30, 2017. Net income was $490 million for the nine months ended September 30, 2018 compared to $338 million for the nine months ended September 30, 2017. The increase for both periods was driven by increases in net interest income partially offset by increases in noninterest expense.

Net interest income increased $72 million and $170 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase in net interest income for both periods was primarily due to increases in FTP credit rates on core deposits as well as increases in interest income on other consumer loans driven by higher average balances. These benefits were partially offset by increases in FTP charge rates on loans and leases and increases in the rates paid on savings and money market deposits. Additionally, for the nine months ended September 30, 2018, the increase in net interest income was partially offset by the impact of a $12 million benefit in the first quarter of 2017 related to a revised estimate of refunds to be offered to certain bankcard customers.

Provision for loan and lease losses decreased $1 million and increased $9 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase for the nine months ended September 30, 2018 was primarily due to increases in net charge-offs on other consumer loans and credit card. Net charge-offs as a percent of average portfolio loans and leases increased to 99 bps and 111 bps for the three and nine months ended September 30, 2018, respectively, compared to 96 bps and 103 bps for the three and nine months ended September 30, 2017, respectively.

Noninterest income increased $13 million and decreased $5 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase for the three months ended September 30, 2018 compared to the same period in the prior year was primarily due to increases in service charges on deposits, card and processing revenue, wealth and asset management revenue and other noninterest income of $4 million, $3 million, $3 million and $3 million, respectively. The decrease for the nine months ended September 30, 2018 compared to the same period in the prior year was primarily due to a decrease in other noninterest income partially offset by increases in card and processing revenue, service charges on deposits and wealth and asset management revenue. Other noninterest income decreased $35 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to the impact of impairment on bank premises and equipment. Card and processing revenue increased $14 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily driven by increases in the number of actively used cards and customer spend volume. Service charges on deposits increased $9 million for the nine months ended September 30, 2018 compared to the same period in the prior year. Wealth and asset management revenue increased $7 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily driven by an increase in brokerage fees and private client service fees.

Noninterest expense increased $14 million and $56 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in other noninterest expense and personnel costs. Other noninterest expense increased $10 million and $47 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in corporate overhead allocations and loan and lease expense. Personnel costs increased $5 million and $17 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to higher base compensation.

 

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

 

 

Average consumer loans increased $164 million and decreased $21 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The change for both the three and nine months ended September 30, 2018 compared to the same periods in the prior year was impacted by increases in average other consumer loans of $1.1 billion and $993 million, respectively, primarily due to growth in point-of-sale loan originations and decreases in both average home equity loans of $536 million and $542 million, respectively, and average residential mortgage loans of $305 million and $314 million, respectively, as payoffs exceeded new loan production.

Average core deposits increased $2.9 billion and $2.4 billion for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase for both periods was primarily driven by growth in average savings and money market deposits of $2.1 billion and $1.7 billion and growth in average demand deposits of $528 million and $471 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in average balances per customer account and the acquisition of new customers.

Consumer Lending

Consumer Lending includes the 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      For the nine months ended  
         September 30,      September 30,  

($ in millions)

        2018      2017      2018     2017  

Income Statement Data

            

Net interest income

  $      60        59          178       179      

Provision for loan and lease losses

       10        8          30       30      

Noninterest income:

            

Mortgage banking net revenue

       48        61          153       164      

Other noninterest income

       2        7          (7     18      

Noninterest expense:

            

Personnel costs

       46        46          148       142      

Other noninterest expense

         54        55          162       171      

(Loss) income before income taxes

       -        18          (16     18      

Applicable income tax (benefit) expense

         -        6          (3     7      

Net (loss) income

  $      -        12          (13     11      

Average Balance Sheet Data

            

Residential mortgage loans, including held for sale

  $      11,896        11,672          11,805       11,422      

Home equity

       237        285          249       299      

Automobile loans

         8,668        8,826          8,669       8,995      

Consumer Lending reported an immaterial amount of net income for the three months ended September 30, 2018 compared to net income of $12 million for the three months ended September 30, 2017. Consumer Lending incurred a net loss of $13 million for the nine months ended September 30, 2018 compared to net income of $11 million for the nine months ended September 30, 2017. The decrease for both periods was driven by decreases in noninterest income partially offset by decreases in the noninterest expense.

Provision for loan and lease losses increased $2 million and was flat for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. Net charge-offs as a percent of average portfolio loans and leases were 20 bps for both the three and nine months ended September 30, 2018 compared to 15 bps and 20 bps for the same periods in the prior year, respectively.

Noninterest income decreased $18 million and $36 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year due to decreases in both mortgage banking net revenue and other noninterest income. Mortgage banking net revenue decreased $13 million and $11 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to decreases in origination fees and gains on loan sales partially offset by increases in net mortgage servicing revenue. Refer to the Noninterest Income subsection of the Statements of Income Analysis section of the MD&A for additional information on the fluctuations in mortgage banking net revenue. Other noninterest income decreased $5 million and $25 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in losses on securities related to non-qualifying hedges on MSRs resulting from increased interest rates.

Noninterest expense decreased $1 million and $3 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in prior year. Other noninterest expense decreased $9 million for the nine months ended September 30, 2018 compared to the same period in prior year primarily due to decreases in operational losses and loan and lease expense. Personnel costs increased $6 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily due to an increase in base compensation.

 

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

 

 

Average consumer loans increased $18 million and $7 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. Average residential mortgage loans increased $224 million and $383 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily driven by the continued retention of certain agency conforming ARMs and certain other fixed-rate loans. Average automobile loans decreased $158 million and $326 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year as payoffs exceeded new loan production due to a strategic shift focusing on improving risk-adjusted returns.

Wealth and Asset Management

Wealth and Asset Management provides a full range of investment alternatives for individuals, companies and not-for-profit organizations. Wealth and Asset Management is made up of five main businesses: FTS; ClearArc Capital, Inc.; Fifth Third Insurance Agency, Inc.; Fifth Third Private Bank; and Fifth Third Institutional Services. FTS offers full service retail brokerage services to individual clients and broker-dealer services to the institutional marketplace. ClearArc Capital, Inc. provides asset management services. Fifth Third Insurance Agency, Inc. assists clients with their financial and risk management needs. Fifth Third Private Bank offers holistic strategies to affluent clients in wealth planning, investing, insurance and wealth protection. Fifth Third Institutional Services provides advisory services for institutional clients including states and municipalities.

The following table contains selected financial data for the Wealth and Asset Management segment:

 

TABLE 29: Wealth and Asset Management

                                          
          For the three months ended          For the nine months ended  
          September 30,          September 30,  

($ in millions)

         2018      2017           2018      2017  

Income Statement Data

                

Net interest income

   $      46            38              134        114    

Provision for (benefit from) loan and lease losses

        3            (1)            8        2    

Noninterest income:

                

Wealth and asset management revenue

        110            99              324        304    

Other noninterest income

        5            2              20        8    

Noninterest expense:

                

Personnel costs

        50            42              154        136    

Other noninterest expense

          76            69                227        209    

Income before income taxes

        32            29              89        79    

Applicable income tax expense

          7            10                19        27    

Net income

   $      25            19                70        52    

Average Balance Sheet Data

                

Loans and leases, including held for sale

   $      3,449            3,265              3,410        3,257    

Core deposits

          9,029            8,543                9,266        8,721    

Net income was $25 million for the three months ended September 30, 2018 compared to net income of $19 million for the three months ended September 30, 2017. Net income was $70 million for the nine months ended September 30, 2018 compared to $52 million for the nine months ended September 30, 2017. The increases for both periods were driven primarily by increases in noninterest income and net interest income partially offset by increases in noninterest expense and provision for loan and lease losses.

Net interest income increased $8 million and $20 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in FTP credit rates on interest checking deposits and savings and money market deposits as well as increases in yields on average loans and leases. These positive impacts were partially offset by increases in the rates paid on interest checking deposits as well as an increase in FTP charge rates on loans and leases.

Provision for loan and lease losses increased $4 million and $6 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year driven by an increase in net charge-offs partially offset by the impact of the benefit of lower criticized assets.

Noninterest income increased $14 million and $32 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year driven by increases in wealth and asset management revenue and other noninterest income. Wealth and asset management revenue increased $11 million and $20 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in private client service fees and brokerage fees driven by an increase in assets under management as a result of strong market performance and increased asset production. Other noninterest income increased $3 million and $12 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year due to increases in insurance income as a result of acquisitions in 2017.

Noninterest expense increased $15 million and $36 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year as a result of increases in personnel costs and other noninterest expense. Personnel costs increased $8 million and $18 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year driven by increases in base compensation and incentive compensation driven by the aforementioned acquisitions in 2017. Other noninterest expense increased $7 million and $18 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily driven by increases in corporate overhead allocations.

 

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

 

 

Average loans and leases increased $184 million and $153 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year driven by increases in average commercial and industrial loans and average residential mortgage loans due to increases in new loan origination activity. These increases were partially offset by a decline in average home equity balances.

Average core deposits increased $486 million and $545 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year primarily due to increases in average interest checking deposits and average savings and money market deposits.

General Corporate and Other

General Corporate and Other includes the unallocated portion of the investment securities portfolio, securities gains and losses, certain non-core deposit funding, unassigned equity, unallocated provision for loan and lease losses expense or a benefit from the reduction of the ALLL, the payment of preferred stock dividends and certain support activities and other items not attributed to the business segments.

Net interest income decreased $13 million for the three months ended September 30, 2018 compared to the same period in the prior year driven by increases in FTP credit rates on deposits allocated to the business segments and increases in interest expense on long-term debt and federal funds purchased as well as the impact of interest rate contracts hedging commercial and industrial loans. The decrease for the three months ended September 30, 2018 was partially offset by an increase in the benefit related to the FTP charges on loans and leases as well as an increase in interest income on taxable securities. Net interest income increased $16 million for the nine months ended September 30, 2018 compared to the same period in the prior year primarily driven by an increase in the benefit related to the FTP charges on loans and leases as well as an increase in interest income on taxable securities. The increase for the nine months ended September 30, 2018 was partially offset by increases in FTP credit rates on deposits allocated to the business segments, the impact of interest rate contracts hedging commercial and industrial loans as well as an increase in interest expense on long-term debt and federal funds purchased.

The provision for loan and lease losses increased $22 million and was flat for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase for the three months ended September 30, 2018 compared to the same period in the prior year was primarily due to a decrease in the allocation of provision expense to the business segments driven by a decrease in commercial criticized assets.

Noninterest income decreased $1 billion and $455 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year driven by the recognition of a $1.0 billion gain on the sale of Worldpay, Inc. shares during the third quarter of 2017. The decrease for nine months ended September 30, 2018 was partially offset by the recognition of a $205 million gain on the sale of Worldpay, Inc. shares during the second quarter of 2018 and a $414 million gain related to Vantiv, Inc.’s acquisition of Worldpay Group plc. during the first quarter of 2018. Both periods were impacted by negative valuation adjustments related to the Visa total return swap which were $17 million and $66 million for the three and nine months ended September 30, 2018, respectively, compared with $47 million and $69 million for the same periods in the prior year. Additionally, equity method earnings from the Bancorp’s interest in Worldpay Holding, LLC decreased $11 million and $36 million compared to the three and nine months ended September 30, 2017, respectively, primarily due to a decrease in the Bancorp’s ownership percentage in Worldpay Holding, LLC and the impact of Worldpay, Inc.’s acquisition and integration costs on its earnings.

Noninterest expense increased $4 million and $30 million for the three and nine months ended September 30, 2018, respectively, compared to the same periods in the prior year. The increase for both periods was primarily due to increases in technology and communications expense and personnel costs partially offset by increases in corporate overhead allocations from General Corporate and Other to the other business segments. Additionally, the nine months ended September 30, 2018 included an increase of $10 million in donations expense compared to the same period in the prior year as a result of a contribution to the Fifth Third Foundation in the second quarter of 2018 partially offset by an increased benefit from the reserve for unfunded commitments for the same period.

 

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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.

 

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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

                       
            Unpaid         
       Carrying        Principal           

As of September 30, 2018 ($ in millions)

     Value      Balance      Exposure    

Commercial and industrial loans

   $ 558        558        801   

Commercial mortgage loans

     111        112        111   

Commercial leases

     60        60        60   

Total potential problem portfolio loans and leases

   $ 729        730        972   

TABLE 31: Potential Problem Portfolio Loans and Leases

                          
        Unpaid     
       Carrying        Principal     

As of December 31, 2017 ($ in millions)

       Value        Balance        Exposure    

Commercial and industrial loans

   $ 911        912        1,370   

Commercial mortgage loans

     138        138        138   

Commercial leases

     70        70        70   

Total potential problem portfolio loans and leases

   $             1,119        1,120        1,578   

In addition to the individual review of larger commercial loans that exhibit probable or observed credit weaknesses, the commercial credit review process includes the use of two risk grading systems. The risk grading system currently utilized for allowance for credit loss analysis purposes encompasses ten categories. The Bancorp also maintains a dual risk rating system for credit approval and pricing, portfolio monitoring and capital allocation that includes a “through-the-cycle” rating philosophy for assessing a 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 2016-13Measurement 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.

 

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

 

 

Overview

Inflationary expectations by market professionals continue to have an increased focus on wages, interest rates, input costs, tariffs, trade negotiations and foreign exchange. During September 2018, the FOMC enacted an additional 25 bp increase in the target rate for Federal Funds. The Federal Reserve median forecast for change in 2018 real GDP was again raised this quarter to 3.1%. The Federal Reserve, in their minutes, continues to be concerned that tariffs could hurt the current economic recovery but are waiting to see evidence of any damage. Also concerning is the recent slowdown in homebuilding. Interest rates are expected to rise one more time in 2018 and multiple times during 2019, with no major downturns expected until 2021.

The Bancorp maintains a focus on commercial real estate exposure. Market data and vacancies remain positive. Competition for term loans on stabilized or near-stabilized assets has become increasingly more aggressive in terms of pricing, recourse and repayment structures, as banks seek to diversify away from construction. Construction costs continue to escalate and will likely be exacerbated by the impact of tariffs. The Bancorp is also monitoring potential increased risks in the Retail sector as a result of changes in distribution models with increasing levels of online purchasing and recent weakness in certain specialty retailers. However, the Bancorp is seeing an interesting trend in brick and mortar retailers called “clicks to bricks”. Mixed use retail centers are continuing to be developed and successfully leased up. The Bancorp has been focused on tenants that have multi-channel distribution and/or provide entertainment such as restaurants, cosmetic stores, fitness, grocery and drug. The Bancorp is now seeing retailers that originated as exclusively online distributers shift to bricks and mortar locations.

During the third quarter of 2018, the southeastern United States experienced a major hurricane impacting the eastern portions of the states of North Carolina and South Carolina. The Bancorp has limited credit exposure in the coastal regions of both states, however assistance was provided to customers that were negatively impacted. There is no expectation of any material net charge-offs as a result of the hurricane.

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 September 30, 2018 ($ in millions)

   LTV > 100%     LTV 80-100%     LTV < 80%      

Commercial mortgage owner-occupied loans

   $             120              163             2,175          

Commercial mortgage nonowner-occupied loans

     10              63             2,354          

Total

   $ 130              226             4,529          

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          

 

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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)

       September 30, 2018        December 31, 2017  

($ in millions)

     Outstanding        Exposure        Nonaccrual        Outstanding        Exposure        Nonaccrual  

By Industry:

                 

Manufacturing

   $     10,160                19,518        63          10,044            18,948        74      

Real estate

     8,269                12,967        30          7,713            12,493        25      

Financial services and insurance

     6,224                12,699        2          5,792            11,933        1      

Healthcare

     4,484                6,286        30          4,712            6,486        35      

Business services

     4,158                7,024        31          4,147            6,512        42      

Retail trade

     3,446                7,250        3          3,617            7,950        3      

Accommodation and food

     3,379                5,481        26          3,268            5,321        4      

Wholesale trade

     3,285                5,585        15          3,017            5,363        6      

Communication and information

     2,931                5,541        -          3,322            5,308        -      

Transportation and warehousing

     2,824                4,800        22          3,012            4,621        29      

Construction

     2,493                4,600        3          2,374            4,449        2      

Mining

     2,253                3,938        40          1,454            3,001        56      

Entertainment and recreation

     1,537                3,102        1          1,624            2,911        7      

Utilities

     855                2,499        -          869            2,333        -      

Other services

     814                1,045        10          714            1,017        16      

Public administration

     485                692        -          370            474        -      

Agribusiness

     254                425        2          304            478        2      

Individuals

     64                103        -          27            57        -      

Other

     -                -        -          15            15        4      

Total

   $ 57,915                103,555        278          56,395            99,670        306      

By Size:

                 

Less than $200,000

     1 %           1        5          1            1        5      

$200,000 - $1 million

     2                2        7          3            2        8      

$1 million - $5 million

     7                6        18          7            6        15      

$5 million - $10 million

     6                5        13          6            5        10      

$10 million - $25 million

     20                17        48          21            18        57      

Greater than $25 million

     64                69        9          62            68        5      

Total

     100 %           100        100          100            100        100      

By State:

                 

Ohio

     14 %           14        6          14            15        7      

Florida

     8                8        17          8            8        6      

Michigan

     7                7        8          7            7        13      

Illinois

     6                6        7          7            6        9      

Indiana

     4                4        9          4            4        3      

Georgia

     4                5        9          4            5        2      

North Carolina

     3                3        1          3            3        1      

Tennessee

     3                3        -          3            3        8      

Kentucky

     3                3        1          3            3        1      

Other

     48                47        42          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.

 

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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)

                 
                                

Net Charge-offs (Recoveries) for

 

As of September 30, 2018 ($ in millions)

                                   September 30, 2018  
      Outstanding      Exposure     

90 Days

Past Due

     Nonaccrual      Three Months
Ended
    

Nine Months    

Ended    

 

By State:

                 

Ohio

   $             1,641             2,079        -        1          -            -        

Florida

     1,000             1,578        -        -          -            -        

North Carolina

     739             985        -        -          -            -        

Illinois

     677             920        -        -          -            -        

Michigan

     604             725        -        -          (1)          -        

Indiana

     528             822        -        -          -            -        

All other states

     2,849             4,664        -        2          -            1        

Total

   $ 8,038             11,773        -        3          (1)          1        

(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)

                 
                                 Net Charge-offs for  

As of September 30, 2017 ($ in millions)

                                   September 30, 2017  
      Outstanding      Exposure     

90 Days

Past Due

     Nonaccrual      Three Months
Ended
    

Nine Months    

Ended    

 

By State:

                 

Ohio

   $               1,695             2,219        -        2          -            8        

Florida

     1,040             1,536        -        1          -            -        

North Carolina

     499             754        -        -          -            -        

Illinois

     755             1,042        -        -          -            -        

Michigan

     573             732        -        1          -            -        

Indiana

     611             973        -        -          -            -        

All other states

     2,801             4,717        -        2          1            1        

Total

   $ 7,974             11,973        -        6          1            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.

 

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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, automobile loans, credit card and other consumer loans. 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 September 30, 2018, consumer real estate loans, consisting of residential mortgage loans and home equity loans, originated from 2005 through 2008 represent approximately 12% of the consumer real estate portfolio. These loans accounted for 51% of total consumer real estate secured losses for the nine months ended September 30, 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. The Bancorp has adjusted credit standards focused on improving risk-adjusted returns while maintaining credit risk tolerance. The Bancorp 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 $659 million of ARM loans will have rate resets during the next twelve months. Of these resets, 99.5% 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 92% of the portfolio as of September 30, 2018 and had a weighted-average LTV of 73% 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

 
         September 30, 2018          December 31, 2017  

($ in millions)

        Outstanding        Weighted-
    Average LTV
          Outstanding   

    Weighted-    

    Average LTV    

 

LTV £ 80%

   $   11,629        66.7 %      $   11,767        66.4%      

LTV > 80%, with mortgage insurance(a)

     1,999      95.1             1,890      94.8         

LTV > 80%, no mortgage insurance

       1,957      94.4               1,934      94.7         

Total

   $   15,585        74.2 %      $   15,591        73.7%      

(a)

Includes loans with both borrower and lender paid mortgage insurance.

The following tables provide an analysis of the residential mortgage portfolio loans outstanding 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 September 30, 2018 ($ in millions)

                   Net Charge-offs for September 30, 2018  
            90 Days             Three Months      Nine Months  
      Outstanding      Past Due      Nonaccrual      Ended      Ended  

By State:

              

Ohio

   $ 439        2        3        -        -  

Illinois

     395        -        2        -        -  

Florida

     286        1        2        -        -  

Michigan

     219        1        1        -        -  

Indiana

     145        1        -        -        -  

North Carolina

     91        -        1        -        -  

Kentucky

     80        -        -        -        -  

All other states

     302        2        1        -        1  

Total

   $                 1,957        7        10        -        1  

 

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

 

 

TABLE 39: Residential Mortgage Portfolio Loans, LTV Greater than 80%, No Mortgage Insurance

 

As of September 30, 2017 ($ in millions)

                           Net Charge-offs for September 30, 2017    
        90 Days          Three Months       Nine Months  
       Outstanding        Past Due        Nonaccrual       Ended       Ended  

By State:

            

Ohio

   $ 443        4        3       -       1  

Illinois

     380        -        2       -       -  

Florida

     288        1        2       -       1  

Michigan

     228        1        1       -       -  

Indiana

     138        1        1       -       -  

North Carolina

     87        -        1       -       -  

Kentucky

     74        1        -       -       -  

All other states

     295        3        2       -       -  

Total

   $                 1,933        11        12       -       2  

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 $6.5 billion of outstanding home equity loans:

 

 

89% reside within the Bancorp’s Midwest footprint of Ohio, Michigan, Kentucky, Indiana and Illinois as of September 30, 2018;

 

 

37% are in senior lien positions and 63% are in junior lien positions at September 30, 2018;

 

 

81% of non-delinquent borrowers made at least one payment greater than the minimum payment during the three months ended September 30, 2018; and

 

 

The portfolio had an average refreshed FICO score of 745 at September 30, 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. 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.

 

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

 

 

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

 
          

        September 30, 2018         

          

        December 31, 2017         

 

($ in millions)

         

Outstanding

         % of Total                     Outstanding          % of Total          

Senior Liens:

               

FICO £ 659

   $         230              4 %                            $         246              4 %     

FICO 660-719

       329              5                 358              5         

FICO ³ 720

             1,809              28                       1,976              28         

Total senior liens

       2,368              37                 2,580              37         

Junior Liens:

               

FICO £ 659

       488              7                 541              8         

FICO 660-719

       781              12                 853              12         

FICO ³ 720

             2,848              44                       3,040              43         

Total junior liens

             4,117              63                       4,434              63         

Total

   $         6,485              100 %                            $         7,014              100 %     

The Bancorp believes that home equity portfolio 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 portfolio loans outstanding in a senior and junior lien position by LTV at origination:

 

TABLE 41: Home Equity Portfolio Loans Outstanding by LTV at Origination

 

                 
          

        September 30, 2018        

        

        December 31, 2017         

 

($ in millions)

           Outstanding    

Weighted-        

    Average LTV        

 

 

       Outstanding     

Weighted-       

    Average LTV       

 

 

Senior Liens:

              

LTV £ 80%

   $       2,066           54.6 %                    $   2,266            54.9 %      

LTV > 80%

           302           88.9                 314            88.9          

Total senior liens

     2,368           59.2               2,580            59.3          

Junior Liens:

              

LTV £ 80%

     2,396           67.3               2,603            67.5          

LTV > 80%

           1,721           90.2                 1,831            90.4          

Total junior liens

           4,117           78.1                 4,434            78.3          

Total

   $       6,485           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 September 30, 2018 ($ in millions)

                             Net Charge-offs for September 30, 2018
                          90 Days             Three Months   Nine Months
             

Outstanding

     Exposure      Past Due      Nonaccrual      Ended   Ended

By State:

                   

Ohio

   $          1,052        2,050          -        9      -   2

Michigan

        311        511          -        5      -   1

Illinois

        207        331          -        4      1   2

Indiana

        138        239          -        3      -   -

Kentucky

        123        233          -        2      -   -

Florida

        62        90          -        2      -   -

All other states

              130        196          -        3      -   -

Total

   $          2,023        3,650          -        28      1   5

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

            

 

As of September 30, 2017 ($ in millions)

                             Net Charge-offs for September 30, 2017
                              90 Days             Three Months   Nine Months
             

Outstanding

         Exposure          Past Due          Nonaccrual      Ended   Ended

By State:

                   

Ohio

   $          1,040        1,908        -        7      1   3

Michigan

        375        590        -        5      -   1

Illinois

        236        366        -        4      1   2

Indiana

        162        273        -        3      -   1

Kentucky

        149        266        -        2      -   1

Florida

        70        100        -        2      -   -

All other states

              154        225        -        3      -   -

Total

   $          2,186        3,728        -        26      2   8

 

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

 

 

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 nine months ended September 30, 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

 
                     September 30, 2018                                   December 31, 2017               

($ in millions)

        Outstanding      % of Total               Outstanding      % of Total       

FICO £ 690

   $     1,621              18 %                      $     1,563              17 %    

FICO > 690

         7,381              82                 7,549              83        

Total

   $     9,002              100 %      $     9,112              100 %    

The automobile portfolio is characterized by direct and indirect lending products to consumers. As of September 30, 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

                     
                     September 30, 2018                                   December 31, 2017               

($ in millions)

        Outstanding     Weighted-
Average LTV
          Outstanding    

Weighted-  

Average LTV  

 

LTV £ 100%

   $     5,613             82.3 %                      $     5,814             82.1 %    

LTV > 100%

         3,389             112.8                 3,298             112.4        

Total

   $     9,002             94.2 %      $     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)

                           Net Charge-offs for the  
      Outstanding      90 Days Past Due
and Accruing
             Nonaccrual              Three Months
Ended
     Nine Months
Ended
 

September 30, 2018

   $             3,389            6        1                6        19  

September 30, 2017

     3,287            5        1                5        17  

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 September 30, 2018 and December 31, 2017. At September 30, 2018 and December 31, 2017, 72% and 76%, respectively, of the outstanding balances were originated through branch-based relationships with the remainder coming from direct mail campaigns and online acquisitions.

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

 
                     September 30, 2018                              December 31, 2017               

($ in millions)

        Outstanding      % of Total               Outstanding      % of Total      

FICO £ 659

   $     72              3 %                          $     61                3 %    

FICO 660-719

       644              28               581                25        

FICO ³ 720

         1,609              69                 1,657                72        

Total

   $     2,325              100 %                          $     2,299                100 %    

Other consumer portfolio loans

The other consumer portfolio loans are 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 $572 million, or 37%, from December 31, 2017 primarily due to an increase in originations in connection with third-party financial technology companies. Additionally, the Bancorp has approximately $337 million in unfunded commitments associated with loans originated in connection with third-party financial technology companies as of September 30, 2018. Fifth Third closely monitors the credit performance of these point-of-sale loans which, for Fifth Third, is impacted by the credit loss protection coverage provided by the third-party financial technology companies.

 

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

 

 

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

 
                     September 30, 2018                                  December 31, 2017               

($ in millions)

        Outstanding              % of Total          Outstanding      % of Total       

Unsecured

   $     554                26  %                $     461                30 %    

Other secured

       492                23         482                31        

Point-of-sale

         1,085                51           616                39        

Total

   $     2,131                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 Consolidated Financial Statements included in the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2017.

Nonperforming assets were $483 million at September 30, 2018 compared to $495 million at December 31, 2017. At September 30, 2018, $35 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 0.48% as of September 30, 2018 compared to 0.53% as of December 31, 2017. Nonaccrual loans and leases secured by real estate were 28% of nonaccrual loans and leases as of September 30, 2018 compared to 33% as of December 31, 2017.

Commercial portfolio nonaccrual loans and leases were $278 million at September 30, 2018, a decrease of $28 million from December 31, 2017. Consumer portfolio nonaccrual loans and leases were $125 million at September 30, 2018, a decrease of $6 million from December 31, 2017. Refer to Tables 50 and 51 for rollforwards of the portfolio nonaccrual loans and leases.

OREO and other repossessed property was $45 million at September 30, 2018, compared to $52 million at December 31, 2017. The Bancorp recognized $2 million and $3 million in losses on the transfer, sale or write-down of OREO properties for the three months ended September 30, 2018 and 2017, respectively, and $6 million and $8 million in losses on the transfer, sale or write-down of OREO properties for the nine months ended September 30, 2018 and 2017, respectively.

For the three and nine months ended September 30, 2018, approximately $9 million and $24 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. For the three and nine months ended September 30, 2017 approximately $9 million and $28 million, respectively, of interest income would have been recognized. 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.

 

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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)

   September 30, 2018      December 31, 2017            

Nonaccrual portfolio loans and leases:

     

Commercial and industrial loans

   $ 69                            144                    

Commercial mortgage loans

     7                            12                    

Commercial leases

     22                            -                    

Residential mortgage loans(a)

     11                            17                    

Home equity

     58                            56                    

Automobile loans

     -                            -                    

Other consumer loans

     1                            -                    

Nonaccrual portfolio restructured loans and leases:

     

Commercial and industrial loans

     171                            132                    

Commercial mortgage loans

     5                            14                    

Commercial leases

     4                            4                    

Residential mortgage loans(a)

     12                            13                    

Home equity

     16                            18                    

Automobile loans

     1                            1                    

Credit card

     26                            26                    

Total nonaccrual portfolio loans and leases(b)

     403                            437                    

OREO and other repossessed property

     45                            52                    

Total nonperforming portfolio assets

     448                            489                    

Nonaccrual loans held for sale

     18                            5                    

Nonaccrual restructured loans held for sale

     17                            1                    

Total nonperforming assets

   $                     483                             495                    

Total portfolio loans 90 days past due and still accruing

     

Commercial and industrial loans

   $ 3                            3                    

Commercial mortgage loans

     1                            -                    

Residential mortgage loans(a)

     40                            57                    

Automobile loans

     11                            10                    

Credit card

     32                            27                    

Total portfolio loans 90 days past due and still accruing

   $ 87                            97                    

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

     0.48%                        0.53                    

ALLL as a percent of nonperforming portfolio assets

     243                            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 $198 as of September 30, 2018 and $290 as of December 31, 2017. The Bancorp recognized losses of $1 and $4 for both the three and nine months ended September 30, 2018 and 2017, respectively, due to claim denials and curtailments associated with these insured or guaranteed loans.

(b)

Includes $4 and $3 of nonaccrual government insured commercial loans whose repayments are insured by the SBA at September 30, 2018 and December 31, 2017, respectively, of which $2 and $3 were restructured nonaccrual government insured commercial loans at September 30, 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

                      
            Residential                    

For the nine months ended September 30, 2018 ($ in millions)

     Commercial        Mortgage       Consumer       Total          

Balance, beginning of period

   $ 306           30       101       437    

Transfers to nonaccrual status

     230           27       106       363    

Transfers to accrual status

     (3)          (18     (49     (70  

Transfers to held for sale

     (25)          -       -       (25  

Loan paydowns/payoffs

     (135)          (6     (24     (165  

Transfers to OREO

     (2)          (8     (5     (15  

Charge-offs

     (125)          (2     (27     (154  

Draws/other extensions of credit

     32           -       -       32          

Balance, end of period

   $                     278           23       102       403          

TABLE 51: Rollforward of Portfolio Nonaccrual Loans and Leases

 

                       
        Residential        

For the nine months ended September 30, 2017 ($ in millions)

     Commercial        Mortgage       Consumer       Total          

Balance, beginning of period

   $ 523           34       103       660    

Transfers to nonaccrual status

     249           38       93       380    

Transfers to accrual status

     (59)          (21     (38     (118  

Transfers to held for sale

     (20)          -       -       (20  

Loan paydowns/payoffs

     (223)          (8     (22     (253  

Transfers to OREO

     (2)          (9     (5     (16  

Charge-offs

     (120)          (3     (29     (152  

Draws/other extensions of credit

     25           -       -       25          

Balance, end of period

   $ 373           31       102       506          

 

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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 $987 million and $927 million at September 30, 2018 and December 31, 2017, respectively. As of September 30, 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 24%, 12% and 38%, 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 September 30, 2018 ($ in millions)

        Current          Past Due      More Past Due        Nonaccruing    Total

Commercial loans(b)

   $       80          -          -          180        260

Residential mortgage loans(a)

         578          49          118          12        757

Home equity

         208          12          -          16        236

Automobile loans

         5          -          -          1        6

Credit card

           14          3          -          26        43

Total

   $       885          64          118          235        1,302

(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 September 30, 2018, these advances represented $345 of current loans, $39 of 30-89 days past due loans and $99 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          -          -          150        399

Residential mortgage loans(a)

         478          52          122          13        665

Home equity

         236          12          -          18        266

Automobile loans

         8          -          -          1        9

Credit card

           16          3          -          26        45

Total

   $       987          67          122          208        1,384

(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 December 31, 2017, these advances represented $282 of current loans, $40 of 30-89 days past due loans and $108 of 90 days or more past due loans.

(b)

Excludes restructured nonaccrual loans held for sale.

Analysis of Net Loan Charge-offs

Net charge-offs were 30 bps and 29 bps of average portfolio loans and leases for the three months ended September 30, 2018 and 2017, respectively, and were 36 bps and 32 bps of average portfolio loans and leases for the nine months ended September 30, 2018 and 2017, respectively. Table 54 provides a summary of credit loss experience and net charge-offs as a percent of average portfolio loans and leases outstanding by loan category.

The ratio of commercial loan and lease net charge-offs to average portfolio commercial loans and leases was 19 bps and 24 bps during the three and nine months ended September 30, 2018, respectively, compared to 21 bps and 22 bps during the three and nine months ended September 30, 2017, respectively.

The ratio of consumer loan net charge-offs to average portfolio consumer loans was 50 bps and 54 bps during the three and nine months ended September 30, 2018, respectively, compared to 43 bps and 48 bps for the three and nine months ended September 30, 2017, respectively. The increases for both the three and nine months ended September 30, 2018 were primarily due to increases in net charge-offs on other consumer loans of $2 million and $9 million, respectively, and increases in net charge-offs on credit card of $1 million and $8 million, respectively, as a result of growth in unsecured loans.

 

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

 

 

TABLE 54: Summary of Credit Loss Experience

               

 

 
          For the three months ended          For the nine months ended    
          September 30,          September 30,    

($ in millions)

       2018            2017            2018            2017        

Losses charged-off:

            

Commercial and industrial loans

  $     (36)            (30)          (119)          (102)    

Commercial mortgage loans

      -              (3)          (5)          (15)    

Commercial leases

      -              -            -            (2)    

Residential mortgage loans

      (3)            (2)          (10)          (12)    

Home equity

      (6)            (6)          (17)          (24)    

Automobile loans

      (15)            (13)          (45)          (42)    

Credit card

      (33)            (23)          (91)          (71)    

Other consumer loans(a)

      (19)            (8)          (47)          (19)    

 

 

Total losses charged-off

  $     (112)            (85)          (334)          (287)    

 

 

Recoveries of losses previously charged-off:

            

Commercial and industrial loans

  $     8             3           17           23     

Commercial mortgage loans

      1             -           2           2     

Residential mortgage loans

      1             3           4           7     

Home equity

      3             3           8           10     

Automobile loans

      6             5           17           16     

Credit card

      12             3           19           7     

Other consumer loans(a)

      9             -           20           1     

 

 

Total recoveries of losses previously charged-off

  $     40             17           87           66     

 

 

Net losses charged-off:

            

Commercial and industrial loans

  $     (28)            (27)          (102)          (79)    

Commercial mortgage loans

      1             (3)          (3)          (13)    

Commercial leases

      -              -            -            (2)    

Residential mortgage loans

      (2)            1           (6)          (5)    

Home equity

      (3)            (3)          (9)          (14)    

Automobile loans

      (9)            (8)          (28)          (26)    

Credit card

      (21)            (20)          (72)          (64)    

Other consumer loans

      (10)            (8)          (27)          (18)    

 

 

Total net losses charged-off

  $     (72)            (68)          (247)          (221)    

 

 

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

            

Commercial and industrial loans

      0.26 %        0.26           0.32           0.26     

Commercial mortgage loans

      (0.03)            0.16           0.05           0.26     

Commercial leases

      -              0.01           -           0.05     

 

 

Total commercial loans and leases

      0.19 %        0.21           0.24           0.22     

 

 

Residential mortgage loans

      0.04             (0.02)          0.05           0.05     

Home equity

      0.16             0.18           0.18           0.26     

Automobile loans

      0.41             0.35           0.41           0.37     

Credit card

      3.53             3.75           4.29           4.00     

Other consumer loans

      1.94             2.80           1.98           2.66     

 

 

Total consumer loans

      0.50 %        0.43           0.54           0.48     

 

 

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

      0.30 %        0.29           0.36           0.32     

 

 

(a)  For the three and nine months ended September 30, 2018, the Bancorp recorded $8 and $18, respectively, in both losses charged-off and recoveries of losses charged-off related to customer defaults on point-of-sale loans for which the Bancorp obtained recoveries under third-party credit enhancements.

    

Allowance for Credit Losses

The allowance for credit losses is comprised of the ALLL and the reserve for unfunded commitments. The ALLL provides coverage for probable and estimable losses in the loan and lease portfolio. The Bancorp evaluates the ALLL each quarter to determine its adequacy to cover inherent losses. Several factors are taken into consideration in the determination of the overall ALLL, including an unallocated component. These factors include, but are not limited to, the overall risk profile of the loan and lease portfolios, net charge-off experience, the extent of impaired loans and leases, the level of nonaccrual loans and leases, the level of 90 days past due loans and leases and the overall level of the ALLL as a percent of portfolio loans and leases. The Bancorp also considers overall asset quality trends, credit administration and portfolio management practices, risk identification practices, credit policy and underwriting practices, overall portfolio growth, portfolio concentrations and current economic conditions that might impact the portfolio. More information on the ALLL can be found in the Critical Accounting Policies section of the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2017.

During the three months ended September 30, 2018, the Bancorp did not substantively change any material aspect of its overall approach in the determination of the ALLL and there have been no material changes in assumptions or estimation techniques as compared to prior periods that impacted the determination of the current period allowance. In addition to the ALLL, the Bancorp maintains a reserve for unfunded commitments recorded in other liabilities in the Condensed Consolidated Balance Sheets. The methodology used to determine the adequacy of this reserve is similar to the Bancorp’s methodology for determining the ALLL. The provision for unfunded commitments is included in other noninterest expense in the Condensed Consolidated Statements of Income.

 

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

 

 

The ALLL attributable to the portion of the residential mortgage and consumer loan and lease portfolio that has not been restructured is determined on a pooled basis with the segmentation based on the similarity of credit risk characteristics. Loss factors for consumer loans are developed for each pool based on the trailing twelve month historical loss rate, as adjusted for certain prescriptive loss rate factors and certain qualitative adjustment factors. The prescriptive loss rate factors and qualitative adjustments are designed to reflect risks associated with current conditions and trends which are not believed to be fully reflected in the trailing twelve month historical loss rate. For real estate backed consumer loans, the prescriptive loss rate factors include adjustments for delinquency trends, LTV trends, refreshed FICO score trends and product mix, and 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 in its footprint and the volatility of collateral valuation trends when determining the collateral value qualitative factor.

The Bancorp’s determination of the ALLL for commercial loans is sensitive to the risk grades it assigns to these loans. In the event that 10% of commercial loans in each risk category would experience a downgrade of one risk category, the allowance for commercial loans would increase by approximately $161 million at September 30, 2018. In addition, the Bancorp’s determination of the ALLL for residential mortgage loans and consumer loans is sensitive to changes in estimated loss rates. In the event that estimated loss rates would increase by 10%, the ALLL for residential mortgage loans and consumer loans would increase by approximately $33 million at September 30, 2018. As several qualitative and quantitative factors are considered in determining the ALLL, these sensitivity analyses do not necessarily reflect the nature and extent of future changes in the ALLL. They are intended to provide insights into the impact of adverse changes to risk grades and estimated loss rates and do not imply any expectation of future deterioration in the risk ratings or loss rates. Given current processes employed by the Bancorp, management believes the risk grades and estimated loss rates currently assigned are appropriate.

 

TABLE 55: Changes in Allowance for Credit Losses

                              

 

 
          For the three months ended          For the nine months ended    
          September 30,          September 30,    
   

 

 

 

($ in millions)

      2018      2017      2018      2017  

 

 

ALLL:

            

Balance, beginning of period

  $     1,077            1,226            1,196            1,253      

Losses charged-off(a)

      (112)           (85)           (334)           (287)     

Recoveries of losses previously charged-off(a)

      40            17            87            66      

Provision for loan and lease losses

      86            67            142            193      

Deconsolidation of a VIE(b)

      -            (20)           -            (20)     

 

 

Balance, end of period

  $     1,091            1,205            1,091            1,205      

 

 

Reserve for unfunded commitments:

            

Balance, beginning of period

  $     131            162            161            161      

Benefit from the reserve for unfunded commitments

      (2)           (5)           (32)           (4)     

 

 

Balance, end of period

  $     129            157            129            157      

 

 

(a)

For the three and nine months ended September 30, 2018, the Bancorp recorded $8 and $18, respectively, in both losses charged-off and recoveries of losses charged-off related to customer defaults on point-of-sale loans for which the Bancorp obtained recoveries under third-party credit enhancements.

(b)

Refer to Note 10 of the Notes to Condensed Consolidated Financial Statements for further discussion on the deconsolidation of a VIE.

Certain inherent but unconfirmed losses are probable within the loan and lease portfolio. The Bancorp’s current methodology for determining the level of losses is based on historical loss rates, current credit grades, specific allocation on impaired commercial credits above specified thresholds and restructured loans and other qualitative adjustments. Due to the heavy reliance on realized historical losses and the credit grade rating process, the model-derived estimate of ALLL tends to slightly lag behind the deterioration in the portfolio in a stable or deteriorating credit environment, and tends not to be as responsive when improved conditions have presented themselves. Given these model limitations, the qualitative adjustment factors may be incremental or decremental to the quantitative model results.

An unallocated component of the ALLL is maintained to recognize the imprecision in estimating and measuring loss. The unallocated allowance as a percent of total portfolio loans and leases was 0.12% and 0.13% at September 30, 2018 and December 31, 2017, respectively. The unallocated allowance was 10% of the total allowance at both September 30, 2018 and December 31, 2017.

As shown in Table 56, the ALLL as a percent of portfolio loans and leases was 1.17% and 1.30% at September 30, 2018 and December 31, 2017, respectively. The ALLL was $1.1 billion and $1.2 billion at September 30, 2018 and December 31, 2017, respectively.

 

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

 

 

TABLE 56: Attribution of Allowance for Loan and Lease Losses to Portfolio Loans and Leases

      

As of ($ in millions)

     September 30, 2018   December 31, 2017

Attributed ALLL:

        

Commercial and industrial loans

   $ 533          651    

Commercial mortgage loans

     73          65    

Commercial construction loans

     29          23    

Commercial leases

     21          14    

Residential mortgage loans

     83          89    

Home equity

     37          46    

Automobile loans

     39          38    

Credit card

     136          117    

Other consumer loans

     31          33    

Unallocated

     109            120      

Total ALLL

   $ 1,091            1,196      

Portfolio loans and leases:

        

Commercial and industrial loans

   $               42,631          41,170    

Commercial mortgage loans

     6,695          6,604    

Commercial construction loans

     4,892          4,553    

Commercial leases

     3,697          4,068    

Residential mortgage loans

     15,585          15,591    

Home equity

     6,485          7,014    

Automobile loans

     9,002          9,112    

Credit card

     2,325          2,299    

Other consumer loans

     2,131            1,559      

Total portfolio loans and leases

   $ 93,443            91,970      

Attributed ALLL as a percent of respective portfolio loans and leases:

        

Commercial and industrial loans

     1.25        1.58    

Commercial mortgage loans

     1.09          0.98    

Commercial construction loans

     0.59          0.51    

Commercial leases

     0.57          0.34    

Residential mortgage loans

     0.53          0.57    

Home equity

     0.57          0.66    

Automobile loans

     0.43          0.42    

Credit card

     5.85          5.09    

Other consumer loans

     1.45          2.12    

Unallocated (as a percent of total portfolio loans and leases)

     0.12            0.13      

Total ALLL as a percent of total portfolio loans and leases

     1.17          1.30      

MARKET RISK MANAGEMENT

Market risk is the day-to-day potential for the value of a financial instrument to increase or decrease due to movements in market factors. The Bancorp’s market risk includes risks resulting from movements in interest rates, foreign exchange rates, equity prices and commodity prices. Interest rate risk, a component of market risk, primarily impacts the Bancorp’s NII and interest sensitive fee income categories through changes in interest income on earning assets and cost of interest-bearing liabilities, and through fee items that are related to interest sensitive activities such as mortgage origination and servicing income. Management considers interest rate risk a prominent market risk in terms of its potential impact on earnings. Interest rate risk may occur for any one or more of the following reasons:

 

 

Assets and liabilities mature or reprice at different times;

 

 

Short-term and long-term market interest rates change by different amounts; or

 

 

The expected maturities of various assets or liabilities shorten or lengthen as interest rates change.

In addition to the direct impact of interest rate changes on NII, interest rates can indirectly impact earnings through their effect on loan and deposit demand, credit losses, mortgage originations, the value of servicing rights and other sources of the Bancorp’s earnings. Stability of the Bancorp’s net income is largely dependent upon the effective management of interest rate risk. Management continually reviews the Bancorp’s balance sheet composition and earnings flows and models the interest rate risk, and possible actions to reduce this risk, given numerous possible future interest rate scenarios. A series of Policy Limits and Key Risk Indicators are employed to ensure that this risk is managed within the Bancorp’s risk tolerance.

Interest Rate Risk Management Oversight

The Bancorp’s ALCO, which includes senior management representatives and is accountable to the ERMC, monitors and manages interest rate risk within Board approved policy limits. In addition to the risk management activities of ALCO, the Bancorp has a Market Risk Management function as part of ERM that provides independent oversight of market risk activities.

Net Interest Income Sensitivity

The Bancorp employs a variety of measurement techniques to identify and manage its interest rate risk, including the use of an NII simulation model to analyze the sensitivity of NII to changes in interest rates. The model is based on contractual and assumed cash flows and repricing characteristics for all of the Bancorp’s assets, liabilities and off-balance sheet exposures and incorporates market-based assumptions regarding the effect of changing interest rates on the prepayment rates of certain assets and attrition rates of certain liabilities. The model also includes senior management’s projections of the future volume and pricing of each of the product lines offered by the Bancorp as well as other pertinent assumptions. Actual results may differ from simulated results due to timing, magnitude and frequency of interest rate changes, deviations from projected assumptions, as well as changes in market conditions and management strategies.

 

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

 

 

As of September 30, 2018, the Bancorp’s interest rate risk exposure is governed by a risk framework that utilizes the change in NII over 12-month and 24-month horizons assuming a 200 bps parallel ramped increase and a 125 bps parallel ramped decrease in interest rates. Additionally, the Bancorp routinely analyzes various potential and extreme scenarios, including ramps, shocks and twists to assess where risks to net interest income persist or develop as changes in the balance sheet and market rates evolve.

In order to recognize the risk of noninterest-bearing demand deposit balance run-off in a rising interest rate environment, the Bancorp’s NII sensitivity modeling assumes that approximately $500 million of balances run-off over 24 months above what is included in senior management’s baseline projections for each 100 bps increase in short-term market interest rates. Similarly, the Bancorp’s NII sensitivity modeling incorporates approximately $500 million of incremental growth in noninterest-bearing deposit balances over 24 months above senior management’s baseline projections for each 100 bps decrease in short-term market interest rates. The incremental balance run-off and growth are modeled to flow into and out of funding products that reprice in conjunction with market rate changes.

Another important deposit modeling assumption is the amount by which interest-bearing deposit rates will increase or decrease when market interest rates increase or decrease. This deposit repricing sensitivity is known as the beta, and it represents the expected amount by which Bancorp deposit rates will change for a given change in short-term market rates. The Bancorp’s NII sensitivity modeling assumes a weighted-average rising rate interest-bearing deposit beta of 70% at September 30, 2018, which is approximately 20 percentage points higher than the average beta that the Bancorp experienced in the last FRB tightening cycle from June 2004 to June 2006 and approximately 35 percentage points higher than the average beta experienced in the current tightening cycle to date. In addition, the Bancorp’s NII sensitivity modeling assumes there is no lag between the timing of changes in market rates and the timing of deposit repricing despite such timing lags having occurred for each rate move thus far in the current tightening cycle.

The Bancorp continually evaluates the sensitivity of its interest rate risk measures to these important deposit modeling assumptions. The Bancorp also regularly monitors the sensitivity of other important modeling assumptions, such as loan and security prepayments and early withdrawals on fixed-rate customer liabilities.

The following table shows the Bancorp’s estimated net interest income sensitivity profile and ALCO policy limits as of:

 

TABLE 57: Estimated NII Sensitivity Profile and ALCO Policy Limits

                       

 

    September 30, 2018           September 30, 2017      
 

 

 

   

 

 

    % Change in NII (FTE)       ALCO Policy Limits       % Change in NII (FTE)           ALCO Policy Limits      
 

 

 

   

 

 

   

 

 

   

 

 

    12     13-24     12     13-24     12     13-24       12     13-24      

Change in Interest Rates (bps)

  Months     Months     Months     Months     Months     Months       Months     Months      

 

+200 Ramp over 12 months

    (0.15 )%      3.45       (4.00)       (6.00)       1.52       4.73       (4.00)       (6.00)    

+100 Ramp over 12 months

    0.02       1.95       N/A       N/A       0.96       3.03       N/A       N/A    

-125 Ramp over 12 months

    (3.72     (9.82     (8.00)       (12.00)       N/A       N/A       N/A       N/A    

-62.5 Ramp over 7 months

    (2.64     (4.92     N/A       N/A       (3.61)       (6.40)       (6.00)       (8.00)    

 

At September 30, 2018, the Bancorp’s NII is near asset/liability neutral in year one and would benefit in year two under the parallel rate ramp increases. The Bancorp’s NII would decline in both year one and year two under the parallel 125 bps ramp decrease in interest rates. The NII sensitivity profile is attributable to the combination of floating-rate assets, including the predominantly floating-rate commercial loan portfolio, and certain intermediate-term fixed-rate liabilities. As the FRB has increased its target range for the federal funds rate, the sensitivity to declining rates has increased, which is a reflection of the balance sheet mix described above. Reductions in the yield of the commercial loan portfolio would be expected to be only partially offset by a decline in the cost of interest-bearing deposits in this scenario. In October of 2018, the Bancorp executed hedges with notional amounts of $4 billion in receive-fixed interest rate swaps and $3 billion in interest rate floors, which reduced the Bancorp’s exposure to falling rates while allowing the balance sheet to remain asset sensitive over the 24-month horizon. The changes in the estimated NII sensitivity profile as of September 30, 2018 compared to September 30, 2017 were primarily attributable to an increase in outstanding taxable securities balances, the addition of receive-fixed swaps against floating-rate commercial loans, the addition of forward starting floors against one-month LIBOR, and a decrease in outstanding fixed-rate long-term debt. These items were partially offset by an increase in core deposit balances and a reduction in fixed-rate commercial leases and residential mortgages.

Tables 58 and 59 provide the Bancorp’s estimated NII profile at September 30, 2018 with changes to certain deposit balances and deposit repricing sensitivity (betas) assumptions.

 

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

 

 

The following table includes the Bancorp’s estimated NII sensitivity profile at September 30, 2018 with an immediate $1 billion decrease and an immediate $1 billion increase in demand deposit balances:

TABLE 58: Estimated NII Sensitivity Profile at September 30, 2018 with a $1 Billion Change in Demand Deposit Assumption

     % Change in NII (FTE)         
    Immediate $1 Billion Balance      
Decrease
        Immediate $1 Billion Balance
Increase
        

Change in Interest Rates (bps)

 

12

Months

   

13-24

Months

        

12

Months

    13-24
Months
        

+200 Ramp over 12 months

    (0.38 )%      3.00         0.09       3.90    

+100 Ramp over 12 months

    (0.10     1.73         0.13       2.18    

-125 Ramp over 12 months

    (3.87     (10.10         (3.58     (9.54        

The following table includes the Bancorp’s estimated NII sensitivity profile at September 30, 2018 with a 25% increase and a 25% decrease to the rising rate deposit beta assumptions as of September 30, 2018. The resulting weighted-average interest-bearing deposit betas included in this analysis were approximately 88% and 53%, respectively, as of September 30, 2018:

TABLE 59: Estimated NII Sensitivity Profile at September 30, 2018 with Deposit Beta Assumptions

     % Change in NII (FTE)          
                Betas 25% Higher                              Betas 25% Lower                  

Change in Interest Rates (bps)

 

12

Months

   

13-24

Months

        

12

Months

     13-24
Months
         

+200 Ramp over 12 months

    (3.02 )%      (2.08       2.72        8.97     

+100 Ramp over 12 months

    (1.42     (0.79         1.45        4.69           

Economic Value of Equity Sensitivity

The Bancorp also uses EVE as a measurement tool in managing interest rate risk. Whereas the NII sensitivity analysis highlights the impact on forecasted NII on an FTE basis (non-GAAP) over one and two year time horizons, EVE is a point in time analysis of the economic sensitivity of current positions that incorporates all cash flows over their estimated remaining lives. The EVE of the balance sheet is defined as the discounted present value of all asset and net derivative cash flows less the discounted value of all liability cash flows. Due to this longer horizon, the sensitivity of EVE to changes in the level of interest rates is a measure of longer-term interest rate risk. EVE values only the current balance sheet and does not incorporate the balance growth assumptions used in the NII sensitivity analysis. As with the NII simulation model, assumptions about the timing and variability of existing balance sheet cash flows are critical in the EVE analysis. Particularly important are assumptions driving loan and security prepayments and the expected balance attrition and pricing of transaction deposits.

The following table shows the Bancorp’s estimated EVE sensitivity profile as of:

TABLE 60: Estimated EVE Sensitivity Profile

             September 30, 2018                               September 30, 2017         

Change in Interest Rates (bps)

 

% Change in EVE

   

ALCO

Policy Limit

   

 

 

% Change in EVE

 

ALCO

    Policy Limit

 

+200 Shock

    (6.00)     (12.00)         (4.11)       (12.00)  

+100 Shock

    (2.75)       N/A         (1.43)       N/A  

+25 Shock

    N/A       N/A         (0.16)       N/A  

-100 Shock

    0.54       N/A           (1.67)       N/A  

The EVE sensitivity to the +200 bps rising rate scenario is moderately negative at September 30, 2018 and slightly positive to a 100 bps decline in market rates. The changes in the estimated EVE sensitivity profile from September 30, 2017 were primarily related to an increase in the outstanding taxable securities balances, migration from noninterest-bearing deposits to interest-bearing deposits with higher attrition assumptions and the addition of receive-fixed swaps against floating-rate commercial loans. These items were partially offset by net run-off of the fixed-rate commercial lease and residential mortgage portfolios.

While an instantaneous shift in interest rates is used in this analysis to provide an estimate of exposure, the Bancorp believes that a gradual shift in interest rates would have a much more modest impact. Since EVE measures the discounted present value of cash flows over the estimated lives of instruments, the change in EVE does not directly correlate to the degree that earnings would be impacted over a shorter time horizon (e.g., the current fiscal year). Further, EVE does not take into account factors such as future balance sheet growth, changes in product mix, changes in yield curve relationships and changing product spreads that could mitigate or exacerbate the impact of changes in interest rates. The NII simulations and EVE analyses do not necessarily include certain actions that management may undertake to manage risk in response to actual changes in interest rates.

The Bancorp regularly evaluates its exposures to a static balance sheet forecast, LIBOR, Prime Rate and other basis risks, yield curve twist risks and embedded options risks. In addition, the impacts on NII on an FTE basis and EVE of extreme changes in interest rates are modeled, wherein the Bancorp employs the use of yield curve shocks and environment-specific scenarios.

 

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

 

 

Use of Derivatives to Manage Interest Rate Risk

An integral component of the Bancorp’s interest rate risk management strategy is its use of derivative instruments to minimize significant fluctuations in earnings caused by changes in market interest rates. Examples of derivative instruments that the Bancorp may use as part of its interest rate risk management strategy include interest rate swaps, interest rate floors, interest rate caps, forward contracts, forward starting interest rate swaps, options, swaptions and TBA securities.

As part of its overall risk management strategy relative to its residential mortgage banking activities, the Bancorp enters into forward contracts accounted for as free-standing derivatives to economically hedge IRLCs that are also considered free-standing derivatives. Additionally, the Bancorp economically hedges its exposure to residential mortgage loans held for sale through the use of forward contracts and mortgage options.

The Bancorp also enters into derivatives contracts with major financial institutions to economically hedge market risks assumed in interest rate derivative contracts with commercial customers. Generally, these contracts have similar terms in order to protect the Bancorp from market volatility. Credit risk arises from the possible inability of counterparties to meet the terms of their contracts, which the Bancorp minimizes through collateral arrangements, approvals, limits and monitoring procedures. For further information including the notional amount and fair values of these derivatives, refer to Note 12 of the Notes to Condensed Consolidated Financial Statements.

Portfolio Loans and Leases and Interest Rate Risk

Although the Bancorp’s portfolio loans and leases contain both fixed and floating/adjustable-rate products, the rates of interest earned by the Bancorp on the outstanding balances are generally established for a period of time. The interest rate sensitivity of loans and leases is directly related to the length of time the rate earned is established.

The following table summarizes the carrying value of the Bancorp’s portfolio loans and leases expected cash flows, excluding interest receivable, as of September 30, 2018:

 

TABLE 61: Portfolio Loans and Leases Expected Cash Flows

                       

($ in millions)

   Less than 1 year    1-5 years    Over 5 years    Total      

Commercial and industrial loans

     $ 23,405                18,204        1,022        42,631     

Commercial mortgage loans

       2,496                3,576        623        6,695     

Commercial construction loans

       2,081                2,676        135        4,892     

Commercial leases

       870                1,682        1,145        3,697           

Total commercial loans and leases

       28,852                26,138        2,925        57,915           

Residential mortgage loans

       2,270                6,278        7,037        15,585     

Home equity

       1,628                3,299        1,558        6,485     

Automobile loans

       3,737                4,898        367        9,002     

Credit card

       465                1,860        -        2,325     

Other consumer loans

       1,432                643        56        2,131           

Total consumer loans

       9,532                16,978        9,018        35,528           

Total portfolio loans and leases

     $               38,384                    43,116        11,943        93,443           

Additionally, the following table displays a summary of expected cash flows, excluding interest receivable, occurring after one year for both fixed and floating/adjustable-rate loans and leases as of September 30, 2018:

 

TABLE 62: Portfolio Loans and Leases Expected Cash Flows Occurring After 1 Year

    Interest Rate

($ in millions)

  Fixed            Floating or Adjustable        

Commercial and industrial loans

    $ 2,482        16,744

Commercial mortgage loans

      893        3,306

Commercial construction loans

      31        2,780

Commercial leases

      2,827        -

Total commercial loans and leases

      6,233        22,830

Residential mortgage loans

      10,033        3,282

Home equity

      476        4,381

Automobile loans

      5,235        30

Credit card

      454        1,406

Other consumer loans

      424        275

Total consumer loans

      16,622        9,374

Total portfolio loans and leases

    $                     22,855        32,204

Residential Mortgage Servicing Rights and Interest Rate Risk

The fair value of the residential MSR portfolio was $1 billion and $858 million at September 30, 2018 and December 31, 2017, respectively. The value of servicing rights can fluctuate sharply depending on changes in interest rates and other factors. Generally, as interest rates decline and loans are prepaid to take advantage of refinancing, the total value of existing servicing rights declines because no further servicing fees are collected on repaid loans. The Bancorp maintains a non-qualifying hedging strategy relative to its mortgage banking activity in order to manage a portion of the risk associated with changes in the value of its MSR portfolio as a result of changing interest rates.

 

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

 

 

Mortgage rates increased during both the three and nine months ended September 30, 2018 which caused modeled prepayment speeds to slow. The fair value of the MSR increased $25 million and $103 million, respectively, due to changes to inputs to the valuation model including prepayment speeds and OAS spread assumptions and decreased $33 million and $95 million, respectively, due to the passage of time, including the impact of regularly scheduled repayments, paydowns and payoffs for the three and nine months ended September 30, 2018.

Mortgage rates decreased during both the three and nine months ended September 30, 2017 which caused modeled prepayments speeds to increase, which led to fair value adjustments on servicing rights. The fair value of the MSR decreased $2 million and $15 million, respectively, due to changes to inputs to the valuation model including prepayment speeds and OAS spread assumptions and decreased $32 million and $89 million, respectively, due to the passage of time, including the impact of regularly scheduled repayments, paydowns and payoffs for the three and nine months ended September 30, 2017.

The Bancorp recognized net losses of $25 million and $107 million, respectively, on its non-qualifying hedging strategy for the three and nine months ended September 30, 2018 compared to net gains of $3 million and $20 million, respectively, during the three and nine months ended September 30, 2017. These amounts include net losses on securities related to the Bancorp’s non-qualifying hedging strategy which were $1 million and $18 million, respectively, during the three and nine months ended September 30, 2018 and net gains of $2 million and $4 million, respectively, during the three and nine months ended September 30, 2017. The Bancorp may adjust its hedging strategy to reflect its assessment of the composition of its MSR portfolio, the cost of hedging and the anticipated effectiveness of the hedges given the economic environment. Refer to Note 11 of the Notes to Condensed Consolidated Financial Statements for further discussion on servicing rights and the instruments used to hedge interest rate risk on MSRs.

Foreign Currency Risk

The Bancorp may enter into foreign exchange derivative contracts to economically hedge certain foreign denominated loans. The derivatives are classified as free-standing instruments with the revaluation gain or loss being recorded in other noninterest income in the Condensed Consolidated Statements of Income. The balance of the Bancorp’s foreign denominated loans at September 30, 2018 and December 31, 2017 was $984 million and $939 million, respectively. The Bancorp also enters into foreign exchange contracts for the benefit of commercial customers to hedge their exposure to foreign currency fluctuations. Similar to the hedging of interest rate risk from interest rate derivative contracts, the Bancorp also enters into foreign exchange contracts with major financial institutions to economically hedge a substantial portion of the exposure from client driven foreign exchange activity. The Bancorp has risk limits and internal controls in place to help ensure excessive risk is not being taken in providing this service to customers. These controls include an independent determination of currency volatility and credit equivalent exposure on these contracts, counterparty credit approvals and country limits performed by the Capital Markets Credit department and Capital Markets Risk department.

Commodity Risk

The Bancorp also enters into commodity contracts for the benefit of commercial customers to hedge their exposure to commodity price fluctuations. Similar to the hedging of foreign exchange and interest rate risk from interest rate derivative contracts, the Bancorp also enters into commodity contracts with major financial institutions to economically hedge a substantial portion of the exposure from client driven commodity activity. The Bancorp may also offset this risk with exchange-traded commodity contracts. The Bancorp has risk limits and internal controls in place to help ensure excessive risk is not taken in providing this service to customers. These controls include an independent determination of commodity volatility and credit equivalent exposure on these contracts and counterparty credit approvals performed by the Capital Markets Credit department and Capital Markets Risk department.

LIQUIDITY RISK MANAGEMENT

The goal of liquidity management is to provide adequate funds to meet changes in loan and lease demand, unexpected levels of deposit withdrawals and other contractual obligations. Mitigating liquidity risk is accomplished by maintaining liquid assets in the form of cash and investment securities, maintaining sufficient unused borrowing capacity in the debt markets and delivering consistent growth in core deposits. A summary of certain obligations and commitments to make future payments under contracts is included in Note 16 of the Notes to Condensed Consolidated Financial Statements.

The Bancorp’s Treasury department manages funding and liquidity based on point-in-time metrics as well as forward-looking projections, which incorporate different sources and uses of funds under base and stress scenarios. Liquidity risk is monitored and managed by the Treasury department and a series of Policy Limits and Key Risk Indicators are established to ensure risks are managed within the Bancorp’s risk tolerance. The Bancorp maintains a contingency funding plan that provides for liquidity stress testing, which assesses the liquidity needs under varying market conditions, time horizons, asset growth rates and other events. The contingency plan provides for ongoing monitoring of unused borrowing capacity and available sources of contingent liquidity to prepare for unexpected liquidity needs and to cover unanticipated events that could affect liquidity. The contingency plan also outlines the Bancorp’s response to various levels of liquidity stress and actions that should be taken during various scenarios.

Liquidity Risk Management Oversight

The Bancorp’s ALCO, which includes senior management representatives and is accountable to the ERMC, monitors and manages liquidity and funding risk within Board-approved policy limits. In addition to the risk management activities of ALCO, the Bancorp has a Market Risk Management function as part of ERM that provides independent oversight of liquidity risk management.

Sources of Funds

The Bancorp’s primary sources of funds relate to cash flows from loan and lease repayments, payments from securities related to sales and maturities, the sale or securitization of loans and leases and funds generated by core deposits, in addition to the use of public and private debt offerings.

 

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

 

 

Table 61 of the Market Risk Management subsection of the Risk Management section of MD&A illustrates the expected maturities from loan and lease repayments. Of the $31.8 billion of securities in the Bancorp’s available-for-sale debt and other securities portfolio at September 30, 2018, $3.1 billion in principal and interest is expected to be received in the next 12 months and an additional $3.1 billion is expected to be received in the next 13 to 24 months. For further information on the Bancorp’s securities portfolio, refer to the Investment Securities subsection of the Balance Sheet Analysis section of MD&A.

Asset-driven liquidity is provided by the Bancorp’s ability to sell or securitize loans and leases. In order to reduce the exposure to interest rate fluctuations and to manage liquidity, the Bancorp has developed securitization and sale procedures for several types of interest-sensitive assets. A majority of the long-term, fixed-rate single-family residential mortgage loans underwritten according to FHLMC or FNMA guidelines are sold for cash upon origination. Additional assets such as certain other residential mortgage loans, certain commercial loans, home equity loans, automobile loans and other consumer loans are also capable of being securitized or sold. The Bancorp sold or securitized loans totaling $1.7 billion and $4.3 billion during the three and nine months ended September 30, 2018, respectively, compared to $2.6 billion and $5.8 billion during the three and nine months ended September 30, 2017, respectively. For further information on the transfer of financial assets, refer to Note 11 of the Notes to Condensed Consolidated Financial Statements.

Core deposits have historically provided the Bancorp with a sizeable source of relatively stable and low-cost funds. The Bancorp’s average core deposits and average shareholders’ equity funded 83% of its average total assets for both the three and nine months ended September 30, 2018 and 82% and 83% for the three and nine months ended September 30, 2017, respectively. In addition to core deposit funding, the Bancorp also accesses a variety of other short-term and long-term funding sources, which include the use of the FHLB system. Certificates $100,000 and over and certain deposits in the Bancorp’s foreign branch located in the Cayman Islands are wholesale funding tools utilized to fund asset growth. Management does not rely on any one source of liquidity and manages availability in response to changing balance sheet needs.

As of September 30, 2018, $7.3 billion of debt or other securities were available for issuance under the current Bancorp’s Board of Directors’ authorizations and the Bancorp is authorized to file any necessary registration statements with the SEC to permit ready access to the public securities markets; however, access to these markets may depend on market conditions. During the nine months ended September 30, 2018, the Bancorp issued and sold $900 million of senior notes.

The Bank’s global bank note program has a borrowing capacity of $25.0 billion, of which $17.0 billion was available for issuance as of September 30, 2018. During the nine months ended September 30, 2018, the Bank issued and sold $1.55 billion of senior bank notes. Additionally, at September 30, 2018, the Bank had approximately $44.3 billion of borrowing capacity available through secured borrowing sources including the FHLB and FRB.

Liquidity Coverage Ratio and Net Stable Funding Ratio

The Bancorp is subject to the Modified LCR requirement, which stipulates that BHCs with at least $50 billion but less than $250 billion in total consolidated assets that are not internationally active, such as the Bancorp, maintain HQLA equal to their calculated net cash outflows over a 30 calendar-day stress period multiplied by a factor of 0.7. The Bancorp’s Modified LCR was 119% at September 30, 2018.

On June 1, 2016, the U.S. banking agencies published a notice of proposed rulemaking to implement a modified NSFR for certain bank holding companies with at least $50 billion but less than $250 billion in total consolidated assets and with less than $10 billion in on-balance sheet foreign exposures, including the Bancorp. Generally consistent with the BCBS’ framework, under the proposed rule banking organizations would be required to hold an amount of ASF over a one-year time horizon that equals or exceeds the institution’s amount of RSF, with the ASF representing the numerator and the RSF representing the denominator of the NSFR. Banking organizations subject to the modified NSFR would multiply the RSF amount by 70%, such that the RSF amount required for these institutions would be equivalent to 70% of the RSF amount that would be required pursuant to the full NSFR generally applicable to institutions with at least $250 billion in total consolidated assets or $10 billion or more in on-balance sheet foreign exposures under the proposed rule. The comment period for this proposal ended on August 5, 2016.

On October 31, 2018, the Board of Governors of the FRB released a series of regulatory proposals to implement the Economic Growth, Regulatory Relief, and Consumer Protection Act (“Reform Act”). Among the proposals, the Board of Governors, joined by the Department of Treasury, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation proposed to remove the application of the LCR regulations and the NSFR from certain BHCs that qualify under the proposal as “Category IV” institutions, primarily those BHCs with consolidated assets between $100 billion and $250 billion, including Fifth Third Bancorp.

The NPR is open for public comment and could be further amended by the FRB and other financial regulators prior to adoption. As such, the ultimate impacts of the NPR to Fifth Third Bancorp, Fifth Third Bank and their respective subsidiaries and activities will be subject to the final form of these NPRs and additional rulemakings issued. Fifth Third cannot predict future changes in the applicable laws, regulations and regulatory agency policies, yet such changes may have a material effect on its business, financial condition or results of operations.

Credit Ratings

The cost and availability of financing to the Bancorp and Bank are impacted by its credit ratings. A downgrade to the Bancorp’s or Bank’s credit ratings could affect its ability to access the credit markets and increase its borrowing costs, thereby adversely impacting the Bancorp’s or Bank’s financial condition and liquidity. Key factors in maintaining high credit ratings include a stable and diverse earnings stream, strong credit quality, strong capital ratios and diverse funding sources, in addition to disciplined liquidity monitoring procedures.

The Bancorp’s and Bank’s credit ratings are summarized in Table 63. The ratings reflect the ratings agency’s view on the Bancorp’s and Bank’s capacity to meet financial commitments.*

*As an investor, you should be aware that a security rating is not a recommendation to buy, sell or hold securities, that it may be subject to revision or withdrawal at any time by the assigning rating organization and that each rating should be evaluated independently of any other rating. Additional information on the credit rating ranking within the overall classification system is located on the website of each credit rating agency.

 

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

 

 

TABLE 63: Agency Ratings

                       

As of November 6, 2018

   Moody’s    Standard and Poor’s    Fitch    DBRS

Fifth Third Bancorp:

           

Short-term borrowings

   No rating    A-2    F1    R-1L

Senior debt

   Baa1    BBB+    A-    A

Subordinated debt

   Baa1    BBB    BBB+    AL

Fifth Third Bank:

           

Short-term borrowings

   P-2    A-2    F1    R-1M

Short-term deposit

   P-1    No rating    F1    No rating

Long-term deposit

   Aa3    A-    A    AH

Senior debt

   A3    A-    A-    AH

Subordinated debt

   Baa1    BBB+    BBB+    A

Rating Agency Outlook for Fifth Third Bancorp and Fifth Third Bank:

   Stable    Stable    Stable    Stable

 

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

 

 

OPERATIONAL RISK MANAGEMENT

Operational risk is the risk of loss resulting from inadequate or failed processes or systems or due to external events that are neither market nor credit-related. Operational risk is inherent in the Bancorp’s activities and can manifest itself in various ways including fraudulent acts, business interruptions, inappropriate behavior of employees, unintentional failure to comply with applicable laws and regulations, cyber-security incidents and privacy breaches or failure of vendors to perform in accordance with their arrangements. These events could result in financial losses, litigation and regulatory fines, as well as other damage to the Bancorp. The Bancorp’s risk management goal is to keep operational risk at appropriate levels consistent with the Bancorp’s risk appetite, financial strength, the characteristics of its businesses, the markets in which it operates and the competitive and regulatory environment to which it is subject.

To control, monitor and govern operational risk, the Bancorp maintains an overall Risk Management Framework which comprises governance oversight, risk assessment, capital measurement, monitoring and reporting as well as a formal three lines of defense approach. ERM is responsible for prescribing the framework to the lines of business and corporate functions, and to provide independent oversight of its implementation (second line of defense). Business Controls groups are in place in each of the lines of business to ensure consistent implementation and execution of managing day-to-day operational risk (first line of defense).

The Bancorp’s risk management framework consists of five integrated components, including identifying, assessing, managing, monitoring and independent governance reporting of risk. The corporate Operational Risk Management function within Enterprise Risk is responsible for developing and overseeing the implementation of the Bancorp’s approach to managing operational risk. This includes providing governance, awareness and training, tools, guidance and oversight to support implementation of key risk programs and systems as they relate to operational risk management, such as risk and control self-assessments, new product/initiative risk reviews, key risk indicators, Vendor Risk Management, cyber security risk management and review of operational losses. The function is also responsible for developing reports that support the proactive management of operational risk across the enterprise. The lines of business and corporate functions are responsible for managing the operational risks associated with their areas in accordance with the risk management framework. The framework is intended to enable the Bancorp to function with a sound and well-controlled operational environment. These processes support the Bancorp’s goals to minimize future operational losses and strengthen the Bancorp’s performance by maintaining sufficient capital to absorb operational losses that are incurred.

The Bancorp also maintains a robust information security program to support the management of cyber security risk within the organization with a focus on prevention, detection and recovery processes. Fifth Third utilizes a wide array of techniques to secure its operations and proprietary information such as Board-approved policies and programs, network monitoring and testing, access controls and dedicated security personnel. Fifth Third has adopted the National Institute of Standards and Technology Cyber Security Framework for the management and deployment of cyber security controls and is an active participant in the financial sector information sharing organization structure, known as the Financial Services Information Sharing and Analysis Center. To ensure resiliency of key Bancorp functions, Fifth Third also employs redundancy protocols that include a robust business continuity function that works to mitigate any potential impacts to Fifth Third customers and its systems.

Fifth Third also focuses on the reporting and escalation of operational control issues to senior management and the Board of Directors. The Operational Risk Committee is the key committee that oversees and supports Fifth Third in the management of operational risk across the enterprise. The Operational Risk Committee reports to the ERMC, which reports to the Risk and Compliance Committee of the Board of Directors.

COMPLIANCE RISK MANAGEMENT

Regulatory compliance risk is defined as the risk of legal or regulatory sanctions, financial loss or damage to reputation as a result of noncompliance with (i) applicable laws, regulations, rules and other regulatory requirements (including but not limited to the risk of consumers experiencing economic loss or other legal harm as a result of noncompliance with consumer protection laws, regulations and requirements); (ii) internal policies and procedures, standards of best practice or codes of conduct; and (iii) principles of integrity and fair dealing applicable to Fifth Third’s activities and functions. Fifth Third focuses on managing regulatory compliance risk in accordance with the Bancorp’s integrated risk management framework, which ensures consistent processes for identifying, assessing, managing, monitoring and reporting risks. The Bancorp’s risk management goal is to keep compliance risk at appropriate levels consistent with the Bancorp’s risk appetite.

To mitigate compliance risk, Compliance Risk Management provides independent oversight to ensure consistency and sufficiency in the execution of the program, and ensures that lines of business, regions and support functions are adequately identifying, assessing and monitoring compliance risks and adopting proper mitigation strategies. The lines of business and enterprise functions are responsible for managing the compliance risks associated with their areas. Additionally, the Chief Compliance Officer is responsible for establishing and overseeing the Compliance Risk Management program which implements key compliance processes, including but not limited to, executive- and board-level governance and reporting routines, compliance-related policies, risk assessments, key risk indicators, issues tracking, regulatory compliance testing and monitoring, anti-money laundering, privacy and, in partnership with the Community and Economic Development team, oversees the Bancorp’s compliance with the Community Reinvestment Act.

Fifth Third also focuses on the reporting and escalation of compliance issues to senior management and the Board of Directors. The Management Compliance Committee, which is chaired by the Chief Compliance Officer, is the key committee that oversees and supports Fifth Third in the management of compliance risk across the enterprise. The Management Compliance Committee oversees Fifth Third-wide compliance issues, industry best practices, legislative developments (in coordination with the Regulatory Change Management Committee), regulatory concerns and other leading indicators of compliance risk. The Management Compliance Committee reports to the ERMC, which reports to the Risk and Compliance Committee of the Board of Directors.

 

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

 

 

CAPITAL MANAGEMENT

Management regularly reviews the Bancorp’s capital levels to help ensure it is appropriately positioned under various operating environments. The Bancorp has established a Capital Committee which is responsible for making capital plan recommendations to management. These recommendations are reviewed by the ERMC and the annual capital plan is approved by the Board of Directors. The Capital Committee is responsible for execution and oversight of the capital actions of the capital plan.

Regulatory Capital Ratios

The Basel III Final Rule sets minimum regulatory capital ratios as well as defines the measure of “well-capitalized”.

 

TABLE 64: Prescribed Capital Ratios

 
      Minimum     Well-Capitalized        

CET1 capital

     4.50  %      6.50      

Tier I risk-based capital

     6.00       8.00      

Total risk-based capital

     8.00       10.00      

Tier I leverage

     4.00       5.00      

On January 1, 2016, the Bancorp became subject to a capital conservation buffer which will be phased in over a three-year period ending January 1, 2019. Once fully phased-in, the capital conservation buffer will be 2.5% in addition to the minimum capital ratios, in order to avoid limitations on certain capital distributions and discretionary bonus payments to executive officers. The capital conservation buffer was 0.625% in 2016, 1.25% in 2017 and is 1.875% in 2018. The Bancorp exceeded these “well-capitalized” and “capital conservation buffer” ratios for all periods presented.

In April 2018, the federal banking regulators proposed transitional arrangements to permit banking organizations to phase in the day-one impact of the adoption of ASU 2016-13, referred to as the current expected credit loss model, on regulatory capital over a period of three years. For additional information on ASU 2016-13, refer to Note 3 of the Notes to Condensed Consolidated Financial Statements. The Bancorp is evaluating the impact of this proposal.

The following table summarizes the Bancorp’s capital ratios as of:    

 

TABLE 65: Capital Ratios

 

($ in millions)

   September 30, 2018     December 31, 2017      

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

     11.39  %      11.69      

Tangible equity as a percent of tangible assets(a)

     10.07       9.90      

Tangible common equity as a percentage of tangible assets(a)(c)

     9.12       8.94      
     Basel III(b)                              

CET1 capital

   $ 12,809       12,517      

Tier I capital

     14,140       13,848      

Total regulatory capital

     17,932       17,887      

Risk-weighted assets

     120,002       117,997      

Regulatory capital ratios:

    

CET1 capital

     10.67  %      10.61      

Tier I risk-based capital

     11.78       11.74      

Total risk-based capital

     14.94       15.16      

Tier I leverage

     10.10       10.01      

(a)

These are non-GAAP measures. For further information, refer to the Non-GAAP Financial Measures section of MD&A.

(b)

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 resulting in the Bancorp’s total risk-weighted assets. Under the banking agencies’ Final Rule published in November 2017 pertaining to certain regulatory items for banks subject to the standardized approach, the Bancorp is no longer subject to certain transition provisions and phase-outs beyond 2017.

(c)

Excludes unrealized gains and losses.

Stress Tests and CCAR

In 2011 the FRB adopted the capital plan rule, which requires BHCs with consolidated assets of $50 billion or more to submit annual capital plans to the FRB for review. Under the rule, these capital plans must include detailed descriptions of the following: the BHC’s internal processes for assessing capital adequacy; the policies governing capital actions such as common stock issuances, dividends and share repurchases; and all planned capital actions over a nine-quarter planning horizon. Further, each BHC must also report to the FRB the results of stress tests conducted by the BHC under a number of scenarios that assess the sources and uses of capital under baseline and stressed economic scenarios. The FRB launched the 2018 stress testing program and CCAR on February 1, 2018, with submissions of stress test results and capital plans to the FRB due on April 5, 2018, which the Bancorp submitted as required.

The FRB’s review of the capital plan assessed the comprehensiveness of the capital plan, the reasonableness of the assumptions and the analysis underlying the capital plan. Additionally, the FRB reviewed the robustness of the capital adequacy process, the capital policy and the Bancorp’s ability to maintain capital above each minimum regulatory capital ratio on a pro forma basis under expected and stressful conditions throughout the planning horizon.

 

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

 

 

On June 28, 2018, the Bancorp announced the results of its capital plan submitted to the FRB as part of the 2018 CCAR. For BHCs that proposed capital distributions in their plans, the FRB either objected to the plan or provided a non-objection whereby the FRB permitted the proposed capital distributions. The FRB indicated to the Bancorp that it did not object to the following capital actions for the period beginning July 1, 2018 and ending June 30, 2019:

 

 

 

The increase in the quarterly common stock dividend to $0.22 from $0.18 beginning in the fourth quarter of 2018 and to $0.24 beginning in the second quarter of 2019, a 33% increase over the current dividend rate;

 

 

The repurchase of common shares in an amount up to $1.651 billion, or a 42% increase over the 2017 capital plan. These repurchases include $81 million in repurchases related to share issuances under employee benefit plans and $53 million in repurchases related to previously-recognized TRA transaction after-tax gains;

 

 

The additional ability to repurchase common shares in the amount of any after-tax capital generated from the sale of Worldpay, Inc. common stock;

 

 

The additional ability to repurchase common shares in the amount of any after-tax cash income generated from the termination and settlement of gross cash flows from existing TRAs with Worldpay, Inc. or potential future TRAs that may be generated from additional sales of Worldpay, Inc.

On May 21, 2018, the Bancorp announced the planned acquisition of MB Financial. As a result of this transaction, the FRB required the Bancorp to resubmit its CCAR plan recognizing the pro forma impact of the combined Fifth Third MB Financial post-merger entity. Fifth Third resubmitted its capital plan to the FRB on October 5, 2018. The FRB is currently evaluating the resubmission. In the meantime, Fifth Third has resumed capital distribution activities consistent with its original capital plan submitted in April 2018.

Additionally, as a CCAR institution, the Bancorp is required to disclose the results of its company-run stress test under the supervisory adverse and supervisory severely adverse scenarios and to provide information related to the types of risk included in its stress testing, a description of the methodologies used, estimates of certain financial results and pro forma capital ratios, and an explanation of the most significant causes of changes in regulatory capital ratios. On June 21, 2018, the Bancorp publicly disclosed the results of its company-run stress test as required by the DFA stress testing rules, which are available on Fifth Third’s website at www.53.com. With Fifth Third’s designation as a Large and Non-complex Bank, it is no longer subject to the qualitative aspects of the CCAR program. It is, however, subject to the FRB’s Horizontal Capital Review, which was conducted in the third quarter of 2018.

In April 2018, the FRB proposed to introduce stress buffer requirements. Under the proposal, a SCB would replace the 2.5% capital conservation buffer. The SCB would reflect stressed losses in the supervisory severely adverse scenario of the FRB’s CCAR stress tests plus four quarters of planned common stock dividends, subject to a floor of 2.5%. The proposal would also introduce a SLB requirement, analogous to the SCB, that would apply to the Tier I leverage ratio. In addition, the proposal would require BHCs to reduce their planned capital distributions if those distributions would not be consistent with the applicable capital buffer constraints based on the BHCs’ own baseline scenario projections. The proposal is applicable for BHCs with $50 billion or more in total consolidated assets, including the Bancorp. Under the proposal, a BHC’s first SCB and SLB requirements would become effective on October 1, 2019. The Bancorp is evaluating the impact of this proposal.

Dividend Policy and Stock Repurchase Program

The Bancorp’s common stock dividend policy and stock repurchase program reflect its earnings outlook, desired payout ratios, the need to maintain adequate capital levels, the ability of its subsidiaries to pay dividends, the need to comply with safe and sound banking practices as well as meet regulatory requirements and expectations. The Bancorp declared dividends per common share of $0.18 and $0.16 for the three months ended September 30, 2018 and 2017, respectively, and $0.52 and $0.44 for the nine months ended September 30, 2018 and 2017, respectively. As contemplated by the 2017 CCAR, during the third quarter of 2018, the Bancorp settled $500 million of open market share repurchase transactions. Refer to Note 15 of the Notes to Condensed Consolidated Financial Statements for additional information on share repurchase activity.

The following table summarizes the monthly share repurchase activity for the three months ended September 30, 2018:

 

TABLE 66: Share Repurchases

                               

Period

   Total Number
of Shares
Purchased(a)
     Average Price
Paid Per Share
     Total Number of Shares
Purchased as Part of
Publicly Announced Plans
or Programs
     Maximum Number of
Shares that May Yet be
Purchased Under the Plans
or Programs(b)
 

July 1, 2018 - July 31, 2018

     10,206,897      $ 29.29        10,131,123        82,294,511  

August 1, 2018 - August 31, 2018

     6,846,815        29.80        6,813,897        75,480,614  

September 1, 2018 - September 30, 2018

     17,839        26.59        -        75,480,614  

Total

     17,071,551      $ 29.50        16,945,020        75,480,614  

(a)

Includes 126,531 shares repurchased during the third quarter of 2018 in connection with various employee compensation plans. These purchases do not count against the maximum number of shares that may yet be purchased under the Board of Directors’ authorization.

(b)

During the first quarter of 2018, the Bancorp announced that its Board of Directors had authorized management to purchase 100 million shares of the Bancorp’s common stock through the open market or in any private party transactions. The authorization does not include specific price targets or an expiration date.

 

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

 

 

OFF-BALANCE SHEET ARRANGEMENTS

In the ordinary course of business, the Bancorp enters into financial transactions that are considered off-balance sheet arrangements as they involve varying elements of market, credit and liquidity risk in excess of the amounts recognized in the Bancorp’s Condensed Consolidated Balance Sheets. The Bancorp’s off-balance sheet arrangements include commitments, guarantees, contingent liabilities and transactions with non-consolidated VIEs. A brief discussion of these transactions is as follows:

Commitments

The Bancorp has certain commitments to make future payments under contracts, including commitments to extend credit, letters of credit, forward contracts related to residential mortgage loans held for sale, noncancelable operating lease obligations, purchase obligations, capital commitments for private equity investments, capital expenditures and capital lease obligations. Refer to Note 16 of the Notes to Condensed Consolidated Financial Statements for additional information on commitments.

Guarantees and Contingent Liabilities

The Bancorp has performance obligations upon the occurrence of certain events provided in certain contractual arrangements, including residential mortgage loans sold with representation and warranty provisions or credit recourse. Refer to Note 16 of the Notes to Condensed Consolidated Financial Statements for additional information on guarantees and contingent liabilities.

Transactions with Non-consolidated VIEs

The Bancorp engages in a variety of activities that involve VIEs, which are legal entities that lack sufficient equity to finance their activities, or the equity investors of the entities as a group lack any of the characteristics of a controlling interest. The investments in those entities in which the Bancorp was determined not to be the primary beneficiary but holds a variable interest in the entity are accounted for under the equity method of accounting or other accounting standards as appropriate and not consolidated. Refer to Note 10 of the Notes to Condensed Consolidated Financial Statements for additional information on non-consolidated VIEs.

 

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Quantitative and Qualitative Disclosure about Market Risk (Item 3)    

 

Information presented in the Market Risk Management section of Management’s Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference.

Controls and Procedures (Item 4)    

 

The Bancorp conducted an evaluation, under the supervision and with the participation of the Bancorp’s management, including the Bancorp’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Bancorp’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on the foregoing, as of the end of the period covered by this report, the Bancorp’s Chief Executive Officer and Chief Financial Officer concluded that the Bancorp’s disclosure controls and procedures were effective, in all material respects, to ensure that information required to be disclosed in the reports the Bancorp files and submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported as and when required and information is accumulated and communicated to the Bancorp’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

The Bancorp’s management also conducted an evaluation of internal control over financial reporting to determine whether any changes occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Bancorp’s internal control over financial reporting. Based on this evaluation, there has been no such change during the period covered by this report.

 

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Fifth Third Bancorp and Subsidiaries

Condensed Consolidated Financial Statements and Notes (Item 1)

 

 

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

              
     As of  
     September 30,     December 31,  

($ in millions, except share data)

   2018     2017  

Assets

    

Cash and due from banks

   $ 2,100       2,514  

Other short-term investments(a)

     1,429       2,753  

Available-for-sale debt and other securities(b)

     31,808       31,751  

Held-to-maturity securities(c)

     18       24  

Trading debt securities

     269       492  

Equity securities

     500       439  

Loans and leases held for sale(d)

     663       492  

Portfolio loans and leases(a)(e)

     93,443       91,970  

Allowance for loan and lease losses(a)

     (1,091     (1,196

Portfolio loans and leases, net

     92,352       90,774  

Bank premises and equipment(f)

     1,896       2,003  

Operating lease equipment

     546       646  

Goodwill

     2,462       2,445  

Intangible assets

     28       27  

Servicing rights

     1,010       858  

Other assets(a)

     6,604       6,975  

Total Assets

   $ 141,685       142,193  

Liabilities

    

Deposits:

    

Noninterest-bearing deposits

   $ 31,803       35,276  

Interest-bearing deposits

     72,539       67,886  

Total deposits

     104,342       103,162  

Federal funds purchased

     2,316       174  

Other short-term borrowings

     1,114       4,012  

Accrued taxes, interest and expenses

     1,155       1,412  

Other liabilities(a)

     2,448       2,144  

Long-term debt(a)

     14,460       14,904  

Total Liabilities

   $ 125,835       125,808  

Equity

    

Common stock(g)

   $ 2,051       2,051  

Preferred stock(h)

     1,331       1,331  

Capital surplus

     2,856       2,790  

Retained earnings

     16,440       15,122  

Accumulated other comprehensive (loss) income

     (775     73  

Treasury stock(g)

     (6,073     (5,002

Total Bancorp shareholders’ equity

   $ 15,830       16,365  

Noncontrolling interests

     20       20  

Total Equity

     15,850       16,385  

Total Liabilities and Equity

   $ 141,685       142,193  

(a)

Includes $41 and $62 of other short-term investments, $793 and $1,297 of portfolio loans and leases, $(4) and $(6) of ALLL, $5 and $7 of other assets, $1 and $2 of other liabilities, and $710 and $1,190 of long-term debt from consolidated VIEs that are included in their respective captions above at September 30, 2018 and December 31, 2017, respectively. For further information refer to Note 10.

(b)

Amortized cost of $32,707 and $31,577 at September 30, 2018 and December 31, 2017, respectively.

(c)

Fair value of $18 and $24 at September 30, 2018 and December 31, 2017, respectively.

(d)

Includes $563 and $399 of residential mortgage loans held for sale measured at fair value and $6 and $0 of commercial loans held for sale measured at fair value at September 30, 2018 and December 31, 2017, respectively.

(e)

Includes $172 and $137 of residential mortgage loans measured at fair value at September 30, 2018 and December 31, 2017, respectively.

(f)

Includes $38 and $27 of bank premises and equipment held for sale at September 30, 2018 and December 31, 2017, respectively. For further information refer to Note 7.

(g)

Common shares: Stated value $2.22 per share; authorized 2,000,000,000; outstanding at September 30, 2018 – 661,372,797 (excludes 262,519,784 treasury shares), December 31, 2017 – 693,804,893 (excludes 230,087,688 treasury shares).

(h)

446,000 shares of undesignated no par value preferred stock are authorized and unissued at September 30, 2018 and December 31, 2017; fixed-to-floating rate non-cumulative Series H perpetual preferred stock with a $25,000 liquidation preference: 24,000 authorized shares, issued and outstanding at September 30, 2018 and December 31, 2017; fixed-to-floating rate non-cumulative Series I perpetual preferred stock with a $25,000 liquidation preference; 18,000 authorized shares, issued and outstanding at September 30, 2018 and December 31, 2017; and fixed-to-floating rate non-cumulative Series J perpetual preferred stock with a $25,000 liquidation preference: 12,000 authorized shares, issued and outstanding at September 30, 2018 and December 31, 2017.

Refer to the Notes to Condensed Consolidated Financial Statements.

 

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CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)

                       
     For the three months ended      For the nine months ended  
     September 30,      September 30,  

($ in millions, except share data)

   2018     2017      2018     2017  

Interest Income

         

Interest and fees on loans and leases

   $ 1,040       899        2,975       2,595  

Interest on securities

     269       249        798       739  

Interest on other short-term investments

     6       4        17       10  

Total interest income

     1,315       1,152        3,790       3,344  

Interest Expense

         

Interest on deposits

     144       73        359       197  

Interest on federal funds purchased

     10       2        17       4  

Interest on other short-term borrowings

     6       12        25       24  

Interest on long-term debt

     112       95        330       277  

Total interest expense

     272       182        731       502  

Net Interest Income

     1,043       970        3,059       2,842  

Provision for loan and lease losses

     86       67        142       193  

Net Interest Income After Provision for Loan and Lease Losses

     957       903        2,917       2,649  

Noninterest Income

         

Service charges on deposits

     139       138        414       415  

Wealth and asset management revenue

     114       102        335       313  

Corporate banking revenue

     100       101        308       276  

Card and processing revenue

     82       79        245       232  

Mortgage banking net revenue

     49       63        158       170  

Other noninterest income

     86       1,076        794       1,237  

Securities (losses) gains, net

     (6     -        (21     1  

Securities (losses) gains, net - non-qualifying hedges on mortgage servicing rights

     (1     2        (18     4  

Total noninterest income

     563       1,561        2,215       2,648  

Noninterest Expense

         

Salaries, wages and incentives

     421       407        1,339       1,215  

Employee benefits

     82       77        270       274  

Net occupancy expense

     70       74        219       221  

Technology and communications

     71       62        206       177  

Equipment expense

     31       30        92       88  

Card and processing expense

     31       32        91       95  

Other noninterest expense

     302       293        873       848  

Total noninterest expense

     1,008       975        3,090       2,918  

Income Before Income Taxes

     512       1,489        2,042       2,379  

Applicable income tax expense

     79       475        321       694  

Net Income

     433       1,014        1,721       1,685  

Less: Net income attributable to noncontrolling interests

     -       -        -       -  

Net Income Attributable to Bancorp

     433       1,014        1,721       1,685  

Dividends on preferred stock

     15       15        52       52  

Net Income Available to Common Shareholders

   $ 418       999        1,669       1,633  

Earnings per share - basic

   $ 0.62       1.37        2.43       2.19  

Earnings per share - diluted

   $ 0.61       1.35        2.38       2.16  

Average common shares outstanding - basic

         667,624,132       721,280,389        680,181,785       736,686,213  

Average common shares outstanding - diluted

     679,198,715       733,284,502        693,078,647       748,706,522  

Refer to the Notes to Condensed Consolidated Financial Statements.

 

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CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)

               
     For the three months ended     For the nine months ended  
     September 30,     September 30,  

($ in millions)

   2018     2017     2018     2017  

Net Income

   $ 433       1,014       1,721       1,685  

Other Comprehensive (Loss) Income, Net of Tax:

        

Unrealized (losses) gains on available-for-sale debt securities:

        

Unrealized holding (losses) gains arising during period

     (207     22       (834     130  

Reclassification adjustment for net losses included in net income

     -       1       7       2  

Unrealized (losses) gains on cash flow hedge derivatives:

        

Unrealized holding (losses) gains arising during period

     (19     -       (24     2  

Reclassification adjustment for net losses (gains) included in net income

     2       (2     2       (11

Defined benefit pension plans, net:

        

Net actuarial loss arising during period

     (2     (2     (2     (3

Reclassification of amounts to net periodic benefit costs

     3       3       5       6  

Other comprehensive (loss) income, net of tax

     (223     22       (846     126  

Comprehensive Income

     210       1,036       875       1,811  

Less: Comprehensive income attributable to noncontrolling interests

     -       -       -       -  

Comprehensive Income Attributable to Bancorp

   $ 210       1,036       875       1,811  

Refer to the Notes to Condensed Consolidated Financial Statements.

 

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CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (unaudited)

                      
    Bancorp Shareholders’ Equity              
                            Accumulated           Total              
                            Other           Bancorp     Non-        
    Common     Preferred     Capital     Retained     Comprehensive     Treasury     Shareholders’     Controlling     Total  

($ in millions, except per share data)

  Stock     Stock     Surplus     Earnings     (Loss) Income     Stock     Equity     Interests     Equity  

Balance at December 31, 2016

  $ 2,051       1,331       2,756       13,441       59       (3,433     16,205       27       16,232  

Net income

          1,685           1,685         1,685  

Other comprehensive income, net of tax

            126         126         126  

Cash dividends declared:

                 

Common stock(a)

          (324         (324       (324

Preferred stock(b)

          (52         (52       (52

Shares acquired for treasury

        (113         (1,219     (1,332       (1,332

Impact of stock transactions under stock
compensation plans, net

        39           12       51         51  

Other

                            (2             3       1       (7     (6

Balance at September 30, 2017

  $ 2,051       1,331       2,682       14,748       185       (4,637     16,360       20       16,380  
                                                                         

Balance at December 31, 2017

  $ 2,051       1,331       2,790       15,122       73       (5,002     16,365       20       16,385  

Impact of cumulative effect of change
in accounting principles(c)

                            6       (2             4               4  

Balance at January 1, 2018

  $ 2,051       1,331       2,790       15,128       71       (5,002     16,369       20       16,389  

Net income

          1,721           1,721         1,721  

Other comprehensive loss, net of tax

            (846       (846       (846

Cash dividends declared:

                 

Common stock(a)

          (355         (355       (355

Preferred stock(b)

          (52         (52       (52

Shares acquired for treasury

        41           (1,094     (1,053       (1,053

Impact of stock transactions under stock
compensation plans, net

        25           21       46         46  

Other

                            (2             2       -               -  

Balance at September 30, 2018

  $ 2,051       1,331       2,856       16,440       (775     (6,073     15,830       20       15,850  

(a)

Dividends declared per common share were $0.18 and $0.16 for the three months ended September 30, 2018 and 2017, respectively, and $0.52 and $0.44 for the nine months ended September 30, 2018 and 2017, respectively.

(b)

For both the three months ended September 30, 2018 and 2017, dividends were $414.06 per preferred share for Perpetual Preferred Stock, Series I and $612.50 per preferred share for Perpetual Preferred Stock, Series J. For both the nine months ended September 30, 2018 and 2017, dividends were $637.50 per preferred share for Perpetual Preferred Stock, Series H, $1,242.18 per preferred share for Perpetual Preferred Stock, Series I and $1,225.00 per preferred share for Perpetual Preferred Stock, Series J.

(c)

Related to the adoption as of January 1, 2018 of ASU 2016-01, ASU 2017-12 and ASU 2018-02. Refer to Note 3 for additional information.

Refer to the Notes to Condensed Consolidated Financial Statements.

 

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

     For the nine months ended September 30,

($ in millions)

             2018                       2017            

Operating Activities

    

Net income

   $ 1,721       1,685  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Provision for loan and lease losses

     142       193  

Depreciation, amortization and accretion

     275       255  

Stock-based compensation expense

     106       95  

Benefit from deferred income taxes

     (15     (97

Securities losses (gains), net

     23       (2

Securities losses (gains), net - non-qualifying hedges on mortgage servicing rights

     18       (4

MSR fair value adjustment

     (8     104  

Net gains on sales of loans and fair value adjustments on loans held for sale

     (52     (82

Net losses on disposition and impairment of bank premises and equipment

     37       3  

Net losses on disposition and impairment of operating lease equipment

     1       18  

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

     (414     -  

Gain on sale of Worldpay, Inc. shares

     (205     (1,037

Proceeds from sales of loans held for sale

     4,017       4,741  

Loans originated for sale, net of repayments

     (4,222     (4,608

Dividends representing return on equity method investments

     9       29  

Net change in:

    

Trading and equity securities

     131       (430

Other assets

     372       121  

Accrued taxes, interest and expenses

     2       288  

Other liabilities

     (11     (44

Net Cash Provided by Operating Activities

     1,927       1,228  

Investing Activities

    

Proceeds from sales:

    

Available-for-sale debt and other securities

     10,867       7,484  

Loans

     211       105  

Bank premises and equipment

     40       25  

Proceeds from repayments / maturities:

    

Available-for-sale debt and other securities

     1,450       1,799  

Held-to-maturity securities

     6       1  

Purchases:

    

Available-for-sale debt and other securities

     (13,322     (8,849

Bank premises and equipment

     (145     (155

MSRs

     (82     (109

Proceeds from settlement of BOLI

     11       8  

Proceeds from sales and dividends representing return of equity method investments

     601       1,358  

Net cash paid on acquisitions

     (20     (12

Net change in:

    

Other short-term investments

     1,324       (544

Loans and leases

     (1,882     (191

Operating lease equipment

     40       (6

Net Cash (Used in) Provided by Investing Activities

     (901     914  

Financing Activities

    

Net change in:

    

Deposits

     1,180       (2,369

Federal funds purchased

     2,142       (14

Other short-term borrowings

     (2,898     2,153  

Dividends paid on common stock

     (347     (339

Dividends paid on preferred stock

     (60     (38

Proceeds from issuance of long-term debt

     2,438       1,444  

Repayment of long-term debt

     (2,774     (1,794

Repurchase of treasury stock and related forward contract

     (1,053     (1,332

Other

     (68     (40

Net Cash Used in Financing Activities

     (1,440     (2,329

Decrease in Cash and Due from Banks

     (414     (187

Cash and Due from Banks at Beginning of Period

     2,514       2,392  

Cash and Due from Banks at End of Period

   $ 2,100       2,205  

Refer to the Notes to Condensed Consolidated Financial Statements. Note 2 contains cash payments related to interest and income taxes in addition to non-cash investing and financing activities.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

1. Basis of Presentation

The Condensed Consolidated Financial Statements include the accounts of the Bancorp and its majority-owned subsidiaries and VIEs in which the Bancorp has been determined to be the primary beneficiary. Other entities, including certain joint ventures, in which the Bancorp has the ability to exercise significant influence over operating and financial policies of the investee, but upon which the Bancorp does not possess control, are accounted for by the equity method and not consolidated. Those entities in which the Bancorp does not have the ability to exercise significant influence are generally accounted for utilizing the measurement alternative to fair value which permits carrying the investment at its cost basis, as adjusted for impairments and observable price changes. Intercompany transactions and balances have been eliminated.

In the opinion of management, the unaudited Condensed Consolidated Financial Statements include all adjustments, which consist of normal recurring accruals, necessary to present fairly the results for the periods presented. In accordance with U.S. GAAP and the rules and regulations of the SEC for interim financial information, these statements do not include certain information and footnote disclosures required for complete annual financial statements and it is suggested that these Condensed Consolidated Financial Statements be read in conjunction with the Bancorp’s Annual Report on Form 10-K. The results of operations and comprehensive income for the three and nine months ended September 30, 2018 and 2017 and the cash flows and changes in equity for the nine months ended September 30, 2018 and 2017 are not necessarily indicative of the results to be expected for the full year. Financial information as of December 31, 2017 has been derived from the Bancorp’s Annual Report on Form 10-K.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

2. Supplemental Cash Flow Information

Cash payments related to interest and income taxes in addition to non-cash investing and financing activities are presented in the following table for the nine months ended September 30:

 

 

($ in millions)

   2018      2017  

Cash Payments:

     

Interest

   $         760        556  

Income taxes

     297        439  

Transfers:

     

Portfolio loans to loans held for sale

     212        152  

Loans held for sale to portfolio loans

     83        11  

Portfolio loans to OREO

     28        28  

3. Accounting and Reporting Developments

Standards Adopted in 2018

The Bancorp adopted the following new accounting standards effective January 1, 2018:

ASU 2014-09 – Revenue from Contracts with Customers (Topic 606)

In May 2014, the FASB issued ASU 2014-09 which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most contract revenue recognition guidance, including industry-specific guidance. The core principle of the amended guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Subsequent to the issuance of ASU 2014-09, the FASB issued additional guidance to clarify certain implementation issues, including ASUs 2016-08 (Principal versus Agent Considerations), 2016-10 (Identifying Performance Obligations and Licensing), 2016-12 (Narrow-Scope Improvements and Practical Expedients), and 2016-20 (Technical Corrections and Improvements) in March, April, May and December 2016, respectively. These amendments did not change the core principles in ASU 2014-09 and follow the same effective date and transition requirements. The Bancorp adopted the amended guidance on January 1, 2018, using a modified retrospective approach. Because the amended guidance does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under other U.S. GAAP, the adoption of this amended guidance did not have a material impact on the Bancorp’s Condensed Consolidated Financial Statements. However, the Bancorp is subject to expanded disclosure requirements and has updated its revenue recognition policies and procedures. While the Bancorp has concluded the following changes are not material to its Condensed Consolidated Financial Statements, upon adoption the Bancorp changed its presentation of certain underwriting expenses incurred by its broker-dealer subsidiary from net to gross presentation and also changed its presentation of certain credit card rewards program expenses from gross to net presentation. Neither change impacts income before income taxes or net income.

In conjunction with adoption of ASU 2014-09, the Bancorp is providing the following additional disclosures about its significant accounting and reporting policies related to revenue recognition.

Revenue Recognition

The Bancorp generally measures revenue based on the amount of consideration the Bancorp expects to be entitled for the transfer of goods or services to a customer, then recognizes this revenue when or as the Bancorp satisfies its performance obligations under the contract, except in transactions where U.S. GAAP provides other applicable guidance. When the amount of consideration is variable, the Bancorp will only recognize revenue to the extent that it is probable that the cumulative amount recognized will not be subject to a significant reversal in the future.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

Substantially all of the Bancorp’s contracts with customers have expected durations of one year or less and payments are typically due when or as the services are rendered or shortly thereafter. When third parties are involved in providing goods or services to customers, the Bancorp recognizes revenue on a gross basis when it has control over those goods or services prior to transfer to the customer; otherwise, revenue is recognized for the net amount of any fee or commission. The Bancorp excludes sales taxes from the recognition of revenue and recognizes the incremental costs of obtaining contracts as an expense if the period of amortization for those costs would be one year or less.

The Bancorp’s interest income is derived from loans and leases, securities and other short-term investments. The Bancorp recognizes interest income in accordance with the applicable guidance in U.S. GAAP for these assets. Refer to the Portfolio Loans and Leases and Securities sections in Note 1 of the Notes to Consolidated Financial Statements included in the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2017 for further information. The following provides additional information about the components of noninterest income:

 

 

 

Service charges on deposits consist primarily of treasury management fees for commercial clients, monthly service charges on consumer deposit accounts, transaction-based fees (such as overdraft fees and wire transfer fees), and other deposit account-related charges. The Bancorp’s performance obligations for treasury management fees and consumer deposit account service charges are typically satisfied over time while performance obligations for transaction-based fees are typically satisfied at a point in time. Revenues are recognized on an accrual basis when or as the services are provided to the customer, net of applicable discounts, waivers and reversals. Payments are typically collected from customers directly from the related deposit account at the time the transaction is processed and/or at the end of the customer’s statement cycle (typically monthly).

 

 

Wealth and asset management revenue consists primarily of service fees for investment management, custody, and trust administration services provided to commercial and consumer clients. The Bancorp’s performance obligations for these services are generally satisfied over time and revenues are recognized monthly based on the fee structure outlined in individual contracts. Transaction prices are most commonly based on the market value of assets under management or care and/or a fee per transaction processed. The Bancorp offers certain services, like tax return preparation, for which the performance obligations are satisfied and revenue is recognized at a point in time, when the services are performed. Wealth and asset management revenue also includes trailing commissions received from investments and annuities held in customer accounts, which are recognized in revenue when the Bancorp determines it is probable that the commission will be received.

 

 

Corporate banking revenue consists primarily of service fees and other income related to loans and leases to commercial clients, underwriting revenue recognized by the Bancorp’s broker-dealer subsidiary and fees for other services provided to commercial clients. Revenue related to loans and leases is recognized in accordance with the Bancorp’s policies for portfolio loans and leases. Underwriting revenue is generally recognized on the trade date, which is when the Bancorp’s performance obligations are satisfied.

 

 

Card and processing revenue consists primarily of ATM fees and interchange fees earned when the Bancorp’s credit and debit cards are processed through card association networks. The Bancorp’s performance obligations are generally complete when the transactions generating the fees are processed. Revenue is recognized on an accrual basis as such services are performed, net of certain costs not controlled by the Bancorp (primarily interchange fees charged by credit card associations and expenses of certain transaction-based rewards programs offered to customers). These costs reduced card and processing revenue by approximately $33 million and $93 million for the three and nine months ended September 30, 2018, respectively.

 

 

Mortgage banking net revenue consists primarily of origination fees and gains on loan sales, mortgage servicing fees and the impact of MSRs. Refer to the Loans and Leases Held for Sale and Loan Sales and Securitizations sections in Note 1 of the Notes to Consolidated Financial Statements included in the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2017 for further information.

 

 

Other noninterest income includes income from operating leases, certain fees derived from loans and leases, BOLI income, gains and losses on other assets, and other miscellaneous revenues and gains.

ASU 2016-01 – Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities

In January 2016, the FASB issued ASU 2016-01 which revises an entity’s accounting related to 1) the classification and measurement of investments in equity securities, 2) the presentation of certain fair value changes for financial liabilities measured at fair value, and 3) certain disclosure requirements associated with the fair value of financial instruments. The amendments require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes as a result of an observable price change. The amendments also simplify the impairment assessment of equity investments for which fair value is not readily determinable by requiring an entity to perform a qualitative assessment to identify impairment. If qualitative indicators are identified, the entity will be required to measure the investment at fair value. For financial liabilities that an entity has elected to measure at fair value, the amendments require an entity to present separately in OCI the portion of the change in fair value that results from a change in instrument-specific credit risk. For public business entities, the amendments 1) eliminate the requirement to disclose the method(s) and significant assumptions used to estimate fair value for financial instruments measured at amortized cost and 2) require, for disclosure purposes, the use of an exit price notion in the determination of the fair value of financial instruments. In February 2018, the FASB also issued ASU 2018-03 which makes technical corrections and improvements to the amendments in ASU 2016-01. The Bancorp adopted the amended guidance on January 1, 2018. As permitted, the Bancorp elected to early adopt ASU 2018-03 on January 1, 2018, concurrent with the adoption of ASU 2016-01. The adoption did not have a material impact on the Condensed Consolidated Financial Statements. However, equity securities affected by the amended guidance which were previously classified as trading or available-for-sale have been reclassified in the Condensed Consolidated Balance Sheets as equity securities. For certain equity securities without a readily determinable fair value that are not accounted for using the equity method, the Bancorp has elected to use the permitted measurement alternative, which is to adjust the cost basis of the investment upon either the occurrence of an observable price change or the identification of an impairment. For these securities, the amended guidance was applied prospectively to investments that existed on or after January 1, 2018. The other portions of the amended guidance were applied on a modified retrospective basis.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

ASU 2016-04 – Liabilities—Extinguishments of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products

In March 2016, the FASB issued ASU 2016-04 which permits proportional derecognition of the liability for unused funds on certain prepaid stored-value products (known as breakage) to the extent that it is probable that a significant reversal of the recognized breakage amount will not subsequently occur. The amendments do not apply to any prepaid stored-value products that are attached to a segregated customer deposit account or products for which unused funds are subject to unclaimed property remittance laws. The Bancorp adopted the amended guidance on January 1, 2018 using a modified retrospective approach. The adoption did not have a material impact on the Condensed Consolidated Financial Statements.

ASU 2016-15 – Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments

In August 2016, the FASB issued ASU 2016-15 to clarify the classification of certain cash receipts and payments within an entity’s statement of cash flows. These items include debt prepayment or extinguishment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of BOLI policies, distributions received from equity method investees, and beneficial interests in securitization transactions. The amended guidance also specifies how to address classification of cash receipts and payments that have aspects of more than one class of cash flows. The Bancorp adopted the amended guidance retrospectively on January 1, 2018. The adoption did not have a material impact on the Condensed Consolidated Financial Statements.

ASU 2016-16 – Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory

In October 2016, the FASB issued ASU 2016-16 which requires an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Current U.S. GAAP prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. The Bancorp adopted the amended guidance on January 1, 2018 using a modified retrospective approach. The adoption did not have a material impact on the Condensed Consolidated Financial Statements.

ASU 2017-01 – Business Combinations (Topic 805): Clarifying the Definition of a Business

In January 2017, the FASB issued ASU 2017-01 which clarifies the definition of a business in order to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amended guidance provides a screen which states that when substantially all of the fair value of assets acquired (or disposed) is concentrated in a single asset or group of similar assets, then the set of assets and activities would not be considered a business. The Bancorp adopted the amended guidance prospectively on January 1, 2018 and will apply this amended guidance to future transactions to determine if they should be accounted for as acquisitions (or disposals) of assets or businesses.

ASU 2017-05 – Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets

In February 2017, the FASB issued ASU 2017-05 which clarifies the scope of Subtopic 610-20 and defines the term “in substance nonfinancial asset.” The amendments require that an entity should initially identify each distinct nonfinancial asset or in substance nonfinancial asset promised to a counterparty and derecognize each asset when a counterparty obtains control of it. The amendments provide specific guidance on accounting for partial sales of nonfinancial assets, which require an entity to derecognize a distinct nonfinancial asset or in substance nonfinancial asset in a partial sale transaction when it 1) does not have (or ceases to have) a controlling financial interest in the legal entity that holds the asset and 2) transfers control of the asset. Once an entity transfers control of a distinct nonfinancial asset or distinct in substance nonfinancial asset, it is required to measure any noncontrolling interest it receives (or retains) at fair value. The Bancorp adopted the amended guidance on January 1, 2018 using a modified retrospective approach. The adoption did not have a material impact on the Condensed Consolidated Financial Statements.

ASU 2017-09 Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting

In May 2017, the FASB issued ASU 2017-09 which provides guidance about which changes to the terms or conditions of a share-based payment award require the application of modification accounting in Topic 718. The amendments specify that an entity should account for the effects of such changes as a modification unless the fair value, vesting conditions and classification (as an equity or liability) of the awards are all unaffected by the change. The Bancorp adopted the amended guidance prospectively on January 1, 2018. The adoption did not have a material impact on the Condensed Consolidated Financial Statements.

ASU 2017-12 Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities

In August 2017, the FASB issued ASU 2017-12 which makes several amendments to existing guidance for hedge accounting. As permitted, the Bancorp elected to early adopt the amended guidance on January 1, 2018. For certain fair value hedges of interest rate risk, the Bancorp elected to modify the measurement methodology for the hedged item to be the benchmark rate component of the contractual coupon cash flows and also elected to de-designate a portion of the existing hedging relationship, as permitted. Upon adoption, changes in the fair value of cash flow hedges are recorded in AOCI and then subsequently reclassified into earnings when the hedged item affects earnings. Also, for both fair value hedges and cash flow hedges, changes in the fair value of the derivative instrument are recorded in the same income statement line item as the effects of the hedged item, eliminating the separate measurement of hedge ineffectiveness. The Bancorp recorded a cumulative-effect adjustment to retained earnings for the impact of these elections as well as the elimination of the separate measurement of ineffectiveness from AOCI for cash flow hedges existing at January 1, 2018, the amount of which was not material. The amended presentation and disclosure guidance was applied prospectively.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

ASU 2018-02 Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income

In February 2018, the FASB issued ASU 2018-02 which allows for reclassification from AOCI to retained earnings of stranded tax effects resulting from the TCJA. Stranded tax effects result from the reduction in the top federal statutory income tax rate from 35 percent to 21 percent as deferred tax assets and liabilities are adjusted for the impact of a change in tax rate through income tax expense, even in situations when the related items giving rise to the deferred taxes are components of AOCI, which are carried net of tax. As permitted, the Bancorp elected to early adopt this amended guidance and recorded a reclassification adjustment from AOCI to retained earnings as of January 1, 2018, the amount of which was not material.

Standards Issued but Not Yet Adopted

The following accounting standards were issued but not yet adopted by the Bancorp as of September 30, 2018:

ASU 2016-02 – Leases (Topic 842)

In February 2016, the FASB issued ASU 2016-02 which establishes a new accounting model for leases. The amended guidance requires lessees to record lease liabilities on the lessees’ balance sheets along with corresponding right-of-use assets for all leases with terms longer than twelve months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the lessee’s statements of income. From a lessor perspective, the accounting model is largely unchanged, except that the amended guidance includes certain targeted improvements to align, where necessary, lessor accounting with the lessee accounting model and the revenue recognition guidance in ASC Topic 606. The amendments also modify disclosure requirements for an entity’s lease arrangements. The amended guidance is effective for the Bancorp on January 1, 2019, with early adoption permitted. The amended guidance contains certain transition relief provisions that, among other things, permit an entity to elect not to reassess the classification of leases which existed or expired as of the date the amendments are effective.

Subsequent to the issuance of ASU 2016-02, the FASB has issued additional guidance to clarify certain implementation issues and provide transition relief in certain circumstances including ASUs 2018-01 (Land Easement Practical Expedient, issued in January 2018), 2018-10 (Codification Improvements, issued in July 2018), and 2018-11 (Targeted Improvements, also issued in July 2018). These subsequent amendments do not change the core principles in the original ASU, but do provide an additional optional transition method which is to initially apply the amended guidance at the adoption date and record a cumulative-effect adjustment to opening retained earnings without retrospective application to prior comparative periods. Entities not electing to use this optional transition method must apply the amended guidance on a modified retrospective basis to all periods presented.

The Bancorp will adopt the amended guidance on the required effective date of January 1, 2019, and expects to elect the transition relief provisions and the optional transition method to record a cumulative effect adjustment to retained earnings on the adoption date without applying the guidance to prior comparative periods. From a lessee perspective, the Bancorp has finalized its inventory of leases, accumulated the data necessary to apply the amended guidance and is in the process of implementing a business process to execute the new measurement and disclosure requirements. The Bancorp is continuing to finalize its evaluation of the impact of the amended guidance on its Condensed Consolidated Financial Statements, but the effects of recognizing most operating leases on the Condensed Consolidated Balance Sheets are expected to be material. As of September 30, 2018, the Bancorp expects to recognize right-of-use assets and lease liabilities in the range of $400 million to $500 million for substantially all of its operating lease commitments based on the present value of unpaid lease payments as of the date of adoption, but does not expect a material impact to expense recognition. From a lessor perspective, given the limited changes, the Bancorp does not currently expect adoption of the amended guidance to have a material impact on its Condensed Consolidated Financial Statements at transition. While the evaluation process is ongoing, the Bancorp currently expects that the amended guidance may prospectively impact the classification of certain leases, the presentation of lessor costs and the recognition and measurement of initial direct costs. The Bancorp also expects to record a cumulative-effect adjustment to retained earnings upon adoption to recognize any remaining deferred gains on sale-leaseback transactions that occurred prior to the date of initial application. The Bancorp had approximately $14 million of such deferred gains recorded as of September 30, 2018. These expectations may change as the implementation process continues.

ASU 2016-13 – Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments

In June 2016, the FASB issued ASU 2016-13 which establishes a new approach to estimate credit losses on certain types of financial instruments. The new approach changes the impairment model for most financial assets, and will require the use of an “expected credit loss” model for financial instruments measured at amortized cost and certain other instruments. This model applies to trade and other receivables, loans, debt securities, net investments in leases, and off-balance-sheet credit exposures (such as loan commitments, standby letters of credit, and financial guarantees not accounted for as insurance). This model requires entities to estimate the lifetime expected credit loss on such instruments and record an allowance that represents the portion of the amortized cost basis that the entity does not expect to collect. This allowance is deducted from the financial asset’s amortized cost basis to present the net amount expected to be collected. The new expected credit loss model will also apply to purchased financial assets with credit deterioration, superseding current accounting guidance for such assets. The amended guidance also amends the impairment model for available-for-sale debt securities, requiring entities to determine whether all or a portion of the unrealized loss on such securities is a credit loss, and also eliminating the option for management to consider the length of time a security has been in an unrealized loss position as a factor in concluding whether or not a credit loss exists. The amended model states that an entity will recognize an allowance for credit losses on available-for-sale debt securities as a contra account to the amortized cost basis, instead of a direct reduction of the amortized cost basis of the investment, as under current guidance. As a result, entities will recognize improvements to estimated credit losses on available-for-sale debt securities immediately in earnings as opposed to in interest income over time. There are also additional disclosure requirements included in this guidance. The amended guidance is effective for the Bancorp on January 1, 2020. Early adoption is permitted as soon as January 1, 2019, but the Bancorp currently expects to adopt on the mandatory effective date.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

The amended guidance is to be applied on a modified retrospective basis with the cumulative effect of initially applying the amendments recognized in retained earnings at the date of initial application. However, certain provisions of the guidance are only required to be applied on a prospective basis. While the Bancorp is currently in the process of evaluating the impact of the amended guidance on its Condensed Consolidated Financial Statements, it currently expects the ALLL to increase upon adoption given that the allowance will be required to cover the full remaining expected life of the portfolio upon adoption, rather than the incurred loss model under current U.S. GAAP. The extent of this increase is still being evaluated and will depend on economic conditions and the composition of the Bancorp’s loan and lease portfolio at the time of adoption.

ASU 2017-04 – Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment

In January 2017, the FASB issued ASU 2017-04 which simplifies the test for goodwill impairment by removing the second step, which measures the amount of impairment loss, if any. Instead, the amended guidance states that an entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, except that the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. This would apply to all reporting units, including those with zero or negative carrying amounts of net assets. The amended guidance is effective for the Bancorp on January 1, 2020, with early adoption permitted, and is to be applied prospectively to all goodwill impairment tests performed after the adoption date.

ASU 2017-08 Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities

In March 2017, the FASB issued ASU 2017-08 which shortens the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. The amended guidance is effective for the Bancorp on January 1, 2019, with early adoption permitted, and is to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Bancorp shall provide a disclosure regarding the change in accounting principle. The Bancorp plans to adopt the amended guidance on its required effective date of January 1, 2019 and is currently in the process of evaluating the impact of the amended guidance on its Condensed Consolidated Financial Statements. However, the Bancorp does not currently expect the impact of adoption to be material.

ASU 2018-13 Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement

In August 2018, the FASB issued ASU 2018-13 which modifies the disclosure requirements for fair value measurements. The amendments remove the requirements to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing of transfers between levels and the valuation processes for Level 3 fair value measurements. The amendments also add new disclosure requirements regarding unrealized gains and losses from recurring Level 3 fair value measurements and the significant unobservable inputs used to develop Level 3 fair value measurements. The amended guidance is effective for the Bancorp on January 1, 2020 with early adoption permitted. Certain of the amendments are to be applied prospectively while others are to be applied retrospectively. Also, early adoption of the removed and modified disclosure requirements is permitted before adoption of the newly added requirements. The Bancorp is in the process of evaluating the impact of the amended guidance on its Condensed Consolidated Financial Statements.

ASU 2018-15: Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract

In August 2018, the FASB issued ASU 2018-15 which provides guidance on the accounting for implementation, setup, and other upfront costs incurred by customers in cloud computing arrangements that are accounted for as service contracts. The amendments require that implementation costs be evaluated for capitalization using the framework applicable to costs incurred to develop or obtain internal-use software. Those capitalized costs are to be expensed over the term of the cloud computing arrangement and presented in the same financial statement line items as the service contract and its associated fees. The amended guidance is effective for the Bancorp on January 1, 2020, with early adoption permitted, and may be applied either retrospectively or prospectively. The Bancorp is in the process of evaluating the impact of the amended guidance on its Condensed Consolidated Financial Statements.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

4. Investment Securities

The following tables provide the amortized cost, unrealized gains and losses and fair value for the major categories of the available-for-sale debt and other securities and held-to-maturity investment securities portfolios as of:

 

 

     Amortized      Unrealized      Unrealized        Fair  

September 30, 2018 ($ in millions)

   Cost      Gains      Losses        Value  

Available-for-sale debt and other securities:

             

U.S. Treasury and federal agencies securities

   $ 98        -            (3        95  

Obligations of states and political subdivisions securities

     2        -            -          2  

Mortgage-backed securities:

             

Agency residential mortgage-backed securities

     16,447        15            (489        15,973  

Agency commercial mortgage-backed securities

     10,405        4            (363        10,046  

Non-agency commercial mortgage-backed securities

     3,169        4            (76        3,097  

Asset-backed securities and other debt securities

     2,035        20            (11        2,044  

Other securities(a)

     551        -            -            551  

Total available-for-sale debt and other securities

   $ 32,707        43            (942          31,808  

Held-to-maturity securities:

             

Obligations of states and political subdivisions securities

   $ 16        -            -          16  

Asset-backed securities and other debt securities

     2        -            -            2  

Total held-to-maturity securities

   $ 18        -            -            18  

(a)

Other securities consist of FHLB, FRB and DTCC restricted stock holdings of $184, $365 and $2, respectively, at September 30, 2018, that are carried at cost.

 

      Amortized      Unrealized      Unrealized        Fair  

December 31, 2017 ($ in millions)

   Cost      Gains      Losses        Value  

Available-for-sale debt and other securities:

             

U.S. Treasury and federal agencies securities

   $ 98        -            -          98  

Obligations of states and political subdivisions securities

     43        1            -          44  

Mortgage-backed securities:

             

Agency residential mortgage-backed securities(a)

     15,281        118            (80        15,319  

Agency commercial mortgage-backed securities

     10,113        92            (38        10,167  

Non-agency commercial mortgage-backed securities

     3,247        51            (5        3,293  

Asset-backed securities and other debt securities

     2,183        46            (11        2,218  

Other securities(b)

     612        -            -            612  

Total available-for-sale debt and other securities

   $ 31,577        308            (134          31,751  

Held-to-maturity securities:

             

Obligations of states and political subdivisions securities

   $ 22        -            -          22  

Asset-backed securities and other debt securities

     2        -            -            2  

Total held-to-maturity securities

   $ 24        -            -            24  

(a)

Includes interest-only mortgage-backed securities of $34 as of December 31, 2017, recorded at fair value with fair value changes recorded in securities (losses) gains, net, in the Condensed Consolidated Statements of Income.

(b)

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

The following table provides the fair value of trading debt securities and equity securities as of:

 

 

     September 30,      December 31,  

($ in millions)

   2018      2017  

Trading debt securities

   $ 269        492  

Equity securities

     500        439  

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

The following table presents net realized gains and losses that were recognized in income from available-for-sale debt and other securities as well as total (losses) gains that were recognized in income from trading debt securities and equity securities:

 

      For the three months ended    

For the nine months ended

      
     September 30,     September 30,       

($ in millions)

   2018     2017     2018     2017       

Available-for-sale debt and other securities:

          

Realized gains

   $ 4       24       60       53    

Realized losses

     (4     (21     (69     (28  

OTTI(a)

     -       (4     -       (28    

Net realized losses on available-for sale debt and other securities(b)

   $ -       (1     (9     (3    

Total trading debt securities (losses) gains(c)

   $ (1     2       (20     5      

Total equity securities (losses) gains(d)(e)

   $ (6     3       (13     6      

Total (losses) gains recognized in income from available-for-sale debt and other securities, trading debt securities and equity securities

   $ (7     4       (42     8      

(a)

Included in securities (losses) gains, net in the Condensed Consolidated Statements of Income.

(b)

Excludes net gains on interest-only mortgage-backed securities of $0 and $1 for the three and nine months ended September 30, 2018, respectively, and net losses of $1 and $2 for the three and nine months ended September 30, 2017, respectively.

(c)

Includes an immaterial net loss and a net loss of $2 for the three and nine months ended September 30, 2018, respectively, and net gains of $1 for both the three and nine months ended September 30, 2017 recorded in corporate banking revenue and wealth and asset management revenue in the Condensed Consolidated Statements of Income.

(d)

Includes an immaterial net loss and an immaterial net gain for the three and nine months ended September 30, 2018, respectively, and immaterial net gains for both the three and nine months ended September 30, 2017 recorded in corporate banking revenue and wealth and asset management revenue in the Condensed Consolidated Statements of Income.

(e)

Includes net unrealized losses of $6 and $12 for the three and nine months ended September 30, 2018, respectively, and net unrealized gains of $2 and $4 for the three and nine months ended September 30, 2017, respectively.

At September 30, 2018 and December 31, 2017, investment securities with a fair value of $6.3 billion and $7.8 billion, respectively, were pledged to secure borrowings, public deposits, trust funds, derivative contracts and for other purposes as required or permitted by law.

The expected maturity distribution of the Bancorp’s mortgage-backed securities and the contractual maturity distribution of the remainder of the Bancorp’s available-for-sale debt and other securities and held-to-maturity investment securities as of September 30, 2018 are shown in the following table:

 

     Available-for-Sale Debt and  Other      Held-to-Maturity       

($ in millions)

  Amortized Cost      Fair Value      Amortized Cost      Fair Value       

Debt securities:(a)

            

Less than 1 year

  $ 14        14        -        -    

1-5 years

    9,080        8,882        16        16    

5-10 years

    18,305        17,771        -        -    

Over 10 years

    4,757        4,590        2        2    

Other securities

    551        551        -        -      

Total

  $ 32,707        31,808        18        18      

(a)

Actual maturities may differ from contractual maturities when a right to call or prepay obligations exists with or without call or prepayment penalties.

The following table provides the fair value and gross unrealized losses on available-for-sale debt and other securities in an unrealized loss position, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position as of:

 

      Less than 12 months     12 months or more     Total       
            Unrealized            Unrealized            Unrealized      

($ in millions)

   Fair Value      Losses     Fair Value      Losses     Fair Value      Losses       

September 30, 2018

                                                       

U.S. Treasury and federal agency securities

   $ 95        (3     -        -       95        (3  

Agency residential mortgage-backed securities

     11,073        (286     3,559        (203     14,632        (489  

Agency commercial mortgage-backed securities

     7,820        (269     1,701        (94     9,521        (363  

Non-agency commercial mortgage-backed securities

     2,511        (63     214        (13     2,725        (76  

Asset-backed securities and other debt securities

     627        (4     397        (7     1,024        (11    

Total

   $ 22,126        (625     5,871        (317     27,997        (942    

December 31, 2017

                                                       

U.S. Treasury and federal agency securities

   $ 98        -       -        -       98        -    

Agency residential mortgage-backed securities

     7,337        (59     479        (21     7,816        (80  

Agency commercial mortgage-backed securities

     2,900        (22     526        (16     3,426        (38  

Non-agency commercial mortgage-backed securities

     449        (2     145        (3     594        (5  

Asset-backed securities and other debt securities

     317        (2     386        (9     703        (11    

Total

   $ 11,101        (85     1,536        (49     12,637        (134    

At both September 30, 2018 and December 31, 2017, an immaterial amount of unrealized losses in the available-for-sale debt and other securities portfolio were represented by non-rated securities.

 

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5. Loans and Leases

The Bancorp diversifies its loan and lease portfolio by offering a variety of loan and lease products with various payment terms and rate structures. Lending activities are generally concentrated within those states in which the Bancorp has banking centers and are primarily located in the Midwestern and Southeastern regions of the U.S. The Bancorp’s commercial loan and lease portfolio consists of lending to various industry types. Management periodically reviews the performance of its loan and lease products to evaluate whether they are performing within acceptable interest rate and credit risk levels and changes are made to underwriting policies and procedures as needed. The Bancorp maintains an allowance to absorb loan and lease losses inherent in the portfolio. For further information on credit quality and the ALLL, refer to Note 6.

The following table provides a summary of commercial loans and leases classified by primary purpose and consumer loans classified based upon product or collateral as of:

 

      September 30,      December 31,       

($ in millions)

   2018      2017       

Loans and leases held for sale:

       

Commercial and industrial loans

   $ 94        -    

Commercial mortgage loans

     6        6    

Residential mortgage loans

     563        486      

Total loans and leases held for sale

   $ 663        492      

Portfolio loans and leases:

       

Commercial and industrial loans

   $ 42,631        41,170    

Commercial mortgage loans

     6,695        6,604    

Commercial construction loans

     4,892        4,553    

Commercial leases

     3,697        4,068      

Total commercial loans and leases

   $ 57,915        56,395      

Residential mortgage loans

   $ 15,585        15,591    

Home equity

     6,485        7,014    

Automobile loans

     9,002        9,112    

Credit card

     2,325        2,299    

Other consumer loans

     2,131        1,559      

Total consumer loans

   $ 35,528        35,575      

Total portfolio loans and leases

   $ 93,443        91,970      

Portfolio loans and leases are recorded net of unearned income, which totaled $485 million as of September 30, 2018 and $523 million as of December 31, 2017. Additionally, portfolio loans and leases are recorded net of unamortized premiums and discounts, deferred direct loan origination fees and costs and fair value adjustments (associated with acquired loans or loans designated as fair value upon origination) which totaled a net premium of $294 million and $282 million as of September 30, 2018 and December 31, 2017, respectively.

The Bancorp’s FHLB and FRB advances are generally secured by loans. The Bancorp had loans of $13.2 billion and $13.0 billion at September 30, 2018 and December 31, 2017, respectively, pledged at the FHLB, and loans of $41.9 billion and $39.8 billion at September 30, 2018 and December 31, 2017, respectively, pledged at the FRB.

 

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The following table presents a summary of the total loans and leases owned by the Bancorp as of:

 

                    90 Days Past Due       
     Carrying Value     and Still Accruing       
     September 30,     December 31,     September 30,      December 31,      

($ in millions)

   2018     2017     2018      2017       

Commercial and industrial loans

   $ 42,725       41,170       3        3    

Commercial mortgage loans

     6,701       6,610       1        -    

Commercial construction loans

     4,892       4,553       -        -    

Commercial leases

     3,697       4,068       -        -    

Residential mortgage loans

     16,148       16,077       40        57    

Home equity

     6,485       7,014       -        -    

Automobile loans

     9,002       9,112       11        10    

Credit card

     2,325       2,299       32        27    

Other consumer loans

     2,131       1,559       -        -      

Total loans and leases

   $ 94,106       92,462       87        97      

Less: Loans and leases held for sale

     663       492                       

Total portfolio loans and leases

   $ 93,443       91,970                       

 

The following table presents a summary of net charge-offs (recoveries):

 

            
      For the three months ended     For the nine months ended       
      September 30,     September 30,       

($ in millions)

   2018     2017     2018      2017       

Commercial and industrial loans

   $ 28       27       102        79    

Commercial mortgage loans

     (1     3       3        13    

Commercial construction loans

     -       -       -        -    

Commercial leases

     -       -       -        2    

Residential mortgage loans

     2       (1     6        5    

Home equity

     3       3       9        14    

Automobile loans

     9       8       28        26    

Credit card

     21       20       72        64    

Other consumer loans

     10       8       27        18      

Total net charge-offs

   $ 72       68       247        221      

 

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Fifth Third Bancorp and Subsidiaries

Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

6. Credit Quality and the Allowance for Loan and Lease Losses

The Bancorp disaggregates ALLL balances and transactions in the ALLL by portfolio segment. Credit quality related disclosures for loans and leases are further disaggregated by class.

Allowance for Loan and Lease Losses

The following tables summarize transactions in the ALLL by portfolio segment:

 

             Residential                             

For the three months ended September 30, 2018 ($ in millions)

   Commercial     Mortgage     Consumer     Unallocated      Total       

Balance, beginning of period

   $ 654       86       229       108        1,077    

Losses charged-off(a)

     (36     (3     (73     -        (112  

Recoveries of losses previously charged-off(a)

     9       1       30       -        40    

Provision for (benefit from) loan and lease losses

     29       (1     57       1        86      

Balance, end of period

   $ 656       83       243       109        1,091      

(a)

For the three months ended September 30, 2018, the Bancorp recorded $8 in both losses charged-off and recoveries of losses charged-off related to customer defaults on point-of-sale consumer loans for which the Bancorp obtained recoveries under third-party credit enhancements.

 

             Residential                            

For the three months ended September 30, 2017 ($ in millions)

   Commercial     Mortgage     Consumer     Unallocated     Total       

Balance, beginning of period

   $ 817       93       206       110       1,226    

Losses charged-off

     (33     (2     (50     -       (85  

Recoveries of losses previously charged-off

     3       3       11       -       17    

Provision for (benefit from) loan and lease losses

     9       (4     51       11       67    

Deconsolidation of a VIE(a)

     (19     -       -       (1     (20    

Balance, end of period

   $ 777       90       218       120       1,205      

(a)

Refer to Note 10 for further discussion on the deconsolidation of a VIE.

 

             Residential                            

For the nine months ended September 30, 2018 ($ in millions)

   Commercial     Mortgage     Consumer     Unallocated     Total       

Balance, beginning of period

   $ 753       89       234       120       1,196    

Losses charged-off(a)

     (124     (10     (200     -       (334  

Recoveries of losses previously charged-off(a)

     19       4       64       -       87    

Provision for (benefit from) loan and lease losses

     8       -       145       (11     142      

Balance, end of period

   $ 656       83       243       109       1,091      

(a)

For the nine months ended September 30, 2018, the Bancorp recorded $18 in both losses charged-off and recoveries of losses charged-off related to customer defaults on point-of-sale consumer loans for which the Bancorp obtained recoveries under third-party credit enhancements.

 

             Residential                            

For the nine months ended September 30, 2017 ($ in millions)

   Commercial     Mortgage     Consumer     Unallocated     Total       

Balance, beginning of period

   $ 831       96       214       112       1,253    

Losses charged-off

     (119     (12     (156     -       (287  

Recoveries of losses previously charged-off

     25       7       34       -       66    

Provision for (benefit from) loan and lease losses

     59       (1     126       9       193    

Deconsolidation of a VIE(a)

     (19     -       -       (1     (20    

Balance, end of period

   $ 777       90       218       120       1,205      

(a)

Refer to Note 10 for further discussion on the deconsolidation of a VIE.

The following tables provide a summary of the ALLL and related loans and leases classified by portfolio segment:

 

              Residential                               

As of September 30, 2018 ($ in millions)

   Commercial      Mortgage      Consumer      Unallocated      Total       

ALLL:(a)

                

Individually evaluated for impairment

   $ 66        64        38        -        168    

Collectively evaluated for impairment

     590        19        205        -        814    

Unallocated

     -        -        -        109        109      

Total ALLL

   $ 656        83        243        109        1,091      

Portfolio loans and leases:(b)

                

Individually evaluated for impairment

   $ 345        757        285        -        1,387    

Collectively evaluated for impairment

     57,570        14,656        19,658        -        91,884      

Total portfolio loans and leases

   $ 57,915        15,413        19,943        -        93,271      

(a)

Includes $1 related to leveraged leases at September 30, 2018.

(b)

Excludes $172 of residential mortgage loans measured at fair value and includes $638 of leveraged leases, net of unearned income at September 30, 2018.

 

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Fifth Third Bancorp and Subsidiaries

Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

              Residential                               

As of December 31, 2017 ($ in millions)

   Commercial      Mortgage      Consumer      Unallocated      Total       

ALLL:(a)

                

Individually evaluated for impairment

   $ 94        64        42        -        200    

Collectively evaluated for impairment

     659        25        192        -        876    

Unallocated

     -        -        -        120        120      

Total ALLL

   $ 753        89        234        120        1,196      

Portfolio loans and leases:(b)

                

Individually evaluated for impairment

   $ 560        665        320        -        1,545    

Collectively evaluated for impairment

     55,835        14,787        19,664        -        90,286    

Loans acquired with deteriorated credit quality

     -        2        -        -        2      

Total portfolio loans and leases

   $ 56,395        15,454        19,984        -        91,833      

(a)

Includes $1 related to leveraged leases at December 31, 2017.

(b)

Excludes $137 of residential mortgage loans measured at fair value and includes $674 of leveraged leases, net of unearned income at December 31, 2017.

CREDIT RISK PROFILE

Commercial Portfolio Segment

For purposes of analyzing historical loss rates used in the determination of the ALLL and monitoring the credit quality and risk characteristics of its commercial portfolio segment, the Bancorp disaggregates the segment into the following classes: commercial and industrial, commercial mortgage owner-occupied, commercial mortgage nonowner-occupied, commercial construction and commercial leases.

To facilitate the monitoring of credit quality within the commercial portfolio segment, and for purposes of analyzing historical loss rates used in the determination of the ALLL for the commercial portfolio segment, the Bancorp utilizes the following categories of credit grades: pass, special mention, substandard, doubtful and loss. The five categories, which are derived from standard regulatory rating definitions, are assigned upon initial approval of credit to borrowers and updated periodically thereafter.

Pass ratings, which are assigned to those borrowers that do not have identified potential or well-defined weaknesses and for which there is a high likelihood of orderly repayment, are updated at least annually based on the size and credit characteristics of the borrower. All other categories are updated on a quarterly basis during the month preceding the end of the calendar quarter.

The Bancorp assigns a special mention rating to loans and leases that have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may, at some future date, result in the deterioration of the repayment prospects for the loan or lease or the Bancorp’s credit position.

The Bancorp assigns a substandard rating to loans and leases that are inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged. Substandard loans and leases have well-defined weaknesses or weaknesses that could jeopardize the orderly repayment of the debt. Loans and leases in this grade also are characterized by the distinct possibility that the Bancorp will sustain some loss if the deficiencies noted are not addressed and corrected.

The Bancorp assigns a doubtful rating to loans and leases that have all the attributes of a substandard rating with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonable specific pending factors that may work to the advantage of and strengthen the credit quality of the loan or lease, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors may include a proposed merger or acquisition, liquidation proceeding, capital injection, perfecting liens on additional collateral or refinancing plans.

Loans and leases classified as loss are considered uncollectible and are charged-off in the period in which they are determined to be uncollectible. Because loans and leases in this category are fully charged-off, they are not included in the following tables.

The following tables summarize the credit risk profile of the Bancorp’s commercial portfolio segment, by class:

 

              Special                               

As of September 30, 2018 ($ in millions)

   Pass      Mention      Substandard      Doubtful      Total       

Commercial and industrial loans

   $       41,008        776        847        -        42,631    

Commercial mortgage owner-occupied loans

     3,162        50        112        -        3,324    

Commercial mortgage nonowner-occupied loans

     3,316        40        15        -        3,371    

Commercial construction loans

     4,892        -        -        -        4,892    

Commercial leases

     3,538        74        85        -        3,697      

Total commercial loans and leases

   $ 55,916        940        1,059        -        57,915      

 

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Fifth Third Bancorp and Subsidiaries

Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

              Special                               

As of December 31, 2017 ($ in millions)

   Pass      Mention      Substandard      Doubtful      Total       

Commercial and industrial loans

   $     38,813        1,115        1,235        7        41,170    

Commercial mortgage owner-occupied loans

     3,207        75        80        -        3,362    

Commercial mortgage nonowner-occupied loans

     3,117        28        97        -        3,242    

Commercial construction loans

     4,553        -        -        -        4,553    

Commercial leases

     3,922        72        74        -        4,068      

Total commercial loans and leases

   $     53,612        1,290        1,486        7        56,395      

Residential Mortgage and Consumer Portfolio Segments

For purposes of monitoring the credit quality and risk characteristics of its consumer portfolio segment, the Bancorp disaggregates the segment into the following classes: home equity, automobile loans, credit card and other consumer loans. The Bancorp’s residential mortgage portfolio segment is also a separate class.

The Bancorp considers repayment performance as the best indicator of credit quality for residential mortgage and consumer loans, which includes both the delinquency status and performing versus nonperforming status of the loans. The delinquency status of all residential mortgage and consumer loans is presented by class in the age analysis section while the performing versus nonperforming status is presented in the following table. Refer to the nonaccrual loans and leases section of Note 1 of the Notes to Consolidated Financial Statements included in the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2017 for additional delinquency and nonperforming information.

The following table presents a summary of the Bancorp’s residential mortgage and consumer portfolio segments, by class, disaggregated into performing versus nonperforming status as of:

 

      September 30, 2018      December 31, 2017       

($ in millions)

   Performing      Nonperforming      Performing      Nonperforming       

Residential mortgage loans(a)

   $ 15,390        23        15,424        30    

Home equity

     6,411        74        6,940        74    

Automobile loans

     9,001        1        9,111        1    

Credit card

     2,299        26        2,273        26    

Other consumer loans

     2,130        1        1,559        -      

Total residential mortgage and consumer loans

   $ 35,231        125        35,307        131      

(a)

Excludes $172 and $137 of residential mortgage loans measured at fair value at September 30, 2018 and December 31, 2017, respectively.

Age Analysis of Past Due Loans and Leases

The following tables summarize the Bancorp’s recorded investment in portfolio loans and leases, by age and class:

 

      Current      Past Due              90 Days Past       
     Loans and      30-89      90 Days      Total      Total Loans      Due and Still      

As of September 30, 2018 ($ in millions)

   Leases(b)(c)      Days(c)      or More(c)      Past Due      and Leases      Accruing       

Commercial loans and leases:

                   

Commercial and industrial loans

   $ 42,481        22        128        150        42,631        3    

Commercial mortgage owner-occupied loans

     3,314        3        7        10        3,324        1    

Commercial mortgage nonowner-occupied loans

     3,363        5        3        8        3,371        -    

Commercial construction loans

     4,884        8        -        8        4,892        -    

Commercial leases

     3,693        -        4        4        3,697        -    

Residential mortgage loans(a)

     15,321        29        63        92        15,413        40    

Consumer loans:

                   

Home equity

     6,366        68        51        119        6,485        -    

Automobile loans

     8,891        99        12        111        9,002        11    

Credit card

     2,245        42        38        80        2,325        32    

Other consumer loans

     2,116        14        1        15        2,131        -      

Total portfolio loans and leases

   $ 92,674        290        307        597        93,271        87      

(a)

Excludes $172 of residential mortgage loans measured at fair value at September 30, 2018.

(b)

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 September 30, 2018, $80 of these loans were 30-89 days past due and $198 were 90 days or more past due. The Bancorp recognized $1 and $4 of losses during the three and nine months ended September 30, 2018, respectively, due to claim denials and curtailments associated with these insured or guaranteed loans.

(c)

Includes accrual and nonaccrual loans and leases.

 

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Fifth Third Bancorp and Subsidiaries

Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

     

Current

Loans and

Leases(b)(c)

        Past Due         

90 Days Past

Due and Still

Accruing

         

30-89

    Days(c)    

  

90 Days

or More(c)

  

Total

Past Due

       

Total Loans

and Leases

As of December 31, 2017 ($ in millions)

Commercial loans and leases:

                                               

Commercial and industrial loans

     $     41,027          42        101        143            41,170        3

Commercial mortgage owner-occupied loans

       3,351          3        8        11            3,362        -

Commercial mortgage nonowner-occupied loans

       3,235          -        7        7            3,242        -

Commercial construction loans

       4,552          1        -        1            4,553        -

Commercial leases

       4,065          3        -        3            4,068        -

Residential mortgage loans(a)

       15,301          66        87        153            15,454        57

Consumer loans:

                                   

Home equity

       6,888          70        56        126            7,014        -

Automobile loans

       8,992          107        13        120            9,112        10

Credit card

       2,230          36        33        69            2,299        27

Other consumer loans

       1,554            5        -        5                  1,559        -

Total portfolio loans and leases

     $     91,195            333        305        638                  91,833        97

(a)

Excludes $137 of residential mortgage loans measured at fair value at December 31, 2017.

(b)

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 December 31, 2017, $95 of these loans were 30-89 days past due and $290 were 90 days or more past due. The Bancorp recognized $1 and $4 of losses during the three and nine months ended September 30, 2017, respectively, due to claim denials and curtailments associated with these insured or guaranteed loans.

(c)

Includes accrual and nonaccrual loans and leases.

Impaired Portfolio Loans and Leases

Larger commercial loans and leases included within aggregate borrower relationship balances exceeding $1 million that exhibit probable or observed credit weaknesses are subject to individual review for impairment. The Bancorp also performs an individual review on loans and leases that are restructured in a TDR. The Bancorp considers the current value of collateral, credit quality of any guarantees, the loan structure and other factors when evaluating whether an individual loan or lease is impaired. Other factors may include the geography and industry of the borrower, size and financial condition of the borrower, cash flow and leverage of the borrower and the Bancorp’s evaluation of the borrower’s management. Smaller-balance homogenous loans or leases that are collectively evaluated for impairment are not included in the following tables.

The following tables summarize the Bancorp’s impaired portfolio loans and leases, by class, that were subject to individual review, which includes all portfolio loans and leases restructured in a TDR:

 

      Unpaid                 
     Principal      Recorded        

As of September 30, 2018 ($ in millions)

   Balance      Investment     ALLL  

With a related ALLL:

       

Commercial loans and leases:

       

Commercial and industrial loans

   $ 199        150         55  

Commercial mortgage owner-occupied loans

     2        2         1  

Commercial mortgage nonowner-occupied loans

     1        1         -  

Commercial leases

     27        27         10  

Restructured residential mortgage loans

     484        481         64  

Restructured consumer loans:

       

Home equity

     152        152         22  

Automobile loans

     5        5         1  

Credit card

     47        43         15  

Total impaired portfolio loans and leases with a related ALLL

   $ 917        861         168  

With no related ALLL:

       

Commercial loans:

       

Commercial and industrial loans

   $ 171        148         -  

Commercial mortgage owner-occupied loans

     8        5         -  

Commercial mortgage nonowner-occupied loans

     13        12         -  

Restructured residential mortgage loans

     294        276         -  

Restructured consumer loans:

       

Home equity

     87        84         -  

Automobile loans

     2        1         -  

Total impaired portfolio loans with no related ALLL

   $ 575        526         -  

Total impaired portfolio loans and leases

   $ 1,492        1,387   (a)       168  

(a)

Includes $80, $745 and $242, respectively, of commercial, residential mortgage and consumer portfolio TDRs on accrual status and $180, $12 and $43, respectively, of commercial, residential mortgage and consumer portfolio TDRs on nonaccrual status at September 30, 2018.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

      Unpaid                
     Principal    Recorded        

As of December 31, 2017 ($ in millions)

   Balance    Investment   ALLL     

With a related ALLL:

               

Commercial loans and leases:

               

Commercial and industrial loans

     $ 433        358       87  

Commercial mortgage owner-occupied loans

       16        14       7  

Commercial mortgage nonowner-occupied loans

       4        3       -  

Commercial leases

       4        4       -  

Restructured residential mortgage loans

       469        465       64  

Restructured consumer loans:

               

Home equity

       172        172       27  

Automobile loans

       8        7       1  

Credit card

       52        45       14    

Total impaired portfolio loans and leases with a related ALLL

     $     1,158        1,068       200    

With no related ALLL:

               

Commercial loans:

               

Commercial and industrial loans

     $ 151        131       -  

Commercial mortgage owner-occupied loans

       18        15       -  

Commercial mortgage nonowner-occupied loans

       35        35       -  

Restructured residential mortgage loans

       218        200       -  

Restructured consumer loans:

               

Home equity

       97        94       -  

Automobile loans

       2        2       -    

Total impaired portfolio loans with no related ALLL

     $ 521        477       -    

Total impaired portfolio loans and leases

     $ 1,679        1,545  (a)        200    

(a)

Includes $249, $652 and $275, respectively, of commercial, residential mortgage and consumer portfolio TDRs on accrual status and $150, $13 and $45, respectively, of commercial, residential mortgage and consumer portfolio TDRs on nonaccrual status at December 31, 2017.

The following tables summarize the Bancorp’s average impaired portfolio loans and leases, by class, and interest income, by class:

 

      For the three months ended
September 30, 2018
    For the nine months ended
September 30, 2018
 
     Average      Interest     Average      Interest  
     Recorded      Income     Recorded      Income  

($ in millions)

   Investment      Recognized     Investment      Recognized  

Commercial loans and leases:

          

Commercial and industrial loans

     $               313            3           408            13  

Commercial mortgage owner-occupied loans

     11            -           17            -  

Commercial mortgage nonowner-occupied loans

     21            -           27            -  

Commercial leases

     28            -           17            -  

Restructured residential mortgage loans

     767            7           744            21  

Restructured consumer loans:

          

Home equity

     239            3           248            9  

Automobile loans

     7            -           8            -  

Credit card

     44            1           44            3  

Total average impaired portfolio loans and leases

     $            1,430            14           1,513            46  

 

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Fifth Third Bancorp and Subsidiaries

Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

       

For the three months ended    

September 30, 2017    


          
For the nine months ended
September 30, 2017

($ in millions)

     

Average
Recorded
Investment


      

Interest
Income
Recognized


          

Average
Recorded
Investment


      

Interest
Income
Recognized


Commercial loans and leases:

 

Commercial and industrial loans

    $ 581        4            611          6

Commercial mortgage owner-occupied loans

      50        -            55          -

Commercial mortgage nonowner-occupied loans

      40        -            69          1

Commercial leases

      1        -            2          -

Restructured residential mortgage loans

      654        6            655          18

Restructured consumer loans:

                    

Home equity

      275        3            285          9   

Automobile loans

      11        -            12          -

Credit card

      48        1              49          3

Total average impaired loans and leases

    $ 1,660        14              1,738          37

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.

The following table presents the Bancorp’s nonaccrual loans and leases, by class, and OREO and other repossessed property as of:

 

         September 30,        December 31,

($ in millions)

       2018        2017

Commercial loans and leases:

         

Commercial and industrial loans

     $ 240                276     

Commercial mortgage owner-occupied loans

       9                19

Commercial mortgage nonowner-occupied loans

       3                7

Commercial leases

       26                4

Total nonaccrual portfolio commercial loans and leases

       278                306

Residential mortgage loans

       23                30

Consumer loans:

         

Home equity

       74                74

Automobile loans

       1                1

Credit card

       26                26

Other consumer loans

       1                -

Total nonaccrual portfolio consumer loans

       102                101

Total nonaccrual portfolio loans and leases(a)(b)

     $ 403                437

OREO and other repossessed property

       45                52

Total nonperforming portfolio assets(a)(b)

     $ 448                489

(a)

Excludes $35 and $6 of nonaccrual loans held for sale at September 30, 2018 and December 31, 2017, respectively.

(b)

Includes $4 and $3 of nonaccrual government insured commercial loans whose repayments are insured by the SBA at September 30, 2018 and December 31, 2017, respectively, of which $2 and $3 are restructured nonaccrual government insured commercial loans at September 30, 2018 and December 31, 2017, respectively.

The Bancorp’s recorded investment of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process according to local requirements of the applicable jurisdiction was $163 million and $235 million as of September 30, 2018 and December 31, 2017, respectively.

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. Within each of the Bancorp’s loan classes, TDRs typically involve either a reduction of the stated interest rate of the loan, an extension of the loan’s maturity date with a stated rate lower than the current market rate for a new loan with similar risk or, in limited circumstances, a reduction of the principal balance of the loan or the loan’s accrued interest. Modifying the terms of a loan may result in an increase or decrease to the ALLL depending upon the terms modified, the method used to measure the ALLL for a loan prior to modification and whether any charge-offs were recorded on the loan before or at the time of modification. Refer to the ALLL section of Note 1 of the Notes to Consolidated Financial Statements included in the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2017 for information on the Bancorp’s ALLL methodology. Upon modification of a loan, the Bancorp measures the related impairment as the difference between the estimated future cash flows expected to be collected on the modified loan, discounted at the original effective yield of the loan, and the carrying value of the loan. The resulting measurement may result in the need for minimal or no allowance because it is probable that all cash flows will be collected under the modified terms of the loan. In addition, if the stated interest rate was increased in a TDR, the cash flows on the modified loan, using the pre-modification interest rate as the discount rate, often exceed the recorded investment of the loan. Conversely, upon a modification that reduces the stated interest rate on a loan, the Bancorp recognizes an impairment loss as an increase to the ALLL. If a TDR involves a reduction of the principal balance of the loan or the loan’s accrued interest, that amount is charged off to the ALLL.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

The Bancorp had commitments to lend additional funds to borrowers whose terms have been modified in a TDR, consisting of line of credit and letter of credit commitments of $28 million and $69 million, respectively, as of September 30, 2018 compared with $53 million and $78 million, respectively, as of December 31, 2017.

The following tables provide a summary of loans and leases, by class, modified in a TDR by the Bancorp during the three months ended:

 

      Number of Loans
Modified in a TDR
    

Recorded Investment
in Loans Modified

in a TDR

     (Decrease)
Increase
to ALLL Upon
     Charge-offs
Recognized Upon
 

September 30, 2018 ($ in millions)(a)

   During the Period(b)      During the Period      Modification      Modification  

Commercial loans:

           

Commercial and industrial loans

     16        $              52          (7)            7        

Residential mortgage loans

     185        24          1             -        

Consumer loans:

          

    

      

      

 

Home equity

     30        2          -             -        

Automobile loans

     25        -          -             -        

Credit card

     1,547        8          2             -        

Total portfolio loans

     1,803        $              86          (4)            7        

(a)

Excludes all loans and leases held for sale and loans acquired with deteriorated credit quality which were accounted for within a pool.

(b)

Represents number of loans post-modification and excludes loans previously modified in a TDR.

 

      Number of Loans
Modified in a TDR
    

Recorded Investment
in Loans Modified

in a TDR

     (Decrease)
Increase
to ALLL Upon
     Charge-offs
Recognized Upon
 

September 30, 2017 ($ in millions)(a)

   During the Period(b)      During the Period      Modification      Modification  

Commercial loans:

           

Commercial and industrial loans

     17        $                73          (6)            -        

Commercial mortgage owner-occupied loans

     1        -          -             -        

Commercial mortgage nonowner-occupied loans

     1        -          -             -        

Residential mortgage loans

     247        35          1             -        

Consumer loans:

           

Home equity

     38        2          -             -        

Automobile loans

     28        -          -             -        

Credit card

     2,021        10          2             -        

Total portfolio loans

     2,353        $             120          (3)            -        

(a)

Excludes all loans and leases held for sale and loans acquired with deteriorated credit quality which were accounted for within a pool.

(b)

Represents number of loans post-modification and excludes loans previously modified in a TDR.

The following tables provide a summary of loans and leases, by class, modified in a TDR by the Bancorp during the nine months ended:

 

      Number of Loans
Modified in a TDR
    

Recorded Investment
in Loans Modified

in a TDR

     Increase
to ALLL Upon
     Charge-offs
Recognized Upon
 

September 30, 2018 ($ in millions)(a)

   During the Period(b)      During the Period      Modification      Modification  

Commercial loans:

           

Commercial and industrial loans

     41        $             187         2            7        

Commercial mortgage owner-occupied loans

     2               -            -        

Residential mortgage loans

     969        148         4            -        

Consumer loans:

             

      

 

Home equity

     84               -            -        

Automobile loans

     64               -            -        

Credit card

     5,187        27         6            1        

Total portfolio loans

     6,347        $             368         12            8        

(a)

Excludes all loans and leases held for sale and loans acquired with deteriorated credit quality which were accounted for within a pool.

(b)

Represents number of loans post-modification and excludes loans previously modified in a TDR.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

      Number of Loans
Modified in a TDR
     Recorded Investment
in Loans and Leases
Modified in a TDR
     Increase
(Decrease)
to ALLL Upon
     Charge-offs
Recognized Upon
 

September 30, 2017 ($ in millions)(a)

   During the Period(b)      During the Period      Modification      Modification  

Commercial loans and leases:

           

Commercial and industrial loans

     67        $            226          (4)            6      

Commercial mortgage owner-occupied loans

     8        8          5             -      

Commercial mortgage nonowner-occupied loans

     3        -          -             -      

Residential mortgage loans

     649        92          4             -      

Consumer loans:

           

Home equity

     113        7          -             -      

Automobile loans

     73        -          -             -      

Credit card

     5,929        27          5             1      

Total portfolio loans and leases

     6,842        $            360          10             7      

(a)

Excludes all loans and leases held for sale and loans acquired with deteriorated credit quality which were accounted for within a pool.

(b)

Represents number of loans post-modification and excludes loans previously modified in a TDR.

The Bancorp considers TDRs that become 90 days or more past due under the modified terms as subsequently defaulted. For commercial loans not subject to individual review for impairment, loss rates that are applied for purposes of determining the ALLL include historical losses associated with subsequent defaults on loans previously modified in a TDR. For consumer loans, the Bancorp performs a qualitative assessment of the adequacy of the consumer ALLL by comparing the consumer ALLL to forecasted consumer losses over the projected loss emergence period (the forecasted losses include the impact of subsequent defaults of consumer TDRs). When a residential mortgage, home equity, automobile or other consumer loan that has been modified in a TDR subsequently defaults, the present value of expected cash flows used in the measurement of the potential impairment loss is generally limited to the expected net proceeds from the sale of the loan’s underlying collateral and any resulting impairment loss is reflected as a charge-off or an increase in ALLL. The Bancorp recognizes an ALLL for the entire balance of the credit card loans modified in a TDR that subsequently default.

The following tables provide a summary of TDRs that subsequently defaulted during the three months ended September 30, 2018 and 2017 and were within twelve months of the restructuring date:

 

      Number of      Recorded  

September 30, 2018 ($ in millions)(a)

   Contracts      Investment  

Commercial loans:

     

Commercial and industrial loans

     5      $ 32  

Residential mortgage loans

     28        4  

Consumer loans:

     

Home equity

     4        -  

Credit card

     146        1  

Total portfolio loans

     183      $ 37  

(a)

Excludes all loans and leases held for sale and loans acquired with deteriorated credit quality.

 

      Number of      Recorded  

September 30, 2017 ($ in millions)(a)

   Contracts      Investment  

Commercial loans:

     

Commercial and industrial loans

     3      $ 1  

Commercial mortgage owner-occupied loans

     1        -  

Residential mortgage loans

     49        7  

Consumer loans:

     

Home equity

     2        -  

Credit card

     417        2  

Total portfolio loans

     472      $ 10  

(a)

Excludes all loans and leases held for sale and loans acquired with deteriorated credit quality.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

The following tables provide a summary of TDRs that subsequently defaulted during the nine months ended September 30, 2018 and 2017 and were within twelve months of the restructuring date:

 

      Number of      Recorded  

September 30, 2018 ($ in millions)(a)

   Contracts      Investment  

Commercial loans:

     

Commercial and industrial loans

     8      $ 61  

Commercial mortgage owner-occupied loans

     2        -  

Residential mortgage loans

     138        24  

Consumer loans:

     

Home equity

     6        -  

Credit card

     525        3  

Total portfolio loans

     679      $ 88  

(a)

Excludes all loans and leases held for sale and loans acquired with deteriorated credit quality.

 

      Number of      Recorded  

September 30, 2017 ($ in millions)(a)

   Contracts      Investment  

Commercial loans:

     

Commercial and industrial loans

     7      $ 17  

Commercial mortgage owner-occupied loans

     4        1  

Residential mortgage loans

     132        19  

Consumer loans:

     

Home equity

     13        2  

Credit card

     1,254        6  

Total portfolio loans

     1,410      $ 45  

(a)

Excludes all loans and leases held for sale and loans acquired with deteriorated credit quality.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

7. Bank Premises and Equipment

The following table provides a summary of bank premises and equipment as of:

 

($ in millions)

   September 30, 2018    December 31, 2017  

Land and improvements(a)

     $ 597          644     

Buildings(a)

     1,593          1,679     

Equipment

     1,962          1,876     

Leasehold improvements

     404          399     

Construction in progress(a)

     89          93     

Bank premises and equipment held for sale:

          

Land and improvements

     24          17     

Buildings

     11          9     

Equipment

     3          1     

Accumulated depreciation and amortization

     (2,787          (2,715         

Total bank premises and equipment

     $ 1,896            2,003           

(a)

At September 30, 2018 and December 31, 2017, land and improvements, buildings and construction in progress included $55 and $91, respectively, associated with parcels of undeveloped land intended for future branch expansion.

The Bancorp monitors changing customer preferences associated with the channels it uses for banking transactions to evaluate the efficiency, competitiveness and quality of the customer service experience in its consumer distribution network. As part of this ongoing assessment, the Bancorp may determine that it is no longer fully committed to maintaining full-service branches at certain of its existing banking center locations. Similarly, the Bancorp may also determine that it is no longer fully committed to building banking centers on certain parcels of land which had previously been held for future branch expansion.

During the second quarter of 2018, the Bancorp adopted a plan to close approximately 100 to 125 branches over the next three years (the “2018 Branch Optimization Plan”). As of September 30, 2018, the Bancorp had identified 31 specific branches for closure under the 2018 Branch Optimization Plan with these closures expected to be completed prior to December 31, 2018. The Bancorp expects to identify the remaining branches to be closed under the 2018 Branch Optimization Plan prior to December 31, 2019. As part of the adoption of the 2018 Branch Optimization Plan, the Bancorp has also elected to sell 21 parcels of land which had previously been held for future branch expansion.

The Bancorp performs assessments of the recoverability of long-lived assets when events or changes in circumstances indicate that their carrying values may not be recoverable. Impairment losses associated with such assessments and lower of cost or market adjustments were immaterial and $41 million for the three and nine months ended September 30, 2018, respectively, and $1 million and $6 million for the three and nine months ended September 30, 2017, respectively. The recognized impairment losses were recorded in other noninterest income in the Condensed Consolidated Statements of Income.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

8. Goodwill

Business combinations entered into by the Bancorp typically include the acquisition of goodwill. Acquisition activity includes acquisitions in the respective period in addition to purchase accounting adjustments related to previous acquisitions. The Bancorp completed its annual goodwill impairment test as of September 30, 2018 by performing a qualitative assessment of goodwill at the reporting unit level to determine whether any indicators of impairment existed. In performing this qualitative assessment, the Bancorp evaluated events and circumstances since the last impairment analysis, macroeconomic conditions, banking industry and market conditions and key financial metrics of the Bancorp as well as reporting unit and overall Bancorp financial performance. After assessing the totality of the events and circumstances, the Bancorp determined that it was not more likely than not that the fair values of the Commercial Banking, Branch Banking and Wealth and Asset Management reporting units were less than their respective carrying amounts and, therefore, the first and second steps of the quantitative goodwill impairment test were deemed unnecessary.

Changes in the net carrying amount of goodwill, by reporting unit, for the nine months ended September 30, 2018 and 2017 were as follows:

 

      Commercial     Branch      Consumer       Wealth and Asset          

($ in millions)

   Banking     Banking      Lending       Management      Total          

Goodwill

   $ 1,363       1,655        215       148        3,381  

Accumulated impairment losses

     (750     -        (215     -        (965

Net carrying value as of December 31, 2016

   $ 613       1,655        -       148        2,416  

Acquisition activity

     -       -        -       7        7  

Net carrying value as of September 30, 2017

   $ 613       1,655        -       155        2,423  
                                            

Net carrying value as of December 31, 2017

   $ 613       1,655        -       177        2,445  

Acquisition activity

     17       -        -       -        17  

Net carrying value as of September 30, 2018

   $ 630       1,655        -       177        2,462  

9. Intangible Assets

Intangible assets consist of core deposit intangibles, customer relationships, non-compete agreements, trade names and rent intangibles. Intangible assets are amortized on either a straight-line or an accelerated basis over their estimated useful lives. The increase in gross carrying amount of intangible assets from the year ended December 31, 2017 primarily reflects acquisition activity during the first quarter of 2018.

The details of the Bancorp’s intangible assets are shown in the following table:

 

      Gross Carrying      Accumulated     Net Carrying  

($ in millions)

   Amount      Amortization     Amount  

As of September 30, 2018

       

Core deposit intangibles

   $ 34        (30     4  

Customer relationships

     20        (2     18  

Non-compete agreements

     14        (11     3  

Other

     6        (3     3  

Total intangible assets

   $ 74        (46     28  

As of December 31, 2017

       

Core deposit intangibles

   $ 34        (29     5  

Customer relationships

     16        -       16  

Non-compete agreements

     13        (10     3  

Other

     6        (3     3  

Total intangible assets

   $ 69        (42     27  

As of September 30, 2018, all of the Bancorp’s intangible assets were being amortized. Amortization expense recognized on intangible assets was $2 million and immaterial for the three months ended September 30, 2018 and 2017, respectively, and $4 million and $1 million for the nine months ended September 30, 2018 and 2017, respectively. The Bancorp’s projection of amortization expense shown in the following table is based on existing balances as of September 30, 2018. Future amortization expense may vary from these projections.

Estimated amortization expense for the remainder of 2018 through 2022 is as follows:

 

($ in millions)

   Total  

Remainder of 2018

   $                             1  

2019

     5  

2020

     3  

2021

     3  

2022

     2  

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

10. Variable Interest Entities

The Bancorp, in the normal course of business, engages in a variety of activities that involve VIEs, which are legal entities that lack sufficient equity at risk to finance their activities without additional subordinated financial support or the equity investors of the entities as a group lack any of the characteristics of a controlling interest. The Bancorp evaluates its interest in certain entities to determine if these entities meet the definition of a VIE and whether the Bancorp is the primary beneficiary and should consolidate the entity based on the variable interests it held both at inception and when there is a change in circumstances that requires a reconsideration. If the Bancorp is determined to be the primary beneficiary of a VIE, it must account for the VIE as a consolidated subsidiary. If the Bancorp is determined not to be the primary beneficiary of a VIE but holds a variable interest in the entity, such variable interests are accounted for under the equity method of accounting or other accounting standards as appropriate.

Consolidated VIEs

The following tables provide a summary of the classifications of consolidated VIE assets, liabilities and noncontrolling interests included in the Condensed Consolidated Balance Sheets as of:

 

      Automobile Loan      CDC          

September 30, 2018 ($ in millions)

   Securitizations      Investments      Total          

Assets:

        

Other short-term investments

   $ 41                -                41  

Commercial mortgage loans

     -                20                20  

Automobile loans

     773                -                773  

ALLL

     (4)                -                (4

Other assets

     5                -                5  

Total assets

   $ 815                20                835  

Liabilities:

        

Other liabilities

   $ 1                -                1  

Long-term debt

     710                -                710  

Total liabilities

   $ 711                -                711  

Noncontrolling interests

   $ -                20                20  
                      
      Automobile Loan      CDC          

December 31, 2017 ($ in millions)

   Securitizations      Investments      Total  

Assets:

        

Other short-term investments

   $ 62                -                62  

Commercial mortgage loans

     -                20                20  

Automobile loans

     1,277                -                1,277  

ALLL

     (6)                -                (6

Other assets

     7                -                7  

Total assets

   $ 1,340                20                1,360  

Liabilities

        

Other liabilities

   $ 2                -                2  

Long-term debt

     1,190                -                1,190  

Total liabilities

   $ 1,192                -                1,192  

Noncontrolling interests

   $ -                20                20  

Automobile loan securitizations

In a securitization transaction that occurred in the third quarter of 2017, the Bancorp transferred an aggregate amount of $1.1 billion in consumer automobile loans to a bankruptcy remote trust which was deemed to be a VIE. This trust then subsequently issued approximately $1.0 billion of asset-backed notes, of which approximately $261 million were retained by the Bancorp. Additionally, in prior years the Bancorp completed securitization transactions in which the Bancorp transferred certain consumer automobile loans to bankruptcy remote trusts which were also deemed to be VIEs. The primary purposes of the VIEs were to issue asset-backed securities with varying levels of credit subordination and payment priority, as well as residual interests, and to provide the Bancorp with access to liquidity for its originated loans. The Bancorp retained residual interests in the VIEs and, therefore, has an obligation to absorb losses and a right to receive benefits from the VIEs that could potentially be significant to the VIEs. In addition, the Bancorp retained servicing rights for the underlying loans and, therefore, holds the power to direct the activities of the VIEs that most significantly impact the economic performance of the VIEs. As a result, the Bancorp concluded that it is the primary beneficiary of the VIEs and has consolidated these VIEs. The assets of the VIEs are restricted to the settlement of the asset-backed securities and other obligations of the VIEs. Third-party holders of the notes do not have recourse to the general assets of the Bancorp.

The economic performance of the VIEs is most significantly impacted by the performance of the underlying loans. The principal risks to which the VIEs are exposed include credit risk and prepayment risk. The credit and prepayment risks are managed through credit enhancements in the form of reserve accounts, overcollateralization, excess interest on the loans and the subordination of certain classes of asset-backed securities to other classes.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

CDC investments

CDC, a wholly-owned indirect subsidiary of the Bancorp, was created to invest in projects to create affordable housing, revitalize business and residential areas and preserve historic landmarks. CDC generally co-invests with other unrelated companies and/or individuals and typically makes investments in a separate legal entity that owns the property under development. The entities are usually formed as limited partnerships and LLCs and CDC typically invests as a limited partner/investor member in the form of equity contributions. The economic performance of the VIEs is driven by the performance of their underlying investment projects as well as the VIEs’ ability to operate in compliance with the rules and regulations necessary for the qualification of tax credits generated by equity investments. The Bancorp’s subsidiaries serve as the managing member of certain LLCs invested in business revitalization projects and have the right to make decisions that most significantly impact the economic performance of the LLCs. Additionally, the investor members do not hold substantive kick-out rights or substantive participating rights over the managing member. The Bancorp has provided an indemnification guarantee to the investor member of these LLCs related to the qualification of tax credits generated by the investor members’ investment. Accordingly, the Bancorp concluded that it is the primary beneficiary and, therefore, has consolidated these VIEs. As a result, the investor members’ interests in these VIEs are presented as noncontrolling interests in the Condensed Consolidated Financial Statements. This presentation includes reporting separately the equity attributable to the noncontrolling interests in the Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Changes in Equity and reporting separately the comprehensive income attributable to the noncontrolling interests in the Condensed Consolidated Statements of Comprehensive Income and the net income attributable to the noncontrolling interests in the Condensed Consolidated Statements of Income.

During the third quarter of 2017, the Bancorp’s indemnification guarantee for one of the CDC investments for which a Bancorp subsidiary served as the managing member expired and the Bancorp transferred its remaining ownership interest in the VIE to the investor member thus removing the Bancorp from future operations of the VIE. As a result, the Bancorp deconsolidated the VIE during the third quarter of 2017 resulting in a decrease of $27 million in commercial mortgage loans, a decrease of $20 million in ALLL associated with the commercial mortgage loans and a decrease of $18 million in indemnification guarantee exposure. The Bancorp’s maximum exposure related to the remaining indemnifications at September 30, 2018 and December 31, 2017 was $19 million and $17 million, respectively, which is based on an amount required to meet the investor member’s defined target rate of return.

Non-consolidated VIEs

The following tables provide a summary of assets and liabilities carried on the Condensed Consolidated Balance Sheets related to non-consolidated VIEs for which the Bancorp holds an interest, but is not the primary beneficiary of the VIE, as well as the Bancorp’s maximum exposure to losses associated with its interests in the entities as of:

 

      Total      Total      Maximum  

September 30, 2018 ($ in millions)

   Assets      Liabilities      Exposure  

CDC investments

   $ 1,229        378          1,229    

Private equity investments

     40        -          73    

Loans provided to VIEs

     2,239        -          3,404    
                            
       Total        Total        Maximum  

December 31, 2017 ($ in millions)

     Assets        Liabilities        Exposure  

CDC investments

   $                 1,376        355          1,376    

Private equity investments

     102        -          150    

Loans provided to VIEs

     1,845        -          2,910    

CDC investments

As noted previously, CDC typically invests in VIEs as a limited partner or investor member in the form of equity contributions and has no substantive kick-out or substantive participating rights over the managing member. The Bancorp has determined that it is not the primary beneficiary of these VIEs because it lacks the power to direct the activities that most significantly impact the economic performance of the underlying project or the VIEs’ ability to operate in compliance with the rules and regulations necessary for the qualification of tax credits generated by equity investments. This power is held by the managing members who exercise full and exclusive control of the operations of the VIEs. Accordingly, the Bancorp accounts for these investments under the equity method of accounting.

The Bancorp’s funding requirements are limited to its invested capital and any additional unfunded commitments for future equity contributions. The Bancorp’s maximum exposure to loss as a result of its involvement with the VIEs is limited to the carrying amounts of the investments, including the unfunded commitments. The carrying amounts of these investments, which are included in other assets in the Condensed Consolidated Balance Sheets, and the liabilities related to the unfunded commitments, which are included in other liabilities in the Condensed Consolidated Balance Sheets, are included in the previous tables for all periods presented. The Bancorp has no other liquidity arrangements or obligations to purchase assets of the VIEs that would expose the Bancorp to a loss. In certain arrangements, the general partner/managing member of the VIE has guaranteed a level of projected tax credits to be received by the limited partners/investor members, thereby minimizing a portion of the Bancorp’s risk.

At September 30, 2018 and December 31, 2017, the Bancorp’s CDC investments included $1.1 billion and $1.3 billion, respectively, of investments in affordable housing tax credits recognized in other assets in the Condensed Consolidated Balance Sheets. The unfunded commitments related to these investments were $368 million and $355 million at September 30, 2018 and December 31, 2017, respectively. The unfunded commitments as of September 30, 2018 are expected to be funded from 2018 to 2034.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

The Bancorp has accounted for all of its investments in qualified affordable housing tax credits using the equity method of accounting. The following table summarizes the impact to the Condensed Consolidated Statements of Income relating to investments in qualified affordable housing investments:

 

      Condensed Consolidated    For the three months ended
September 30,
          For the nine months ended
September 30,
 

($ in millions)

   Statements of Income Caption    2018     2017           2018     2017  

Pre-tax investment and impairment losses(a)

  

Other noninterest expense

   $ 38       36          131       107  

Tax credits and other benefits

  

Applicable income tax expense

     (43     (56          (146     (168

(a)

The Bancorp did not recognize impairment losses resulting from the forfeiture or ineligibility of tax credits or other circumstances during both the three and nine months ended September 30, 2018 and 2017.

Private equity investments

The Bancorp, through Fifth Third Capital Holdings, a wholly-owned indirect subsidiary of the Bancorp, invests as a limited partner in private equity investments which provide the Bancorp an opportunity to obtain higher rates of return on invested capital, while also creating cross-selling opportunities for the Bancorp’s commercial products. Each of the limited partnerships has an unrelated third-party general partner responsible for appointing the fund manager. The Bancorp has not been appointed fund manager for any of these private equity investments. The funds finance primarily all of their activities from the partners’ capital contributions and investment returns. The Bancorp has determined that it is not the primary beneficiary of the funds because it does not have the obligation to absorb the funds’ expected losses or the right to receive the funds’ expected residual returns that could potentially be significant to the funds and lacks the power to direct the activities that most significantly impact the economic performance of the funds. The Bancorp, as a limited partner, does not have substantive participating or substantive kick-out rights over the general partner. Therefore, the Bancorp accounts for its investments in these limited partnerships under the equity method of accounting.

The Bancorp is exposed to losses arising from the negative performance of the underlying investments in the private equity investments. As a limited partner, the Bancorp’s maximum exposure to loss is limited to the carrying amounts of the investments plus unfunded commitments. The carrying amounts of these investments, which are included in other assets in the Condensed Consolidated Balance Sheets, are included in the previous tables. Also, at September 30, 2018 and December 31, 2017, the unfunded commitment amounts to the funds were $33 million and $48 million, respectively. As part of previous commitments, the Bancorp made capital contributions to private equity investments of $1 million and $2 million during the three months ended September 30, 2018 and 2017, respectively and $6 million and $9 million during the nine months ended September 30, 2018 and 2017, respectively. The Bancorp recognized zero and $8 million of OTTI associated with certain nonconforming investments affected by the Volcker Rule during the three and nine months ended September 30, 2018, respectively and did not recognize OTTI during both the three and nine months ended September 30, 2017, respectively. Refer to Note 22 for further information.

Loans provided to VIEs

The Bancorp has provided funding to certain unconsolidated VIEs sponsored by third parties. These VIEs are generally established to finance certain consumer and small business loans originated by third parties. The entities are primarily funded through the issuance of a loan from the Bancorp or a syndication through which the Bancorp is involved. The sponsor/administrator of the entities is responsible for servicing the underlying assets in the VIEs. Because the sponsor/administrator, not the Bancorp, holds the servicing responsibilities, which include the establishment and employment of default mitigation policies and procedures, the Bancorp does not hold the power to direct the activities that most significantly impact the economic performance of the entity and, therefore, is not the primary beneficiary.

The principal risk to which these entities are exposed is credit risk related to the underlying assets. The Bancorp’s maximum exposure to loss is equal to the carrying amounts of the loans and unfunded commitments to the VIEs. The Bancorp’s outstanding loans to these VIEs are included in commercial loans in Note 5. As of September 30, 2018 and December 31, 2017, the Bancorp’s unfunded commitments to these entities were $1.2 billion and $1.1 billion, respectively. The loans and unfunded commitments to these VIEs are included in the Bancorp’s overall analysis of the ALLL and reserve for unfunded commitments, respectively. The Bancorp does not provide any implicit or explicit liquidity guarantees or principal value guarantees to these VIEs.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

11. Sales of Receivables and Servicing Rights

Residential Mortgage Loan Sales

The Bancorp sold fixed and adjustable-rate residential mortgage loans during both the three and nine months ended September 30, 2018 and 2017. In those sales, the Bancorp obtained servicing responsibilities and provided certain standard representations and warranties, however the investors have no recourse to the Bancorp’s other assets for failure of debtors to pay when due. The Bancorp receives annual servicing fees based on a percentage of the outstanding balance. The Bancorp identifies classes of servicing assets based on financial asset type and interest rates.

Information related to residential mortgage loan sales and the Bancorp’s mortgage banking activity, which is included in mortgage banking net revenue in the Condensed Consolidated Statements of Income, is as follows:

 

      For the three months ended           For the nine months ended  
     September 30,          September 30,  

($ in millions)

   2018      2017               2018      2017  

Residential mortgage loan sales(a)

   $ 1,446        1,593          3,919         4,740    

Origination fees and gains on loan sales

     25        40          77         106    

Gross mortgage servicing fees

     56        56            162         152    

(a)

Represents the unpaid principal balance at the time of the sale.

Servicing Rights

The Bancorp measures all of its servicing rights at fair value with changes in fair value reported in mortgage banking net revenue in the Condensed Consolidated Statements of Income.

The following table presents changes in the servicing rights related to residential mortgage loans for the nine months ended September 30:

 

($ in millions)

   2018      2017  

Balance, beginning of period

   $ 858        744  

Servicing rights originated - residential mortgage loans

     62        99  

Servicing rights acquired - residential mortgage loans

     82        109  

Changes in fair value:

     

Due to changes in inputs or assumptions(a)

     103        (15

Other changes in fair value(b)

     (95      (89

Balance, end of period

   $             1,010        848  

(a)

Primarily reflects changes in prepayment speed and OAS spread assumptions which are updated based on market interest rates.

(b)

Primarily reflects changes due to collection of contractual cash flows and the passage of time.

The Bancorp maintains a non-qualifying hedging strategy to manage a portion of the risk associated with changes in the value of the MSR portfolio. This strategy may include the purchase of free-standing derivatives and various available-for-sale and trading securities. The interest income, mark-to-market adjustments and gain or loss from sale activities associated with these portfolios are expected to economically hedge a portion of the change in value of the MSR portfolio caused by fluctuating OAS spreads, earnings rates and prepayment speeds. The fair value of the servicing asset is based on the present value of expected future cash flows.

The following table presents activity related to valuations of the MSR portfolio and the impact of the non-qualifying hedging strategy:

 

      For the three months ended           For the nine months ended  
     September 30,          September 30,  

($ in millions)

   2018     2017           2018     2017  

Securities (losses) gains, net - non-qualifying hedges on MSRs

   $ (1     2          (18     4  

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

     (24     1          (89     16  

MSR fair value adjustment due to changes in inputs or assumptions(a)

     25       (2          103       (15

(a)

Included in mortgage banking net revenue in the Condensed Consolidated Statements of Income.

The key economic assumptions used in measuring the interests in residential mortgage loans that continued to be held by the Bancorp at the date of sale, securitization or purchase resulting from transactions completed during the three months ended September 30, 2018 and 2017 were as follows:

 

            September 30, 2018           September 30, 2017  
      Rate    Weighted-
Average Life
(in years)
    

Prepayment
Speed

(annual)

   

OAS Spread

(bps)

          Weighted-
Average Life
(in years)
    

Prepayment
Speed

(annual)

   

OAS Spread

(bps)

 

Residential mortgage loans:

                 

Servicing rights

   Fixed      6.5            11.1     517          7.6        9.2 %        499  

Servicing rights

   Adjustable      3.3            23.7       700            2.5        35.1       650  

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

Based on historical credit experience, expected credit losses for residential mortgage loan servicing rights have been deemed immaterial, as the Bancorp sold the majority of the underlying loans without recourse. At September 30, 2018 and December 31, 2017, the Bancorp serviced $64.0 billion and $60.0 billion, respectively, of residential mortgage loans for other investors. The value of MSRs that continue to be held by the Bancorp is subject to credit, prepayment and interest rate risks on the sold financial assets.

At September 30, 2018, the sensitivity of the current fair value of residual cash flows to immediate 10%, 20% and 50% adverse changes in prepayment speed assumptions and immediate 10% and 20% adverse changes in OAS spread are as follows:

 

                           

Prepayment

Speed Assumption

   

OAS

Spread Assumption

 
                                               

OAS

Spread

     Impact of  
                 Weighted-            Impact of Adverse Change      Adverse Change  
          Fair      Average Life            on Fair Value      on Fair Value  

($ in millions)(a)

   Rate    Value      (in years)      Rate     10%     20%     50%     (bps)      10%     20%  

Residential mortgage loans:

                     

Servicing rights

   Fixed    $ 996        6.6            9.1   $ (36     (70     (162     533      $ (20     (39

Servicing rights

   Adjustable      14        3.5            23.2       (1     (2     (4     842        -       (1

(a) The impact of the weighted-average default rate on the current fair value of residual cash flows for all scenarios is immaterial.

These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on these variations in the assumptions typically cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. The Bancorp believes variations of these levels are reasonably possible; however, there is the potential that adverse changes in key assumptions could be even greater. Also, in the previous table, the effect of a variation in a particular assumption on the fair value of the interests that continue to be held by the Bancorp is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which might magnify or counteract these sensitivities.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

12. Derivative Financial Instruments

The Bancorp maintains an overall risk management strategy that incorporates the use of derivative instruments to reduce certain risks related to interest rate, prepayment and foreign currency volatility. Additionally, the Bancorp holds derivative instruments for the benefit of its commercial customers and for other business purposes. The Bancorp does not enter into unhedged speculative derivative positions.

The Bancorp’s interest rate risk management strategy involves modifying the repricing characteristics of certain financial instruments so that changes in interest rates do not adversely affect the Bancorp’s net interest margin and cash flows. Derivative instruments that the Bancorp may use as part of its interest rate risk management strategy include interest rate swaps, interest rate floors, interest rate caps, forward contracts, forward starting interest rate swaps, options, swaptions and TBA securities. Interest rate swap contracts are exchanges of interest payments, such as fixed-rate payments for floating-rate payments, based on a stated notional amount and maturity date. Interest rate floors protect against declining rates, while interest rate caps protect against rising interest rates. Forward contracts are contracts in which the buyer agrees to purchase, and the seller agrees to make delivery of, a specific financial instrument at a predetermined price or yield. Options provide the purchaser with the right, but not the obligation, to purchase or sell a contracted item during a specified period at an agreed upon price. Swaptions are financial instruments granting the owner the right, but not the obligation, to enter into or cancel a swap.

Prepayment volatility arises mostly from changes in fair value of the largely fixed-rate MSR portfolio, mortgage loans and mortgage-backed securities. The Bancorp may enter into various free-standing derivatives (principal-only swaps, interest rate swaptions, interest rate floors, mortgage options, TBAs and interest rate swaps) to economically hedge prepayment volatility. Principal-only swaps are total return swaps based on changes in the value of the underlying mortgage principal-only trust. TBA securities are a forward purchase agreement for a mortgage-backed securities trade whereby the terms of the security are undefined at the time the trade is made.

Foreign currency volatility occurs as the Bancorp enters into certain loans denominated in foreign currencies. Derivative instruments that the Bancorp may use to economically hedge these foreign denominated loans include foreign exchange swaps and forward contracts.

The Bancorp also enters into derivative contracts (including foreign exchange contracts, commodity contracts and interest rate contracts) for the benefit of commercial customers and other business purposes. The Bancorp economically hedges significant exposures related to these free-standing derivatives by entering into offsetting third-party contracts with approved, reputable and independent counterparties with substantially matching terms and currencies. Credit risk arises from the possible inability of counterparties to meet the terms of their contracts. The Bancorp’s exposure is limited to the replacement value of the contracts rather than the notional, principal or contract amounts. Credit risk is minimized through credit approvals, limits, counterparty collateral and monitoring procedures.

The fair value of derivative instruments is presented on a gross basis, even when the derivative instruments are subject to master netting arrangements. Derivative instruments with a positive fair value are reported in other assets in the Condensed Consolidated Balance Sheets while derivative instruments with a negative fair value are reported in other liabilities in the Condensed Consolidated Balance Sheets. Cash collateral payables and receivables associated with the derivative instruments are not added to or netted against the fair value amounts with the exception of certain variation margin payments that are considered legal settlements of the derivative contracts. For derivative contracts cleared through certain central clearing parties who have modified their rules to treat variation margin payments as settlements, the variation margin payments are applied to net the fair value of the respective derivative contracts.

The Bancorp’s derivative assets include certain contractual features in which the Bancorp requires the counterparties to provide collateral in the form of cash and securities to offset changes in the fair value of the derivatives, including changes in the fair value due to credit risk of the counterparty. As of September 30, 2018 and December 31, 2017, the balance of collateral held by the Bancorp for derivative assets was $306 million and $409 million, respectively. For derivative contracts cleared through certain central clearing parties who have modified their rules to treat variation margin payments as settlement of the derivative contract, the payments for variation margin of $91 million were applied to reduce the respective derivative contracts and were also not included in the total amount of collateral held as of September 30, 2018. The credit component negatively impacting the fair value of derivative assets associated with customer accommodation contracts as of both September 30, 2018 and December 31, 2017 was $3 million.

In measuring the fair value of derivative liabilities, the Bancorp considers its own credit risk, taking into consideration collateral maintenance requirements of certain derivative counterparties and the duration of instruments with counterparties that do not require collateral maintenance. When necessary, the Bancorp posts collateral primarily in the form of cash and securities to offset changes in fair value of the derivatives, including changes in fair value due to the Bancorp’s credit risk. As of September 30, 2018 and December 31, 2017, the balance of collateral posted by the Bancorp for derivative liabilities was $490 million and $365 million, respectively, and $143 million of variation margin payments were applied to the respective derivative contracts to reduce the Bancorp’s derivative liabilities as of September 30, 2018 and were also not included in the total amount of collateral posted. Certain of the Bancorp’s derivative liabilities contain credit risk related contingent features that could result in the requirement to post additional collateral upon the occurrence of specified events. As of September 30, 2018 and December 31, 2017, the fair value of the additional collateral that could be required to be posted as a result of the credit risk related contingent features being triggered was immaterial to the Condensed Consolidated Financial Statements. The posting of collateral has been determined to remove the need for further consideration of credit risk. As a result, the Bancorp determined that the impact of the Bancorp’s credit risk to the valuation of its derivative liabilities was immaterial to the Condensed Consolidated Financial Statements.

The Bancorp holds certain derivative instruments that qualify for hedge accounting treatment and are designated as either fair value hedges or cash flow hedges. Derivative instruments that do not qualify for hedge accounting treatment, or for which hedge accounting is not established, are held as free-standing derivatives. All customer accommodation derivatives are held as free-standing derivatives.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

The following tables reflect the notional amounts and fair values for all derivative instruments included in the Condensed Consolidated Balance Sheets as of:

 

              Fair Value  
     Notional      Derivative      Derivative  

September 30, 2018 ($ in millions)

   Amount      Assets      Liabilities  

Derivatives Designated as Qualifying Hedging Instruments:

        

Fair value hedges:

        

Interest rate swaps related to long-term debt

   $ 3,455        203        9  

Total fair value hedges

              203        9  

Cash flow hedges:

        

Interest rate swaps related to C&I loans

     6,150        2        17  

Total cash flow hedges

              2        17  

Total derivatives designated as qualifying hedging instruments

              205        26  

Derivatives Not Designated as Qualifying Hedging Instruments:

        

Free-standing derivatives - risk management and other business purposes:

        

Interest rate contracts related to MSR portfolio

     13,745        49        15  

Forward contracts related to residential mortgage loans held for sale

     955        4        -  

Swap associated with the sale of Visa, Inc. Class B Shares

     2,473        -        144  

Total free-standing derivatives - risk management and other business purposes

              53        159  

Free-standing derivatives - customer accommodation:

        

Interest rate contracts

     53,651        280        322  

Interest rate lock commitments

     397        7        -  

Commodity contracts

     5,818        315        296  

TBA securities

     20        -        -  

Foreign exchange contracts

     12,940        124        110  

Total free-standing derivatives - customer accommodation

              726        728  

Total derivatives not designated as qualifying hedging instruments

              779        887  

Total

            $ 984        913  
                            
            Fair Value  
     Notional      Derivative      Derivative  

December 31, 2017 ($ in millions)

   Amount      Assets      Liabilities  

Derivatives Designated as Qualifying Hedging Instruments:

        

Fair value hedges:

        

Interest rate swaps related to long-term debt

   $ 3,705        297        5  

Total fair value hedges

              297        5  

Cash flow hedges:

        

Interest rate swaps related to C&I loans

     4,475        -        12  

Total cash flow hedges

              -        12  

Total derivatives designated as qualifying hedging instruments

              297        17  

Derivatives Not Designated as Qualifying Hedging Instruments:

        

Free-standing derivatives - risk management and other business purposes:

        

Interest rate contracts related to MSR portfolio

     11,035        54        15  

Forward contracts related to residential mortgage loans held for sale

     1,284        1        1  

Stock warrant

     20        20        -  

Swap associated with the sale of Visa, Inc. Class B Shares

     1,900        -        137  

Foreign exchange contracts

     112        -        1  

Total free-standing derivatives - risk management and other business purposes

              75        154  

Free-standing derivatives - customer accommodation:

        

Interest rate contracts

     42,216        154        145  

Interest rate lock commitments

     446        8        -  

Commodity contracts

     4,125        165        167  

TBA securities

     26        -        -  

Foreign exchange contracts

     12,654        124        119  

Total free-standing derivatives - customer accommodation

              451        431  

Total derivatives not designated as qualifying hedging instruments

              526        585  

Total

            $ 823        602  

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

Fair Value Hedges

The Bancorp may enter into interest rate swaps to convert its fixed-rate funding to floating-rate. Decisions to convert fixed-rate funding to floating are made primarily through consideration of the asset/liability mix of the Bancorp, the desired asset/liability sensitivity and interest rate levels. For all designated fair value hedges of interest rate risk as of September 30, 2018, the Bancorp performed an assessment of hedge effectiveness using regression analysis (quantitative approach) with changes in the fair value of the derivative instrument and changes in the fair value of the hedged asset or liability attributable to the hedged risk recorded in the same income statement line in current period net income.

The following table reflects the change in fair value of interest rate contracts, designated as fair value hedges, as well as the change in fair value of the related hedged items attributable to the risk being hedged, included in the Condensed Consolidated Statements of Income:

 

                  For the three months         For the nine months
     Condensed Consolidated         ended September 30,        ended September 30,

($ in millions)

   Statements of Income Caption          2018   2017         2018   2017

Change in fair value of interest rate swaps hedging long-term debt

  

Interest on long-term debt

     $          (29 )       (6 )            (110 )       (13 )

Change in fair value of hedged long-term debt attributable to the risk being hedged

  

Interest on long-term debt

                  31       5                  113       11

The following amounts were recorded in the Condensed Consolidated Balance Sheets related to cumulative basis adjustments for fair value hedges as of:

 

          Condensed Consolidated           

($ in millions)

       Balance Sheets Caption         September 30, 2018

Carrying amount of the hedged item

  

Long-term debt

    $          3,917

Cumulative amount of fair value hedging adjustments included in the carrying amount of the hedged items

  

Long-term debt

                 (182 )

Cash Flow Hedges

The Bancorp may enter into interest rate swaps to convert floating-rate assets and liabilities to fixed rates or to hedge certain forecasted transactions for the variability in cash flows attributable to the contractually specified interest rate. The assets or liabilities may be grouped in circumstances where they share the same risk exposure that the Bancorp desires to hedge. The Bancorp may also enter into interest rate caps and floors to limit cash flow variability of floating-rate assets and liabilities. As of September 30, 2018, all hedges designated as cash flow hedges were assessed for effectiveness using regression analysis. The entire change in the fair value of the interest rate swap included in the assessment of hedge effectiveness is recorded in AOCI and reclassified from AOCI to current period earnings when the hedged item affects earnings. As of September 30, 2018, the maximum length of time over which the Bancorp is hedging its exposure to the variability in future cash flows is 70 months.

Reclassified gains and losses on interest rate contracts related to commercial and industrial loans are recorded within interest income in the Condensed Consolidated Statements of Income. As of September 30, 2018 and December 31, 2017, $33 million and $9 million, respectively, of net deferred losses, net of tax, on cash flow hedges were recorded in AOCI in the Condensed Consolidated Balance Sheets. As of September 30, 2018, $20 million in net unrealized gains, net of tax, recorded in AOCI are expected to be reclassified into earnings during the next twelve months. This amount could differ from amounts actually recognized due to changes in interest rates, hedge de-designations, and the addition of other hedges subsequent to September 30, 2018.

During both the three and nine months ended September 30, 2018 and 2017, there were no gains or losses reclassified from AOCI into earnings associated with the discontinuance of cash flow hedges because it was probable that the original forecasted transaction would no longer occur by the end of the originally specified time period or within the additional period of time as defined by U.S. GAAP.

The following table presents the pretax net (losses) gains recorded in the Condensed Consolidated Statements of Income and in the Condensed Consolidated Statements of Comprehensive Income relating to derivative instruments designated as cash flow hedges:

 

              For the three months ended              For the nine months ended  
            September 30,             September 30,  

($ in millions)

           2018     2017(a)              2018     2017(a)  

Amount of pretax net (losses) gains recognized in OCI

   $          (25     -           (31     3      

Amount of pretax net (losses) gains reclassified from OCI into net income

              (2     3                 (2     17      

(a)

For both the three and nine months ended September 30, 2017, the amount of pretax net losses recognized in OCI represented the effective portion of the cumulative gains or losses on cash flow hedges and ineffectiveness was reported within noninterest income. Upon the adoption of ASU 2017-12, the Bancorp recorded a cumulative effect adjustment to retained earnings effective January 1, 2018 related to the elimination of the separate measurement of ineffectiveness. Refer to Note 3 for additional information.

Free-Standing Derivative Instruments – Risk Management and Other Business Purposes

As part of its overall risk management strategy relative to its mortgage banking activity, the Bancorp may enter into various free-standing derivatives (principal-only swaps, interest rate swaptions, interest rate floors, mortgage options, TBA securities and interest rate swaps) to economically hedge changes in fair value of its largely fixed-rate MSR portfolio. Principal-only swaps hedge the mortgage-LIBOR spread because these swaps appreciate in value as a result of tightening spreads. Principal-only swaps also provide prepayment protection by increasing in value when prepayment speeds increase, as opposed to MSRs that lose value in a faster prepayment environment. Receive fixed/pay floating interest rate swaps and swaptions increase in value when interest rates do not increase as quickly as expected.

 

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The Bancorp enters into forward contracts and mortgage options to economically hedge the change in fair value of certain residential mortgage loans held for sale due to changes in interest rates. IRLCs issued on residential mortgage loan commitments that will be held for sale are also considered free-standing derivative instruments and the interest rate exposure on these commitments is economically hedged primarily with forward contracts. Revaluation gains and losses from free-standing derivatives related to mortgage banking activity are recorded as a component of mortgage banking net revenue in the Condensed Consolidated Statements of Income.

In conjunction with the sale of Visa, Inc. Class B Shares in 2009, the Bancorp entered into a total return swap in which the Bancorp will make or receive payments based on subsequent changes in the conversion rate of the Class B Shares into Class A Shares. This total return swap is accounted for as a free-standing derivative. Refer to Note 22 for further discussion of significant inputs and assumptions used in the valuation of this instrument.

The net gains (losses) recorded in the Condensed Consolidated Statements of Income relating to free-standing derivative instruments used for risk management and other business purposes are summarized in the following table:

 

              For the three months             For the nine months  
     Condensed Consolidated      ended September 30,            ended September 30,  

($ in millions)

   Statements of Income Caption      2018     2017             2018     2017  

Interest rate contracts:

              

Forward contracts related to residential mortgage loans held for sale

    

Mortgage banking net revenue

     $         7       (1        4       (17

Interest rate contracts related to MSR portfolio

    

Mortgage banking net revenue

       (24     1          (89     16  

Foreign exchange contracts:

              

Foreign exchange contracts for risk management purposes

    

Other noninterest income

       (1     (4        3       (8

Equity contracts:

              

Swap associated with sale of Visa, Inc. Class B Shares

    

Other noninterest income

       (17     (47              (66     (69

Free-Standing Derivative Instruments – Customer Accommodation

The majority of the free-standing derivative instruments the Bancorp enters into are for the benefit of its commercial customers. These derivative contracts are not designated against specific assets or liabilities on the Condensed Consolidated Balance Sheets or to forecasted transactions; and therefore, do not qualify for hedge accounting. These instruments include foreign exchange derivative contracts entered into for the benefit of commercial customers involved in international trade to hedge their exposure to foreign currency fluctuations and commodity contracts to hedge such items as natural gas and various other derivative contracts. The Bancorp may economically hedge significant exposures related to these derivative contracts entered into for the benefit of customers by entering into offsetting contracts with approved, reputable, independent counterparties with substantially matching terms. The Bancorp hedges its interest rate exposure on commercial customer transactions by executing offsetting swap agreements with primary dealers. Revaluation gains and losses on interest rate, foreign exchange, commodity and other commercial customer derivative contracts are recorded as a component of either corporate banking revenue or other noninterest income in the Condensed Consolidated Statements of Income.

The Bancorp enters into risk participation agreements, under which the Bancorp assumes credit exposure relating to certain underlying interest rate derivative contracts. The Bancorp only enters into these risk participation agreements in instances in which the Bancorp has participated in the loan that the underlying interest rate derivative contract was designed to hedge. The Bancorp will make payments under these agreements if a customer defaults on its obligation to perform under the terms of the underlying interest rate derivative contract. As of September 30, 2018 and December 31, 2017, the total notional amount of the risk participation agreements was $3.9 billion and $2.8 billion, respectively, and the fair value was a liability of $8 million and $5 million at September 30, 2018 and December 31, 2017, respectively, which is included in other liabilities in the Condensed Consolidated Balance Sheets. As of September 30, 2018, the risk participation agreements had a weighted-average remaining life of 3.7 years.

The Bancorp’s maximum exposure in the risk participation agreements is contingent on the fair value of the underlying interest rate derivative contracts in an asset position at the time of default. The Bancorp monitors the credit risk associated with the underlying customers in the risk participation agreements through the same risk grading system currently utilized for establishing loss reserves in its loan and lease portfolio.

Risk ratings of the notional amount of risk participation agreements under this risk rating system are summarized in the following table as of:

 

      September 30,      December 31,  

($ in millions)

   2018      2017  

Pass

   $ 3,852        2,748  

Special mention

     69        66  

Substandard

     10        24  

Total

   $         3,931        2,838  

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

The net gains (losses) recorded in the Condensed Consolidated Statements of Income relating to free-standing derivative instruments used for customer accommodation are summarized in the following table:

 

              For the three months             For the nine months  
     Condensed Consolidated      ended September 30,            ended September 30,  

($ in millions)

   Statements of Income Caption      2018      2017             2018     2017  

Interest rate contracts:

               

Interest rate contracts for customers (contract revenue)

    

Corporate banking revenue

     $ 7        5          23       15  

Interest rate lock commitments

    

Mortgage banking net revenue

       17        27          52       76  

Commodity contracts:

               

Commodity contracts for customers (contract revenue)

    

Corporate banking revenue

       3        1          7       4  

Commodity contracts for customers (credit losses)

    

Other noninterest expense

       -        -          -       1  

Commodity contracts for customers (credit portion of fair value adjustment)

    

Other noninterest expense

       -        -          (1     -  

Foreign exchange contracts:

               

Foreign exchange contracts for customers (contract revenue)

    

Corporate banking revenue

       16        11          43       33  

Foreign exchange contracts for customers (contract revenue)

    

Other noninterest income

       3        -          8       -  

Foreign exchange contracts for customers (credit losses)

    

Other noninterest expense

       -        -          -       2  

Foreign exchange contracts for customers (credit portion of fair value adjustment)

    

Other noninterest expense

       -        (1              1       -  

Offsetting Derivative Financial Instruments

The Bancorp’s derivative transactions are generally governed by ISDA Master Agreements and similar arrangements, which include provisions governing the setoff of assets and liabilities between the parties. When the Bancorp has more than one outstanding derivative transaction with a single counterparty, the setoff provisions contained within these agreements generally allow the non-defaulting party the right to reduce its liability to the defaulting party by amounts eligible for setoff, including the collateral received as well as eligible offsetting transactions with that counterparty, irrespective of the currency, place of payment, or booking office. The Bancorp’s policy is to present its derivative assets and derivative liabilities on the Condensed Consolidated Balance Sheets on a gross basis, even when provisions allowing for setoff are in place. However, for derivative contracts cleared through certain central clearing parties who have modified their rules to treat variation margin payments as settlements, the fair value of the respective derivative contracts are reported net of the variation margin payments.

Collateral amounts included in the tables below consist primarily of cash and highly-rated government-backed securities and do not include variation margin payments for derivative contracts with legal rights of setoff for both periods shown.

The following tables provide a summary of offsetting derivative financial instruments:

 

      Gross Amount      Gross Amounts Not Offset in the         
     Recognized in the      Condensed Consolidated Balance Sheets        
     Condensed Consolidated                     

As of September 30, 2018 ($ in millions)

   Balance Sheets(a)      Derivatives     Collateral(b)     Net Amount  

Assets:

         

Derivatives

   $ 977        (287     (260     430  

Total assets

     977        (287     (260     430  

Liabilities:

         

Derivatives

     913        (287     (232     394  

Total liabilities

   $ 913        (287     (232     394  

(a)

Amount does not include IRLCs because these instruments are not subject to master netting or similar arrangements.

(b)

Amount of collateral received as an offset to asset positions or pledged as an offset to liability positions. Collateral values in excess of related derivative amounts recognized in the Condensed Consolidated Balance Sheets were excluded from this table.

 

      Gross Amount      Gross Amounts Not Offset in the         
     Recognized in the      Condensed Consolidated Balance Sheets        
     Condensed Consolidated               

As of December 31, 2017 ($ in millions)

   Balance Sheets(a)      Derivatives     Collateral(b)     Net Amount  

Assets:

         

Derivatives

   $ 815        (213     (362     240  

Total assets

     815        (213     (362     240  

Liabilities:

         

Derivatives

     602        (213     (155     234  

Total liabilities

   $ 602        (213     (155     234  

(a)

Amount does not include IRLCs because these instruments are not subject to master netting or similar arrangements.

(b)

Amount of collateral received as an offset to asset positions or pledged as an offset to liability positions. Collateral values in excess of related derivative amounts recognized in the Condensed Consolidated Balance Sheets were excluded from this table.

 

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13. Other Short-Term Borrowings

Borrowings with original maturities of one year or less are classified as short-term. The following table presents a summary of the Bancorp’s other short-term borrowings as of:

 

      September 30,      December 31,  

($ in millions)

   2018      2017  

FHLB advances

   $ 600        3,125  

Securities sold under repurchase agreements

     287        546  

Derivative collateral

     227        341  

Total other short-term borrowings

   $ 1,114        4,012  

The Bancorp’s securities sold under repurchase agreements are accounted for as secured borrowings and are collateralized by securities included in available-for-sale debt and other securities in the Condensed Consolidated Balance Sheets. These securities are subject to changes in market value and, therefore, the Bancorp may increase or decrease the level of securities pledged as collateral based upon these movements in market value. As of both September 30, 2018 and December 31, 2017, all securities sold under repurchase agreements were secured by agency residential mortgage-backed securities and the repurchase agreements have an overnight remaining contractual maturity.

14. Long-Term Debt

On March 14, 2018, the Bancorp issued and sold $650 million of 3.95% senior fixed-rate notes, with a maturity of ten years, due on March 14, 2028. These notes will be redeemable by the Bancorp, in whole or in part, on or after the date that is 30 days prior to the maturity date at a redemption price equal to 100% of the principal amount of the notes to be redeemed plus accrued and unpaid interest thereon to, but excluding, the redemption date.

On June 5, 2018, the Bancorp issued and sold $250 million of senior floating-rate notes, with a maturity of three years, due on June 4, 2021. Interest on the floating-rate notes is 3-month LIBOR plus 47 bps. These notes will be redeemable, in whole or in part, on or after the date that is 30 days prior to the maturity date at a redemption price equal to 100% of the principal amount of the notes to be redeemed plus accrued and unpaid interest thereon to, but excluding, the redemption date.

On July 26, 2018 the Bank issued and sold $1.55 billion in aggregate principal amount of unsecured senior bank notes. The bank notes consisted of $500 million of 3.35% senior fixed-rate notes, with a maturity of three years, due on July 26, 2021; $300 million of senior floating-rate notes at three-month LIBOR plus 44 bps, with a maturity of three years, due on July 26, 2021; and $750 million of 3.95% senior fixed-rate notes, with a maturity of seven years, due July 28, 2025. The Bank entered into interest rate swaps to convert the fixed-rate notes due in 2021 and 2025 to a floating-rate, which resulted in an effective interest rate of one-month LIBOR plus 53 bps and 104 bps, respectively. These bank notes will be redeemable by the Bank, in whole or in part, on or after the date that is 30 days prior to the maturity date at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest up to, but excluding, the redemption date.

15. Capital Actions

Accelerated Share Repurchase Transactions

During the nine months ended September 30, 2018, the Bancorp entered into or settled accelerated share repurchase transactions. As part of these transactions, the Bancorp entered into forward contracts in which the final number of shares delivered at settlement was based generally on a discount to the average daily volume weighted-average price of the Bancorp’s common stock during the term of these repurchase agreements. The accelerated share repurchases were treated as two separate transactions, (i) the acquisition of treasury shares on the repurchase date and (ii) a forward contract indexed to the Bancorp’s common stock.

The following table presents a summary of the Bancorp’s accelerated share repurchase transactions that were entered into or settled during the nine months ended September 30, 2018:

 

Repurchase Date

  

Amount

($ in millions)

     Shares Repurchased on
Repurchase Date
    

Shares Received

from Forward

Contract Settlement

     Total Shares
Repurchased
     Settlement Date  

December 19, 2017

   $ 273        7,727,273        824,367        8,551,640        March 19, 2018  

February 12, 2018

     318        8,691,318        1,015,731        9,707,049        March 26, 2018  

May 25, 2018

     235        6,402,244        1,172,122        7,574,366        June 15, 2018  

Open Market Share Repurchase Transactions

Between July 20, 2018 and August 2, 2018, the Bancorp repurchased 16,945,020 shares, or approximately $500 million, of its outstanding common stock through open market repurchase transactions, which settled between July 24, 2018 and August 6, 2018.

For further information on a subsequent event related to capital actions, refer to Note 25.

 

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16. Commitments, Contingent Liabilities and Guarantees

The Bancorp, in the normal course of business, enters into financial instruments and various agreements to meet the financing needs of its customers. The Bancorp also enters into certain transactions and agreements to manage its interest rate and prepayment risks, provide funding, equipment and locations for its operations and invest in its communities. These instruments and agreements involve, to varying degrees, elements of credit risk, counterparty risk and market risk in excess of the amounts recognized in the Condensed Consolidated Balance Sheets. The creditworthiness of counterparties for all instruments and agreements is evaluated on a case-by-case basis in accordance with the Bancorp’s credit policies. The Bancorp’s significant commitments, contingent liabilities and guarantees in excess of the amounts recognized in the Condensed Consolidated Balance Sheets are discussed in the following sections.

Commitments

The Bancorp has certain commitments to make future payments under contracts. The following table reflects a summary of significant commitments as of:

 

 

     September 30,      December 31,  

($ in millions)

   2018      2017  

Commitments to extend credit

   $ 70,689        68,106  

Letters of credit

     2,062        2,185  

Forward contracts related to residential mortgage loans held for sale

     955        1,284  

Noncancelable operating lease obligations

     591        568  

Purchase obligations

     108        144  

Capital commitments for private equity investments

     33        48  

Capital expenditures

     31        37  

Capital lease obligations

     19        26  

Commitments to extend credit

Commitments to extend credit are agreements to lend, typically having fixed expiration dates or other termination clauses that may require payment of a fee. Since many of the commitments to extend credit may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash flow requirements. The Bancorp is exposed to credit risk in the event of nonperformance by the counterparty for the amount of the contract. Fixed-rate commitments are also subject to market risk resulting from fluctuations in interest rates and the Bancorp’s exposure is limited to the replacement value of those commitments. As of September 30, 2018 and December 31, 2017, the Bancorp had a reserve for unfunded commitments, including letters of credit, totaling $129 million and $161 million, respectively, included in other liabilities in the Condensed Consolidated Balance Sheets. The Bancorp monitors the credit risk associated with commitments to extend credit using the same standard regulatory risk rating system utilized for its loan and lease portfolio.

Risk ratings of outstanding commitments to extend credit under this risk rating system are summarized in the following table as of:

 

 

     September 30,      December 31,  

($ in millions)

   2018      2017  

Pass

   $ 70,149        67,254  

Special mention

     283        330  

Substandard

     257        522  

Total commitments to extend credit

   $ 70,689        68,106  

Letters of credit

Standby and commercial letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party and expire as summarized in the following table as of September 30, 2018:

 

 

($ in millions)

       

Less than 1 year(a)

   $ 1,062  

1 - 5 years(a)

     989  

Over 5 years

     11  

Total letters of credit

   $         2,062  

(a)

Includes $4 and $5 issued on behalf of commercial customers to facilitate trade payments in U.S. dollars and foreign currencies which expire less than 1 year and between 1 - 5 years, respectively.

Standby letters of credit accounted for approximately 99% of total letters of credit at both September 30, 2018 and December 31, 2017, and are considered guarantees in accordance with U.S. GAAP. Approximately 61% of the total standby letters of credit were collateralized as of both September 30, 2018 and December 31, 2017. In the event of nonperformance by the customers, the Bancorp has rights to the underlying collateral, which can include commercial real estate, physical plant and property, inventory, receivables, cash and marketable securities. The reserve related to these standby letters of credit, which was included in the total reserve for unfunded commitments, was $5 million and $6 million at September 30, 2018 and December 31, 2017, respectively. The Bancorp monitors the credit risk associated with letters of credit using the same standard regulatory risk rating system utilized for its loan and lease portfolio.

 

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Risk ratings of outstanding letters of credit under this risk rating system are summarized in the following table as of:

 

 

     September 30,      December 31,  

($ in millions)

   2018      2017  

Pass

   $ 1,894        1,830  

Special mention

     22        67  

Substandard

     146        218  

Doubtful

     -        70  

Total letters of credit

   $ 2,062        2,185  

At September 30, 2018 and December 31, 2017, the Bancorp had outstanding letters of credit that were supporting certain securities issued as VRDNs. The Bancorp facilitates financing for its commercial customers, which consist of companies and municipalities, by marketing the VRDNs to investors. The VRDNs pay interest to holders at a rate of interest that fluctuates based upon market demand. The VRDNs generally have long-term maturity dates, but can be tendered by the holder for purchase at par value upon proper advance notice. When the VRDNs are tendered, a remarketing agent generally finds another investor to purchase the VRDNs to keep the securities outstanding in the market. As of September 30, 2018 and December 31, 2017, total VRDNs in which the Bancorp was the remarketing agent or were supported by a Bancorp letter of credit were $519 million and $602 million, respectively, of which FTS acted as the remarketing agent to issuers on $514 million and $508 million, respectively. As remarketing agent, FTS is responsible for actively remarketing VRDNs to other investors when they have been tendered. If another investor is not identified, FTS may choose to purchase the VRDNs into inventory at its discretion while it continues to remarket them. If FTS purchases the VRDNs into inventory, it can subsequently tender back the VRDNs to the issuer’s trustee with proper advance notice. The Bancorp issued letters of credit, as a credit enhancement, to $273 million and $331 million of the VRDNs remarketed by FTS, in addition to $5 million and $94 million in VRDNs remarketed by third parties at September 30, 2018 and December 31, 2017, respectively. These letters of credit are included in the total letters of credit balance provided in the previous table. The Bancorp held $15 million and $1 million of these VRDNs in its portfolio and classified them as trading securities at September 30, 2018 and December 31, 2017, respectively.

Forward contracts related to residential mortgage loans held for sale

The Bancorp enters into forward contracts to economically hedge the change in fair value of certain residential mortgage loans held for sale due to changes in interest rates. The outstanding notional amounts of these forward contracts are included in the summary of significant commitments table for all periods presented.

Noncancelable operating lease obligations and other commitments

The Bancorp’s subsidiaries have entered into a number of noncancelable lease agreements. The minimum rental commitments under noncancelable lease agreements are shown in the summary of significant commitments table. The Bancorp has also entered into a limited number of agreements for work related to banking center construction and to purchase goods or services.

Contingent Liabilities

Legal claims

There are legal claims pending against the Bancorp and its subsidiaries that have arisen in the normal course of business. Refer to Note 17 for additional information regarding these proceedings.

Guarantees

The Bancorp has performance obligations upon the occurrence of certain events under financial guarantees provided in certain contractual arrangements as discussed in the following sections.

Residential mortgage loans sold with representation and warranty provisions

Conforming residential mortgage loans sold to unrelated third parties are generally sold with representation and warranty provisions. A contractual liability arises only in the event of a breach of these representations and warranties and, in general, only when a loss results from the breach. The Bancorp may be required to repurchase any previously sold loan, indemnify or make whole the investor or insurer for which the representation or warranty of the Bancorp proves to be inaccurate, incomplete or misleading. For more information on how the Bancorp establishes the residential mortgage repurchase reserve, refer to Note 1 of the Notes to Consolidated Financial Statements included in the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2017.

As of September 30, 2018 and December 31, 2017, the Bancorp maintained reserves related to loans sold with representation and warranty provisions totaling $6 million and $9 million, respectively, included in other liabilities in the Condensed Consolidated Balance Sheets.

The Bancorp uses the best information available when estimating its mortgage representation and warranty reserve; however, the estimation process is inherently uncertain and imprecise and, accordingly, losses in excess of the amounts reserved as of September 30, 2018 are reasonably possible. The Bancorp currently estimates that it is reasonably possible that it could incur losses related to mortgage representation and warranty provisions in an amount up to approximately $10 million in excess of amounts reserved. This estimate was derived by modifying the key assumptions to reflect management’s judgment regarding reasonably possible adverse changes to those assumptions. The actual repurchase losses could vary significantly from the recorded mortgage representation and warranty reserve or this estimate of reasonably possible losses, depending on the outcome of various factors, including those previously discussed.

 

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For both the three months ended September 30, 2018 and 2017, the Bancorp paid an immaterial amount in the form of make whole payments and repurchased $4 million in outstanding principal of loans to satisfy investor demands. For both the nine months ended September 30, 2018 and 2017, the Bancorp paid immaterial amounts in the form of make whole payments and repurchased $11 million and $9 million, respectively, in outstanding principal of loans to satisfy investor demands. Total repurchase demand requests during the three months ended September 30, 2018 and 2017 were $6 million and $4 million, respectively. Total repurchase demand requests during the nine months ended September 30, 2018 and 2017 were $17 million and $12 million, respectively. Total outstanding repurchase demand inventory was $5 million and $1 million at September 30, 2018 and December 31, 2017, respectively.

The following table summarizes activity in the reserve for representation and warranty provisions:

 

 

     For the three months ended     For the nine months ended  
     September 30,     September 30,  

($ in millions)

   2018     2017     2018     2017  

Balance, beginning of period

   $ 7       11       9       13  

Net reductions to the reserve

     (1     (1     (3     (3

Balance, end of period

   $ 6       10       6       10  

The following tables provide a rollforward of unresolved claims by claimant type for the nine months ended:

 

 

     GSE            Private Label  

September 30, 2018 ($ in millions)

   Units     Dollars             Units        Dollars  

Balance, beginning of period

     6     $ 1          1        $ -  

New demands

     104       17          -          -  

Resolved demands

     (85     (13              -          -  

Balance, end of period

     25     $ 5                1        $ -  

 

      GSE             Private Label  

September 30, 2017 ($ in millions)

   Units     Dollars             Units        Dollars  

Balance, beginning of period

     13     $ 2          -        $ -  

New demands

     86       12          -          -  

Loan paydowns/payoffs

     (2     -          -          -  

Resolved demands

     (90     (13              -          -  

Balance, end of period

     7     $ 1                -        $ -  

Residential mortgage loans sold with credit recourse

The Bancorp sold certain residential mortgage loans in the secondary market with credit recourse. In the event of any customer default, pursuant to the credit recourse provided, the Bancorp is required to reimburse the third party. The maximum amount of credit risk in the event of nonperformance by the underlying borrowers is equivalent to the total outstanding balance. In the event of nonperformance, the Bancorp has rights to the underlying collateral value securing the loan. The outstanding balances on these loans sold with credit recourse were $282 million and $312 million at September 30, 2018 and December 31, 2017, respectively, and the delinquency rates were 2.4% and 3.0% at September 30, 2018 and December 31, 2017, respectively. The Bancorp maintained an estimated credit loss reserve on these loans sold with credit recourse of $5 million at both September 30, 2018 and December 31, 2017 recorded in other liabilities in the Condensed Consolidated Balance Sheets. To determine the credit loss reserve, the Bancorp used an approach that is consistent with its overall approach in estimating credit losses for various categories of residential mortgage loans held in its loan portfolio.

Margin accounts

FTS, an indirect wholly-owned subsidiary of the Bancorp, guarantees the collection of all margin account balances held by its brokerage clearing agent for the benefit of its customers. FTS is responsible for payment to its brokerage clearing agent for any loss, liability, damage, cost or expense incurred as a result of customers failing to comply with margin or margin maintenance calls on all margin accounts. The margin account balances held by the brokerage clearing agent were $18 million and $15 million at September 30, 2018 and December 31, 2017, respectively. In the event of any customer default, FTS has rights to the underlying collateral provided. Given the existence of the underlying collateral provided and negligible historical credit losses, the Bancorp does not maintain a loss reserve related to the margin accounts.

Long-term borrowing obligations

The Bancorp had certain fully and unconditionally guaranteed long-term borrowing obligations issued by wholly-owned issuing trust entities of $62 million at both September 30, 2018 and December 31, 2017.

Visa litigation

The Bancorp, as a member bank of Visa prior to Visa’s reorganization and IPO (the “IPO”) of its Class A common shares (the “Class A Shares”) in 2008, had certain indemnification obligations pursuant to Visa’s certificate of incorporation and by-laws and in accordance with their membership agreements. In accordance with Visa’s by-laws prior to the IPO, the Bancorp could have been required to indemnify Visa for the Bancorp’s proportional share of losses based on the pre-IPO membership interests. As part of its reorganization and IPO, the Bancorp’s indemnification obligation was modified to include only certain known or anticipated litigation (the “Covered Litigation”) as of the date of the restructuring. This modification triggered a requirement for the Bancorp to recognize a liability equal to the fair value of the indemnification liability.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

In conjunction with the IPO, the Bancorp received 10.1 million of Visa’s Class B common shares (the “Class B Shares”) based on the Bancorp’s membership percentage in Visa prior to the IPO. The Class B Shares are not transferable (other than to another member bank) until the later of the third anniversary of the IPO closing or the date which the Covered Litigation has been resolved; therefore, the Bancorp’s Class B Shares were classified in other assets and accounted for at their carryover basis of $0. Visa deposited $3 billion of the proceeds from the IPO into a litigation escrow account, established for the purpose of funding judgments in, or settlements of, the Covered Litigation. Since then, when Visa’s litigation committee determined that the escrow account was insufficient; Visa issued additional Class A Shares and deposited the proceeds from the sale of the Class A Shares into the litigation escrow account. When Visa funded the litigation escrow account, the Class B Shares were subjected to dilution through an adjustment in the conversion rate of Class B Shares into Class A Shares.

In 2009, the Bancorp completed the sale of Visa, Inc. Class B Shares and entered into a total return swap in which the Bancorp will make or receive payments based on subsequent changes in the conversion rate of the Class B Shares into Class A Shares. The swap terminates on the later of the third anniversary of Visa’s IPO or the date on which the Covered Litigation is settled. Refer to Note 22 for additional information on the valuation of the swap. The counterparty to the swap as a result of its ownership of the Class B Shares will be impacted by dilutive adjustments to the conversion rate of the Class B Shares into Class A Shares caused by any Covered Litigation losses in excess of the litigation escrow account. If actual judgments in, or settlements of, the Covered Litigation significantly exceed current expectations, then additional funding by Visa of the litigation escrow account and the resulting dilution of the Class B Shares could result in a scenario where the Bancorp’s ultimate exposure associated with the Covered Litigation (the “Visa Litigation Exposure”) exceeds the value of the Class B Shares owned by the swap counterparty (the “Class B Value”). In the event the Bancorp concludes that it is probable that the Visa Litigation Exposure exceeds the Class B Value, the Bancorp would record a litigation reserve liability and a corresponding amount of other noninterest expense for the amount of the excess. Any such litigation reserve liability would be separate and distinct from the fair value derivative liability associated with the total return swap.

As of the date of the Bancorp’s sale of the Visa Class B Shares and through September 30, 2018, the Bancorp has concluded that it is not probable that the Visa Litigation Exposure will exceed the Class B value. Based on this determination, upon the sale of Class B Shares, the Bancorp reversed its net Visa litigation reserve liability and recognized a free-standing derivative liability associated with the total return swap. The fair value of the swap liability was $144 million at September 30, 2018 and $137 million at December 31, 2017. Refer to Note 12 and Note 22 for further information.

After the Bancorp’s sale of the Class B Shares, Visa has funded additional amounts into the litigation escrow account which have resulted in further dilutive adjustments to the conversion of Class B Shares into Class A Shares, and along with other terms of the total return swap, required the Bancorp to make cash payments in varying amounts to the swap counterparty as follows:

 

Period ($ in millions)

   Visa
Funding Amount
     Bancorp Cash
Payment Amount
 

Q2 2010

   $ 500        20  

Q4 2010

     800        35  

Q2 2011

     400        19  

Q1 2012

     1,565        75  

Q3 2012

     150        6  

Q3 2014

     450        18  

Q2 2018

     600        26  

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

17. Legal and Regulatory Proceedings

Litigation

Visa/MasterCard Merchant Interchange Litigation

In April 2006, the Bancorp was added as a defendant in a consolidated antitrust class action lawsuit originally filed against Visa®, MasterCard® and several other major financial institutions in the United States District Court for the Eastern District of New York (In re: Payment Card Interchange Fee and Merchant Discount Antitrust Litigation, Case No. 05-MD-1720). The plaintiffs, merchants operating commercial businesses throughout the U.S. and trade associations, claimed that the interchange fees charged by card-issuing banks were unreasonable and sought injunctive relief and unspecified damages. In addition to being a named defendant, the Bancorp is also subject to a possible indemnification obligation of Visa as discussed in Note 16 and has also entered into judgment and loss sharing agreements with Visa, MasterCard and certain other named defendants. In October 2012, the parties to the litigation entered into a settlement agreement. On January 14, 2014, the trial court entered a final order approving the class settlement. A number of merchants filed appeals from that approval. The U.S. Court of Appeals for the Second Circuit held a hearing on those appeals and on June 30, 2016, reversed the district court’s approval of the class settlement, remanding the case to the district court for further proceedings. On March 27, 2017, the Supreme Court of the United States denied a petition for writ of certiorari seeking to review the Second Circuit’s decision. Pursuant to the terms of the overturned settlement agreement, the Bancorp previously paid $46 million into a class settlement escrow account. Approximately 8,000 merchants requested exclusion from the class settlement, and therefore, pursuant to the terms of the overturned settlement agreement, approximately 25% of the funds paid into the class settlement escrow account were already returned to the control of the defendants. The remaining approximately 75% of the settlement funds paid by the Bancorp are maintained in the escrow account. More than 500 of the merchants who requested exclusion from the class filed separate federal lawsuits against Visa, MasterCard and certain other defendants alleging similar antitrust violations. These individual federal lawsuits were transferred to the United States District Court for the Eastern District of New York. While the Bancorp is only named as a defendant in one of the individual federal lawsuits, it may have obligations pursuant to indemnification arrangements and/or the judgment or loss sharing agreements noted above. On June 5, 2018, the defendants in the consolidated class action reached an agreement to settle in principle with the proposed plaintiffs’ class seeking monetary damages (the “Plaintiff Damages Class”). On September 17, 2018, those parties signed a settlement agreement (the “Amended Settlement Agreement”) superseding the original settlement agreement entered into in October 2012. The Amended Settlement Agreement includes, among other terms, a release from participating class members for liability for claims that accrue no later than five years after the Amended Settlement Agreement becomes final. The Amended Settlement Agreement provides for a total payment by all defendants of $6.24 billion, composed of approximately $5.3 billion held in escrow and an additional $900 million. The Bancorp’s allocated share of the putative settlement is within existing reserves. If more than 15% of class members (by payment volume) opt out of the class, up to $700 million of the settlement payment may be returned to the defendants. The settlement is subject to District Court approval, and on September 18, 2018, the Plaintiff Damages Class filed a Motion for Preliminary Approval of the Amended Settlement Agreement. This settlement does not resolve the claims of the separate proposed plaintiffs’ class seeking injunctive relief or the claims of merchants who are pursuing separate lawsuits. The ultimate outcome in this matter, including the timing of resolution, therefore remains uncertain. Refer to Note 16 for further information.

Klopfenstein v. Fifth Third Bank

On August 3, 2012, William Klopfenstein and Adam McKinney filed a lawsuit against Fifth Third Bank in the United States District Court for the Northern District of Ohio (Klopfenstein et al. v. Fifth Third Bank), alleging that the 120% APR that Fifth Third disclosed on its Early Access program was misleading. Early Access is a deposit-advance program offered to eligible customers with checking accounts. The plaintiffs sought to represent a nationwide class of customers who used the Early Access program and repaid their cash advances within 30 days. On October 31, 2012, the case was transferred to the United States District Court for the Southern District of Ohio. In 2013, four similar putative class actions were filed against Fifth Third Bank in federal courts throughout the country (Lori and Danielle Laskaris v. Fifth Third Bank, Janet Fyock v. Fifth Third Bank, Jesse McQuillen v. Fifth Third Bank, and Brian Harrison v. Fifth Third Bank). Those four lawsuits were transferred to the Southern District of Ohio and consolidated with the original lawsuit as In re: Fifth Third Early Access Cash Advance Litigation (Case No. 1:12-CV-00851). On behalf of a putative class, the plaintiffs seek unspecified monetary and statutory damages, injunctive relief, punitive damages, attorney’s fees, and pre- and post-judgment interest. On March 30, 2015, the court dismissed all claims alleged in the consolidated lawsuit except a claim under the TILA. On January 10, 2018, plaintiffs filed a motion to hear the immediate appeal of the dismissal of their breach of contract claim. On March 28, 2018, the court granted plaintiffs’ motion and stayed the TILA claim pending that appeal. On April 26, 2018, plaintiffs filed their notice of appeal for the breach of contract claim with the U.S. Court of Appeals for the Sixth Circuit.

Helton v. Fifth Third Bank

On August 31, 2015, trust beneficiaries filed an action against Fifth Third Bank, as trustee, in the Probate Court for Hamilton County, Ohio (Helen Clarke Helton, et al. v. Fifth Third Bank, Case No. 2015003814). The plaintiffs allege breach of the duty to diversify, breach of the duty of impartiality, breach of trust/fiduciary duty, and unjust enrichment, based on Fifth Third’s alleged failure to diversify assets held in two trusts for the plaintiffs’ benefit. The lawsuit seeks over $800 million in alleged damages, attorney’s fees, removal of Fifth Third as trustee, and injunctive relief. Fifth Third denies all liability. On April 20, 2018, the Court denied plaintiffs’ motion for summary judgment and granted summary judgment to Fifth Third, dismissing the case in its entirety. The plaintiffs filed a notice of appeal on May 5, 2018.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

Upsher-Smith Laboratories, Inc. v. Fifth Third Bank

On February 12, 2016, Upsher-Smith Laboratories, Inc. (“Upsher-Smith”) filed suit against Fifth Third Bank in the Fourth Judicial District, Hennepin County, Minnesota (Upsher-Smith Laboratories Inc. v. Fifth Third Bank, Case No. 16-cv-00556), alleging that Fifth Third improperly implemented foreign exchange transactions requested by plaintiff’s authorized employee who allegedly was the victim of fraud by a third party. Plaintiff asserts claims for breach of contract and the implied covenant of good faith and fair dealing under Article 4A-202 of the Uniform Commercial Code, with losses allegedly totaling almost $40 million, plus interest. Fifth Third denies all liability in this matter. On March 3, 2016, Fifth Third removed the case to the United States District Court for the District of Minnesota. No trial date has been scheduled.

Other litigation

The Bancorp and its subsidiaries are not parties to any other material litigation. However, there are other litigation matters that arise in the normal course of business. While it is impossible to ascertain the ultimate resolution or range of financial liability with respect to these contingent matters, management believes that the resulting liability, if any, from these other actions would not have a material effect upon the Bancorp’s consolidated financial position, results of operations or cash flows.

Governmental Investigations and Proceedings

The Bancorp and/or its affiliates are or may become involved in information-gathering requests, reviews, investigations and proceedings (both formal and informal) by various governmental regulatory agencies and law enforcement authorities, including but not limited to the FRB, CFPB, SEC, FINRA, U.S. Department of Justice, etc., as well as state and other governmental authorities and self-regulatory bodies regarding their respective businesses. Additional matters will likely arise from time to time. Any of these matters may result in material adverse consequences or reputational harm to the Bancorp, its affiliates and/or their respective directors, officers and other personnel, including adverse judgments, findings, settlements, fines, penalties, orders, injunctions or other actions, amendments and/or restatements of the Bancorp’s SEC filings and/or financial statements, as applicable, and/or determinations of material weaknesses in our disclosure controls and procedures. Investigations by regulatory authorities may from time to time result in civil or criminal referrals to law enforcement. Additionally, in some cases, regulatory authorities may take supervisory actions that are considered to be confidential supervisory information which may not be publicly disclosed.

Reasonably Possible Losses in Excess of Accruals

The Bancorp and its subsidiaries are parties to numerous claims and lawsuits as well as threatened or potential actions or claims concerning matters arising from the conduct of its business activities. The outcome of claims or litigation and the timing of ultimate resolution are inherently difficult to predict. The following factors, among others, contribute to this lack of predictability: claims often include significant legal uncertainties, damages alleged by plaintiffs are often unspecified or overstated, discovery may not have started or may not be complete and material facts may be disputed or unsubstantiated. As a result of these factors, the Bancorp is not always able to provide an estimate of the range of reasonably possible outcomes for each claim. An accrual for a potential litigation loss is established when information related to the loss contingency indicates both that a loss is probable and that the amount of loss can be reasonably estimated. Any such accrual is adjusted from time to time thereafter as appropriate to reflect changes in circumstances. The Bancorp also determines, when possible (due to the uncertainties described above), estimates of reasonably possible losses or ranges of reasonably possible losses, in excess of amounts accrued. Under U.S. GAAP, an event is “reasonably possible” if “the chance of the future event or events occurring is more than remote but less than likely” and an event is “remote” if “the chance of the future event or events occurring is slight.” Thus, references to the upper end of the range of reasonably possible loss for cases in which the Bancorp is able to estimate a range of reasonably possible loss mean the upper end of the range of loss for cases for which the Bancorp believes the risk of loss is more than slight. For matters where the Bancorp is able to estimate such possible losses or ranges of possible losses, the Bancorp currently estimates that it is reasonably possible that it could incur losses related to legal and regulatory proceedings in an aggregate amount up to approximately $9 million in excess of amounts accrued, with it also being reasonably possible that no losses will be incurred in these matters. The estimates included in this amount are based on the Bancorp’s analysis of currently available information, and as new information is obtained the Bancorp may change its estimates.

For these matters and others where an unfavorable outcome is reasonably possible but not probable, there may be a range of possible losses in excess of the established accrual that cannot be estimated. Based on information currently available, advice of counsel, available insurance coverage and established accruals, the Bancorp believes that the eventual outcome of the actions against the Bancorp and/or its subsidiaries, including the matters described above, will not, individually or in the aggregate, have a material adverse effect on the Bancorp’s consolidated financial position. However, in the event of unexpected future developments, it is possible that the ultimate resolution of those matters, if unfavorable, may be material to the Bancorp’s results of operations for any particular period, depending, in part, upon the size of the loss or liability imposed and the operating results for the applicable period.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

18. Related Party Transactions

Worldpay, Inc. and Worldpay Holding, LLC

On January 16, 2018, Vantiv, Inc. completed its previously announced acquisition of Worldpay Group plc. with the resulting combined company named Worldpay, Inc. As a result of this transaction, the Bancorp recognized a gain of $414 million in other noninterest income during the first quarter of 2018 associated with the dilution in its ownership interest in Worldpay Holding, LLC from approximately 8.6% to approximately 4.9%.

On June 27, 2018, the Bancorp completed the sale of 5 million shares of Class A common stock of Worldpay, Inc. The Bancorp had previously received these Class A shares in exchange for Class B Units of Worldpay Holding, LLC. The Bancorp recognized a gain of $205 million related to the sale. As a result of the sale, the Bancorp beneficially owns approximately 3.3% of Worldpay’s equity through its ownership of approximately 10.3 million Class B Units. At September 30, 2018, the Bancorp’s remaining interest in Worldpay Holding, LLC of $424 million continues to be accounted for as an equity method investment given the nature of Worldpay Holding, LLC’s structure as a limited liability company and contractual arrangements between Worldpay Holding, LLC and the Bancorp.

GS Holdings

In May 2018, GreenSky, Inc. launched an IPO and issued 38 million shares of Class A common stock for a valuation of $23 per share. In connection with this IPO, the Bancorp’s investment in GreenSky, LLC, which was comprised of 252,550 membership units, was converted to 2,525,498 units of the newly formed GreenSky Holdings, LLC (“GS Holdings”), representing a 1.4% interest in GS Holdings. The Bancorp’s units in GS Holdings are exchangeable on a one-to-one basis for Class A common stock or cash after the initial 180-day lock-up period expires.

At the time of the IPO, the Bancorp recognized a $16 million gain on its investment in GreenSky, LLC, which was included in other noninterest income in the Condensed Consolidated Statements of Income for the three and six months ended June 30, 2018. At September 30, 2018, the investment in GS Holdings was $45 million, which was included in equity securities in the Condensed Consolidated Balance Sheets.

19. Income Taxes

The applicable income tax expense was $79 million and $475 million for the three months ended September 30, 2018 and 2017, respectively, and $321 million and $694 million for the nine months ended September 30, 2018 and 2017, respectively. The effective tax rates for the three months ended September 30, 2018 and 2017 were 15.6% and 31.9%, respectively, and 15.7% and 29.2% for the nine months ended September 30, 2018 and 2017, respectively. The decrease in the effective tax rate for both the three and nine months ended September 30, 2018 compared to the same periods 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.

While it is reasonably possible that the amount of the unrecognized tax benefits with respect to certain of the Bancorp’s uncertain tax positions could increase or decrease during the next 12 months, the Bancorp believes it is unlikely that its unrecognized tax benefits will change by a material amount during the next 12 months.

 

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20. Accumulated Other Comprehensive Income

The tables below present the activity of the components of OCI and AOCI for the three months ended:

 

             Total OCI      Total AOCI  
           Pretax     Tax     Net            Beginning     Net     Ending        

September 30, 2018 ($ in millions)

          Activity     Effect     Activity             Balance     Activity     Balance         

Unrealized holding losses on available-for-sale debt securities arising during period

  $          (271     64       (207           

Reclassification adjustment for net losses on available-for-sale debt securities included in net income

             -       -       -                   

Net unrealized losses on available-for-sale debt securities

       (271     64       (207        (485     (207     (692  

Unrealized holding losses on cash flow hedge derivatives arising during period

       (25     6       (19           

Reclassification adjustment for net losses on cash flow hedge derivatives included in net income

             2       -       2                   

Net unrealized losses on cash flow hedge derivatives

       (23     6       (17        (16     (17     (33  

Net actuarial loss arising during the period

       (2     -       (2           

Reclassification of amounts to net periodic benefit costs

             3       -       3                   

Defined benefit pension plans, net

             1       -       1                (51     1       (50        

Total

  $          (293     70       (223              (552     (223     (775        
                                                                           
             Total OCI      Total AOCI  
           Pretax     Tax     Net            Beginning     Net     Ending        

September 30, 2017 ($ in millions)

          Activity     Effect     Activity             Balance     Activity     Balance         

Unrealized holding gains on available-for-sale securities arising during period

  $          34       (12     22             

Reclassification adjustment for net losses on available-for-sale securities included in net income

             1       -       1                   

Net unrealized gains on available-for-sale securities

       35       (12     23          210       23       233    

Unrealized holding gains on cash flow hedge derivatives arising during period

       -       -       -             

Reclassification adjustment for net gains on cash flow hedge derivatives included in net income

             (3     1       (2                 

Net unrealized gains on cash flow hedge derivatives

       (3     1       (2        3       (2     1    

Net actuarial loss arising during the period

       (3     1       (2           

Reclassification of amounts to net periodic benefit costs

             5       (2     3                   

Defined benefit pension plans, net

             2       (1     1                (50     1       (49        

Total

  $          34       (12     22                163       22       185          

 

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The tables below present the activity of the components of OCI and AOCI for the nine months ended:

 

             Total OCI      Total AOCI  
           Pretax     Tax     Net            Beginning     Net     Ending        

September 30, 2018 ($ in millions)

          Activity     Effect     Activity             Balance(a)     Activity     Balance         

Unrealized holding losses on available-for-sale debt securities arising during period

  $          (1,082     248       (834           

Reclassification adjustment for net losses on available-for-sale debt securities included in net income

             9       (2     7                   

Net unrealized losses on available-for-sale debt securities

       (1,073     246       (827        135       (827     (692  

Unrealized holding losses on cash flow hedge derivatives arising during period

       (31     7       (24           

Reclassification adjustment for net losses on cash flow hedge derivatives included in net income

             2       -       2                   

Net unrealized losses on cash flow hedge derivatives

       (29     7       (22        (11     (22     (33  

Net actuarial loss arising during the period

       (2     -       (2           

Reclassification of amounts to net periodic benefit costs

             7       (2     5                   

Defined benefit pension plans, net

             5       (2     3                (53     3       (50        

Total

  $          (1,097     251       (846              71       (846     (775        

(a) The Bancorp’s AOCI balance was adjusted as of January 1, 2018 to reflect the adoption of new accounting standards. Refer to Note 3 for additional information.

 

  

       
           Total OCI      Total AOCI  
           Pretax     Tax     Net            Beginning     Net     Ending        

September 30, 2017 ($ in millions)

          Activity     Effect     Activity             Balance     Activity     Balance         

Unrealized holding gains on available-for-sale securities arising during period

  $          204       (74     130             

Reclassification adjustment for net losses on available-for-sale securities included in net income

             3       (1     2                   

Net unrealized gains on available-for-sale securities

       207       (75     132          101       132       233    

Unrealized holding gains on cash flow hedge derivatives arising during period

       3       (1     2             

Reclassification adjustment for net gains on cash flow hedge derivatives included in net income

             (17     6       (11                 

Net unrealized gains on cash flow hedge derivatives

       (14     5       (9        10       (9     1    

Net actuarial loss arising during the period

       (4     1       (3           

Reclassification of amounts to net periodic benefit costs

             9       (3     6                   

Defined benefit pension plans, net

             5       (2     3                (52     3       (49        

Total

  $          198       (72     126                59       126       185          

 

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The table below presents reclassifications out of AOCI:

 

 

     Condensed Consolidated         

For the three months
ended September 30,

          

For the nine months
ended September 30,

 

Components of AOCI: ($ in millions)

   Statements of Income Caption              2018       2017                2018       2017  

Net unrealized losses on available-for-sale debt securities:(b)

             

Net losses included in net income

  

Securities (losses) gains, net

  $          -       (1        (9     (3
  

Income before income taxes

       -       (1        (9     (3
  

Applicable income tax expense

       -       -          2       1  
  

Net income

       -       (1        (7     (2

Net unrealized (losses) gains on cash flow hedge derivatives:(b)

             

Interest rate contracts related to C&I loans

  

Interest and fees on loans and leases

       (2     3          (2     17  
  

Income before income taxes

       (2     3          (2     17  
  

Applicable income tax expense

       -       (1        -       (6
  

Net income

       (2     2          (2     11  

Net periodic benefit costs:(b)

             

Amortization of net actuarial loss

  

Employee benefits expense(a)

       (1     (2        (5     (6

Settlements

  

Employee benefits expense(a)

       (2     (3        (2     (3
  

Income before income taxes

       (3     (5        (7     (9
  

Applicable income tax expense

       -       2          2       3  
  

Net income

       (3     (3        (5     (6
                                                        

Total reclassifications for the period

  

Net income

  $          (5     (2              (14     3  

(a)

This AOCI component is included in the computation of net periodic benefit cost. Refer to Note 21 of the Notes to Consolidated Financial Statements included in the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2017 for further information.

(b)

Amounts in parentheses indicate reductions to net income.

 

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21. Earnings Per Share

The following tables provide the calculation of earnings per share and the reconciliation of earnings per share and earnings per diluted share:

 

 

           2018      2017  

For the three months ended September 30,

                Average      Per Share             Average      Per Share  

(in millions, except per share data)

          Income      Shares      Amount      Income      Shares      Amount  

Earnings Per Share:

                   

Net income available to common shareholders

  $          418              999        

Less: Income allocated to participating securities

             5                          10                    

Net income allocated to common shareholders

  $          413        668        0.62        989        721        1.37  

Earnings Per Diluted Share:

                   

Net income available to common shareholders

  $          418              999        

Effect of dilutive securities:

                   

Stock-based awards

             -        11                 -        12           

Net income available to common shareholders plus assumed conversions

       418              999        

Less: Income allocated to participating securities

             5                          10                    

Net income allocated to common shareholders plus assumed conversions

  $          413        679        0.61        989        733        1.35  

 

             2018      2017  

For the nine months ended September 30,

                Average      Per Share             Average      Per Share  

(in millions, except per share data)

          Income      Shares      Amount      Income      Shares      Amount  

Earnings Per Share:

                   

Net income available to common shareholders

  $          1,669              1,633        

Less: Income allocated to participating securities

             18                          18                    

Net income allocated to common shareholders

  $          1,651        680        2.43        1,615        737        2.19  

Earnings Per Diluted Share:

                   

Net income available to common shareholders

  $          1,669              1,633        

Effect of dilutive securities:

                   

Stock-based awards

             -        13                 -        12           

Net income available to common shareholders plus assumed conversions

       1,669              1,633        

Less: Income allocated to participating securities

             18                          18                    

Net income allocated to common shareholders plus assumed conversions

  $          1,651        693        2.38        1,615        749        2.16  

Shares are excluded from the computation of earnings per diluted share when their inclusion has an anti-dilutive effect on earnings per share. The diluted earnings per share computation for both the three and nine months ended September 30, 2018 excludes 2 million of SARs and an immaterial amount of stock options because their inclusion would have been anti-dilutive. The diluted earnings per share computation for the three and nine months ended September 30, 2017 excludes 4 million and 5 million, respectively, of SARs and an immaterial amount of stock options because their inclusion would have been anti-dilutive.

The diluted earnings per share computation for the three and nine months ended September 30, 2017 excludes the impact of the forward contract related to the August 17, 2017 accelerated share repurchase transaction. Based upon the average daily volume weighted-average price of the Bancorp’s common stock during the third quarter of 2017, the counterparty to the transaction would have been required to deliver additional shares for the settlement of the forward contract as of September 30, 2017, and thus the impact of the forward contract related to the accelerated share repurchase transaction would have been anti-dilutive to earnings per share.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

22. Fair Value Measurements

The Bancorp measures certain financial assets and liabilities at fair value in accordance with U.S. GAAP, which defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. U.S. GAAP also establishes a fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the instrument’s fair value measurement. For more information regarding the fair value hierarchy, refer to Note 1 of the Notes to Consolidated Financial Statements included in the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2017.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following tables summarize assets and liabilities measured at fair value on a recurring basis as of:

 

 

           Fair Value Measurements Using         

September 30, 2018 ($ in millions)

          Level 1(c)      Level 2(c)      Level 3      Total Fair Value  

Assets:

             

Available-for-sale debt and other securities:

             

U.S. Treasury and federal agencies securities

  $          95        -        -        95  

Obligations of states and political subdivisions securities

       -        2        -        2  

Mortgage-backed securities:

             

Agency residential mortgage-backed securities

       -        15,973        -        15,973  

Agency commercial mortgage-backed securities

       -        10,046        -        10,046  

Non-agency commercial mortgage-backed securities

       -        3,097        -        3,097  

Asset-backed securities and other debt securities

             -        2,044        -        2,044  

Available-for-sale debt and other securities(a)

       95        31,162        -        31,257  

Trading debt securities:

             

U.S. Treasury and federal agencies securities

       5        15        -        20  

Obligations of states and political subdivisions securities

       -        69        -        69  

Agency residential mortgage-backed securities

       -        63        -        63  

Asset-backed securities and other debt securities

             -        117        -        117  

Trading debt securities

       5        264        -        269  

Equity securities

       499        1        -        500  

Residential mortgage loans held for sale

       -        563        -        563  

Residential mortgage loans(b)

       -        -        172        172  

Commercial loans held for sale

       -        6        -        6  

MSRs

       -        -        1,010        1,010  

Derivative assets:

             

Interest rate contracts

       4        534        7        545  

Foreign exchange contracts

       -        124        -        124  

Commodity contracts

             34        281        -        315  

Derivative assets(d)

             38        939        7        984  

Total assets

  $          637        32,935        1,189        34,761  

Liabilities:

             

Derivative liabilities:

             

Interest rate contracts

  $          -        355        8        363  

Foreign exchange contracts

       -        110        -        110  

Equity contracts

       -        -        144        144  

Commodity contracts

             104        192        -        296  

Derivative liabilities(e)

       104        657        152        913  

Short positions(e)

             47        51        -        98  

Total liabilities

  $          151        708        152        1,011  

(a)

Excludes FHLB, FRB and DTCC restricted stock holdings totaling $184, $365 and $2, respectively, at September 30, 2018.

(b)

Includes residential mortgage loans originated as held for sale and subsequently transferred to held for investment.

(c)

During both the three and nine months ended September 30, 2018, no assets or liabilities were transferred between Level 1 and Level 2.

(d)

Included in other assets in the Condensed Consolidated Balance Sheets.

(e)

Included in other liabilities in the Condensed Consolidated Balance Sheets.

 

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             Fair Value Measurements Using          

December 31, 2017 ($ in millions)

          Level 1(c)      Level 2(c)      Level 3      Total Fair Value  

Assets:

             

Available-for-sale debt and other securities:

             

U.S. Treasury and federal agencies securities

  $          98        -        -        98  

Obligations of states and political subdivisions securities

       -        44        -        44  

Mortgage-backed securities:

             

Agency residential mortgage-backed securities

       -        15,319        -        15,319  

Agency commercial mortgage-backed securities

       -        10,167        -        10,167  

Non-agency commercial mortgage-backed securities

       -        3,293        -        3,293  

Asset-backed securities and other debt securities

             -        2,218        -        2,218  

Available-for-sale debt and other securities(a)

       98        31,041        -        31,139  

Trading debt securities:

             

U.S. Treasury and federal agencies securities

       1        11        -        12  

Obligations of states and political subdivisions securities

       -        22        -        22  

Residential mortgage-backed securities

       -        395        -        395  

Asset-backed securities and other debt securities

             -        63        -        63  

Trading debt securities

       1        491        -        492  

Equity securities

       438        1        -        439  

Residential mortgage loans held for sale

       -        399        -        399  

Residential mortgage loans(b)

       -        -        137        137  

MSRs

       -        -        858        858  

Derivative assets:

             

Interest rate contracts

       1        505        8        514  

Foreign exchange contracts

       -        124        -        124  

Equity contracts

       -        20        -        20  

Commodity contracts

             39        126        -        165  

Derivative assets(d)

             40        775        8        823  

Total assets

  $          577        32,707        1,003        34,287  

Liabilities:

             

Derivative liabilities:

             

Interest rate contracts

  $          1        172        5        178  

Foreign exchange contracts

       -        120        -        120  

Equity contracts

       -        -        137        137  

Commodity contracts

             38        129        -        167  

Derivative liabilities(e)

       39        421        142        602  

Short positions(e)

             25        6        -        31  

Total liabilities

  $          64        427        142        633  

(a)

Excludes FHLB, FRB, and DTCC restricted stock holdings totaling $248, $362 and $2, respectively, at December 31, 2017.

(b)

Includes residential mortgage loans originated as held for sale and subsequently transferred to held for investment.

(c)

During the year ended December 31, 2017, no assets or liabilities were transferred between Level 1 and Level 2.

(d)

Included in other assets in the Condensed Consolidated Balance Sheets.

(e)

Included in other liabilities in the Condensed Consolidated Balance Sheets.

The following is a description of the valuation methodologies used for significant instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Available-for-sale debt and other securities, trading debt securities and equity securities

Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include U.S. Treasury securities and equity securities. If quoted market prices are not available, then fair values are estimated using pricing models, quoted prices of securities with similar characteristics or DCFs. Level 2 securities may include federal agencies securities, obligations of states and political subdivisions securities, agency and non-agency residential mortgage-backed securities, agency and non-agency commercial mortgage-backed securities, asset-backed securities and other debt securities and equity securities. These securities are generally valued using a market approach based on observable prices of securities with similar characteristics.

Residential mortgage loans held for sale

For residential mortgage loans held for sale for which the fair value election has been made, fair value is estimated based upon mortgage-backed securities prices and spreads to those prices or, for certain ARM loans, DCF models that may incorporate the anticipated portfolio composition, credit spreads of asset-backed securities with similar collateral and market conditions. The anticipated portfolio composition includes the effect of interest rate spreads and discount rates due to loan characteristics such as the state in which the loan was originated, the loan amount and the ARM margin. Residential mortgage loans held for sale that are valued based on mortgage-backed securities prices are classified within Level 2 of the valuation hierarchy as the valuation is based on external pricing for similar instruments. ARM loans classified as held for sale are also classified within Level 2 of the valuation hierarchy due to the use of observable inputs in the DCF model. These observable inputs include interest rate spreads from agency mortgage-backed securities market rates and observable discount rates.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

Residential mortgage loans

Residential mortgage loans held for sale that are reclassified to held for investment are transferred from Level 2 to Level 3 of the fair value hierarchy. It is the Bancorp’s policy to value any transfers between levels of the fair value hierarchy based on end of period fair values. For residential mortgage loans for which the fair value election has been made, and that are reclassified from held for sale to held for investment, the fair value estimation is based on mortgage-backed securities prices, interest rate risk and an internally developed credit component. Therefore, these loans are classified within Level 3 of the valuation hierarchy. An adverse change in the loss rate or severity assumption would result in a decrease in fair value of the related loan. The Secondary Marketing department, which reports to the Bancorp’s Head of the Consumer Bank, in conjunction with the Consumer Credit Risk department, which reports to the Bancorp’s Chief Risk Officer, are responsible for determining the valuation methodology for residential mortgage loans held for investment. The Secondary Marketing department reviews loss severity assumptions quarterly to determine if adjustments are necessary based on decreases in observable housing market data. This group also reviews trades in comparable benchmark securities and adjusts the values of loans as necessary. Consumer Credit Risk is responsible for the credit component of the fair value which is based on internally developed loss rate models that take into account historical loss rates and loss severities based on underlying collateral values.

Commercial loans held for sale

For commercial loans held for sale for which the fair value election has been made, fair value is estimated based upon quoted prices of identical or similar assets in an active market, which are reviewed and approved by the Market Risk department, which reports to the Bancorp’s Chief Risk Officer. These loans are generally valued using a market approach based on observable prices and are classified within Level 2 of the valuation hierarchy.

MSRs

MSRs do not trade in an active, open market with readily observable prices. While sales of MSRs do occur, the precise terms and conditions typically are not readily available. Accordingly, the Bancorp estimates the fair value of MSRs using internal OAS models with certain unobservable inputs, primarily prepayment speed assumptions, OAS and weighted-average lives, resulting in a classification within Level 3 of the valuation hierarchy. Refer to Note 11 for further information on the assumptions used in the valuation of the Bancorp’s MSRs. The Secondary Marketing department and Treasury department are responsible for determining the valuation methodology for MSRs. Representatives from Secondary Marketing, Treasury, Accounting and Risk Management are responsible for reviewing key assumptions used in the internal OAS model. Two external valuations of the MSR portfolio are obtained from third parties quarterly that use valuation models in order to assess the reasonableness of the internal OAS model. Additionally, the Bancorp participates in peer surveys that provide additional confirmation of the reasonableness of key assumptions utilized in the MSR valuation process and the resulting MSR prices.

Derivatives

Exchange-traded derivatives valued using quoted prices and certain over-the-counter derivatives valued using active bids are classified within Level 1 of the valuation hierarchy. Most of the Bancorp’s derivative contracts are valued using DCF or other models that incorporate current market interest rates, credit spreads assigned to the derivative counterparties and other market parameters and, therefore, are classified within Level 2 of the valuation hierarchy. Such derivatives include basic and structured interest rate, foreign exchange and commodity swaps and options. Derivatives that are valued based upon models with significant unobservable market parameters are classified within Level 3 of the valuation hierarchy. At September 30, 2018 and December 31, 2017, derivatives classified as Level 3, which are valued using models containing unobservable inputs, consisted primarily of a total return swap associated with the Bancorp’s sale of Visa, Inc. Class B Shares. Level 3 derivatives also include IRLCs, which utilize internally generated loan closing rate assumptions as a significant unobservable input in the valuation process.

Under the terms of the total return swap, the Bancorp will make or receive payments based on subsequent changes in the conversion rate of the Visa, Inc. Class B Shares into Class A Shares. Additionally, the Bancorp will make a quarterly payment based on Visa’s stock price and the conversion rate of the Visa, Inc. Class B Shares into Class A Shares until the date on which the Covered Litigation is settled. The fair value of the total return swap was calculated using a DCF model based on unobservable inputs consisting of management’s estimate of the probability of certain litigation scenarios, the timing of the resolution of the Covered Litigation and Visa litigation loss estimates in excess, or shortfall, of the Bancorp’s proportional share of escrow funds.

An increase in the loss estimate or a delay in the resolution of the Covered Litigation would result in an increase in the fair value of the derivative liability; conversely, a decrease in the loss estimate or an acceleration of the resolution of the Covered Litigation would result in a decrease in the fair value of the derivative liability. The Accounting and Treasury departments, both of which report to the Bancorp’s Chief Financial Officer, determined the valuation methodology for the total return swap. Accounting and Treasury review the changes in fair value on a quarterly basis for reasonableness based on Visa stock price changes, litigation contingencies and escrow funding.

The net asset fair value of the IRLCs at September 30, 2018 was $7 million. Immediate decreases in current interest rates of 25 bps and 50 bps would result in increases in the fair value of the IRLCs of approximately $3 million and $5 million, respectively. Immediate increases of current interest rates of 25 bps and 50 bps would result in decreases in the fair value of the IRLCs of approximately $3 million and $7 million, respectively. The decrease in fair value of IRLCs due to both immediate 10% and 20% adverse changes in the assumed loan closing rates would be approximately $1 million and the increase in fair value due to both immediate 10% and 20% favorable changes in the assumed loan closing rates would be approximately $1 million. These sensitivities are hypothetical and should be used with caution, as changes in fair value based on a variation in assumptions typically cannot be extrapolated because the relationship of the change in assumptions to the change in fair value may not be linear.

The Consumer Line of Business Finance department, which reports to the Bancorp’s Chief Financial Officer, and the aforementioned Secondary Marketing department are responsible for determining the valuation methodology for IRLCs. Secondary Marketing, in conjunction with a third party valuation provider, periodically review loan closing rate assumptions and recent loan sales to determine if adjustments are needed for current market conditions not reflected in historical data.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

Short positions

Where quoted prices are available in an active market, short positions are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated using pricing models, quoted prices of securities with similar characteristics or DCFs and therefore are classified within Level 2 of the valuation hierarchy.

The following tables are a reconciliation of assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3):

 

            Fair Value Measurements Using Significant Unobservable Inputs (Level 3)  

For the three months ended September 30, 2018 ($ in millions)

       

Residential

Mortgage

Loans

   

MSRs

   

Interest Rate

Derivatives,

Net(a)

   

Equity

Derivatives

   

Total

Fair Value

 

Balance, beginning of period

  $         162       959       4       (164     961  

Total (losses) gains (realized/unrealized):

           

Included in earnings

      (1     (8     18       (17     (8

Purchases/originations

      -       59       (1     -       58  

Settlements

      (4     -       (22     37       11  

Transfers into Level 3(b)

            15       -       -       -       15  

Balance, end of period

  $         172       1,010       (1     (144     1,037  

The amount of total (losses) gains for the period included in earnings attributable to the change in unrealized gains or losses relating to instruments still held at September 30, 2018(c)

  $         (1     (8     7       (17     (19

(a)

Net interest rate derivatives include derivative assets and liabilities of $7 and $8, respectively, as of September 30, 2018.

(b)

Includes certain residential mortgage loans originated as held for sale that were transferred to held for investment.

(c)

Includes interest income and expense.

 

            Fair Value Measurements Using Significant Unobservable Inputs (Level 3)  

For the three months ended September 30, 2017 ($ in millions)

       

Residential

Mortgage

Loans

   

MSRs

   

Interest Rate

Derivatives,

Net(a)

   

Equity

Derivatives

   

Total

Fair Value

 

Balance, beginning of period

  $         142       849       9       (98     902  

Total (losses) gains (realized/unrealized):

           

Included in earnings

      -       (34     28       (47     (53

Purchases/originations

      -       33       (1     -       32  

Settlements

      (6     -       (28     9       (25

Transfers into Level 3(b)

            4       -       -       -       4  

Balance, end of period

  $         140       848       8       (136     860  

The amount of total (losses) gains for the period included in earnings attributable to the change in unrealized gains or losses relating to instruments still held at September 30, 2017(c)

  $         -       (34     13       (47     (68

(a)

Net interest rate derivatives include derivative assets and liabilities of $13 and $5, respectively, as of September 30, 2017.

(b)

Includes certain residential mortgage loans held for sale that were transferred to held for investment.

(c)

Includes interest income and expense.

 

            Fair Value Measurements Using Significant Unobservable Inputs (Level 3)  

For the nine months ended September 30, 2018 ($ in millions)

       

Residential

Mortgage

Loans

   

MSRs

   

Interest Rate

Derivatives,

Net(a)

   

Equity

Derivatives

   

Total

Fair Value

 

Balance, beginning of period

  $         137       858       3       (137     861  

Total (losses) gains (realized/unrealized):

           

Included in earnings

      (5     8       54       (66     (9

Purchases/originations

      -       144       (5     -       139  

Settlements

      (12     -       (53     59       (6

Transfers into Level 3(b)

            52       -       -       -       52  

Balance, end of period

  $         172       1,010       (1     (144     1,037  

The amount of total (losses) gains for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at September 30, 2018(c)

  $         (5     8       9       (66     (54

(a)

Net interest rate derivatives include derivative assets and liabilities of $7 and $8, respectively, as of September 30, 2018.

(b)

Includes certain residential mortgage loans held for sale that were transferred to held for investment.

(c)

Includes interest income and expense.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

             Fair Value Measurements Using Significant Unobservable Inputs (Level 3)  

For the nine months ended September 30, 2017 ($ in millions)

        

Residential

Mortgage

Loans

   

MSRs

   

Interest Rate

Derivatives,

Net(a)

   

Equity

Derivatives

   

Total

Fair Value

 

Balance, beginning of period

  $          143       744       8       (91     804  

Total (losses) gains (realized/unrealized):

            

Included in earnings

       2       (104     77       (69     (94

Purchases/originations

       -       208       (2     -       206  

Settlements

       (16     -       (75     24       (67

Transfers into Level 3(b)

             11       -       -       -       11  

Balance, end of period

  $          140       848       8       (136     860  

The amount of total (losses) gains for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at September 30, 2017(c)

  $          2       (104     14       (69     (157

(a)

Net interest rate derivatives include derivative assets and liabilities of $13 and $5, respectively, as of September 30, 2017.

(b)

Includes certain residential mortgage loans originated as held for sale that were transferred to held for investment.

(c)

Includes interest income and expense.

The total losses included in earnings for assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) were recorded in the Condensed Consolidated Statements of Income as follows:

 

             For the three months ended
September 30,
    For the nine months ended
September 30,
 

($ in millions)

          2018     2017     2018     2017    

Mortgage banking net revenue

  $          9       (6     56       (27 )   

Corporate banking revenue

       -       -       1       2    

Other noninterest income

             (17     (47     (66     (69 )   

Total losses

  $          (8     (53     (9     (94 )   

The total losses included in earnings attributable to changes in unrealized gains and losses related to Level 3 assets and liabilities still held at September 30, 2018 and 2017 were recorded in the Condensed Consolidated Statements of Income as follows:

 

             For the three months ended     For the nine months ended  
           September 30,     September 30,  

($ in millions)

          2018     2017     2018     2017  

Mortgage banking net revenue

  $          (2     (21     11       (90 )   

Corporate banking revenue

       -       -       1       2    

Other noninterest income

             (17     (47     (66     (69 )   

Total losses

  $          (19     (68     (54     (157 )   

The following tables present information as of September 30, 2018 and 2017 about significant unobservable inputs related to the Bancorp’s material categories of Level 3 financial assets and liabilities measured at fair value on a recurring basis:

 

As of September 30, 2018 ($ in millions)

                  
Financial Instrument       

Fair Value

  Valuation Technique   Significant Unobservable
Inputs
  Ranges of
Inputs
    Weighted-Average  

Residential mortgage loans

  $   172  

Loss rate model

 

Interest rate risk factor

   

(12.7) - 11.0%

      -0.6%  
               

Credit risk factor

    0 - 40.3%       0.7%  

MSRs

    1,010  

DCF

 

Prepayment speed

    0.5-97.0%      

(Fixed) 9.1%

(Adjustable) 23.2%

 

 

               

OAS spread (bps)

    449-1,513      

(Fixed) 533

(Adjustable) 842

 

 

IRLCs, net

      7  

DCF

 

Loan closing rates

    6.2 - 96.7%       76.6%  

Swap associated with the sale of Visa, Inc.

    (144)  

DCF

 

Timing of the resolution

    1/31/2021 -       9/6/2021  

Class B Shares

             

    of the Covered Litigation

    11/30/2023          

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

As of September 30, 2017 ($ in millions)

                    
Financial Instrument           

Fair Value

  Valuation Technique    Significant Unobservable
Inputs
  Ranges of
Inputs
     Weighted-Average  

Residential mortgage loans

   $        140  

Loss rate model

  

Interest rate risk factor

    (9.2) - 14.9%        3.2%  
                      

Credit risk factor

    0 - 46.2%        1.0%  

MSRs

      848  

DCF

  

Prepayment speed

    0.8-98.0%       

(Fixed) 11.8%

(Adjustable) 25.2%

 

 

                      

OAS spread (bps)

    430-1,515       

(Fixed) 502

(Adjustable) 784

 

 

IRLCs, net

            13  

DCF

  

Loan closing rates

    3.3- 96.5%        72.8%  

Swap associated with the sale of Visa, Inc.

      (136)  

DCF

  

Timing of the resolution

    12/31/2020 -        8/15/2021  

Class B Shares

                    

    of the Covered Litigation

    12/31/2023           

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

Certain assets and liabilities are measured at fair value on a nonrecurring basis. These assets and liabilities are not measured at fair value on an ongoing basis; however, they are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment.

The following tables provide the fair value hierarchy and carrying amount of all assets that were held as of September 30, 2018 and 2017 and for which a nonrecurring fair value adjustment was recorded during the three and nine months ended September 30, 2018 and 2017, and the related gains and losses from fair value adjustments on assets sold during the period as well as assets still held as of the end of the period:

 

 

          

Fair Value Measurements Using

     Total (Losses) Gains     Total (Losses) Gains  

As of September 30, 2018 ($ in millions)

          Level 1      Level 2      Level 3      Total     

For the three months

ended September 30, 2018

    For the nine months
ended September 30, 2018
 

Commercial loans held for sale

  $          -        -        3        3        (1     (2

Commercial and industrial loans

       -        -        156        156        (16     (46

Commercial mortgage loans

       -        -        2        2        -       6  

Commercial leases

       -        -        14        14        1       (9

OREO

       -        -        21        21        (2     (6

Bank premises and equipment

       -        -        36        36        -       (41

Operating lease equipment

       -        -        10        10        (1     (4

Private equity investments

             -        69        3        72        14       44  

Total

  $          -        69        245        314        (5     (58

 

 

          

Fair Value Measurements Using

     Total Losses     Total Losses  

As of September 30, 2017 ($ in millions)

          Level 1      Level 2      Level 3      Total     

For the three months

ended September 30, 2017

   

For the nine months

ended September 30, 2017

 

Commercial loans held for sale

  $          -        -        8        8        (1     (33

Commercial and industrial loans

       -        -        354        354        (10     (68

Commercial mortgage loans

       -        -        20        20        (1     (12

Commercial leases

       -        -        1        1        -       (2

OREO

       -        -        20        20        (3     (8

Bank premises and equipment

       -        -        25        25        (1     (6

Operating lease equipment

             -        -        56        56        -       (20

Total

  $          -        -        484        484        (16     (149

The following tables present information as of September 30, 2018 and 2017 about significant unobservable inputs related to the Bancorp’s material categories of Level 3 financial assets and liabilities measured on a nonrecurring basis:

 

As of September 30, 2018 ($ in millions)

                     
Financial Instrument         Fair Value    Valuation Technique    Significant Unobservable Inputs    Ranges of
Inputs
     Weighted-Average  

Commercial loans held for sale

  $    3   

Appraised value

  

Appraised value

     NM        NM  
                  

Costs to sell

     NM        10.0%  

Commercial and industrial loans

       156   

Appraised value

  

Collateral value

     NM        NM  

Commercial mortgage loans

       2   

Appraised value

  

Collateral value

     NM        NM  

Commercial leases

       14   

Appraised value

  

Collateral value

     NM        NM  

OREO

       21   

Appraised value

  

Appraised value

     NM        NM  

Bank premises and equipment

       36   

Appraised value

  

Appraised value

     NM        NM  

Operating lease equipment

       10   

Appraised value

  

Appraised value

     NM        NM  

Private equity investments

     -   

Liquidity discount applied

  

Liquidity discount

     0-43.0%        12.9%  
       

to fund’s net asset value

        
         3   

Comparable company analysis

  

Market comparable transactions

     NM        NM  

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

As of September 30, 2017 ($ in millions)

                     
Financial Instrument          Fair Value    Valuation Technique    Significant Unobservable Inputs    Ranges of
Inputs
     Weighted-Average  

Commercial loans held for sale

   $        8   

Appraised value

  

Appraised value

     NM        NM  
                   

Costs to sell

     NM        10.0%  

Commercial and industrial loans

            354   

Appraised value

  

Collateral value

     NM        NM  

Commercial mortgage loans

            20   

Appraised value

  

Collateral value

     NM        NM  

Commercial leases

            1   

Appraised value

  

Collateral value

     NM        NM  

OREO

            20   

Appraised value

  

Appraised value

     NM        NM  

Bank premises and equipment

            25   

Appraised value

  

Appraised value

     NM        NM  

Operating lease equipment

            56   

Appraised value

  

Appraised value

     NM        NM  

Commercial loans held for sale

During the three and nine months ended September 30, 2018, the Bancorp transferred zero and $1 million, respectively, of commercial loans from the portfolio to loans held for sale that upon transfer were measured at lower of cost or fair value. During the three and nine months ended September 30, 2017, the Bancorp transferred $9 million and $84 million, respectively, of commercial loans from the portfolio to loans held for sale that upon transfer were measured at lower of cost or fair value. These loans had fair value adjustments of zero and an immaterial amount during the three and nine months ended September 30, 2018, respectively, and had $1 million and $31 million of fair value adjustments during the three and nine months ended September 30, 2017, respectively. These fair value adjustments were generally based on appraisals of the underlying collateral and were, therefore, classified within Level 3 of the valuation hierarchy. Additionally, fair value adjustments on existing loans held for sale were $1 million and $2 million for the three and nine months ended September 30, 2018, respectively, and immaterial for both the three and nine months ended September 30, 2017. The fair value adjustments were also based on appraisals of the underlying collateral. The Bancorp recognized an immaterial amount of gains on the sale of commercial loans held for sale during both the three and nine months ended September 30, 2018. The Bancorp did not recognize any gains or losses on the sale of commercial loans held for sale during the three months ended September 30, 2017 and recognized $2 million in losses on the sale of commercial loans held for sale for the nine months ended September 30, 2017.

The Accounting department determines the procedures for the valuation of commercial loans held for sale using appraised value which may include a comparison to recently executed transactions of similar type loans. A monthly review of the portfolio is performed for reasonableness. Quarterly, appraisals approaching a year old are updated and the Real Estate Valuation group, which reports to the Bancorp’s Chief Risk Officer, in conjunction with the Commercial Line of Business, reviews the third party appraisals for reasonableness. Additionally, the Commercial Line of Business Finance department, which reports to the Bancorp’s Chief Financial Officer, in conjunction with the Accounting department, reviews all loan appraisal values, carry values and vintages.

Commercial loans held for investment

During the three and nine months ended September 30, 2018 and 2017, the Bancorp recorded nonrecurring impairment adjustments to certain commercial and industrial loans, commercial mortgage loans and commercial leases held for investment. Larger commercial loans included within aggregate borrower relationship balances exceeding $1 million that exhibit probable or observed credit weaknesses are subject to individual review for impairment. The Bancorp considers the current value of collateral, credit quality of any guarantees, the guarantor’s liquidity and willingness to cooperate, the loan structure and other factors when evaluating whether an individual loan is impaired. When the loan is collateral dependent, the fair value of the loan is generally based on the fair value of the underlying collateral supporting the loan and therefore these loans were classified within Level 3 of the valuation hierarchy. In cases where the carrying value exceeds the fair value, an impairment loss is recognized. The fair values and recognized impairment losses are reflected in the previous tables. Commercial Credit Risk, which reports to the Bancorp’s Chief Risk Officer, is responsible for preparing and reviewing the fair value estimates for commercial loans held for investment.

OREO

During the three and nine months ended September 30, 2018 and 2017, the Bancorp recorded nonrecurring adjustments to certain commercial and residential real estate properties classified as OREO and measured at the lower of carrying amount or fair value. These nonrecurring losses were primarily due to declines in real estate values of the properties recorded in OREO. These losses included $1 million and $3 million in losses, recorded as charge-offs on new OREO properties transferred from loans during the three and nine months ended September 30, 2018, respectively, and an immaterial amount and $3 million for the three and nine months ended September 30, 2017, respectively. These losses also included $1 million and $3 million in losses for the three and nine months ended September 30, 2018, respectively, and $3 million and $5 million in losses for the three and nine months ended September 30, 2017, respectively, recorded as negative fair value adjustments on OREO in other noninterest expense in the Condensed Consolidated Statements of Income subsequent to their transfer from loans. As discussed in the following paragraphs, the fair value amounts are generally based on appraisals of the property values, resulting in a classification within Level 3 of the valuation hierarchy. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized. The previous tables reflect the fair value measurements of the properties before deducting the estimated costs to sell.

The Real Estate Valuation department is solely responsible for managing the appraisal process and evaluating the appraisal for commercial properties transferred to OREO. All appraisals on commercial OREO properties are updated on at least an annual basis.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

The Real Estate Valuation department reviews the BPO data and internal market information to determine the initial charge-off on residential real estate loans transferred to OREO. Once the foreclosure process is completed, the Bancorp performs an interior inspection to update the initial fair value of the property. These properties are reviewed at least every 30 days after the initial interior inspections are completed. The Asset Manager receives a monthly status report for each property which includes the number of showings, recently sold properties, current comparable listings and overall market conditions.

Bank premises and equipment

The Bancorp performs assessments of the recoverability of long-lived assets when events or changes in circumstances indicate that their carrying values may not be recoverable. These properties were written down to their lower of cost or market values. At least annually thereafter, the Bancorp will review these properties for market fluctuations. The fair value amounts were generally based on appraisals of the property values, resulting in a classification within Level 3 of the valuation hierarchy. Corporate Facilities, which reports to the Bancorp’s Chief Administrative Officer, in conjunction with Accounting, are responsible for preparing and reviewing the fair value estimates for bank premises and equipment. For further information on bank premises and equipment refer to Note 7.

Operating lease equipment

During the three and nine months ended September 30, 2018 and 2017, the Bancorp recorded nonrecurring impairment adjustments to certain operating lease equipment. When evaluating whether an individual asset is impaired, the Bancorp considers the current fair value of the asset, the changes in overall market demand for the asset and the rate of change in advancements associated with technological improvements that impact the demand for the specific asset under review. As part of this ongoing assessment, the Bancorp determined that the carrying values of certain operating lease equipment were not recoverable and as a result, the Bancorp recorded an impairment loss equal to the amount by which the carrying value of the assets exceeded the fair value. The fair value amounts were generally based on appraised values of the assets, resulting in a classification within Level 3 of the valuation hierarchy. The Bancorp recorded net losses of $1 million and $4 million for the three and nine months ended September 30, 2018, respectively. The Bancorp did not record any losses for the three months ended September 30, 2017 and recorded net losses of $20 million for the nine months ended September 30, 2017 as a reduction to corporate banking revenue in the Condensed Consolidated Statements of Income. The Commercial Leasing department, which reports to the Bancorp’s Chief Operating Officer, is responsible for preparing and reviewing the fair value estimates for operating lease equipment.

Private equity investments

As a result of adopting ASU 2016-01, effective January 1, 2018, the Bancorp accounts for its private equity investments using the measurement alternative to fair value, except for those accounted for under the equity method of accounting. Under the measurement alternative, the Bancorp carries each investment at its cost basis minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. The Bancorp recognized gains of $13 million and $64 million resulting from observable price changes during the three and nine months ended September 30, 2018, respectively. The carrying value of the Bancorp’s private equity investments still held as of September 30, 2018 includes a cumulative $48 million of positive adjustments as a result of observable price changes. Because these adjustments are based on observable transactions in inactive markets, they are classified in Level 2 of the fair value hierarchy.

For private equity investments which are accounted for using the measurement alternative to fair value, the Bancorp qualitatively evaluates each investment quarterly to determine if impairment may exist. If necessary, the Bancorp then measures impairment by estimating the value of its investment and comparing that to the investment’s carrying value, whether or not the Bancorp considers the impairment to be temporary. These valuations are typically developed using a discounted cash flow method, but other methods may be used if more appropriate for the circumstances. These valuations are based on unobservable inputs and therefore are classified in Level 3 of the fair value hierarchy. The Bancorp recognized impairments of an immaterial amount and $11 million during the three and nine months ended September 30, 2018, respectively. The carrying value of the Bancorp’s private equity investments still held as of September 30, 2018 includes a cumulative $11 million of impairment charges recognized since adoption of the measurement alternative to fair value on January 1, 2018.

The Bancorp recognized an immaterial amount and $10 million of OTTI primarily associated with certain nonconforming investments affected by the Volcker Rule during the three and nine months ended September 30, 2018, respectively. The Bancorp performed nonrecurring fair value measurements on a fund by fund basis to determine whether OTTI existed. The Bancorp estimated the fair value of the funds by applying an estimated market discount to the reported net asset value of the fund or through a discounted cash flow analysis. Because the length of time until the investment will become redeemable is generally not certain, these funds were classified within Level 3 of the valuation hierarchy. An adverse change in the reported net asset values or estimated market discounts, where applicable, would result in a decrease in the fair value estimate. In cases where the carrying value exceeds the fair value, an impairment loss is recognized. The Bancorp’s Private Equity department, which reports to the Head of Payments, Strategy and Digital Solutions, in conjunction with Accounting, is responsible for preparing and reviewing the fair value estimates.

Fair Value Option

The Bancorp elected to measure certain residential mortgage and commercial loans held for sale under the fair value option as allowed under U.S. GAAP. Electing to measure residential mortgage loans held for sale at fair value reduces certain timing differences and better matches changes in the value of these assets with changes in the value of derivatives used as economic hedges for these assets. Electing to measure certain commercial loans held for sale at fair value reduces certain timing differences and better reflects changes in fair value of these assets that are expected to be sold in the short term. Management’s intent to sell residential mortgage or commercial loans classified as held for sale may change over time due to such factors as changes in the overall liquidity in markets or changes in characteristics specific to certain loans held for sale. Consequently, these loans may be reclassified to loans held for investment and maintained in the Bancorp’s loan portfolio. In such cases, the loans will continue to be measured at fair value.

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

Fair value changes recognized in earnings for residential mortgage loans held at September 30, 2018 and 2017 for which the fair value option was elected, as well as the changes in fair value of the underlying IRLCs, included gains of $12 million and $27 million for the nine months ended September 30, 2018 and 2017, respectively. These gains are reported in mortgage banking net revenue in the Condensed Consolidated Statements of Income. Fair value changes recognized in earnings for commercial loans held at September 30, 2018 and 2017 for which the fair value option was elected included gains of an immaterial amount for both the nine months ended September 30, 2018 and 2017. These gains are reported in corporate banking revenue in the Condensed Consolidated Statements of Income.

Valuation adjustments related to instrument-specific credit risk for residential mortgage loans measured at fair value negatively impacted the fair value of those loans by $1 million and $2 million at September 30, 2018 and December 31, 2017, respectively. Valuation adjustments related to instrument-specific credit risk for commercial loans measured at fair value had an immaterial impact on the fair value of those loans at September 30, 2018. The Bancorp did not hold any commercial loans held for sale at December 31, 2017. Interest on loans measured at fair value is accrued as it is earned using the effective interest method and is reported as interest income in the Condensed Consolidated Statements of Income.

The following table summarizes the difference between the fair value and the unpaid principal balance for residential mortgage and commercial loans measured at fair value as of:

 

              Aggregate      Aggregate Unpaid          

September 30, 2018 ($ in millions)

           Fair Value      Principal Balance      Difference  

Residential mortgage loans measured at fair value

   $          735        723        12  

Past due loans of 90 days or more

        4        4        -  

Nonaccrual loans

        1        1        -  

Commercial loans measured at fair value

              6        6        -  

December 31, 2017

                                   

Residential mortgage loans measured at fair value

   $          536        522        14  

Past due loans of 90 days or more

        5        5        -  

Nonaccrual loans

              1        1        -  

Fair Value of Certain Financial Instruments

The following tables summarize the carrying amounts and estimated fair values for certain financial instruments, excluding financial instruments measured at fair value on a recurring basis:

 

              Net Carrying     Fair Value Measurements Using          Total  

As of September 30, 2018 ($ in millions)

           Amount     Level 1      Level 2      Level 3      Fair Value  

Financial assets:

                

Cash and due from banks

   $          2,100       2,100        -        -        2,100  

Other short-term investments

        1,429       1,429        -        -        1,429  

Other securities

        551       -        551        -        551  

Held-to-maturity securities

        18       -        -        18        18  

Loans and leases held for sale

        94       -        -        94        94  

Portfolio loans and leases:

                

Commercial and industrial loans

        42,098       -        -        43,066        43,066  

Commercial mortgage loans

        6,622       -        -        6,556        6,556  

Commercial construction loans

        4,863       -        -        4,920        4,920  

Commercial leases

        3,676       -        -        3,266        3,266  

Residential mortgage loans

        15,330       -        -        15,544        15,544  

Home equity

        6,448       -        -        6,816        6,816  

Automobile loans

        8,963       -        -        8,687        8,687  

Credit card

        2,189       -        -        2,599        2,599  

Other consumer loans

        2,100       -        -        2,205        2,205  

Unallocated ALLL

              (109     -        -        -        -  

Total portfolio loans and leases, net

   $          92,180       -        -        93,659        93,659  

Financial liabilities:

                

Deposits

   $          104,342       -        104,279        -        104,279  

Federal funds purchased

        2,316       2,316        -        -        2,316  

Other short-term borrowings

        1,114       -        1,114        -        1,114  

Long-term debt

              14,460       14,200        432        -        14,632  

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

              Net Carrying     Fair Value Measurements Using      Total  

As of December 31, 2017 ($ in millions)

           Amount     Level 1      Level 2      Level 3      Fair Value  

Financial assets:

                

Cash and due from banks

   $          2,514       2,514        -        -        2,514  

Other short-term investments

        2,753       2,753        -        -        2,753  

Other securities

        612       -        612        -        612  

Held-to-maturity securities

        24       -        -        24        24  

Loans and leases held for sale

        93       -        -        93        93  

Portfolio loans and leases:

                

Commercial and industrial loans

        40,519       -        -        41,718        41,718  

Commercial mortgage loans

        6,539       -        -        6,490        6,490  

Commercial construction loans

        4,530       -        -        4,560        4,560  

Commercial leases

        4,054       -        -        3,705        3,705  

Residential mortgage loans

        15,365       -        -        15,996        15,996  

Home equity

        6,968       -        -        7,410        7,410  

Automobile loans

        9,074       -        -        8,832        8,832  

Credit card

        2,182       -        -        2,616        2,616  

Other consumer loans

        1,526       -        -        1,621        1,621  

Unallocated ALLL

              (120     -        -        -        -  

Total portfolio loans and leases, net

   $          90,637       -        -        92,948        92,948  

Financial liabilities:

                

Deposits

   $          103,162       -        103,123        -        103,123  

Federal funds purchased

        174       174        -        -        174  

Other short-term borrowings

        4,012       -        4,012        -        4,012  

Long-term debt

              14,904       15,045        529        -        15,574  

 

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Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

23. Business Segments

The Bancorp reports on four business segments: Commercial Banking, Branch Banking, Consumer Lending and Wealth and Asset Management. 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 the cash flows for each transaction. Assigning the FTP rate based on matching the duration of cash flows allocates interest income and interest expense to each business segment so its resulting net interest income is insulated from future changes in benchmark interest rates. The 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 funding operations by accessing the capital markets as a collective unit.

The results of operations and financial position for the three and nine months ended September 30, 2017 were adjusted to reflect changes in internal expense allocation methodologies.

The following is a description of each of the Bancorp’s business segments and the products and services they provide to their respective client bases.

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.

Branch Banking provides a full range of deposit and loan and lease products to individuals and small businesses through 1,152 full-service banking centers. Branch Banking offers depository and loan products, such as checking and savings accounts, home equity loans and lines of credit, credit cards and loans for automobiles and other personal financing needs, as well as products designed to meet the specific needs of small businesses, including cash management services.

Consumer Lending includes the Bancorp’s residential mortgage, home equity, automobile and other indirect lending activities. Direct 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.

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, an indirect wholly-owned subsidiary of the Bancorp; ClearArc Capital, Inc., an indirect wholly-owned subsidiary of the Bancorp; Fifth Third Insurance Agency, Inc., an indirect wholly-owned subsidiary of the Bancorp; 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.

 

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Fifth Third Bancorp and Subsidiaries

Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

The following tables present the results of operations and assets by business segment for the three months ended:

 

September 30, 2018 ($ in millions)

          

Commercial

Banking

   

Branch

Banking

    

Consumer

Lending

   

Wealth

and Asset

Management

    

General

Corporate

and Other

   

Eliminations

   

Total

 

Net interest income

   $          427       525        60       46        (15     -       1,043  

Provision for (benefit from) loan and lease losses

              (11     34        10       3        50       -       86  

Net interest income after provision for loan and lease losses

        438       491        50       43        (65     -       957  

Noninterest income:

                   

Service charges on deposits

        68       71        -       -        -       -       139  

Wealth and asset management revenue

        1       38        -       110        -       (35 )(a)      114  

Corporate banking revenue

        100       1        -       -        (1     -       100  

Card and processing revenue

        14       67        -       1        -       -       82  

Mortgage banking net revenue

        -       1        48       -        -       -       49  

Other noninterest income

        52       26        3       4        1       -       86  

Securities losses, net

        -       -        -       -        (6     -       (6

Securities losses, net - non-qualifying hedges on MSRs

              -       -        (1     -        -       -       (1

Total noninterest income

        235       204        50       115        (6     (35     563  

Noninterest expense:

                   

Salaries, wages and incentives

        71       109        38       44        159       -       421  

Employee benefits

        8       22        8       6        38       -       82  

Net occupancy expense

        6       44        3       3        14       -       70  

Technology and communications

        2       1        2       -        66       -       71  

Equipment expense

        6       12        -       -        13       -       31  

Card and processing expense

        2       30        -       -        (1     -       31  

Other noninterest expense

              250       215        49       73        (250     (35     302  

Total noninterest expense

              345       433        100       126        39       (35     1,008  

Income (loss) before income taxes

        328       262        -       32        (110     -       512  

Applicable income tax expense (benefit)

              30       55        -       7        (13     -       79  

Net income (loss)

              298       207        -       25        (97     -       433  

Total goodwill

   $          630       1,655        -       177        -       -       2,462  

Total assets

   $          60,135       60,222        22,188       9,171        (10,031 )(b)      -       141,685  

(a)

Revenue sharing agreements between wealth and asset management and branch banking are eliminated in the Condensed Consolidated Statements of Income.

(b)

Includes bank premises and equipment of $38 classified as held for sale. For more information refer to Note 7.

 

September 30, 2017 ($ in millions)

          

Commercial

Banking

   

Branch

Banking

    

Consumer

Lending

    

Wealth

and Asset

Management

   

General

Corporate

and Other

   

Eliminations

   

Total

 

Net interest income

   $          422       453        59        38       (2     -       970  

Provision for (benefit from) loan and lease losses

              (3     35        8        (1     28       -       67  

Net interest income after provision for loan and lease losses

        425       418        51        39       (30     -       903  

Noninterest income:

                   

Service charges on deposits

        71       67        -        -       -       -       138  

Wealth and asset management revenue

        1       35        -        99       (1     (32 )(a)      102  

Corporate banking revenue

        100       1        -        -       -       -       101  

Card and processing revenue

        14       64        -        1       -       -       79  

Mortgage banking net revenue

        -       2        61        -       -       -       63  

Other noninterest income(b)

        30       22        5        1       1,018       -       1,076  

Securities gains, net - non-qualifying hedges on MSRs

              -       -        2        -       -       -       2  

Total noninterest income

        216       191        68        101       1,017       (32     1,561  

Noninterest expense:

                   

Salaries, wages and incentives

        64       104        38        37       164       -       407  

Employee benefits

        7       22        8        5       35       -       77  

Net occupancy expense

        6       43        3        3       19       -       74  

Technology and communications

        2       1        -        -       59       -       62  

Equipment expense

        5       13        -        -       12       -       30  

Card and processing expense

        1       31        -        -       -       -       32  

Other noninterest expense

              256       205        52        66       (254     (32     293  

Total noninterest expense

              341       419        101        111       35       (32     975  

Income before income taxes

        300       190        18        29       952       -       1,489  

Applicable income tax expense

              56       66        6        10       337       -       475  

Net income

              244       124        12        19       615       -       1,014  

Total goodwill

   $          613       1,655        -        155       -       -       2,423  

Total assets

   $          58,752       57,246        22,447        8,821       (5,002 )(c)      -       142,264  

(a)

Revenue sharing agreements between wealth and asset management and branch banking are eliminated in the Condensed Consolidated Statements of Income.

(b)

Includes impairment charges of $1 for branches and land. For more information refer to Note 7 and Note 22.

(c)

Includes bank premises and equipment of $36 classified as held for sale. For more information refer to Note 7.

 

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Fifth Third Bancorp and Subsidiaries

Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

The following tables present the results of operations and assets by business segment for the nine months ended:

 

September 30, 2018 ($ in millions)

          

Commercial

Banking

   

Branch

Banking

    

Consumer

Lending

   

Wealth

and Asset

Management

    

General

Corporate

and Other

   

Eliminations

   

Total

 

Net interest income

   $          1,273       1,490        178       134        (16     -       3,059  

Provision for (benefit from) loan and lease losses

              (41     124        30       8        21       -       142  

Net interest income after provision for loan and lease losses

        1,314       1,366        148       126        (37     -       2,917  

Noninterest income:

                   

Service charges on deposits

        207       205        -       1        1       -       414  

Wealth and asset management revenue

        3       113        -       324        (1     (104 )(a)      335  

Corporate banking revenue

        304 (c)       4        -       1        (1     -       308  

Card and processing revenue

        42       199        -       4        -       -       245  

Mortgage banking net revenue

        -       4        153       1        -       -       158  

Other noninterest income(b)

        125       33        11       13        612       -       794  

Securities losses, net

        -       -        -       -        (21     -       (21

Securities losses, net - non-qualifying hedges on MSRs

              -       -        (18     -        -       -       (18

Total noninterest income

        681       558        146       344        590       (104     2,215  

Noninterest expense:

                   

Salaries, wages and incentives

        214       329        120       131        545       -       1,339  

Employee benefits

        36       75        28       23        108       -       270  

Net occupancy expense

        20       131        8       9        51       -       219  

Technology and communications

        6       4        3       1        192       -       206  

Equipment expense

        18       37        -       -        37       -       92  

Card and processing expense

        3       89        -       -        (1     -       91  

Other noninterest expense

              792       638        151       217        (821     (104     873  

Total noninterest expense

              1,089       1,303        310       381        111       (104     3,090  

Income (loss) before income taxes

        906       621        (16     89        442       -       2,042  

Applicable income tax expense (benefit)

              63       131        (3     19        111       -       321  

Net income (loss)

              843       490        (13     70        331       -       1,721  

Total goodwill

   $          630       1,655        -       177        -       -       2,462  

Total assets

   $          60,135       60,222        22,188       9,171        (10,031 )(d)      -       141,685  

(a)

Revenue sharing agreements between wealth and asset management and branch banking are eliminated in the Condensed Consolidated Statements of Income.

(b)

Includes impairment charges of $41 for branches and land. For more information refer to Note 7 and Note 22.

(c)

Includes impairment charges of $2 for operating lease equipment. For more information refer to Note 22.

(d)

Includes bank premises and equipment of $38 classified as held for sale. For more information refer to Note 7.

 

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Fifth Third Bancorp and Subsidiaries

Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

September 30, 2017 ($ in millions)

          

Commercial

Banking

   

Branch

Banking

    

Consumer

Lending

    

Wealth

and Asset

Management

    

General

Corporate

and Other

   

Eliminations

   

Total

 

Net interest income

   $          1,261       1,320        179        114        (32     -       2,842  

Provision for loan and lease losses

              25       115        30        2        21       -       193  

Net interest income after provision for loan and lease losses

        1,236       1,205        149        112        (53     -       2,649  

Total noninterest income

                    

Service charges on deposits

        217       196        -        1        1       -       415  

Wealth and asset management revenue

        2       106        -        304        -       (99 )(a)      313  

Corporate banking revenue

        272 (c)       4        -        1        (1     -       276  

Card and processing revenue

        43       185        -        4        -       -       232  

Mortgage banking net revenue

        -       5        164        1        -       -       170  

Other noninterest income(b)

        111       67        14        1        1,044       -       1,237  

Securities gains, net

        -       -        -        -        1       -       1  

Securities gains, net - non-qualifying hedges on MSRs

              -       -        4        -        -       -       4  

Total noninterest income

        645       563        182        312        1,045       (99     2,648  

Noninterest expense

                    

Salaries, wages and incentives

        191       312        113        114        485       -       1,215  

Employee benefits

        34       75        29        22        114       -       274  

Net occupancy expense

        20       133        8        8        52       -       221  

Technology and communications

        7       3        2        -        165       -       177  

Equipment expense

        14       39        -        -        35       -       88  

Card and processing expense

        2       93        -        -        -       -       95  

Other noninterest expense

              763       592        161        201        (770     (99     848  

Total noninterest expense

              1,031       1,247        313        345        81       (99     2,918  

Income before income taxes

        850       521        18        79        911       -       2,379  

Applicable income tax expense

              152       183        7        27        325       -       694  

Net income

              698       338        11        52        586       -       1,685  

Total goodwill

   $          613       1,655        -        155        -       -       2,423  

Total assets

   $          58,752       57,246        22,447        8,821        (5,002 )(d)      -       142,264  

(a)

Revenue sharing agreements between wealth and asset management and branch banking are eliminated in the Condensed Consolidated Statements of Income.

(b)

Includes impairment charges of $6 for branches and land. For more information refer to Note 7 and Note 22.

(c)

Includes impairment charges of $31 for operating lease equipment. For more information refer to Note 22.

(d)

Includes bank premises and equipment of $36 classified as held for sale. For more information refer to Note 7.

24. Pending Acquisition

On May 21, 2018, Fifth Third Bancorp and MB Financial, Inc. jointly announced the signing of a definitive merger agreement under which, on the terms and conditions set forth therein, MB Financial, Inc. (“MB Financial”) will merge with a subsidiary of Fifth Third Bancorp in a transaction valued at approximately $4.7 billion based on the closing price of Fifth Third Bancorp’s common shares on May 18, 2018. MB Financial is headquartered in Chicago, Illinois with reported assets of approximately $20 billion as of June 30, 2018 and is the holding company of MB Financial Bank, N.A. In conjunction with the closing of the transaction, two members of MB Financial’s Board of Directors are expected to join the Fifth Third Bancorp Board.

Under the terms of the agreement, common shareholders of MB Financial will receive 1.45 shares of Fifth Third Bancorp common stock and $5.54 in cash for each share of MB Financial common stock, which had an implied value of $54.20 per share of MB Financial common stock, based on the closing price of Fifth Third Bancorp’s common shares on May 18, 2018. The exchange ratio of Fifth Third Bancorp common shares for MB Financial common shares is fixed and will not adjust based on changes in Fifth Third Bancorp’s share trading price.

On September 18, 2018, MB Financial held a special meeting of stockholders at which MB Financial stockholders voted on proposals relating to the pending merger. MB Financial’s common stockholders approved the Common Stockholder Merger Proposal and the Charter Amendment Proposal but an insufficient number of votes were received from MB Financial’s preferred stockholders to approve the Preferred Stockholder Merger Proposal. As a result, the merger will be completed through the Alternative Merger, the merger of a newly-formed subsidiary of Fifth Third Bancorp with and into MB Financial, with MB Financial surviving that merger, as a subsidiary of Fifth Third Bancorp. Detailed voting results are provided in a Current Report on Form 8-K filed with the SEC on September 20, 2018 by MB Financial.

The transaction remains subject to regulatory approval and the satisfaction of other customary closing conditions. The transaction is expected to close in the first quarter of 2019.

25. Subsequent Event

Between October 24, 2018 and November 5, 2018, the Bancorp entered into repurchase transactions of 12,453,042 shares, or approximately $331 million, of its outstanding common stock through the open market.

 

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PART II. OTHER INFORMATION

 

Legal Proceedings (Item 1)

Refer to Note 17 of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 for information regarding legal proceedings.

Risk Factors (Item 1A)

There have been no material changes made during the third quarter of 2018 to any of the risk factors as previously disclosed in the Bancorp’s annual and quarterly reports filed with the SEC.

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

Refer to the “Capital Management” section within Management’s Discussion and Analysis in Part I, Item 2 for information regarding purchases and sales of equity securities by the Bancorp during the third quarter of 2018.

Defaults Upon Senior Securities (Item 3)

None.

Mine Safety Disclosures (Item 4)

Not applicable.

Other Information (Item 5)

None.

Exhibits (Item 6)

 

3.1

 

Amended Articles of Incorporation of Fifth Third Bancorp, as amended. Incorporated by reference to Exhibit 3.1 to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2014.

3.2

 

Code of Regulations of Fifth Third Bancorp as Amended as of September 15, 2014. Incorporated by reference to Exhibit 3.2 to the Registrant’s Annual Report on Form 10-K filed with the SEC on February 25, 2016.

4.1

 

Amendment dated as of August  31, 2018 to Seventh Supplemental Indenture dated as of June 5, 2018 between Fifth Third Bancorp and Wilmington Trust Company, as Trustee, to the Indenture for Senior Debt Securities dated as of April  30, 2008 between Fifth Third Bancorp and the Trustee.

31(i)

 

Certification Pursuant to Section  302 of the Sarbanes-Oxley Act of 2002 by Chief Executive Officer.

31(ii)

 

Certification Pursuant to Section  302 of the Sarbanes-Oxley Act of 2002 by Chief Financial Officer.

32(i)

 

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section  906 of the Sarbanes-Oxley Act of 2002 by Chief Executive Officer.

32(ii)

 

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section  906 of the Sarbanes-Oxley Act of 2002 by Chief Financial Officer.

101

 

Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income, (iii) the Condensed Consolidated Statements of Comprehensive Income, (iv) the Condensed Consolidated Statements of Changes in Equity, (v) the Condensed Consolidated Statements of Cash Flows, and (vi) the Notes to Condensed Consolidated Financial Statements tagged as blocks of text and in detail.

 

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Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

   

Fifth Third Bancorp

Registrant

Date: November 6, 2018

   
   

/s/ Tayfun Tuzun

   

Tayfun Tuzun

   

Executive Vice President and

   

Chief Financial Officer

   

(Duly Authorized Officer & Principal Financial Officer)

 

120