10-Q 1 d134780d10q.htm FORM 10-Q 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 June 30, 2015

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  x    No  ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

There were 809,289,762 shares of the Registrant’s common stock, without par value, outstanding as of July 31, 2015.


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)

  

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

     20   

Business Segment Review

     25   

Risk Management—Overview

     32   

Credit Risk Management

     33   

Market Risk Management

     46   

Liquidity Risk Management

     50   

Operational Risk Management

     51   

Capital Management

     52   

Off-Balance Sheet Arrangements

     55   

Quantitative and Qualitative Disclosures about Market Risk (Item 3)

     56   

Controls and Procedures (Item 4)

     56   

Condensed Consolidated Financial Statements and Notes (Item 1)

  

Balance Sheets (unaudited)

     57   

Statements of Income (unaudited)

     58   

Statements of Comprehensive Income (unaudited)

     59   

Statements of Changes in Equity (unaudited)

     60   

Statements of Cash Flows (unaudited)

     61   

Notes to Condensed Consolidated Financial Statements (unaudited)

     62   

Part II. Other Information

  

Legal Proceedings (Item 1)

     120   

Risk Factors (Item 1A)

     120   

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

     120   

Exhibits (Item 6)

     121   

Signatures

     122   

Certifications

  

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,” “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 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) general economic conditions and weakening in the economy, specifically the real estate market, either nationally or in the states in which Fifth Third, one or more acquired entities and/or the combined company do business, are less favorable than expected; (2) deteriorating credit quality; (3) political developments, wars or other hostilities may disrupt or increase volatility in securities markets or other economic conditions; (4) changes in the interest rate environment reduce interest margins; (5) prepayment speeds, loan origination and sale volumes, charge-offs and loan loss provisions; (6) Fifth Third’s ability to maintain required capital levels and adequate sources of funding and liquidity; (7) maintaining capital requirements and adequate sources of funding and liquidity may limit Fifth Third’s operations and potential growth; (8) changes and trends in capital markets; (9) problems encountered by larger or similar financial institutions may adversely affect the banking industry and/or Fifth Third; (10) competitive pressures among depository institutions increase significantly; (11) effects of critical accounting policies and judgments; (12) changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board (FASB) or other regulatory agencies; (13) legislative or regulatory changes or actions, or significant litigation, adversely affect Fifth Third, one or more acquired entities and/or the combined company or the businesses in which Fifth Third, one or more acquired entities and/or the combined company are engaged, including the Dodd-Frank Wall Street Reform and Consumer Protection Act; (14) ability to maintain favorable ratings from rating agencies; (15) fluctuation of Fifth Third’s stock price; (16) ability to attract and retain key personnel; (17) ability to receive dividends from its subsidiaries; (18) potentially dilutive effect of future acquisitions on current shareholders’ ownership of Fifth Third; (19) effects of accounting or financial results of one or more acquired entities; (20) difficulties from Fifth Third’s investment in, relationship with, and nature of the operations of Vantiv, LLC; (21) loss of income from any sale or potential sale of businesses that could have an adverse effect on Fifth Third’s earnings and future growth; (22) difficulties in separating the operations of any branches or other assets divested; (23) inability to achieve expected benefits from branch consolidations and planned sales within desired timeframes, if at all; (24) ability to secure confidential information and deliver products and services through the use of computer systems and telecommunications networks; and (25) the impact of reputational risk created by these 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

ARM: Adjustable Rate Mortgage

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

CFE: Collateralized Financing Entity

CFPB: United States Consumer Financial Protection Bureau

C&I: Commercial and Industrial

DCF: Discounted Cash Flow

DFA: Dodd-Frank Act

ERISA: Employee Retirement Income Security Act

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)

FNMA: Federal National Mortgage Association

FRB: Federal Reserve Bank

FTE: Fully Taxable Equivalent

FTP: Funds Transfer Pricing

FTS: Fifth Third Securities

GNMA: Government National Mortgage Association

GSE: Government Sponsored Enterprise

  

HAMP: Home Affordable Modification Program

HARP: Home Affordable Refinance Program

HFS: Held for Sale

HQLA: High Quality Liquid Assets

IPO: Initial Public Offering

IRC: Internal Revenue Code

IRLC: Interest Rate Lock Commitment

ISDA: International Swaps and Derivatives Association, Inc.

LCR: Liquidity Coverage Ratio

LIBOR: London Interbank Offered Rate

LLC: Limited Liability Company

LTV: Loan-to-Value

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

MSR: Mortgage Servicing Right

N/A: Not Applicable

NII: Net Interest Income

NM: Not Meaningful

NSFR: Net Stable Funding Ratio

OAS: Option-Adjusted Spread

OCC: Office of the Comptroller of the Currency

OCI: Other Comprehensive Income

OREO: Other Real Estate Owned

OTTI: Other-Than-Temporary Impairment

PMI: Private Mortgage Insurance

SBA: Small Business Administration

SEC: United States Securities and Exchange Commission

TBA: To Be Announced

TDR: Troubled Debt Restructuring

TruPS: Trust Preferred Securities

U.S.: United States of America

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

VA: 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 MD&A 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.

TABLE 1: Selected Financial Data

 

     For the three months ended
June 30,
           For the six months ended
June 30,
        

($ in millions, except for per share data)

   2015     2014      % Change     2015     2014      % Change  

Income Statement Data

              

Net interest income(a)

   $ 892       905        (1   $ 1,744       1,803        (3

Noninterest income

     556       736        (24     1,187       1,300        (9

Total revenue(a)

     1,448       1,641        (12     2,931       3,103        (6

Provision for loan and lease losses

     79       76        4       148       146        1  

Noninterest expense

     947       954        (1     1,871       1,903        (2

Net income attributable to Bancorp

     315       439        (28     676       756        (11

Net income available to common shareholders

     292       416        (30     638       724        (12
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Common Share Data

              

Earnings per share, basic

   $ 0.36       0.49        (27   $ 0.78       0.85        (8

Earnings per share, diluted

     0.36       0.49        (27     0.77       0.84        (8

Cash dividends declared per common share

     0.13       0.13        —          0.26       0.25        4  

Book value per share

     17.62       16.74        5       17.62       16.74        5  

Market value per share

     20.82       21.35        (2     20.82       21.35        (2
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Financial Ratios

              

Return on average assets

     0.90      1.34        (33     0.98      1.17        (16

Return on average common equity

     8.1       11.9        (32     8.9       10.5        (15

Return on average tangible common equity(b)

     9.7       14.4        (33     10.7       12.7        (16

Dividend payout ratio

     36.1       26.5        36       33.3       29.4        13  

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

     11.32       11.57        (2     11.40       11.55        (1

Tangible common equity(b)

     8.33       8.74        (5     8.33       8.74        (5

Net interest margin(a)

     2.90       3.15        (8     2.88       3.18        (9

Efficiency(a)

     65.4       58.2        12       63.8       61.4        4  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Credit Quality

              

Net losses charged-off

   $ 86       101        (15   $ 177       270        (34

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

     0.37      0.45        (18     0.39      0.60        (35

ALLL as a percent of portfolio loans and leases

     1.39       1.61        (14     1.39       1.61        (14

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

     1.54       1.77        (13     1.54       1.77        (13

Nonperforming assets as a percent of portfolio loans, leases and other assets, including OREO(d)

     0.67       0.92        (27     0.67       0.92        (27
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Average Balances

              

Loans and leases, including held for sale

   $ 92,739       91,241        2     $ 92,202       90,742        2  

Total securities and other short-term investments

     30,563       23,940        28       29,805       23,443        27  

Total assets

     139,992       130,965        7       138,828       129,953        7  

Transaction deposits(e)

     96,460       89,148        8       95,322       88,526        8  

Core deposits(f)

     100,534       92,841        8       99,370       92,181        8  

Wholesale funding(g)

     18,362       19,204        (4     18,632       18,726        (1

Bancorp shareholders’ equity

     15,841       15,157        5       15,831       15,011        5  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 
     Basel III
Transitional
(h)
    Basel I(i)            Basel III
Transitional
(h)
    Basel I(i)         

Regulatory Capital Ratios

              

CET1 capital

     9.42      N/A         NM        9.42      N/A         NM   

Tier I risk-based capital

     10.51       10.80        NM        10.51       10.80        NM   

Total risk-based capital

     13.69        14.30        NM        13.69       14.30        NM   

Tier I leverage

     9.44       9.86        NM        9.44       9.86        NM   
     Basel III
Fully Phased-In
                 Basel III
Fully Phased-In
              

CET1 capital(b)

     9.31       N/A         NM        9.31       N/A         NM   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

 

(a) Amounts presented on an FTE basis. The FTE adjustment for the three months ended June 30, 2015 and 2014 was $5 and for the six months ended June 30, 2015 and 2014 was $10.
(b) The return on average tangible common equity, tangible common equity and CET1 capital (fully phased-in) ratios are non-GAAP measures. For further information, see 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) Excludes nonaccrual loans held for sale.
(e) Includes demand, interest checking, savings, money market and foreign office deposits.
(f) Includes transaction deposits plus other time deposits.
(g) Includes certificates $100,000 and over, other deposits, federal funds purchased, other short-term borrowings and long-term debt.
(h) Under the 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.
(i) These capital ratios were calculated under the Supervisory Agencies general risk-based capital rules (Basel I) which were in effect prior to January 1, 2015.

 

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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 June 30, 2015, the Bancorp had $141.7 billion in assets, with 1,299 full-service Banking Centers, including 101 Bank Mart® locations open seven days a week inside select grocery stores, and 2,630 ATMs in 12 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 Investment Advisors. The Bancorp also has an approximate 23% interest in Vantiv Holding, LLC. The carrying value of the Bancorp’s investment in Vantiv Holding, LLC was $415 million as of June 30, 2015.

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, 2014. 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 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 Bancorp’s revenues are dependent on both net interest income and noninterest income. For the three months ended June 30, 2015, net interest income on an FTE basis and noninterest income provided 62% and 38% of total revenue, respectively. For the six months ended June 30, 2015, net interest income on an FTE basis and noninterest income provided 60% and 40% 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. 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 losses 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 due to a weakened economy within the Bancorp’s footprint.

Noninterest income is derived primarily from service charges on deposits, investment advisory revenue, mortgage banking net revenue, corporate banking revenue, card and processing revenue and other noninterest income. Noninterest expense is primarily driven by personnel costs, net occupancy expense, technology and communication costs, card and processing expense, equipment expense and other noninterest expense.

Branch Consolidation and Sales Plan

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. On June 16, 2015, the Bancorp’s Board of Directors authorized management to pursue a plan to further develop its distribution strategy, including a plan to consolidate and/or sell 105 operating branch locations and to sell an additional 31 parcels of undeveloped land that had been acquired by the Bancorp 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 $98 million and $102 million for the three and six months ended June 30, 2015, respectively, and $18 million for both the three and six months ended June 30, 2014. The impairment losses were recorded in other noninterest income in the Condensed Consolidated Statements of Income. For more information on the branch consolidation and sales plan, refer to Note 7 of the Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

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

 

 

Accelerated Share Repurchase Transactions

During the six months ended June 30, 2015, the Bancorp entered into or settled a number of accelerated share repurchase transactions. As part of these transactions, the Bancorp entered into forward contracts in which the final number of shares delivered at settlement was based generally on a discount to the average daily volume weighted average price of the Bancorp’s common stock during the term of the repurchase agreements. For more information on the accelerated share repurchase program, refer to Note 14 of the Notes to Condensed Consolidated Financial Statements. For a summary of the Bancorp’s accelerated share repurchase transactions that were entered into or settled during the six months ended June 30, 2015, 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  

October 23, 2014

   $ 180        8,337,875        794,245        9,132,120        January 8, 2015   

January 27, 2015

     180        8,542,713        1,103,744        9,646,457        April 28, 2015   

April 30, 2015

     155        6,704,835        842,655        7,547,490        July 31, 2015   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

For further information on a subsequent event related to capital actions, refer to Note 22 of the Notes to Condensed Consolidated Financial Statements.

Legislative and Regulatory Developments

On July 21, 2010, the DFA was signed into federal law. This act implements changes to the financial services industry and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The legislation established the CFPB responsible for implementing and enforcing compliance with consumer financial laws, changes the methodology for determining deposit insurance assessments, gives the FRB the ability to regulate and limit interchange rates charged to merchants for the use of debit cards, enacts new limitations on proprietary trading, broadens the scope of derivative instruments subject to regulation, requires on-going stress tests and the submission of annual capital plans for certain organizations, requires changes to rules governing regulatory capital ratios and requires enhanced liquidity standards.

The FRB launched the 2015 capital planning and stress testing program, CCAR, on October 23, 2014. The CCAR program requires BHCs with $50 billion or more of total consolidated assets to submit annual capital plans to the FRB for review and to conduct stress tests under a number of economic scenarios. The capital plan and stress testing results were submitted by the Bancorp to the FRB on January 5, 2015.

In March of 2015, the FRB disclosed its estimates of participating institutions results under the FRB supervisory stress scenario, including capital results, which assume all banks take certain consistently applied future capital actions. In addition, the FRB disclosed its estimates of participating institutions results under the FRB supervisory severe stress scenarios including capital results based on each company’s own base scenario capital actions.

On March 11, 2015, the Bancorp announced the results of its capital plan submitted to the FRB as part of the 2015 CCAR. The FRB indicated to the Bancorp that it did not object to the following capital actions for the period beginning April 1, 2015 and ending June 30, 2016:

 

    The potential increase in the quarterly common stock dividend to $0.14 per share in 2016;

 

    The potential repurchase of common shares in an amount up to $765 million;

 

    The additional ability to repurchase shares in the amount of any after-tax gains from the sale of Vantiv, Inc. common stock.

For more information on the 2015 CCAR results, refer to the Capital Management section of MD&A.

The BHCs that participated in the 2015 CCAR, including the Bancorp, are required to conduct mid-cycle company-run stress tests using data as of March 31, 2015. The stress tests must be based on three BHC defined scenarios – baseline, adverse and severely adverse. The Bancorp submitted the results of its mid-cycle stress test to the FRB by the required July 6, 2015 submission date. For further information on the 2015 mid-cycle stress test, see the Capital Management section of MD&A.

Fifth Third offers qualified deposit customers a deposit advance product if they choose to avail themselves of this product to meet short-term, small-dollar financial needs. In April of 2013, the CFPB issued a “White Paper” which studied financial services industry offerings and customer use of deposit advance products as well as payday loans and is considering whether rules governing these products are warranted. At the same time, the OCC and FDIC each issued proposed supervisory guidance for public comment to institutions they supervise which supplements existing OCC and FDIC guidance, detailing the principles they expect financial institutions to follow in connection with deposit advance products and supervisory expectations for the use of deposit advance products. The Federal Reserve also issued a statement in April of 2013 to state member banks like Fifth Third for whom the Federal Reserve is the primary regulator. This statement encouraged state member banks to respond to customers’ small-dollar credit needs in a responsible manner; emphasized that they should take into consideration the risks associated with deposit advance products, including potential consumer harm and potential elevated compliance risk; and reminded them that these product offerings must comply with applicable laws and regulations.

Fifth Third’s deposit advance product was designed to fully comply with the applicable federal and state laws and use of this product is subject to strict eligibility requirements and advance restriction guidelines to limit dependency on this product as a borrowing source. The Bancorp’s deposit advance balances are included in other consumer loans and leases in the Loans and Leases subsection of the Balance Sheet Analysis section of MD&A and represent substantially all of the revenue reported in interest and fees on other consumer loans and leases in the Bancorp’s Condensed Consolidated Statements of Income and in Tables 7 and 8 in the Statements of Income Analysis section of MD&A.

 

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

 

 

On January 17, 2014, given developments in industry practice, Fifth Third announced that it would no longer enroll new customers in its deposit advance product and expected to phase out the service to existing customers by the end of 2014. To avoid a disruption to its existing customers during the extension period while the banking industry awaits further regulatory guidance on the deposit advance product, on November 3, 2014, Fifth Third announced changes to its current deposit advance product for existing customers beginning January 1, 2015, including a lower transaction fee, an extended repayment period and a reduced maximum advance period. The Bancorp is continuing to offer the service to existing deposit advance customers until further regulatory guidance is finalized. The Bancorp currently expects these changes to the deposit advance product to negatively impact net interest income by approximately $95 million in 2015.

In December of 2010 and revised in June of 2011, the BCBS issued Basel III, a global regulatory framework, to enhance international capital standards. In June of 2012, U.S. banking regulators proposed enhancements to the regulatory capital requirements for U.S. banks, which implement aspects of Basel III, such as re-defining the regulatory capital elements and minimum capital ratios, introducing regulatory capital buffers above those minimums, revising the agencies’ rules for calculating risk-weighted assets and introducing a new CET1 capital ratio. In July of 2013, U.S. banking regulators approved final enhanced regulatory capital requirements (Basel III Final Rule), which included modifications to the proposed rules. The Basel III Final Rule provided for certain banks, including the Bancorp, to opt out of including AOCI in Tier I capital and also retained the treatment of residential mortgage exposures consistent with the current Basel I capital rules. The Basel III Final Rule phases out the inclusion of certain TruPS as a component of Tier I capital. The Bancorp became subject to the Basel III Final Rule on January 1, 2015. The Bancorp made a one-time permanent election not to include AOCI in CET1 capital in the March 31, 2015 FFIEC 031 and FR Y-9C filings. For more information on the impact of the regulatory capital enhancements refer to the Capital Management section of MD&A.

On December 10, 2013, the banking agencies finalized section 619 of the DFA, known as the Volcker Rule, which became effective April 1, 2014. Though the final rule was effective April 1, 2014, the FRB granted the industry an extension of time until July 21, 2015 to conform certain of its activities related to proprietary trading to comply with the Volcker Rule. In addition, the FRB has granted the industry an extension of time until July 21, 2016, and announced its intention to grant a one year extension of the conformance period until July 21, 2017, to conform certain ownership interests in, sponsorship activities of and relationships with private equity or hedge funds as well as holding certain collateralized loan obligations that were in place as of December 31, 2013. It is possible that additional conformance period extensions could be granted either to the entire industry, or, upon request, to requesting banking organizations on a case-by-case basis. The final rule prohibits banks and bank holding companies from engaging in short-term proprietary trading of certain securities, derivatives, commodity futures and options on these instruments for their own account. The Volcker Rule also restricts banks and their affiliated entities from owning, sponsoring or having certain relationships with private equity and hedge funds, as well as holding certain collateralized loan obligations that are deemed to contain ownership interests. Exemptions are provided for certain activities such as underwriting, market making, hedging, trading in certain government obligations and organizing and offering a hedge fund or private equity fund. Fifth Third does not sponsor any private equity or hedge funds that, under the final rule, it is prohibited from sponsoring. As of June 30, 2015, the Bancorp held no collateralized loan obligations. As of June 30, 2015, the Bancorp had approximately $181 million in interests and approximately $38 million in binding commitments to invest in private equity funds that are affected by the Volcker Rule. It is expected that over time the Bancorp may need to sell or redeem these investments, however no formal plan to sell has been approved as of June 30, 2015. As a result of the announced conformance period extension, the Bancorp believes it is likely that these investments will be reduced over time in the ordinary course of events before compliance is required.

On October 10, 2014, the U.S. Banking Agencies published final rules implementing a quantitative liquidity requirement consistent with the LCR standard established by the BCBS for large internationally active banking organizations, generally those with $250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposure. In addition, a modified LCR requirement was implemented for BHCs with $50 billion or more in total consolidated assets but that are not internationally active, such as Fifth Third. The modified LCR is effective January 1, 2016 and requires BHCs to calculate its LCR on a monthly basis. Refer to the Liquidity Risk Management section of MD&A for further discussion on these ratios.

On July 31, 2013, the U.S. District Court for the District of Columbia issued an order granting summary judgment to the plaintiffs in a case challenging certain provisions of the FRB’s rule concerning electronic debit card transaction fees and network exclusivity arrangements (the “Current Rule”) that were adopted to implement Section 1075 of the DFA, known as the Durbin Amendment. The Court held that, in adopting the Current Rule, the FRB violated the Durbin Amendment’s provisions concerning which costs are allowed to be taken into account for purposes of setting fees that are reasonable and proportional to the costs incurred by the issuer and therefore the Current Rule’s maximum permissible fees were too high. In addition, the Court held that the Current Rule’s network non-exclusivity provisions concerning unaffiliated payment networks for debit cards also violated the Durbin Amendment. The Court vacated the Current Rule, but stayed its ruling to provide the FRB an opportunity to replace the invalidated portions. The FRB appealed this decision and on March 21, 2014, the District of Columbia Circuit Court of Appeals reversed the District Court’s grant of summary judgment and remanded the case for further proceedings in accordance with its opinion. The merchants have filed a petition for writ of certiorari to the U.S. Supreme Court. However, on January 20, 2015, the U.S. Supreme Court declined to hear an appeal of the Circuit Court reversal, thereby largely upholding the Current Rule and substantially reducing uncertainty surrounding debit card interchange fees the Bancorp is permitted to charge. Refer to the Noninterest Income subsection of the Statements of Income Analysis section of MD&A for further information regarding the Bancorp’s debit card interchange revenue.

 

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

 

 

Earnings Summary

The Bancorp’s net income available to common shareholders for the second quarter of 2015 was $292 million, or $0.36 per diluted share, which was net of $23 million in preferred stock dividends. The Bancorp’s net income available to common shareholders for the second quarter of 2014 was $416 million, or $0.49 per diluted share, which was net of $23 million in preferred stock dividends. The Bancorp’s net income available to common shareholders for the six months ended June 30, 2015 was $638 million, or $0.77 per diluted share, which was net of $38 million in preferred stock dividends. For the six months ended June 30, 2014, the Bancorp’s net income available to common shareholders was $724 million, or $0.84 per diluted share, which was net of $32 million in preferred stock dividends. Pre-provision net revenue was $496 million and $1.1 billion for the three and six months ended June 30, 2015, respectively, compared to $682 million and $1.2 billion for the same periods in 2014. Pre-provision net revenue is a non-GAAP measure. For further information, see the Non-GAAP Financial Measures section of MD&A.

Net interest income on an FTE basis was $892 million and $1.7 billion for the three and six months ended June 30, 2015, respectively, a decrease of $13 million and $59 million compared to the same periods in the prior year. Net interest income was negatively impacted by lower yields on the Bancorp’s interest-earning assets, changes made to the Bancorp’s deposit advance product beginning January 1, 2015, and increases in average long-term debt of $1.2 billion and $2.7 billion for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. These negative impacts were partially offset by increases in average taxable securities of $5.6 billion and $4.2 billion for the three and six months ended June 30, 2015, respectively, and increases in average loans and leases of $1.5 billion for both the three and six months ended June 30, 2015 compared to the same periods in the prior year. Net interest margin on an FTE basis was 2.90% and 2.88% for the three and six months ended June 30, 2015, respectively, compared to 3.15% and 3.18% for the three and six months ended June 30, 2014, respectively.

Noninterest income decreased $180 million for the three months ended June 30, 2015 compared to the same period in the prior year primarily due to a decrease in other noninterest income, partially offset by an increase in mortgage banking net revenue. Noninterest income decreased $113 million for the six months ended June 30, 2015 compared to the same period in the prior year primarily due to decreases in other noninterest income and corporate banking revenue, partially offset by an increase in mortgage banking net revenue. Other noninterest income decreased $225 million and $103 million for the three and six months ended June 30, 2015, respectively compared to the same period in the prior year. The decrease in other noninterest income for both periods was driven by a gain of $125 million on the sale of Vantiv, Inc. shares in the second quarter of 2014. In addition, the three and six months ended June 30, 2015 included impairment losses associated with lower of cost or market adjustments on long-lived assets of $98 million and $102 million, respectively, compared to $18 million for both the three and six months ended June 30, 2014. Mortgage banking net revenue increased $39 million and $16 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year primarily due to increases in net mortgage servicing revenue. Corporate banking revenue decreased $35 million for the six months ended June 30, 2015 compared to the same period in the prior year primarily driven by impairment charges of $34 million related to certain operating lease equipment that was recognized during the six months ended June 30, 2015.

Noninterest expense decreased $7 million and $32 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year primarily due to a decrease in other noninterest expense, partially offset by increases in personnel costs (salaries, wages and incentives plus employee benefits). Total other noninterest expense decreased $29 million for the three months ended June 30, 2015 compared to the same period in the prior year primarily due to decreases in losses and adjustments, partially offset by increases in the provision for the reserve for unfunded commitments and impairment on affordable housing investments. Total other noninterest expense decreased $68 million for the six months ended June 30, 2015 compared to the same period in the prior year primarily due to decreases in losses and adjustments and FDIC insurance and other taxes, partially offset by a decrease in the benefit from the reserve for unfunded commitments and increases in impairment on affordable housing investments and marketing expense. Total personnel costs increased $14 million and $21 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. The increase for both periods was driven by increases in incentive compensation primarily in the mortgage business and base compensation.

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 $79 million and $148 million for the three and six months ended June 30, 2015, respectively, compared to $76 million and $146 million during the same periods in 2014. Net charge-offs as a percent of average portfolio loans and leases decreased to 0.37% during the three months ended June 30, 2015 compared to 0.45% during the same period in the prior year and decreased to 0.39% for the six months ended June 30, 2015 compared to 0.60% for the six months ended June 30, 2014. At June 30, 2015, nonperforming assets as a percent of portfolio loans, leases and other assets, including OREO (excluding nonaccrual loans held for sale) decreased to 0.67%, compared to 0.82% at December 31, 2014. For further discussion on credit quality, see the Credit Risk Management section of MD&A.

Capital Summary

The Bancorp’s capital ratios exceed the “well-capitalized” guidelines as defined by the FRB. As of June 30, 2015, the transitional CET1 capital ratio was 9.42%, the transitional Tier I risk-based capital ratio was 10.51%, the transitional Total risk-based capital ratio was 13.69% and the transitional Tier I leverage ratio was 9.44%.

 

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

 

 

NON-GAAP FINANCIAL MEASURES

The following are non-GAAP measures which are important to the reader of the Condensed Consolidated Financial Statements but should be supplemental to primary GAAP measures. The Bancorp considers many factors when determining the adequacy of its liquidity profile, including its LCR as defined by the U.S. Banking Agencies Basel III LCR final rule. Generally, the LCR is designed to ensure banks maintain an adequate level of unencumbered HQLA to satisfy the estimated net cash outflows under a 30-day stress scenario. The Bancorp will be subject to the Modified LCR whereby the net cash outflow under the 30-day stress scenario is multiplied by a factor of 0.7. The final rule is not effective for the Bancorp until January 1, 2016. The Bancorp believes there is no comparable U.S. GAAP financial measure to LCR. The Bancorp believes providing an estimated Modified LCR is important for comparability to other financial institutions. For a further discussion on liquidity management and the LCR, refer to the Liquidity Risk Management section of MD&A.

TABLE 3: Non-GAAP Financial Measures—Liquidity Coverage Ratio

 

As of ($ in millions)

   June 30,
2015
 

Estimated HQLA

   $ 21,715  

Estimated net cash outflow

     20,089  
  

 

 

 

Estimated Modified LCR

     108
  

 

 

 

Pre-provision net revenue is net interest income plus noninterest income minus noninterest expense. The Bancorp believes this measure is important because it provides a ready view of the Bancorp’s pre-tax earnings before the impact of provision expense.

The following table reconciles the non-GAAP financial measure of pre-provision net revenue to U.S. GAAP:

TABLE 4: Non-GAAP Financial Measures—Pre-Provision Net Revenue

 

     For the three months ended
June 30,
     For the six months ended
June 30,
 

($ in millions)

   2015      2014      2015      2014  

Net interest income (U.S. GAAP)

   $ 887        900        1,734        1,793  

Add: Noninterest income

     556        736        1,187        1,300  

Less: Noninterest expense

     (947      (954      (1,871      (1,903
  

 

 

    

 

 

    

 

 

    

 

 

 

Pre-provision net revenue

   $ 496        682        1,050        1,190  
  

 

 

    

 

 

    

 

 

    

 

 

 

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.

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

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

 

     For the three months ended
June 30,
     For the six months ended
June 30,
 

($ in millions)

   2015      2014      2015      2014  

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

   $ 292        416        638        724  

Add: Intangible amortization, net of tax

     —          1        1        1  
  

 

 

    

 

 

    

 

 

    

 

 

 

Tangible net income available to common shareholders

   $ 292        417        639        725  

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

     1,171        1,673        1,278        1,451  

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

   $ 15,841        15,157        15,831        15,011  

Less: Average preferred stock

     (1,331      (1,119      (1,331      (1,077

Average goodwill

     (2,416      (2,416      (2,416      (2,416

Average intangible assets and other servicing rights

     (15      (17      (15      (18
  

 

 

    

 

 

    

 

 

    

 

 

 

Average tangible common equity (2)

   $ 12,079        11,605        12,069        11,500  

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

     9.7       14.4        10.6        12.6  
  

 

 

    

 

 

    

 

 

    

 

 

 

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 banking regulators. These calculations are intended to complement the capital ratios defined by banking regulators 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. Additionally, the Bancorp became subject to the Basel III Final Rule on January 1, 2015. The CET1 capital ratio is a new measure defined by the banking regulatory agencies under the Basel III Final Rule. The CET1 capital ratio has transition provisions that will be phased out over time. The Bancorp is presenting the CET1 capital ratio on a fully phased-in basis for comparative purposes with other organizations. Since analysts and banking regulators may assess the Bancorp’s capital adequacy using these ratios, the Bancorp believes they are useful to provide investors the ability to assess its capital adequacy on the same basis. 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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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

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

TABLE 6: Non-GAAP Financial Measures—Capital Ratios

 

As of ($ in millions)

   June 30,
2015
    December 31,
2014
 

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

   $ 15,605       15,626  

Less: Preferred stock

     (1,331     (1,331

Goodwill

     (2,416     (2,416

Intangible assets and other servicing rights

     (14     (16
  

 

 

   

 

 

 

Tangible common equity, including unrealized gains / losses

     11,844       11,863  

Less: AOCI

     (291     (429
  

 

 

   

 

 

 

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

     11,553       11,434  

Add: Preferred stock

     1,331       1,331  
  

 

 

   

 

 

 

Tangible equity (2)

   $ 12,884       12,765  
  

 

 

   

 

 

 

Total assets (U.S. GAAP)

   $ 141,658       138,706  

Less: Goodwill

     (2,416     (2,416

Intangible assets and other servicing rights

     (14     (16

AOCI, before tax

     (448     (660
  

 

 

   

 

 

 

Tangible assets, excluding unrealized gains / losses (3)

   $ 138,780       135,614  
  

 

 

   

 

 

 

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

   $ N/A        15,626  

Less: Goodwill and certain other intangibles

     N/A        (2,476

Unrealized gains

     N/A        (429

Add: Qualifying TruPS

     N/A        60  

Other

     N/A        (17
  

 

 

   

 

 

 

Tier I risk-based capital

     N/A        12,764  

Less: Preferred stock

     N/A        (1,331

Qualifying TruPS

     N/A        (60

Qualified noncontrolling interests in consolidated subsidiaries

     N/A        (1
  

 

 

   

 

 

 

Tier I common equity (4)

   $ N/A        11,372  
  

 

 

   

 

 

 
     Basel III
Transitional
    Basel I  

Risk-weighted assets (5)(a)

   $ 122,986        117,878  

Ratios:

    

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

     9.28      9.41  

Tangible common equity as a percent of tangible assets (excluding unrealized gains/losses) (1) / (3)

     8.33      8.43  

Tier I common equity (4) / (5)(b)

     N/A     9.65  
  

 

 

   

 

 

 

Basel III Final Rule—Transition to fully phased-in

    

CET1 capital (transitional)

   $ 11,582       N/A   

Less: Adjustments to CET1 capital from transitional to fully phased-in(c)

     (12     N/A   
  

 

 

   

 

 

 

CET1 capital (fully phased-in) (6)

     11,570       N/A   
  

 

 

   

 

 

 

Risk-weighted assets (transitional)

     122,986       N/A   

Add: Adjustments to risk-weighted assets from transitional to fully phased-in(d)

     1,280       N/A   
  

 

 

   

 

 

 

Risk-weighted assets (fully phased-in) (7)

   $ 124,266       N/A   
  

 

 

   

 

 

 

Estimated CET1 capital ratio under Basel III Final Rule (fully phased-in) (6) / (7)

     9.31      N/A   
  

 

 

   

 

 

 
(a) Under the banking agencies’ risk-based capital guidelines, assets and credit equivalent amounts of derivatives and off-balance sheet exposures are assigned to broad risk categories. The aggregate dollar amount in each risk category is multiplied by the associated risk-weight of the category. The resulting weighted values are added together, along with the measure for market risk, resulting in the Bancorp’s total risk-weighted assets.
(b) The Bancorp became subject to the Basel III Final Rule on January 1, 2015. This codified in the federal banking regulations the risk-based capital ratios the Bancorp is now subject to, as such these ratios are no longer considered non-GAAP measures.
(c) Primarily relates to disallowed intangible assets (other than goodwill and MSRs, net of associated deferred tax liabilities).
(d) Primarily relates to higher risk weighting for MSRs.

 

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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 Management’s Discussion and Analysis – Critical Accounting Policies in the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2014. No material changes were made to the valuation techniques or models during the six months ended June 30, 2015.

 

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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 securities, loans and leases (including yield-related fees) and other interest-earning assets 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 7 and 8 present the components of net interest income, net interest margin and net interest rate spread for the three and six months ended June 30, 2015 and 2014, 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 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 securities included in other assets.

Net interest income on an FTE basis was $892 million and $1.7 billion for the three and six months ended June 30, 2015, respectively, a decrease of $13 million and $59 million compared to the same periods in the prior year. Net interest income was negatively impacted by lower yields on the Bancorp’s interest-earning assets, changes made to the Bancorp’s deposit advance product beginning January 1, 2015, and increases in average long-term debt of $1.2 billion and $2.7 billion for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. These negative impacts were partially offset by increases in average taxable securities of $5.6 billion and $4.2 billion for the three and six months ended June 30, 2015, respectively, and increases in average loans and leases of $1.5 billion for both the three and six months ended June 30, 2015 compared to the same periods in the prior year. The net interest rate spread decreased to 2.72% and 2.70% during the three and six months ended June 30, 2015, respectively, from 2.99% and 3.03% in the same periods in the prior year due to a 25 bps and 27 bps decrease in yields on average interest-earning assets for the three and six months ended June 30, 2015, respectively, and a 2 bps and 6 bps increase in the rates paid on average interest-bearing liabilities for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year.

Net interest margin on an FTE basis was 2.90% and 2.88% for the three and six months ended June 30, 2015, respectively, compared to 3.15% and 3.18% for the three and six months ended June 30, 2014, respectively. The decrease from both periods in 2014 was driven primarily by the previously mentioned decrease in net interest rate spread coupled with an $8.1 billion and $7.8 billion increase in average interest-earning assets for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year partially offset by increases in average free funding balances.

Interest income on an FTE basis from loans and leases decreased $43 million compared to the three months ended June 30, 2014 and decreased $88 million compared to the six months ended June 30, 2014. The decrease for the three and six months ended June 30, 2015 was primarily the result of a decrease of 24 bps and 26 bps, respectively, in yields on average loans and leases partially offset by an increase of two percent in average loans and leases for both the three and six months ended June 30, 2015 compared to the same periods in the prior year. The decrease in yields for the three and six months ended June 30, 2015 was primarily due to a $25 million and $47 million, respectively, decline in interest income on other consumer loans and leases due to changes made to the Bancorp’s deposit advance product beginning January 1, 2015 coupled with a 13 bps and 16 bps, respectively, decrease in yields on average commercial and industrial loans compared to the same periods in the prior year. The increase in average loans and leases was driven primarily by increases in average commercial loans and leases. 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 $38 million and $60 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year primarily as a result of the aforementioned increases in average taxable securities.

Average core deposits increased $7.7 billion compared to the three months ended June 30, 2014 and increased $7.2 billion compared to the six months ended June 30, 2014. The increase from both the three and six months ended June 30, 2014 was primarily due to increases in average money market deposits, average interest checking deposits and average demand deposits partially offset by decreases in average savings deposits and average foreign office deposits. The cost of average interest-bearing core deposits decreased to 23 bps and 25 bps for the three and six months ended June 30, 2015, respectively, from 26 bps for both the three and six months ended June 30, 2014. Interest expense on deposits decreased during the three months ended June 30, 2015 primarily due to a 10 bps and 6 bps decrease in the rates paid on average money market deposits and average savings deposits, respectively, partially offset by a 41 bps increase in the rates paid on average certificates $100,000 and over. Interest expense on deposits was flat during the six months ended June 30, 2015 compared to the same period in the prior year primarily due to a 45 bps and 19 bps increase in the rates paid on average certificates $100,000 and over and average other time deposits offset by a $2.1 billion decrease in average certificates $100,000 and over. Refer to the Deposits subsection of the Balance Sheet Analysis section of MD&A for additional information on the Bancorp’s deposits.

For the three and six months ended June 30, 2015, interest expense on average wholesale funding increased $11 million and $29 million, respectively, compared to the same periods in the prior year. The increase for the three months ended June 30, 2015 was the result of an increase in interest expense related to long-term debt. Interest expense on long-term debt increased due to a $1.2 billion increase in average long-term debt for the three months ended June 30, 2015 compared to the same period in the prior year coupled with a 15 bps increase in the rates paid on average long-term debt. The increase for the six months ended June 30, 2015 was primarily the result of an increase in interest expense related to long-term debt partially offset by a decrease in interest expense on average certificates $100,000 and over. Interest expense on long-term debt increased due to a $2.7 billion increase in average long-term debt for the six months ended June 30, 2015 compared to the same period in the prior year coupled with a 8 bps increase in the rates paid on average long-term debt.

 

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

 

 

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 six months ended June 30, 2015, average wholesale funding represented 22% of average interest-bearing liabilities compared to 24% and 23% during the three and six months ended June 30, 2014, 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 section of MD&A.

 

12


Table of Contents

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

 

 

TABLE 7: Condensed Average Balance Sheets and Analysis of Net Interest Income on an FTE basis

 

For the three months ended

   June 30, 2015     June 30, 2014     Attribution of Change in
Net Interest Income(a)
 

($ in millions)

   Average
Balance
    Revenue/
Cost
     Average
Yield/
Rate
    Average
Balance
    Revenue/
Cost
     Average
Yield/
Rate
    Volume     Yield/Rate     Total  

Assets

                    

Interest-earning assets:

                    

Loans and leases:(b)

                    

Commercial and industrial loans

   $ 42,554     $ 334        3.14    $ 41,451     $ 338        3.27    $ 9       (13     (4

Commercial mortgage

     7,149       57        3.22       7,886       67        3.39       (7     (3     (10

Commercial construction

     2,549       20        3.17       1,364       12        3.54       9       (1     8  

Commercial leases

     3,776       27        2.83       3,556       27        3.04       2       (2     —    
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal – commercial

     56,028       438        3.13       54,257       444        3.28       13       (19     (6
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Residential mortgage loans

     13,375       123        3.69       13,202       129        3.93       2       (8     (6

Home equity

     8,655       79        3.66       9,101       84        3.71       (4     (1     (5

Automobile loans

     11,902       79        2.65       12,070       83        2.77       —         (4     (4

Credit card

     2,296       59        10.33       2,232       56        10.06       1       2       3  

Other consumer loans and leases

     483       9        8.49       379       34        35.63       6       (31     (25
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal – consumer

     36,711       349        3.82       36,984       386        4.19       5       (42     (37
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total loans and leases

     92,739       787        3.41       91,241       830        3.65       18       (61     (43

Securities:

                    

Taxable

     27,344       218        3.20       21,706       181        3.34       45       (8     37  

Exempt from income taxes(b)

     59       1        4.82       52       1        4.69       —         —         —    

Other short-term investments

     3,160       2        0.25       2,182       1        0.28       1       —         1  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

     123,302       1,008        3.28       115,181       1,013        3.53       64       (69     (5

Cash and due from banks

     2,636            2,847             

Other assets

     15,354            14,417             

Allowance for loan and lease losses

     (1,300          (1,480           
  

 

 

        

 

 

            

Total assets

   $ 139,992          $ 130,965             
  

 

 

        

 

 

            

Liabilities and Equity

                    

Interest-bearing liabilities:

                    

Interest checking

   $ 26,894     $ 12        0.19    $ 25,222     $ 14        0.22    $ (1     (1     (2

Savings

     15,156       3        0.05       16,509       4        0.11       1       (2     (1

Money market

     18,071       10        0.23       13,942       12        0.33       2       (4     (2

Foreign office deposits

     955       —          0.14       2,200       2        0.29       (1     (1     (2

Other time deposits

     4,074       13        1.24       3,693       9        1.03       2       2       4  

Certificates - $100,000 and over

     2,558       8        1.24       3,840       8        0.83       (3     3       —    

Federal funds purchased

     326       —          0.12       606       —          0.10       —         —         —    

Other short-term borrowings

     1,705       1        0.12       2,234       1        0.10       —         —         —    

Long-term debt

     13,773       69        2.04       12,524       58        1.89       6       5       11  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

     83,512       116        0.56       80,770       108        0.54       6       2       8  

Demand deposits

     35,384            31,275             

Other liabilities

     5,215            3,724             
  

 

 

        

 

 

            

Total liabilities

     124,111            115,769             

Total equity

     15,881            15,196             
  

 

 

        

 

 

            

Total liabilities and equity

   $ 139,992          $ 130,965             
  

 

 

        

 

 

            

Net interest income (FTE)

     $ 892          $ 905        $ 58       (71     (13

Net interest margin (FTE)

          2.90           3.15       

Net interest rate spread (FTE)

          2.72            2.99        

Interest-bearing liabilities to interest-earning assets

  

     67.73            70.12        

 

(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 $5 for both the three months ended June 30, 2015 and 2014.

 

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Table of Contents

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

 

 

TABLE 8: Condensed Average Balance Sheets and Analysis of Net Interest Income on an FTE basis

 

For the six months ended

   June 30, 2015     June 30, 2014     Attribution of Change in
Net Interest Income(a)
 

($ in millions)

   Average
Balance
    Revenue/
Cost
     Average
Yield/
Rate
    Average
Balance
    Revenue/
Cost
     Average
Yield/
Rate
    Volume     Yield/Rate     Total  

Assets

                    

Interest-earning assets:

                    

Loans and leases:(b)

                    

Commercial and industrial loans

   $ 42,011     $ 656        3.15    $ 40,933     $ 672        3.31    $ 17       (33     (16

Commercial mortgage

     7,198       116        3.25       7,934       134        3.41       (12     (6     (18

Commercial construction

     2,375       38        3.20       1,242       22        3.51       18       (2     16  

Commercial leases

     3,746       53        2.87       3,582       54        3.06       3       (4     (1
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal – commercial

     55,330       863        3.15       53,691       882        3.31       26       (45     (19
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Residential mortgage loans

     13,444       250        3.76       13,252       259        3.94       3       (12     (9

Home equity

     8,728       158        3.66       9,147       169        3.72       (8     (3     (11

Automobile loans

     11,918       158        2.67       12,047       168        2.82       (1     (9     (10

Credit card

     2,308       118        10.28       2,231       110        9.98       5       3       8  

Other consumer loans/leases

     474       23        9.61       374       70        37.74       15       (62     (47
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal – consumer

     36,872       707        3.86       37,051       776        4.23       14       (83     (69
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total loans and leases

     92,202       1,570        3.43       90,742       1,658        3.69       40       (128     (88

Securities:

                    

Taxable

     25,235       406        3.25       21,049       349        3.34       67       (10     57  

Exempt from income taxes(b)

     59       1        5.03       49       1        5.07       —         —         —    

Other short-term investments

     4,511       6        0.25       2,345       3        0.27       3       —         3  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

     122,007       1,983        3.28       114,185       2,011        3.55       110       (138     (28

Cash and due from banks

     2,733            2,848             

Other assets

     15,399            14,448             

Allowance for loan and lease losses

     (1,311          (1,528           
  

 

 

        

 

 

            

Total assets

   $ 138,828          $ 129,953             
  

 

 

        

 

 

            

Liabilities and Equity

                    

Interest-bearing liabilities:

                    

Interest checking

   $ 26,889     $ 26        0.20    $ 25,565     $ 28        0.22    $ —         (2     (2

Savings

     15,165       5        0.06       16,705       9        0.11       (1     (3     (4

Money market

     17,784       24        0.28       13,195       20        0.31       6       (2     4  

Foreign office deposits

     908       1        0.17       2,109       3        0.29       (1     (1     (2

Other time deposits

     4,048       24        1.20       3,655       18        1.01       2       4       6  

Certificates - $100,000 and over

     2,620       16        1.20       4,703       18        0.75       (10     8       (2

Other deposits

     —         —          —         —         —          0.05       —         —         —    

Federal funds purchased

     249       —          0.11       577       —          0.10       —         —         —    

Other short-term borrowings

     1,654       1        0.11       2,022       1        0.10       —         —         —    

Long-term debt

     14,109       142        2.03       11,424       111        1.95       26       5       31  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

     83,426       239        0.58       79,955       208        0.52       22       9       31  

Demand deposits

     34,576            30,952             

Other liabilities

     4,956            3,997             
  

 

 

        

 

 

            

Total liabilities

     122,958            114,904             

Total equity

     15,870            15,049             
  

 

 

        

 

 

            

Total liabilities and equity

   $ 138,828          $ 129,953             
  

 

 

        

 

 

            

Net interest income (FTE)

     $ 1,744          $ 1,803        $ 88       (147     (59

Net interest margin (FTE)

          2.88           3.18       

Net interest rate spread (FTE)

          2.70            3.03        

Interest-bearing liabilities to interest-earning assets

  

     68.38            70.02        
       

 

 

        

 

 

       

 

(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 $10 for both the six months ended June 30, 2015 and 2014.

Provision for Loan and Lease Losses

The Bancorp provides as an expense an amount for probable 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, 2014. 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 charge-offs. Net charge-offs include current period charge-offs less recoveries on previously charged-off loans and leases.

The provision for loan and lease losses was $79 million and $148 million for the three and six months ended June 30, 2015, respectively, compared to $76 million and $146 million during the three and six months ended June 30, 2014, respectively. The ALLL declined $29 million from December 31, 2014 to $1.3 billion at June 30, 2015. As of June 30, 2015, the ALLL as a percent of portfolio loans and leases decreased to 1.39%, compared to 1.47% at December 31, 2014.

 

14


Table of Contents

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

 

 

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

Noninterest Income

Noninterest income decreased $180 million, or 24%, for the three months ended June 30, 2015 compared to the same period in the prior year and decreased $113 million, or nine percent, for the six months ended June 30, 2015 compared to the same period in the prior year.

The components of noninterest income for the three and six months ended June 30, 2015 and 2014 are as follows:

TABLE 9: Noninterest Income

 

     For the three months ended
June 30,
              For the six months ended
June 30,
          

($ in millions)

   2015        2014        % Change      2015        2014        % Change  

Service charges on deposits

   $ 139          139          —        $ 274          272          1  

Investment advisory revenue

     105          102          3        212          204          4  

Mortgage banking net revenue

     117          78          50        203          187          9  

Corporate banking revenue

     113          107          6        176          211          (17

Card and processing revenue

     77          76          1        148          144          3  

Other noninterest income

     1          226          (100      165          268          (38

Securities gains, net

     4          8          (50      9          14          (36
  

 

 

      

 

 

      

 

 

    

 

 

      

 

 

      

 

 

 

Total noninterest income

   $ 556          736          (24    $ 1,187          1,300          (9
  

 

 

      

 

 

      

 

 

    

 

 

      

 

 

      

 

 

 

Service charges on deposits

Service charges on deposits were flat for the three months ended June 30, 2015 and increased $2 million for the six months ended June 30, 2015, compared to the same period in the prior year, primarily due to a $2 million increase in consumer overdraft fees.

Investment advisory revenue

Investment advisory revenue increased $3 million and $8 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in 2014. The increase for both periods was primarily driven by increases of $3 million and $5 million, respectively, in recurring securities brokerage fees driven by higher sales volume. The six months ended June 30, 2015 also included a $3 million increase in private client service fees due to an increase in personal asset management fees compared to the same period in the prior year. The Bancorp had approximately $304 billion and $305 billion in total assets under care as of June 30, 2015 and 2014, respectively, and managed $27 billion in assets for individuals, corporations and not-for-profit organizations for both period-ends.

Mortgage banking net revenue

Mortgage banking net revenue increased $39 million and $16 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year.

The components of mortgage banking net revenue are as follows:

TABLE 10: Components of Mortgage Banking Net Revenue

 

     For the three months ended
June 30,
    For the six months ended
June 30,
 

($ in millions)

   2015     2014     2015     2014  

Origination fees and gains on loan sales

   $ 43       42       87       84  

Net mortgage servicing revenue:

        

Gross mortgage servicing fees

     56       62       115       125  

MSR amortization

     (39     (32     (73     (55

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

     57       6       74       33  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net mortgage servicing revenue

     74       36       116       103  
  

 

 

   

 

 

   

 

 

   

 

 

 

Mortgage banking net revenue

   $ 117       78       203       187  
  

 

 

   

 

 

   

 

 

   

 

 

 

Origination fees and gains on loan sales increased $1 million and $3 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. The increase for the three and six months ended June 30, 2015 was primarily the result of a 25% and 16% increase in residential mortgage loan originations from the three and six months ended June 30, 2014, respectively. Residential mortgage loan originations increased to $2.5 billion and $4.3 billion during the three and six months ended June 30, 2015, respectively, compared to $2.0 billion and $3.7 billion during the same periods in the prior year due to strong refinancing activity that occurred during the first half of 2015.

Net mortgage servicing revenue is comprised of gross mortgage servicing fees and related mortgage servicing rights amortization as well as valuation adjustments on MSRs and mark-to-market adjustments on both settled and outstanding free-standing derivative financial instruments used to economically hedge the MSR portfolio. Net mortgage servicing revenue increased $38 million for the three months ended June 30, 2015 compared to the three months ended June 30, 2014 driven primarily by an increase of $51 million in net valuation adjustments, partially offset by an increase in mortgage servicing rights amortization of $7 million.

 

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

 

 

Net mortgage servicing revenue increased $13 million for the six months ended June 30, 2015 compared to the same period in the prior year driven primarily by an increase of $41 million in net valuation adjustments partially offset by an increase in mortgage servicing rights amortization of $18 million.

The components of net valuation adjustments on the MSR portfolio and the impact of the non-qualifying hedging strategy are as follows:

TABLE 11: Components of Net Valuation Adjustments on MSRs

 

     For the three months ended
June 30,
    For the six months ended
June 30,
 

($ in millions)

   2015     2014     2015      2014  

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

   $ (30     38       35        61  

Recovery of (provision for) MSR impairment

     87       (32     39        (28
  

 

 

   

 

 

   

 

 

    

 

 

 

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

   $ 57       6       74        33  
  

 

 

   

 

 

   

 

 

    

 

 

 

Mortgage rates increased during the three and six months ended June 30, 2015 which caused modeled prepayment speeds to slow, which led to the recovery of temporary impairment on servicing rights during the respective periods. Mortgage rates decreased during the three and six months ended June 30, 2014 which caused modeled prepayment speeds to increase, which led to temporary impairment on servicing rights during the respective periods.

Servicing rights are deemed impaired when a borrower’s loan rate is distinctly higher than prevailing rates. Impairment on servicing rights is reversed when the prevailing rates return to a level commensurate with the borrower’s loan rate. 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 on 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.

The Bancorp’s total residential loans serviced as of June 30, 2015 and 2014 were $75.4 billion and $81.3 billion, respectively, with $61.7 billion and $68.1 billion, respectively, of residential mortgage loans serviced for others.

Corporate banking revenue

Corporate banking revenue increased $6 million for the three months ended June 30, 2015, compared to the same period in the prior year primarily due to increases in institutional sales revenue and business lending fees, partially offset by a decrease in syndication fees. Corporate banking revenue decreased $35 million for the six months ended June 30, 2015 compared to the six months ended June 30, 2014. The decrease compared to the six months ended June 30, 2014 was primarily driven by impairment charges of $34 million related to certain operating lease equipment that was recognized during the six months ended June 30, 2015. Refer to Note 8 of the Notes to Condensed Consolidated Financial Statements for additional information. The six months ended June 30, 2015 also included a $19 million decrease in syndication fees as a result of decreased activity in the market. The decreases for the six months ended June 30, 2015 were partially offset by higher foreign exchange fees, institutional sales revenue and business lending fees compared to the same period in the prior year.

Card and processing revenue

Card and processing revenue increased $1 million and $4 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. The increase for the three and six months ended June 30, 2015 was primarily the result of an increase in the number of actively used cards and an increase in customer spend volume. Debit card interchange revenue, included in card and processing revenue, was $35 million and $67 million for the three and six months ended June 30, 2015, respectively, compared to $33 million and $63 million for the same periods in the prior year.

 

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

 

 

Other noninterest income

The major components of other noninterest income are as follows:

TABLE 12: Components of Other Noninterest Income

 

     For the three months ended
June 30,
    For the six months ended
June 30,
 

($ in millions)

   2015     2014     2015     2014  

Valuation adjustments on the warrant associated with Vantiv Holding, LLC

   $ 14       63       85       28  

Operating lease income

     22       21       44       42  

Gain on loan sales

     —         —         41       —    

Equity method income from interest in Vantiv Holding, LLC

     16       4       26       19  

BOLI income

     12       11       24       21  

Cardholder fees

     11       11       22       23  

Consumer loan and lease fees

     6       6       12       12  

Banking center income

     6       8       11       16  

Insurance income

     4       3       8       6  

Gain on sale of Vantiv, Inc. shares

     —         125       —         125  

Net losses on disposition and impairment of bank premises and equipment

     (98     (18     (101     (18

Loss on swap associated with the sale of Visa, Inc. class B shares

     (2     (16     (19     (15

Other, net

     10       8       12       9  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other noninterest income

   $ 1       226       165       268  
  

 

 

   

 

 

   

 

 

   

 

 

 

Other noninterest income decreased $225 million in the second quarter of 2015 compared to the second quarter of 2014 and decreased $103 million for the six months ended June 30, 2015 compared to the same period in the prior year. The decrease for both periods included the impact of a gain of $125 million on the sale of Vantiv, Inc. shares in the second quarter of 2014. The three and six months ended June 30, 2015 also included impairment losses associated with lower of cost or market adjustments on long-lived assets of $98 million and $102 million, respectively, compared to $18 million for the three and six months ended June 30, 2014. Refer to Note 7 of the Notes to Condensed Consolidated Financial Statements for additional information on bank premises and equipment.

In addition to the decreases above, the positive valuation adjustment on the stock warrant associated with Vantiv Holding, LLC was $14 million for the three months ended June 30, 2015 compared to the positive valuation adjustment of $63 million during the three months ended June 30, 2014. The positive valuation adjustments on the stock warrant associated with Vantiv Holding, LLC were $85 million for the six months ended June 30, 2015 compared to the positive valuation adjustments of $28 million during the six months ended June 30, 2014. The fair value of the stock warrant is calculated using the Black-Scholes valuation model, which utilizes several key inputs (Vantiv, Inc. stock price, strike price of the warrant and several unobservable inputs). The positive valuation adjustments for the three and six months ended June 30, 2015, were primarily due to increases of one percent and 13%, respectively, in Vantiv, Inc.’s share price from March 31, 2015 to June 30, 2015 and from December 31, 2014 to June 30, 2015, respectively. The positive valuation adjustments of $63 million and $28 million for the three and six months ended June 30, 2014, respectively, were primarily due to increases of 11% and three percent, respectively, in Vantiv, Inc.’s share price from March 31, 2014 to June 30, 2014 and from December 31, 2013 to June 30, 2014. For additional information on the valuation of the warrant, refer to Note 20 of the Notes to Condensed Consolidated Financial Statements. Equity method earnings from the Bancorp’s interest in Vantiv Holding, LLC increased $12 million and $7 million compared to the three and six months ended June 30, 2014, respectively, primarily due to charges taken by Vantiv Holding, LLC during the second quarter of 2014 related to an acquisition.

Other noninterest income also included a $14 million decrease in the negative valuation adjustment related to the Visa total return swap for the three months ended June 30, 2015 compared to the three months ended June 30, 2014. The six months ended June 30, 2015 included a $4 million increase in the negative valuation adjustments related to the Visa total return swap compared to the same period of the prior year. For additional information on the valuation of the swap associated with the sale of Visa, Inc. Class B shares, refer to Note 20 of the Notes to Condensed Consolidated Financial Statements. Gain on loan sales increased $41 million for the six months ended June 30, 2015 compared to the same period in the prior year primarily due to a $37 million gain on the sale of certain HFS residential mortgage loans classified as TDRs during the first quarter of 2015.

 

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

 

 

Noninterest Expense

Total noninterest expense decreased $7 million, or one percent, for the three months ended June 30, 2015 compared to the three months ended June 30, 2014 primarily due to a decrease in other noninterest expense, partially offset by increases in personnel costs (salaries, wages and incentives plus employee benefits) and net occupancy expense. Total noninterest expense decreased $32 million, or two percent, for the six months ended June 30, 2015 compared to the six months ended June 30, 2014, primarily due to a decrease in other noninterest expense, partially offset by increases in personnel costs and card and processing expense.

The major components of noninterest expense are as follows:

TABLE 13: Noninterest Expense

 

     For the three months ended
June 30,
           For the six months ended
June 30,
        

($ in millions)

   2015     2014      % Change     2015     2014      % Change  

Salaries, wages and incentives

   $ 383       368        4     $ 752       727        3  

Employee benefits

     78       79        (1     176       180        (2

Net occupancy expense

     83       79        5       162       158        3  

Technology and communications

     54       52        4       109       105        4  

Card and processing expense

     38       37        3       74       68        9  

Equipment expense

     31       30        3       61       60        2  

Other noninterest expense

     280       309        (9     537       605        (11
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total noninterest expense

   $ 947       954        (1   $ 1,871       1,903        (2
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Efficiency ratio on an FTE basis

     65.4      58.2          63.8      61.4     
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total personnel costs increased $14 million and $21 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. The increase for both periods was driven by increases in incentive compensation, primarily in the mortgage business, and base compensation. Full-time equivalent employees totaled 18,527 at June 30, 2015 compared to 18,732 at June 30, 2014.

The major components of other noninterest expense are as follows:

TABLE 14: Components of Other Noninterest Expense

 

     For the three months ended
June 30,
    For the six months ended
June 30,
 

($ in millions)

   2015      2014     2015     2014  

Impairment on affordable housing investments

   $ 38        32       75       64  

Loan and lease

     33        29       60       58  

Marketing

     27        25       54       46  

FDIC insurance and other taxes

     28        26       44       54  

Operating lease

     18        16       36       33  

Losses and adjustments

     15        72       29       137  

Professional service fees

     15        18       27       36  

Travel

     14        14       27       26  

Postal and courier

     11        12       23       24  

Data processing

     11        10       22       20  

Recruitment and education

     7        7       14       13  

Insurance

     4        4       9       8  

Intangible asset amortization

     1        1       1       2  

(Benefit from) provision for the reserve for unfunded commitments

     2        (11     (3     (19

Other, net

     56        54       119       103  
  

 

 

    

 

 

   

 

 

   

 

 

 

Total other noninterest expense

   $ 280        309       537       605  
  

 

 

    

 

 

   

 

 

   

 

 

 

Total other noninterest expense decreased $29 million for the three months ended June 30, 2015 compared to the same period in the prior year primarily due to a decrease in losses and adjustments, partially offset by increases in the provision for the reserve for unfunded commitments and impairment on affordable housing investments. Losses and adjustments decreased $57 million for the three months ended June 30, 2015 compared to the three months ended June 30, 2014 primarily due to a decrease in legal settlements and reserve expense. The provision for the reserve for unfunded commitments was $2 million for the three months ended June 30, 2015 compared to the benefit from the reserve for unfunded commitments of $11 million for the same period in the prior year. The increase in the provision primarily reflects an increase in unfunded commitments for which the Bancorp holds reserves. Impairment on affordable housing investments increased $6 million for the three months ended June 30, 2015 compared to the same period in the prior year, primarily due to incremental losses resulting from previous growth in the portfolio.

Total other noninterest expense decreased $68 million for the six months ended June 30, 2015 compared to the same period in the prior year primarily due to decreases in losses and adjustments and FDIC insurance and other taxes, partially offset by a decrease in the benefit from the reserve for unfunded commitments and increases in impairment on affordable housing investments and marketing expense. Losses and adjustments decreased $108 million for the six months ended June 30, 2015 compared to the same period in the prior year primarily due to a decrease in legal settlements and reserve expense. FDIC insurance and other taxes decreased $10 million compared to the same period in the prior year primarily due to a settlement of a tax liability related to prior years during the first quarter of 2015. The benefit from the reserve for unfunded commitments was $3 million for the six months ended June 30, 2015 compared to $19 million for the same period in the prior year.

 

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

 

 

The decrease in the benefit recognized primarily reflects an increase in unfunded commitments for which the Bancorp holds reserves. Impairment on affordable housing investments increased $11 million for the six months ended June 30, 2015 compared to the same period in the prior year, primarily due to incremental losses resulting from previous growth in the portfolio. Marketing expense increased $8 million for the six months ended June 30, 2015 compared to the same period in the prior year primarily due to an increase in advertising expense.

The Bancorp continues to focus on efficiency initiatives as part of its core emphasis on operating leverage and expense control. The efficiency ratio (noninterest expense divided by the sum of net interest income (FTE) and noninterest income) was 65.4% and 63.8% for the three and six months ended June 30, 2015, respectively, compared to 58.2% and 61.4% for the three and six months ended June 30, 2014, respectively.

Applicable Income Taxes

The Bancorp’s income before income taxes, applicable income tax expense and effective tax rate are as follows:

TABLE 15: Applicable Income Taxes

 

     For the three months ended
June 30,
     For the six months ended
June 30,
 

($ in millions)

   2015     2014      2015      2014  

Income before income taxes

   $ 417       606        902        1,044  

Applicable income tax expense

     108       167        232        287  

Effective tax rate

     26.1      27.6        25.8        27.5  
  

 

 

   

 

 

    

 

 

    

 

 

 

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

The decrease in the effective tax rate for the three and six months ended June 30, 2015 compared to the same periods in the prior year resulted from the benefit from an increase in the amount of 2015 forecasted income tax credits.

As required under U.S. GAAP, the Bancorp established a deferred tax asset for stock-based awards granted to its employees and directors. When the actual tax deduction for these stock-based awards is less than the expense previously recognized for financial reporting or when the awards expire unexercised and where the Bancorp has not accumulated an excess tax benefit for previously exercised or released stock-based awards, the Bancorp is required to recognize a non-cash charge to income tax expense upon the write-off of the deferred tax asset previously established for these stock-based awards. Based on the accumulated excess tax benefit at June 30, 2015, the Bancorp was not required to recognize a non-cash charge to income tax expense related to stock-based awards for the three and six months ended June 30, 2015.

Based on the Bancorp’s stock price at June 30, 2015 and the amount of the Bancorp’s accumulation of an excess tax benefit through the period ended June 30, 2015, the Bancorp believes it will be required to recognize a $1 million non-cash charge to income tax expense over the next twelve months related to stock-based awards, primarily in the second quarter of 2016. However, the Bancorp cannot predict its stock price or whether its employees will exercise other stock-based awards with lower exercise prices in the future. Therefore, it is possible the Bancorp may be required to recognize a non-cash charge to income tax expense greater than or less than $1 million over the next twelve months.

 

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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 loans and leases based upon their primary purpose. Table 16 summarizes end of period loans and leases, including loans held for sale and Table 17 summarizes average total loans and leases, including loans held for sale.

TABLE 16: Components of Total Loans and Leases (includes held for sale)

 

     June 30, 2015      December 31, 2014  

As of ($ in millions)

   Balance      % of Total      Balance      % of Total  

Commercial loans and leases:

           

Commercial and industrial loans

   $     42,812        45      $ 40,801        45  

Commercial mortgage loans

     7,165        8        7,410        8  

Commercial construction loans

     2,709        3        2,071        2  

Commercial leases

     3,882        4        3,721        4  
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal – commercial loans and leases

     56,568        60        54,003        59  
  

 

 

    

 

 

    

 

 

    

 

 

 

Consumer loans and leases:

           

Residential mortgage loans

     13,792        15        13,582        15  

Home equity

     8,591        9        8,886        10  

Automobile loans

     11,914        13        12,037        13  

Credit card

     2,278        2        2,401        3  

Other consumer loans and leases

     555        1        436        —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal – consumer loans and leases

     37,130        40        37,342        41  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total loans and leases

   $ 93,698        100      $ 91,345        100  
  

 

 

    

 

 

    

 

 

    

 

 

 

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

   $ 92,703         $ 90,084     
  

 

 

       

 

 

    

Loans and leases, including loans held for sale, increased $2.4 billion, or three percent, from December 31, 2014. The increase from December 31, 2014 was the result of a $2.6 billion, or five percent, increase in commercial loans and leases partially offset by a $212 million, or one percent, decrease in consumer loans and leases.

Commercial loans and leases increased from December 31, 2014 primarily due to increases in commercial and industrial loans and commercial construction loans partially offset by a decrease in commercial mortgage loans. Commercial and industrial loans increased $2.0 billion, or five percent, from December 31, 2014 and commercial construction loans increased $638 million, or 31%, from December 31, 2014 primarily as a result of an increase in new loan origination activity resulting from an increase in demand and targeted marketing efforts. Commercial mortgage loans decreased $245 million, or three percent, from December 31, 2014 primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns.

Consumer loans and leases decreased from December 31, 2014 primarily due to decreases in home equity, automobile loans and credit card loans partially offset by an increase in residential mortgage loans. Home equity decreased $295 million, or three percent, from December 31, 2014 and automobile loans decreased $123 million, or one percent, from December 31, 2014 as payoffs exceeded new loan production. Credit card loans decreased $123 million, or five percent, from December 31, 2014 primarily due to seasonal trends from the paydown of year-end balances which were higher due to holiday spending. Residential mortgage loans increased $210 million, or two percent, from December 31, 2014 primarily due to the continued retention of certain conforming ARMs and certain other fixed-rate loans originated during the six months ended June 30, 2015.

TABLE 17: Components of Average Total Loans and Leases (includes held for sale)

 

     June 30, 2015      June 30, 2014  

For the three months ended ($ in millions)

   Balance      % of Total      Balance      % of Total  

Commercial loans and leases:

           

Commercial and industrial loans

   $ 42,554        46      $ 41,451        47  

Commercial mortgage loans

     7,149        7        7,886        9  

Commercial construction loans

     2,549        3        1,364        1  

Commercial leases

     3,776        4        3,556        4  
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal – commercial loans and leases

     56,028        60        54,257        61  
  

 

 

    

 

 

    

 

 

    

 

 

 

Consumer loans and leases:

           

Residential mortgage loans

     13,375        14        13,202        14  

Home equity

     8,655        9        9,101        10  

Automobile loans

     11,902        13        12,070        13  

Credit card

     2,296        3        2,232        2  

Other consumer loans and leases

     483        1        379        —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal – consumer loans and leases

     36,711        40        36,984        39  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total average loans and leases

   $ 92,739        100      $ 91,241        100  
  

 

 

    

 

 

    

 

 

    

 

 

 

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

   $ 92,173         $ 90,549     
  

 

 

       

 

 

    

Average loans and leases, including loans held for sale, increased $1.5 billion, or two percent, from June 30, 2014. The increase from June 30, 2014 was the result of a $1.8 billion, or three percent, increase in average commercial loans and leases partially offset by a $273 million, or one percent, decrease in average consumer loans and leases.

 

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

 

 

Average commercial loans and leases increased from June 30, 2014 primarily due to increases in average commercial and industrial loans and average commercial construction loans partially offset by a decrease in average commercial mortgage loans. Average commercial and industrial loans increased $1.1 billion, or three percent, from June 30, 2014 and average commercial construction loans increased $1.2 billion, or 87%, from June 30, 2014 primarily as a result of an increase in new loan origination activity resulting from an increase in demand due to a strengthening economy and targeted marketing efforts. Average commercial mortgage loans decreased $737 million, or nine percent, from June 30, 2014 primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns.

Average consumer loans and leases decreased from June 30, 2014 primarily due to decreases in average home equity and average automobile loans partially offset by an increase in average residential mortgage loans. Average home equity decreased $446 million, or five percent, from June 30, 2014 and average automobile loans decreased $168 million, or one percent, from June 30, 2014 as payoffs exceeded new loan production. Average residential mortgage loans increased $173 million, or one percent, from June 30, 2014 primarily driven by the continued retention of certain conforming ARMs and certain other fixed-rate loans.

Investment Securities

The Bancorp uses investment securities as a means of managing interest rate risk, providing liquidity support and providing collateral for pledging purposes. Total investment securities were $28.5 billion and $23.0 billion at June 30, 2015 and December 31, 2014, respectively. The taxable investment securities portfolio had an effective duration of 4.9 years at June 30, 2015 compared to 4.5 years at December 31, 2014.

Securities are classified as trading when bought and held principally for the purpose of selling them in the near term. 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.

At June 30, 2015, the Bancorp’s investment portfolio consisted primarily of AAA-rated available-for-sale securities. Securities classified as below investment grade were immaterial as of June 30, 2015 and December 31, 2014. The Bancorp’s management has evaluated the securities in an unrealized loss position in the available-for-sale and held-to-maturity portfolios for OTTI. The Bancorp recognized $4 million and $5 million in OTTI on its available-for-sale and other debt securities, included in securities gains, net, in the Condensed Consolidated Statements of Income, during the three and six months ended June 30, 2015, respectively. The Bancorp did not recognize OTTI during the three months ended June 30, 2014 and recognized $17 million of OTTI on its available-for-sale and other debt securities during the six months ended June 30, 2014. The Bancorp did not recognize OTTI on any of its available-for-sale equity securities or held-to-maturity debt securities during the three and six months ended June 30, 2015 and 2014.

TABLE 18: Components of Investment Securities

 

As of ($ in millions)

   June 30,
2015
     December 31,
2014
 

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

     

U.S. Treasury and federal agencies securities

   $ 1,544        1,545  

Obligations of states and political subdivisions securities

     172        185  

Mortgage-backed securities:

     

Agency residential mortgage-backed securities(a)

     15,653        11,968  

Agency commercial mortgage-backed securities

     5,687        4,465  

Non-agency commercial mortgage-backed securities

     2,382        1,489  

Asset-backed securities and other debt securities

     1,344        1,324  

Equity securities(b)

     701        701  
  

 

 

    

 

 

 

Total available-for-sale and other securities

   $ 27,483        21,677  
  

 

 

    

 

 

 

Held-to-maturity: (amortized cost basis)

     

Obligations of states and political subdivisions securities

   $ 156        186  

Asset-backed securities and other debt securities

     1        1  
  

 

 

    

 

 

 

Total held-to-maturity securities

   $ 157        187  
  

 

 

    

 

 

 

Trading: (fair value)

     

U.S. Treasury and federal agencies securities

   $ 9        14  

Obligations of states and political subdivisions securities

     17        8  

Mortgage-backed securities:

     

Agency residential mortgage-backed securities

     4        9  

Asset-backed securities and other debt securities

     13        13  

Equity securities(b)

     327        316  
  

 

 

    

 

 

 

Total trading securities

   $ 370        360  
  

 

 

    

 

 

 
(a) Includes interest-only mortgage-backed securities of $162 and $175 as of June 30, 2015 and December 31, 2014, respectively, recorded at fair value with fair value changes recorded in securities gains, net in the Condensed Consolidated Financial Statements.
(b) Equity securities consist of FHLB and FRB restricted stock holdings that are carried at par, FHLMC and FNMA preferred stock holdings and certain mutual fund holdings and equity security holdings.

On an amortized cost basis, available-for-sale and other securities increased $5.8 billion, or 27%, from December 31, 2014 primarily due to increases in agency residential mortgage-backed securities, agency commercial mortgage-backed securities and non-agency commercial mortgage-backed securities. Agency residential mortgage-backed securities increased $3.7 billion, or 31%, from December 31, 2014 primarily due to the purchase of $11.7 billion of agency residential mortgage-backed securities partially offset by sales of $6.7 billion and paydowns of $1.3 billion during the six months ended June 30, 2015.

 

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

 

 

Agency commercial mortgage-backed securities increased $1.2 billion, or 27%, from December 31, 2014 primarily due to $2.6 billion in purchases of agency commercial mortgage-backed securities partially offset by $1.3 billion in sales and $91 million in paydowns on the portfolio during the six months ended June 30, 2015. Non-agency commercial mortgage-backed securities increased $893 million, or 60%, from December 31, 2014 primarily due to $1.3 billion in purchases of non-agency commercial mortgage-backed securities partially offset by $315 million in sales and $68 million in paydowns on the portfolio during the six months ended June 30, 2015.

On an amortized cost basis, available-for-sale and other securities were 22% and 18% of total interest-earning assets at June 30, 2015 and December 31, 2014, respectively. The estimated weighted-average life of the debt securities in the available-for-sale and other portfolio was 6.5 years at June 30, 2015 compared to 5.8 years at December 31, 2014. In addition, at June 30, 2015, the available-for-sale and other securities portfolio had a weighted-average yield of 3.29%, compared to 3.31% at December 31, 2014.

Information presented in Table 19 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 and other portfolio exclude equity securities that have no stated yield or maturity. Total net unrealized gains on the available-for-sale and other securities portfolio were $504 million at June 30, 2015 compared to $731 million at December 31, 2014. The decrease from December 31, 2014 was primarily due to an increase in interest rates during the six months ended June 30, 2015. 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 increases when interest rates decrease or when credit spreads contract.

TABLE 19: Characteristics of Available-for-Sale and Other Securities

 

As of June 30, 2015 ($ in millions)

   Amortized Cost      Fair Value      Weighted-Average
Life (in years)
     Weighted-Average
Yield
 

U.S. Treasury and federal agencies securities:

           

Average life of one year or less

   $ 51        51        0.6        2.98 

Average life 1 – 5 years

     1,493        1,564        1.6        3.64  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     1,544        1,615        1.6        3.62  

Obligations of states and political subdivisions securities:(a)

           

Average life of one year or less

     28        29        0.6        2.67  

Average life 1 – 5 years

     109        111        2.5        3.06  

Average life 5 – 10 years

     35        37        7.8        3.95  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     172        177        3.3        3.18  

Agency residential mortgage-backed securities:

           

Average life of one year or less

     24        24        0.6        5.29  

Average life 1 – 5 years

     1,777        1,849        4.1        4.16  

Average life 5 – 10 years

     13,336        13,551        6.7        3.36  

Average life greater than 10 years

     516        530        13.3        3.50  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     15,653        15,954        6.6        3.46  

Agency commercial mortgage-backed securities:

           

Average life of one year or less

     2        2        0.8        7.40  

Average life 1 – 5 years

     925        940        4.6        3.07  

Average life 5 – 10 years

     4,688        4,738        8.0        3.00  

Average life greater than 10 years

     72        71        13.3        3.08  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     5,687        5,751        7.5        3.01  

Non-agency commercial mortgage-backed securities:

           

Average life of one year or less

     103        104        0.8        2.77  

Average life 1 – 5 years

     350        359        2.4        3.11  

Average life 5 – 10 years

     1,929        1,951        8.0        3.27  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     2,382        2,414        6.9        3.23  

Asset-backed securities and other debt securities:

           

Average life of one year or less

     81        87        0.1        2.00  

Average life 1 – 5 years

     564        574        2.9        2.70  

Average life 5 – 10 years

     215        220        7.1        1.95  

Average life greater than 10 years

     484        493        14.4        2.08  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     1,344        1,374        7.5        2.31  

Equity securities

     701        702        
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale and other securities

   $ 27,483        27,987        6.5        3.29 
  

 

 

    

 

 

    

 

 

    

 

 

 
(a) Taxable-equivalent yield adjustments included in the above table are 0.00%, 0.00%, 2.09% and 0.42% 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. Core deposits represented 71% of the Bancorp’s asset funding base at both June 30, 2015 and December 31, 2014.

TABLE 20: Deposits

 

     June 30, 2015      December 31, 2014  

As of ($ in millions)

   Balance      % of Total      Balance      % of Total  

Demand

   $ 35,449        34      $ 34,809        34  

Interest checking

     27,074        26        26,800        26  

Savings

     14,976        15        15,051        15  

Money market

     17,900        17        17,083        17  

Foreign office

     728        1        1,114        1  
  

 

 

    

 

 

    

 

 

    

 

 

 

Transaction deposits

     96,127        93        94,857        93  

Other time

     4,050        4        3,960        4  
  

 

 

    

 

 

    

 

 

    

 

 

 

Core deposits

     100,177        97        98,817        97  

Certificates - $100,000 and over(a)

     2,846        3        2,895        3  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total deposits

   $ 103,023        100      $ 101,712        100  
  

 

 

    

 

 

    

 

 

    

 

 

 
(a) Includes $1,414 and $1,483 of certificates $250,000 and over at June 30, 2015 and December 31, 2014, respectively.

Core deposits increased $1.4 billion, or one percent, from December 31, 2014 driven primarily by an increase of $1.3 billion, or one percent, in transaction deposits. Total transaction deposits increased from December 31, 2014 primarily due to increases in money market deposits, demand deposits and interest checking deposits partially offset by a decrease in foreign office deposits. Money market deposits increased $817 million, or five percent, from December 31, 2014 driven primarily by a promotional product offering and the acquisition of new customers. Demand deposits increased $640 million, or two percent, from December 31, 2014 primarily due to higher balances per account for commercial customers and consumer customer seasonality. Interest checking deposits increased $274 million, or one percent, from December 31, 2014 primarily due to the acquisition of new commercial customers. Foreign office deposits decreased $386 million, or 35%, primarily due to lower balances per account.

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

TABLE 21: Average Deposits

 

     June 30, 2015      June 30, 2014  

($ in millions)

   Balance      % of Total      Balance      % of Total  

Demand

   $ 35,384        34      $ 31,275        32  

Interest checking

     26,894        26        25,222        26  

Savings

     15,156        15        16,509        17  

Money market

     18,071        18        13,942        15  

Foreign office

     955        1        2,200        2  
  

 

 

    

 

 

    

 

 

    

 

 

 

Transaction deposits

     96,460        94        89,148        92  

Other time

     4,074        4        3,693        4  
  

 

 

    

 

 

    

 

 

    

 

 

 

Core deposits

     100,534        98        92,841        96  

Certificates - $100,000 and over(a)

     2,558        2        3,840        4  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total average deposits

   $ 103,092        100      $ 96,681        100  
  

 

 

    

 

 

    

 

 

    

 

 

 
(a) Includes $1,423 and $1,340 of average certificates $250,000 and over for the three months ended June 30, 2015 and 2014, respectively.

On an average basis, core deposits increased $7.7 billion, or eight percent, from June 30, 2014 due to increases of $7.3 billion, or eight percent, in average transaction deposits and $381 million, or 10%, in average other time deposits. The increase in average transaction deposits was driven by increases in average money market deposits, average demand deposits and average interest checking deposits partially offset by decreases in average savings deposits and average foreign office deposits. Average money market deposits increased $4.1 billion, or 30%, from June 30, 2014 primarily driven by a promotional product offering, an increase in average commercial account balances and new commercial customer accounts. The remaining increase in average money market deposits was due to balance migration from savings deposits which decreased $1.4 billion, or eight percent, from June 30, 2014. Average demand deposits increased $4.1 billion, or 13%, from June 30, 2014 primarily due to an increase in average commercial account balances and new commercial customer accounts. Average interest checking deposits increased $1.7 billion, or seven percent, from June 30, 2014 primarily due to an increase in average balance per account and new commercial customer accounts. Average foreign office deposits decreased $1.2 billion, or 57%, primarily due to lower average balances per account. Average other time deposits increased $381 million, or 10%, from June 30, 2014 primarily from the acquisition of new customers due to promotional interest rates since June 30, 2014. The Bancorp uses certificates $100,000 and over as a method to fund earning assets. Average certificates $100,000 and over decreased $1.3 billion, or 33%, from June 30, 2014 due primarily to the maturity and run-off of retail and institutional certificates of deposit since June 30, 2014.

 

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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 June 30, 2015 are summarized in the following table:

TABLE 22: Contractual Maturities of Certificates—$100,000 and over

 

($ in millions)

      

Three months or less

   $ 224  

After three months through six months

     502  

After six months through 12 months

     449  

After 12 months

     1,671  
  

 

 

 

Total certificates - $100,000 and over

   $ 2,846  
  

 

 

 

The contractual maturities of other time deposits and certificates $100,000 and over as of June 30, 2015 are summarized in the following table:

TABLE 23: Contractual Maturities of Other Time Deposits and Certificates $100,000 and over

 

($ in millions)

      

Next 12 months

   $ 2,430  

13-24 months

     1,387  

25-36 months

     1,156  

37-48 months

     345  

49-60 months

     1,538  

After 60 months

     40  
  

 

 

 

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

   $ 6,896  
  

 

 

 

Borrowings

Total borrowings increased $1.1 billion, or seven percent, from December 31, 2014. Table 24 summarizes the end of period components of total borrowings. As of June 30, 2015, total borrowings as a percentage of interest-bearing liabilities were 21% compared to 20% at December 31, 2014.

TABLE 24: Borrowings

 

As of ($ in millions)

   June 30, 2015      December 31, 2014  

Federal funds purchased

   $ 126        144  

Other short-term borrowings

     4,136        1,556  

Long-term debt

     13,521        14,967  
  

 

 

    

 

 

 

Total borrowings

   $ 17,783        16,667  
  

 

 

    

 

 

 

Federal funds purchased decreased $18 million, or 13%, from December 31, 2014 driven by a decrease in excess balances in reserve accounts held at Federal Reserve Banks that the Bancorp purchased from other member banks on an overnight basis. Other short-term borrowings increased $2.6 billion from December 31, 2014 driven by an increase of $2.9 billion in FHLB short-term borrowings, partially offset by a decrease in commercial repurchase agreements. 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 $1.4 billion, or 10%, from December 31, 2014 primarily driven by the maturity of $500 million of subordinated fixed-rate bank notes and $893 million of paydowns on long-term debt associated with automobile loan securitizations. For additional information regarding automobile securitizations, refer to Note 10 of the Notes to Condensed Consolidated Financial Statements.

The following table presents average borrowings for the three months ended:

TABLE 25: Average Borrowings

 

($ in millions)

   June 30, 2015      June 30, 2014  

Federal funds purchased

   $ 326        606  

Other short-term borrowings

     1,705        2,234  

Long-term debt

     13,773        12,524  
  

 

 

    

 

 

 

Total average borrowings

   $ 15,804        15,364  
  

 

 

    

 

 

 

Average total borrowings increased $440 million, or three percent, compared to June 30, 2014, due to an increase in average long-term debt partially offset by decreases in average federal funds purchased and average other short-term borrowings. The increase in average long-term debt of $1.2 billion, or 10%, was driven by the issuance of $850 million of unsecured senior bank notes during the third quarter of 2014, as well as the issuance of asset-backed securities by consolidated VIEs of $1.0 billion related to an automobile loan securitization during the fourth quarter of 2014. The impact of these issuances was partially offset by the aforementioned maturity of subordinated fixed-rate bank notes and paydowns on long-term debt associated with automobile loan securitizations since the second quarter of 2014. The level of average federal funds purchased and average other short-term borrowings can fluctuate significantly from period to period depending on funding needs and which sources are used to satisfy those needs. Additionally, the utilization of short-term funding remained low throughout 2014 and during the first half of 2015 due to strong deposit growth and to comply with regulatory standards which require greater dependency on long-term and stable funding. 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 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 Investment Advisors. Additional information on each business segment is included in Note 21 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 or businesses change.

The Bancorp manages interest rate risk centrally at the corporate level and employs an FTP methodology at the business segment level. This methodology insulates the business segments from interest rate volatility, enabling them to focus on serving customers through loan and deposit products. The FTP system assigns charge rates and credit rates to classes of assets and liabilities, respectively, based on expected duration and the U.S. swap curve. Matching duration allocates interest income and interest expense to each segment so its resulting net interest income is insulated from interest rate risk. In a rising rate environment, the Bancorp benefits from the widening spread between deposit costs and wholesale funding costs. However, the Bancorp’s FTP system credits this benefit to deposit-providing businesses, such as Branch Banking and Investment Advisors, on a duration-adjusted basis. The net impact of the FTP methodology is captured in General Corporate and Other.

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 the estimated durations for the indeterminate-lived deposits. The credit rate provided for demand deposit accounts is reviewed annually based upon the account type, its estimated duration and the corresponding federal funds, U.S. swap curve or swap rate. The credit rates for several deposit products were reset January 1, 2015 to reflect the current market rates and updated duration assumptions. These rates were generally lower than those in place during 2014, thus net interest income for deposit providing businesses was negatively impacted for the three and six months ended June 30, 2015.

The business segments are charged provision expense based on the actual net charge-offs experienced on the loans and leases owned by each segment. Provision expense attributable to loan and lease growth and changes in ALLL factors are captured in General Corporate and Other. The financial results of the business segments include allocations for shared services and headquarters expenses. Additionally, the business segments form synergies by taking advantage of cross-sell opportunities and when funding operations by accessing the capital markets as a collective unit.

The results of operations and financial position for the three and six months ended June 30, 2014 were adjusted to reflect the transfer of certain customers and Bancorp employees from Commercial Banking to Branch Banking, effective January 1, 2015. In addition, the prior year balances were adjusted to reflect a change in internal allocation methodology.

Net income (loss) by business segment is summarized in the following table:

TABLE 26: Business Segment Net Income Available to Common Shareholders

 

     For the three months ended
June 30,
    For the six months ended
June 30,
 

($ in millions)

   2015     2014     2015     2014  

Income Statement Data

        

Commercial Banking

   $ 206       208       368       366  

Branch Banking

     23       80       99       163  

Consumer Lending

     42       (15     91       (19

Investment Advisors

     9       12       23       27  

General Corporate and Other

     29       154       89       220  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     309       439       670       757  

Less: Net income attributable to noncontrolling interests

     (6     —         (6     1  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Bancorp

     315       439       676       756  

Dividends on preferred stock

     23       23       38       32  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income available to common shareholders

   $ 292       416       638       724  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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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 27: Commercial Banking

 

     For the three months ended
June 30,
     For the six months ended
June 30,
 

($ in millions)

   2015      2014      2015      2014  

Income Statement Data

           

Net interest income (FTE)(a)

   $ 407        408        804        811  

Provision for loan and lease losses

     38        40        71        139  

Noninterest income:

           

Corporate banking revenue

     112        107        172        211  

Service charges on deposits

     71        70        140        138  

Other noninterest income

     49        39        92        76  

Noninterest expense:

           

Salaries, incentives and employee benefits

     75        75        155        157  

Other noninterest expense

     281        255        558        506  
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before taxes

     245        254        424        434  

Applicable income tax expense(a)(b)

     39        46        56        68  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income

   $ 206        208        368        366  
  

 

 

    

 

 

    

 

 

    

 

 

 

Average Balance Sheet Data

           

Commercial loans, including held for sale

   $ 52,839        50,987        52,165        50,367  

Demand deposits

     20,773        17,810        20,368        17,723  

Interest checking deposits

     9,272        8,047        9,259        8,167  

Savings and money market deposits

     6,564        5,761        6,310        5,761  

Other time deposits and certificates—$100,000 and over

     1,268        1,302        1,303        1,325  

Foreign office deposits

     950        2,190        901        2,099  
  

 

 

    

 

 

    

 

 

    

 

 

 
(a) Includes FTE adjustments of $5 for both the three months ended June 30, 2015 and 2014 and $10 for both the six months ended June 30, 2015 and 2014.
(b) Applicable income tax expense for all periods includes the tax benefit from tax-exempt income and business tax credits, partially offset by the effect of certain nondeductible expenses. Refer to the Applicable Income Taxes section of MD&A for additional information.

Net income was $206 million for the three months ended June 30, 2015 compared to net income of $208 million for the three months ended June 30, 2014. The decrease was driven by an increase in noninterest expense and a decrease in net interest income on an FTE basis partially offset by a decrease in the provision for loan and lease losses and an increase in noninterest income. Net income was $368 million for the six months ended June 30, 2015 compared to net income of $366 million for the six months ended June 30, 2014. The increase was driven by a decrease in the provision for loan and lease losses partially offset by an increase in noninterest expense and decreases in net interest income on an FTE basis and noninterest income.

Net interest income on an FTE basis decreased $1 million and $7 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. The decreases were primarily driven by a decline in yields of 19 bps and 20 bps on average commercial loans for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. The decreases for both periods were partially offset by increases in FTP credits due to an increase in average demand deposits.

Provision for loan and lease losses decreased $2 million for the three months ended June 30, 2015 and $68 million for the six months ended June 30, 2015 compared to the same periods in the prior year primarily due to improved credit metrics. Net charge-offs as a percent of average portfolio loans and leases decreased to 28 bps for the three months ended June 30, 2015 compared to 32 bps for the same period in the prior year and decreased to 27 bps for the six months ended June 30, 2015 compared to 55 bps for the same period in the prior year.

Noninterest income increased $16 million and decreased $21 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. The increase for the three months ended June 30, 2015 was driven by increases in other noninterest income and corporate banking revenue. Other noninterest income increased $10 million for the three months ended June 30, 2015 from the same period in the prior year driven by increases in foreign exchange translation gains and operating lease income. Corporate banking revenue increased $5 million for the three months ended June 30, 2015 from the same period in the prior year primarily driven by increases in institutional sales revenue and business lending fees partially offset by a decrease in syndication fees as a result of decreased activity in the market. The decrease for the six months ended June 30, 2015 was driven by a decrease in corporate banking revenue partially offset by an increase in other noninterest income. Corporate banking revenue decreased $39 million for the six months ended June 30, 2015 from the same period in the prior year primarily driven by a $34 million impairment charge related to certain operating lease equipment that was recognized during the first half of 2015. Refer to Note 8 of the Notes to Condensed Consolidated Financial Statements for additional information. The decrease was also driven by a decrease in syndication fees as a result of decreased activity in the market partially offset by increases in foreign exchange fees and business lending fees compared to the same period in the prior year. Other noninterest income increased $16 million for the six months ended June 30, 2015 from the same period in the prior year driven by increases in gains on loan sales and operating lease income.

 

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Table of Contents

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

 

 

Noninterest expense increased $26 million and $50 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year as a result of increases in other noninterest expense. The increase in other noninterest expense for both periods was primarily driven by increases in corporate overhead allocations, operating lease expense and impairment on affordable housing investments primarily due to incremental losses resulting from previous growth in the portfolio.

Average commercial loans increased $1.9 billion and $1.8 billion for the three and six months ended June 30, 2015, 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 a decrease in average commercial mortgage loans. Average commercial and industrial portfolio loans increased $1.2 billion for both the three and six months ended June 30, 2015 compared to the same periods in the prior year and average commercial construction portfolio loans increased $1.2 billion and $1.1 billion for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year primarily as a result of an increase in new loan origination activity resulting from an increase in demand due to a strengthening economy and targeted marketing efforts. Average commercial mortgage portfolio loans decreased $643 million and $612 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns.

Average core deposits increased $3.7 billion and $3.1 billion for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. The increase for the three months ended June 30, 2015 was primarily driven by increases in average demand deposits, average interest checking deposits and average savings and money market deposits which increased $3.0 billion, $1.2 billion and $803 million, respectively, compared to the same period in the prior year. This was partially offset by a decrease in average foreign deposits of $1.2 billion for the three months ended June 30, 2015 compared to the same period in the prior year. The increase for the six months ended June 30, 2015 was primarily driven by increases in average demand deposits, average interest checking deposits and average savings and money market deposits which increased $2.6 billion, $1.1 billion and $549 million, respectively, compared to the same period in the prior year. This was partially offset by a decrease in average foreign deposits of $1.2 billion for the six months ended June 30, 2015 compared to the same period in the prior year.

Branch Banking

Branch Banking provides a full range of deposit and loan products to individuals and small businesses through 1,299 full-service Banking Centers. Branch Banking offers depository and loan products, such as checking and savings accounts, home equity loans and lines of credit, credit cards and loans for automobiles and other personal financing needs, as well as products designed to meet the specific needs of small businesses, including cash management services.

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

TABLE 28: Branch Banking

 

     For the three months ended
June 30,
     For the six months ended
June 30,
 

($ in millions)

   2015     2014      2015     2014  

Income Statement Data

         

Net interest income

   $ 376       384        752       775  

Provision for loan and lease losses

     38       47        81       91  

Noninterest income:

         

Service charges on deposits

     68       68        133       133  

Card and processing revenue

     60       58        115       109  

Investment advisory revenue

     41       39        79       75  

Other noninterest income

     (75     6        (57     26  

Noninterest expense:

         

Salaries, incentives and employee benefits

     131       133        266       274  

Net occupancy and equipment expense

     64       62        124       122  

Card and processing expense

     36       34        70       63  

Other noninterest expense

     165       156        327       316  
  

 

 

   

 

 

    

 

 

   

 

 

 

Income before taxes

     36       123        154       252  

Applicable income tax expense

     13       43        55       89  
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income

   $ 23       80        99       163  
  

 

 

   

 

 

    

 

 

   

 

 

 

Average Balance Sheet Data

         

Consumer loans, including held for sale

   $ 14,426       14,968        14,542       15,035  

Commercial loans, including held for sale

     1,973       2,172        1,982       2,224  

Demand deposits

     12,699       11,818        12,444       11,669  

Interest checking deposits

     9,174       9,051        9,143       9,161  

Savings and money market deposits

     25,637       23,835        25,583       23,295  

Other time deposits and certificates - $100,000 and over

     5,164       4,635        5,109       4,563  
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income was $23 million for the three months ended June 30, 2015 compared to net income of $80 million for the three months ended June 30, 2014. The decrease was driven by decreases in noninterest income and net interest income and an increase in noninterest expense partially offset by a decrease in the provision for loan and lease loss. Net income was $99 million for the six months ended June 30, 2015 compared to $163 million for the same period in the prior year. The decrease was driven by decreases in noninterest income and net interest income and an increase in noninterest expense partially offset by a decrease in the provision for loan and lease loss.

 

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

 

 

Net interest income decreased $8 million and $23 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. The decreases for both periods were primarily driven by changes made to the Bancorp’s deposit advance product beginning January 1, 2015 and a decline in yields of 16 bps on average commercial loans for both the three and six months ended June 30, 2015 compared to the same periods in the prior year. The decreases for both periods were partially offset by a decrease in FTP charges on loans and leases due to a decrease in average balances and increases in FTP credits for demand deposits and other time deposits driven by average deposit growth and an increase in FTP credits for interest checking deposits due to an increase in FTP credit rates for this product.

Provision for loan and lease losses decreased $9 million and $10 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year primarily due to improved credit trends. Net charge-offs as a percent of average portfolio loans and leases decreased to 91 bps for the three months ended June 30, 2015 compared to 109 bps for the same period in the prior year and decreased to 97 bps for the six months ended June 30, 2015 compared to 107 bps for the same period in the prior year.

Noninterest income decreased $77 million and $73 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. The decreases for both periods were primarily driven by a decrease in other noninterest income partially offset by increases in card and processing revenue and investment advisory revenue. Other noninterest income decreased $81 million and $83 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year primarily driven by impairment losses associated with lower of cost or market adjustments on long-lived assets of $98 million and $102 million, respectively, compared to $18 million for both the three and six months ended June 30, 2014. Refer to Note 7 of the Notes to Condensed Consolidated Financial Statements for additional information on bank premises and equipment and the branch consolidation and sales plan. Card and processing revenue increased $2 million and $6 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year primarily due to an increase in the number of actively used cards and an increase in customer spend volume. Investment advisory revenue increased $2 million and $4 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year primarily due to an increase in recurring securities and brokerage fees driven by higher sales volume.

Noninterest expense increased $11 million and $12 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. The increases for both periods were due to increases in other noninterest expense and card and processing expense partially offset by a decrease in salaries, incentives and employee benefits. Other noninterest expense increased $9 million for the three months ended June 30, 2015 compared to the same period in the prior year primarily due to increases in corporate overhead allocations, marketing expense and higher operational losses. Other noninterest expense increased $11 million for the six months ended June 30, 2015 compared to the same period in the prior year due to higher operational losses and an increase in marketing expense. Card and processing expense increased $2 million and $7 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year driven by increased fraud prevention related expenses. These increases were partially offset by a decrease of $2 million and $8 million in salaries, incentives and employee benefits for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year driven by a decrease in employee benefits expense due to a change in the Bancorp’s employee benefit plan implemented in 2015.

Average consumer loans decreased $542 million for the three months ended June 30, 2015 and $493 million for the six months ended June 30, 2015 compared to the same periods in the prior year. These decreases were primarily driven by decreases in average home equity portfolio loans of $281 million and $242 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year and decreases in average residential mortgage portfolio loans of $266 million and $268 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year as payoffs exceeded new loan production. Average commercial loans decreased $199 million for the three months ended June 30, 2015 and $242 million for the six months ended June 30, 2015 compared to the same periods in the prior year. These decreases were primarily driven by decreases in average commercial mortgage portfolio loans of $127 million and $151 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year and decreases in average commercial and industrial portfolio loans of $83 million and $100 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year as payoffs exceeded new loan production.

Average core deposits increased $3.2 billion and $3.4 billion for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. These increases were primarily driven by net growth in average savings and money market deposits of $1.8 billion and $2.3 billion, respectively, and growth in average demand deposits of $881 million and $775 million, respectively, for the three and six months ended June 30, 2015 compared to the same periods in the prior year, due to an increase in average balances and new customer accounts.

Consumer Lending

Consumer Lending includes the Bancorp’s mortgage, home equity, automobile and other indirect lending activities. Direct lending activities include the origination, retention and servicing of 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.

 

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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 Consumer Lending segment:

TABLE 29: Consumer Lending

 

     For the three months ended
June 30,
    For the six months ended
June 30,
 

($ in millions)

   2015      2014     2015      2014  

Income Statement Data

          

Net interest income

   $ 63        65       125        129  

Provision for loan and lease losses

     8        13       22        38  

Noninterest income:

          

Mortgage banking net revenue

     115        76       199        184  

Other noninterest income

     7        14       52        25  

Noninterest expense:

          

Salaries, incentives and employee benefits

     47        47       91        96  

Other noninterest expense

     65        118       123        234  
  

 

 

    

 

 

   

 

 

    

 

 

 

Income (loss) before taxes

     65        (23     140        (30

Applicable income tax expense (benefit)

     23        (8     49        (11
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ 42        (15     91        (19
  

 

 

    

 

 

   

 

 

    

 

 

 

Average Balance Sheet Data

          

Residential mortgage loans, including held for sale

   $ 8,840        8,732       8,935        8,775  

Home equity

     434        505       443        514  

Automobile loans

     11,402        11,514       11,412        11,484  

Other consumer loans, including held for sale

     15        20       19        23  
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income was $42 million for the three months ended June 30, 2015 compared to a net loss of $15 million for the same period in the prior year. The increase was driven by an increase in noninterest income and decreases in noninterest expense and the provision for loan and lease losses partially offset by a decrease in net interest income. Net income was $91 million for the six months ended June 30, 2015 compared to a net loss of $19 million for the same period in the prior year. The increase was driven by decreases in noninterest expense and the provision for loan and lease losses and an increase in noninterest income partially offset by a decrease in net interest income.

Net interest income decreased $2 million and $4 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. The decreases were primarily driven by lower yields on average residential mortgage loans and average automobile loans partially offset by decreases in FTP charges on loans and leases.

Provision for loan and lease losses decreased $5 million and $16 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year primarily due to improved delinquency metrics on residential mortgage loans and home equity loans. Net charge-offs as a percent of average portfolio loans and leases decreased to 15 bps for the three months ended June 30, 2015 compared to 26 bps for the same period in the prior year and decreased to 22 bps for the six months ended June 30, 2015 compared to 38 bps for the same period in the prior year.

Noninterest income increased $32 million and $42 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. The increase for the three months ended June 30, 2015 was driven by an increase in mortgage banking net revenue partially offset by a decrease in other noninterest income. Mortgage banking net revenue increased $39 million for the three months ended June 30, 2015 from the same period in the prior year as a result of a $39 million increase in net mortgage servicing revenue. Other noninterest income decreased $7 million for the three months ended June 30, 2015 from the same period in the prior year driven by a decrease in retail service fees. The increase for the six months ended June 30, 2015 was driven by increases in other noninterest income and mortgage banking net revenue. Other noninterest income increased $27 million for the six months ended June 30, 2015 from the same period in the prior year primarily driven by a $37 million gain on the sale of held for sale residential mortgage loans classified as TDRs in the first quarter of 2015. This increase was partially offset by a decrease in retail service fees. Mortgage banking net revenue increased $15 million for the six months ended June 30, 2015 from the same period in the prior year driven by a $12 million increase in net mortgage servicing revenue and a $3 million increase in mortgage origination fees and gains on loan sales. Refer to the Noninterest Income section of MD&A for additional information on the fluctuations in mortgage banking net revenue.

Noninterest expense decreased $53 million and $116 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year driven by decreases in other noninterest expense of $53 million and $111 million, respectively. The decrease for both periods was primarily due to decreased legal expenses and operational losses.

Average consumer loans and leases decreased $80 million and increased $13 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. Average residential mortgage loans, including held for sale, increased $108 million and $160 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year primarily due to the continued retention of certain conforming ARMs and certain other fixed-rate loans during the three and six months ended June 30, 2015. Average automobile loans decreased $112 million and $72 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year and average home equity loans decreased $71 million for both the three and six months ended June 30, 2015 compared to the same periods in the prior year as payoffs exceeded new loan production.

 

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

 

 

Investment Advisors

Investment Advisors provides a full range of investment alternatives for individuals, companies and not-for-profit organizations. Investment Advisors is made up of four main businesses: FTS, an indirect wholly-owned subsidiary of the Bancorp; ClearArc Capital, 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 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 Investment Advisors segment:

TABLE 30: Investment Advisors

 

     For the three months ended
June 30,
     For the six months ended
June 30,
 

($ in millions)

   2015      2014      2015      2014  

Income Statement Data

           

Net interest income

   $ 29        29        58        60  

Provision for loan and lease losses

     2        1        3        2  

Noninterest income:

           

Investment advisory revenue

     102        99        206        199  

Other noninterest income

     1        2        6        6  

Noninterest expense:

           

Salaries, incentives and employee benefits

     42        40        86        83  

Other noninterest expense

     73        71        145        139  
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before taxes

     15        18        36        41  

Applicable income tax expense

     6        6        13        14  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income

   $ 9        12        23        27  
  

 

 

    

 

 

    

 

 

    

 

 

 

Average Balance Sheet Data

           

Loans and leases

   $ 2,709        2,271        2,605        2,240  

Core deposits

     9,739        9,340        9,765        9,448  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income was $9 million for the three months ended June 30, 2015 compared to net income of $12 million for the same period in the prior year. The decrease was driven primarily by an increase in noninterest expense. Net income was $23 million for the six months ended June 30, 2015 compared to net income of $27 million for the same period in the prior year. The decrease was driven primarily by an increase in noninterest expense partially offset by an increase in noninterest income.

Net interest income was flat and decreased $2 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. The decrease for the six months ended was primarily due to increases on FTP charges on loans and leases and an increase in interest expense on core deposits both driven by increases in average balances partially offset by an increase in interest income on loans and leases.

Provision for loan and lease losses increased $1 million for both the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. Net charge-offs as a percent of average portfolio loans and leases increased to 22 bps for the three months ended June 30, 2015 compared to 21 bps for the same period in the prior year and increased to 25 bps for the six months ended June 30, 2015 compared to 14 bps for the same period in the prior year.

Noninterest income increased $2 million and $7 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. The increase for both periods was primarily due to a $3 million and $7 million increase in investment advisory revenue for the three and six months ended June 30, 2015, respectively, as a result of higher recurring securities and brokerage fees driven by higher sales volume. The increase for the six months ended June 30, 2015 also included growth in personal asset management fees.

Noninterest expense increased $4 million and $9 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year primarily driven by increases in other noninterest expense of $2 million and $6 million, respectively, due to increases in corporate overhead allocations. These increases are also driven by higher salaries, incentives and employee benefits primarily due to increased compensation expense.

Average loans and leases increased $438 million and $365 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year primarily due to increases in average residential mortgage loans and average other consumer loans primarily driven by increases in new loan origination activity partially offset by a decrease in average home equity loans as payoffs exceeded new loan production.

Average core deposits increased $399 million and $317 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year primarily due to growth in average interest checking balances as customers have opted to maintain excess funds in liquid transaction accounts as a result of interest rates remaining near historic lows.

 

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

 

 

General Corporate and Other

General Corporate and Other includes the unallocated portion of the investment securities portfolio, securities gains and losses, certain non-core deposit funding, unassigned equity, provision expense in excess of net charge-offs 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 for the three months ended June 30, 2015 was $17 million compared to $19 million in the same period in the prior year. Net interest income for the six months ended June 30, 2015 was $5 million compared to $28 million in the same period in the prior year. Decreases in net interest income for both periods were primarily due to increases in FTP credits on deposits allocated to business segments driven by increases in average deposits. The remaining decrease in net interest income was due to an increase in interest expense on long-term debt and a decrease in the benefit related to the FTP charges on loans and leases partially offset by an increase in interest income on taxable securities. Results for the three and six months ended June 30, 2015 were impacted by a benefit of $7 million and $29 million, respectively, compared to a benefit of $25 million and $124 million for the three and six months ended June 30, 2014, respectively due to reductions in the ALLL.

Noninterest income decreased $152 million and $64 million for the three and six months ended June 30, 2015, respectively, compared to the same periods in the prior year. The decrease in noninterest income for both periods was driven by a gain of $125 million on the sale of Vantiv, Inc. shares in the second quarter of 2014. In addition, the positive valuation adjustment on the stock warrant associated with Vantiv Holding, LLC was $14 million for the three months ended June 30, 2015 compared to the positive valuation adjustment of $63 million during the three months ended June 30, 2014. The positive valuation adjustments on the stock warrant associated with Vantiv Holding, LLC were $85 million for the six months ended June 30, 2015 compared to the positive valuation adjustments of $28 million during the six months ended June 30, 2014. Noninterest income also included $2 million and $19 million of negative valuation adjustments related to the Visa total return swap for the three and six months ended June 30, 2015, respectively, compared with $16 million and $15 million, respectively, for the same periods in the prior year. Additionally, equity method earnings from the Bancorp’s interest in Vantiv Holding, LLC increased $12 million compared to the three months ended June 30, 2014 and increased $7 million compared to the six months ended June 30, 2014.

Noninterest expense for the three and six months ended June 30, 2015 was an expense of $7 million and $2 million, respectively, compared to an expense of $1 million and a benefit of $15 million for the three and six months ended June 30, 2014, respectively. The increase for the three months ended June 30, 2015 compared to the same period in the prior year was primarily due to increases in salaries, incentives and employee benefits and FDIC insurance and other taxes partially offset by increased corporate overhead allocations from General Corporate and Other to the other business segments. The increase for the six months ended June 30, 2015 compared to the same period in the prior year was primarily due to increases in salaries, incentives and employee benefits partially offset by a decrease in corporate overhead allocations from General Corporate and Other to the other business segments and a decrease in FDIC insurance and other taxes.

 

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

 

 

RISK MANAGEMENT – OVERVIEW

Managing risk is an essential component of successfully operating a financial services company. The Bancorp’s risk management approach includes processes for identifying, assessing, managing, monitoring and reporting risks. The ERM division, led by the Bancorp’s Chief Risk Officer ensures the consistency and adequacy of the Bancorp’s risk management approach within the structure of the Bancorp’s operating model. In addition, the Internal Audit division provides an independent assessment of the Bancorp’s internal control structure and related systems and processes.

The assumption of risk requires robust and active risk management practices that comprise an integrated and comprehensive set of activities, measures and strategies that apply to the entire organization. The Bancorp has established a Risk Appetite Framework, approved by the Board, that provides the foundations of corporate risk capacity, risk appetite and risk tolerances. The Bancorp’s risk capacity is represented by its available financial resources. Risk capacity sets an absolute limit on risk-assumption in the Bancorp’s annual and strategic plans. The Bancorp understands that not all financial resources may persist as viable loss buffers over time. Further, consideration must be given to regulatory capital buffers required per Capital Policy Targets that would reduce risk capacity. Those factors take the form of capacity adjustments to arrive at an Operating Risk Capacity which represents the operating risk level the Bancorp can assume while maintaining its solvency standard. The Bancorp’s policy currently discounts its Operating Risk Capacity by a minimum of five percent to provide a buffer; as a result, the Bancorp’s risk appetite is limited by policy to, at most, 95% of its Operating Risk Capacity.

Economic capital is the amount of unencumbered financial resources required to support the Bancorp’s risks. The Bancorp measures economic capital under the assumption that it expects to maintain debt ratings at strong investment grade levels over time. The Bancorp’s capital policies require that the Operating Risk Capacity less the aforementioned buffer exceed the calculated economic capital required in its business.

Risk appetite is the aggregate amount of risk the Bancorp is willing to accept in pursuit of its strategic and financial objectives. By establishing boundaries around risk taking and business decisions, and by incorporating the needs and goals of its shareholders, regulators, rating agencies and customers, the Bancorp’s risk appetite is aligned with its priorities and goals. Risk tolerance is the maximum amount of risk applicable to each of the eight specific risk categories included in its Enterprise Risk Management Framework. This is expressed primarily in qualitative terms, however certain risk types also have quantitative metrics that are used to measure the Bancorp’s level of risk against its risk tolerances. The Bancorp’s risk appetite and risk tolerances are supported by risk targets and risk limits. Those limits are used to monitor the amount of risk assumed at a granular level. On a quarterly basis, the Risk and Compliance Committee of the Board reviews performance against key risk limits as well as current assessments of each of the eight risk types relative to the established tolerance. Any results over limits or outside of tolerance require the development of an action plan that describes actions to be taken to return the measure to within the limit or tolerance.

The risks faced by the Bancorp include, but are not limited to, credit, market, liquidity, operational, regulatory compliance, legal, reputational and strategic. Each of these risks is managed through the Bancorp’s risk program which includes the following key functions:

 

    Enterprise Risk Management is responsible for developing and overseeing the implementation of risk programs and reporting that facilitate a broad integrated view of risk. The department also leads the continual fostering of a strong risk management culture and the framework, policies and committees that support effective risk governance, including the oversight of Sarbanes-Oxley compliance;

 

    Commercial Credit Risk Management is responsible for overseeing the safety and soundness of the commercial loan portfolio within an independent portfolio management framework that supports the Bancorp’s commercial loan growth strategies and underwriting practices, ensuring portfolio optimization and appropriate risk controls;

 

    Risk Strategies and Reporting is responsible for quantitative analysis needed to support the commercial dual rating methodology, ALLL methodology and analytics needed to assess credit risk and develop mitigation strategies related to that risk. The department also provides oversight, reporting and monitoring of commercial underwriting and credit administration processes. The Risk Strategies and Reporting department is also responsible for the economic capital program;

 

    Consumer Credit Risk Management is responsible for overseeing the safety and soundness of the consumer portfolio within an independent management framework that supports the Bancorp’s consumer loan growth strategies, ensuring portfolio optimization, appropriate risk controls and oversight, reporting, and monitoring of underwriting and credit administration processes;

 

    Operational Risk Management works with lines of business and regional management to maintain processes to monitor and manage all aspects of operational risk, including ensuring consistency in application of operational risk programs;

 

    Bank Protection oversees and manages fraud prevention and detection and provides investigative and recovery services for the Bancorp;

 

    Capital Markets Risk Management is responsible for instituting, monitoring, and reporting appropriate trading limits, monitoring liquidity, interest rate risk and risk tolerances within Treasury, Mortgage, and Capital Markets groups and utilizing a value at risk model for Bancorp market risk exposure;

 

    Regulatory Compliance Risk Management ensures that processes are in place to monitor and comply with federal and state banking regulations, including processes related to fiduciary, CRA and fair lending compliance. The function also has the responsibility for maintenance of an enterprise-wide compliance framework; and

 

    The ERM division creates and maintains other functions, committees or processes as are necessary to effectively oversee risk management throughout the Bancorp.

Risk management oversight and governance is provided by the Risk and Compliance Committee of the Board of Directors and through multiple management committees whose membership includes a broad cross-section of line-of-business, regional market and support representatives. The Risk and Compliance Committee of the Board of Directors consists of four outside directors and has the responsibility for the oversight of risk management for the Bancorp, as well as for the Bancorp’s overall aggregate risk profile.

 

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Table of Contents

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

 

 

The Risk and Compliance Committee of the Board of Directors has approved the formation of key management governance committees that are responsible for evaluating risks and controls. The primary committee responsible for the oversight of risk management is the ERMC. Committees accountable to the ERMC, which support the core risk programs, are the Corporate Credit Committee, the Operational Risk Committee, the Management Compliance Committee, the Asset/Liability Committee and the Enterprise Marketing Committee. Other committees accountable to the ERMC oversee the ALLL, capital, model risk and regulatory change management functions. In addition, the Legal and Regulatory Reserve Committee, which is accountable to the Operational Risk Committee, reviews and monitors significant legal and regulatory matters to ensure that accruals for potential litigation losses are established when such losses are both probable and subject to reasonable estimation. There are also new products and initiatives processes applicable to every line of business to ensure an appropriate standard readiness assessment is performed before launching a new product or initiative. Significant risk policies approved by the management governance committees are also reviewed and approved by the Risk and Compliance Committee of the Board of Directors.

Credit Risk Review is an independent function responsible for 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. Credit Risk Review reports directly to the Risk and Compliance Committee of the Board of Directors and administratively to the Chief Auditor.

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. These practices include conservative exposure and counterparty limits and conservative 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 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 reserve 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 nonperforming asset 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.

The following tables provide a summary of potential problem loans and leases:

TABLE 31: Potential Problem Loans and Leases

 

As of June 30, 2015 ($ in millions)

   Carrying
Value
     Unpaid
Principal
Balance
     Exposure  

Commercial and industrial

   $ 1,392        1,396        1,896  

Commercial mortgage

     227        228        229  

Commercial construction

     7        7        10  

Commercial leases

     28        28        28  
  

 

 

    

 

 

    

 

 

 

Total potential problem loans and leases

   $ 1,654        1,659        2,163  
  

 

 

    

 

 

    

 

 

 

TABLE 32: Potential Problem Loans and Leases

 

As of December 31, 2014 ($ in millions)

   Carrying
Value
     Unpaid
Principal
Balance
     Exposure  

Commercial and industrial

   $ 1,022        1,028        1,344  

Commercial mortgage

     272        273        273  

Commercial construction

     7        7        11  

Commercial leases

     29        29        29  
  

 

 

    

 

 

    

 

 

 

Total potential problem loans and leases

   $ 1,330        1,337        1,657  
  

 

 

    

 

 

    

 

 

 

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 reserve 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 modeling expected losses. The dual risk rating system includes thirteen probabilities of default grade categories and an additional six 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.

 

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

 

 

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 make a decision on the use of modified dual risk ratings for purposes of determining the Bancorp’s ALLL once the FASB has issued a final standard regarding proposed methodology changes to the determination of credit impairment as outlined in the FASB’s Proposed ASU-Financial Instruments-Credit Losses (Subtopic 825-15) issued on December 20, 2012. 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.

Overview

The outlook is for reasonably positive economic and employment growth in the U.S. during the remainder of 2015. The job market is slowly but steadily improving. Housing prices have largely stabilized and are increasing in many markets, but overall current economic conditions are causing weaker than desired qualified loan demand and a relatively low interest rate environment, which directly impacts the Bancorp’s growth and profitability.

Among consumer portfolios, residential mortgage and brokered home equity portfolios exhibited the most stress. As of June 30, 2015, consumer real estate loans originated from 2005 to 2008 represent approximately 22% of the consumer real estate portfolio and approximately 57% and 63% of total losses for the three and six months ended June 30, 2015, respectively. Loss rates continue to improve as newer vintages are performing within expectations. Currently, the level of new commercial real estate fundings is slightly above the amortization and pay-off of the portfolio with growth in the commercial construction portfolio as those markets have rebounded. The Bancorp continues to engage in other loss mitigation strategies such as reducing credit commitments, restructuring certain commercial and consumer loans, as well as utilizing commercial and consumer loan workout teams. For commercial and consumer loans owned by the Bancorp, loan modification strategies are developed that are workable for both the borrower and the Bancorp when the borrower displays a willingness to cooperate. These strategies typically involve either a reduction of the stated interest rate of the loan, an extension of the loan’s maturity date(s) 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. For residential mortgage loans serviced for FHLMC and FNMA, the Bancorp participates in the HAMP and HARP 2.0 programs. For loans refinanced under the HARP 2.0 program, the Bancorp strictly adheres to the underwriting requirements of the program and promptly sells the refinanced loan back to the agencies. Loan restructuring under the HAMP program is performed on behalf of FHLMC or FNMA and the Bancorp does not take possession of these loans during the modification process. Therefore, participation in these programs does not significantly impact the Bancorp’s credit quality statistics. The Bancorp participates in trial modifications in conjunction with the HAMP program for loans it services for FHLMC and FNMA. As these trial modifications relate to loans serviced for others, they are not included in the Bancorp’s TDRs as they are not assets of the Bancorp. In the event there is a representation and warranty violation on loans sold through the programs, the Bancorp may be required to repurchase the sold loan. As of June 30, 2015, repurchased loans restructured or refinanced under these programs were immaterial to the Condensed Consolidated Financial Statements. Additionally, as of June 30, 2015, $17 million of loans refinanced under HARP 2.0 were included in loans held for sale in the Condensed Consolidated Balance Sheets. For the three and six months ended June 30, 2015, the Bancorp recognized $2 million and $4 million, respectively, of noninterest income in mortgage banking net revenue in the Condensed Consolidated Statements of Income related to the sale of loans restructured or refinanced under the HAMP and HARP 2.0 programs compared to $4 million and $8 million for the same periods in the prior year.

In the financial services industry, there has been heightened focus on foreclosure activity and processes. The Bancorp actively works with borrowers experiencing difficulties and has regularly modified or provided forbearance to borrowers where a workable solution could be found. Foreclosure is a last resort, and the Bancorp undertakes foreclosures only when it believes they are necessary and appropriate and is careful to ensure that customer and loan data are accurate.

At June 30, 2015, the Bancorp’s non-power producing energy portfolio balance was $1.7 billion, representing approximately two percent of total loans and leases. This portfolio continues to be an important part of the Bancorp’s commercial business strategy. Due to the sensitivity of this portfolio to downward movements in oil prices, the Bancorp has seen migration in the portfolio into criticized classifications during 2015. When establishing the ALLL, all portfolio and general economic factors are considered, including the level of criticized assets and the level of commodity prices.

Commercial Portfolio

The Bancorp’s credit risk management strategy includes minimizing 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 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. In addition, the Bancorp applies incremental valuation adjustments to older appraisals that relate to collateral dependent loans, which can currently be up to 20-30% of the appraised value based on the type of collateral. These incremental valuation adjustments generally reflect the age of the most recent appraisal as well as collateral type. Trends in collateral values, such as home price indices and recent asset dispositions, are monitored in order to determine whether changes to the appraisal adjustments are warranted. Other factors such as local market conditions or location may also be considered as necessary.

 

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

 

 

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 33: Commercial Mortgage Loans Outstanding by LTV, Loans Greater Than $1 Million

 

As of June 30, 2015 ($ in millions)

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

Commercial mortgage owner-occupied loans

   $ 158        322        1,987  

Commercial mortgage nonowner-occupied loans

     196        192        1,971  
  

 

 

    

 

 

    

 

 

 

Total

   $ 354        514        3,958  
  

 

 

    

 

 

    

 

 

 

TABLE 34: Commercial Mortgage Loans Outstanding by LTV, Loans Greater Than $1 Million

 

As of December 31, 2014 ($ in millions)

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

Commercial mortgage owner-occupied loans

   $ 148        248        1,982  

Commercial mortgage nonowner-occupied loans

     243        333        2,423  
  

 

 

    

 

 

    

 

 

 

Total

   $ 391        581        4,405  
  

 

 

    

 

 

    

 

 

 

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 35: Commercial Loan and Lease Portfolio (excluding loans held for sale)

 

     June 30, 2015      December 31, 2014  

($ in millions)

   Outstanding     Exposure      Nonaccrual      Outstanding      Exposure      Nonaccrual  

By industry:

                

Manufacturing

   $ 11,147       20,573        72        10,315        20,496        55  

Financial services and insurance

     6,156       12,620        13        6,097        13,557        20  

Real estate

     5,933       9,392        36        5,392        8,612        32  

Business services

     4,575       7,051        44        4,644        7,109        79  

Wholesale trade

     4,746       8,496        25        4,314        8,004        62  

Healthcare

     4,429       6,355        22        4,133        6,322        20  

Retail trade

     3,983       8,252        10        3,754        7,190        22  

Transportation and warehousing

     3,088       4,581        —          3,012        4,276        1  

Communication and information

     2,689       4,552        2        2,409        4,140        3  

Construction

     1,979       3,369        10        1,864        3,352        25  

Accommodation and food

     1,830       3,052        7        1,712        2,945        9  

Mining

     1,621       2,913        12        1,862        3,323        3  

Entertainment and recreation

     1,476       2,563        8        1,451        2,321        10  

Utilities

     978       2,682        —          1,044        2,551        —    

Other services

     819       1,166        10        881        1,207        11  

Public administration

     582       680        —          567        658        —    

Agribusiness

     341       510        7        318        444        11  

Individuals

     164       199        2        170        201        4  

Other

     4       4        7        14        17        —    
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 56,540       99,010        287        53,953        96,725        367  
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

By loan size:

                

Less than $200,000

         1        7        1        1        6  

$200,000 to $1 million

     4       3        16        5        3        15  

$1 million to $5 million

     10       8        27        11        9        22  

$5 million to $10 million

     8       7        30        8        7        19  

$10 million to $25 million

     24       22        20        25        22        24  

Greater than $25 million

     53       59        —          50        58        14  
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     100      100        100        100        100        100  
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

By state:

                

Ohio

     17      18        12        17        20        11  

Michigan

     8       7        7        9        8        11  

Illinois

     7       7        14        7        8        6  

Florida

     7       7        18        7        6        17  

Indiana

     5       5        6        5        5        5  

North Carolina

     4       4        1        3        4        2  

Kentucky

     3       3        3        3        3        2  

Tennessee

     3       3        1        3        3        —    

Pennsylvania

     3       3        4        3        2        7  

All other states

     43       43        34        43        41        39  
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     100      100        100        100        100        100  
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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

 

 

The Bancorp has identified certain categories of 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. The following tables provide analysis of nonowner-occupied commercial real estate loans (excluding loans held for sale):

TABLE 36: Nonowner-Occupied Commercial Real Estate(a)

 

As of June 30, 2015 ($ in millions)

                               Net Charge-offs (Recoveries) for
June 30, 2015
 

By State:

   Outstanding      Exposure      90 Days
Past Due
     Nonaccrual      Three Months
Ended
    Six Months
Ended
 

Ohio

   $ 1,392        1,721        —          5        —         (1

Michigan

     651        694        —          3        —         —    

Florida

     586        950        —          15        3       3  

Illinois

     547        970        —          6        —         —    

North Carolina

     377        609        —          —          (1     (1

Indiana

     278        399        —          —          —         —    

All other states

     2,092        3,912        —          14        5       5  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 5,923        9,255        —          43        7       6  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
(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 37: Nonowner-Occupied Commercial Real Estate(a)

 

As of June 30, 2014 ($ in millions)

                               Net Charge-offs (Recoveries) for
June 30, 2014
 

By State:

   Outstanding      Exposure      90 Days
Past Due
     Nonaccrual      Three Months
Ended
    Six Months
Ended
 

Ohio

   $ 1,157        1,619        —          11        (1     —    

Michigan

     806        879        —          17        5       5  

Florida

     544        745        —          5        1       1  

Illinois

     495        849        —          9        1       1  

North Carolina

     311        516        —          2        —         —    

Indiana

     214        317        —          3        —         —    

All other states

     1,445        2,518        —          4        —         —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 4,972        7,443        —          51        6       7  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

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

 

 

Consumer Portfolio

The Bancorp’s consumer portfolio is materially comprised of three categories of loans: residential mortgage loans, home equity and automobile loans. The Bancorp has identified certain categories within these loan types which it believes represent a higher level of risk compared to the rest of the consumer loan portfolio due to high loan amount to collateral value. 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.

Residential Mortgage Portfolio

The Bancorp manages credit risk in the residential mortgage portfolio through conservative underwriting and documentation standards and geographic and product 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 and adjustable rate residential mortgage loans. Resets of rates on ARMs are not expected to have a material impact on credit costs in the current interest rate environment, as approximately $850 million of adjustable rate residential mortgage loans will have rate resets during the next twelve months. Approximately 60% of these resets are expected to experience an increase in rate, with an average increase of approximately a fifth of a 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.

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

TABLE 38: Residential Mortgage Portfolio Loans by LTV at Origination

 

     June 30, 2015     December 31, 2014  

($ in millions)

   Outstanding      Weighted
Average
LTV
    Outstanding      Weighted
Average
LTV
 

LTV £ 80%

   $ 9,752        65.3    $ 9,220        65.1 

LTV > 80%, with mortgage insurance

     1,250        93.6       1,206        93.8  

LTV > 80%, no mortgage insurance

     1,931        96.2       1,963        96.2  
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 12,933        72.8    $ 12,389        73.0 
  

 

 

    

 

 

   

 

 

    

 

 

 

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

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

 

As of June 30, 2015 ($ in millions)

                        Net Charge-offs for June 30, 2015  

By State:

   Outstanding      90 Days
Past Due
     Nonaccrual      Three Months
Ended
     Six Months
Ended
 

Ohio

   $ 520        1        6        1        2  

Illinois

     321        —          1        —          1  

Michigan

     272        1        2        1        1  

Florida

     257        2        3        —          —    

Indiana

     126        —          2        —          —    

North Carolina

     106        —          1        —          —    

Kentucky

     78        —          —          —          —    

All other states

     251        1        2        —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,931        5        17        2        4  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

TABLE 40: Residential Mortgage Portfolio Loans, LTV Greater than 80%, No Mortgage Insurance

 

   

As of June 30, 2014 ($ in millions)

                        Net Charge-offs for June 30, 2014  

By State:

   Outstanding      90 Days
Past Due
     Nonaccrual      Three Months
Ended
     Six Months
Ended
 

Ohio

   $ 593        3        15        1        3  

Illinois

     270        —          6        —          1  

Michigan

     323        1        7        1        2  

Florida

     265        1        7        —          1  

Indiana

     132        2        3        —          1  

North Carolina

     105        —          1        —          —    

Kentucky

     90        —          1        —          —    

All other states

     312        —          3        1        1  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,090        7        43        3        9  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

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

 

 

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.

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, refreshed FICO score trends and product mix. The qualitative factors include adjustments for credit administration and portfolio management, credit policy and underwriting and the national and local economy. The Bancorp considers home price index trends when determining the national and local economy 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 80% or less based upon appraisals at origination. The carrying value of the greater than 80% LTV home equity loans and 80% or less LTV home equity loans were $2.8 billion and $5.8 billion, respectively, as of June 30, 2015. Of the total $8.5 billion of outstanding home equity loans:

 

    85% reside within the Bancorp’s Midwest footprint of Ohio, Michigan, Kentucky, Indiana and Illinois;

 

    35% are in senior lien positions and 65% are in junior lien positions at June 30, 2015;

 

    Over 80% of non-delinquent borrowers made at least one payment greater than the minimum payment during the three months ended June 30, 2015; and

 

    The portfolio had an average refreshed FICO score of 740 at June 30, 2015 and December 31, 2014.

The Bancorp actively manages lines of credit and makes reductions 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 section of MD&A for more information.

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

TABLE 41: Home Equity Portfolio Loans Outstanding by Refreshed FICO Score

 

     June 30, 2015     December 31, 2014  

($ in millions)

   Outstanding      % of
Total
    Outstanding      % of
Total
 

Senior Liens:

          

FICO < 620

   $ 170          $ 178       

FICO 621-719

     587        7       613        7  

FICO > 720

     2,217        26       2,257        25  
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Senior Liens

     2,974        35       3,048        34  

Junior Liens:

          

FICO < 620

     434        5       471        6  

FICO 621-719

     1,481        17       1,542        17  

FICO > 720

     3,658        43       3,825        43  
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Junior Liens

     5,573        65       5,838        66  
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 8,547        100    $ 8,886        100 
  

 

 

    

 

 

   

 

 

    

 

 

 

 

38


Table of Contents

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

 

 

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 as of:

TABLE 42: Home Equity Portfolio Loans Outstanding by LTV at Origination

 

     June 30, 2015     December 31, 2014  

($ in millions)

   Outstanding      Weighted
Average LTV
    Outstanding      Weighted
Average LTV
 

Senior Liens:

          

LTV £ 80%

   $ 2,584        55.2    $ 2,635        55.2 

LTV > 80%

     390        89.1       413        89.1  
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Senior Liens

     2,974        59.9       3,048        60.0  

Junior Liens:

          

LTV £ 80%

     3,181        67.5       3,281