DBRS Comments on Fifth Third Bancorp’s 1Q11 Earnings – Senior at A (low) Remains Unchanged

DBRS Inc. (DBRS) has today commented that the ratings for Fifth Third Bancorp (Fifth Third or the Company), including its Issuer & Senior Debt rating of A (low), remain unchanged, following the release of its 1Q11 financial results. The trend on all ratings remains Stable. DBRS views the Company’s 1Q11 results as in line with expectations, with net income available to common shareholders of $241 million (adjusted for the $153 million TARP-related accretion cost) down $29 million or 10.7% from the seasonally stronger 4Q10, but significantly improved from the net loss of $72 million recorded in 1Q10.

Noteworthy was the Company’s February 2011 repurchase of $3.4 billion in preferred shares held by the U.S. Treasury under the TARP capital purchase program following successful $1.7 billion common stock and $1 billion senior debt offerings in January 2011. DBRS notes that Fifth Third’s financial fundamentals remain solid post-TARP repayment.

The first quarter earnings were indicative of the broader trends for banks within the economy, with loan growth challenges and the low rate environment pressuring revenues while expenses remain elevated. First quarter net interest income declined $35 million, or 4%, from 4Q10, including the full quarter effect of refinancing FTPS loans, lower mortgage warehouse balances in loans held-for-sale (HFS), and the effect of the $1 billion debt issuance related to the TARP repayment, all of which reduced net interest income by approximately $23 million. The quarter also had two fewer days, impacting results by $12 million. DBRS notes that results did benefit from higher average loan balances and interest earning assets, lower interest reversal on nonperforming loans (NPLs), and lower deposit costs. Nevertheless, the positive variances were offset by lower yields on loans and lower loan purchase accounting accretion. As a result, NIM compressed 4 basis points (bps) in the quarter to 3.71%, partially offset by the lower day count (adding 3 bps to margin). The Company expects similar net interest income performance in the second quarter (other than the benefit of higher day count) and anticipates improved 2H11 results driven by stronger net loan growth and favorable funding costs.

Despite the first quarter being seasonally weaker than 4Q10, non-interest income results were weaker than Company expectations. The 11% or $72 million decline in sequential fee revenues decline was largely driven by a $56 million reduction in mortgage-related revenue, to $102 million reflecting significantly lower origination volumes and narrower spreads. For 2Q11, total mortgage-related revenue is expected to improve benefiting from seasonally stronger origination activity. Also, lower investment securities gains, seasonally lower corporate banking revenue and deposit services charges added to the decline in fee revenues, partially offset by lower credit-related costs recognized in other income. Positively, investment advisory revenue increased 5% in the quarter driven by seasonally higher tax preparation fees. DBRS is mindful of the pending regulatory changes, in particular, the Durbin Amendment and the regulatory enforcement orders related to foreclosure practices that will likely pressure fee income. Nonetheless, Fifth Third expects fee income to be relatively stable in 2Q11.

DBRS sees Fifth Third maintaining a disciplined management of expenses in 1Q11. Noninterest expense of $918 million at 1Q11 decreased 7% from $987 million in the prior quarter, driven by lower salary and benefits expense and lower credit-related expense. Positively, credit-related costs improved, declining $22 million, or 42%, from the prior quarter, to $31 million in 1Q11. This improvement included lower provision for mortgage repurchases expense, which declined 60% to $8 million from $20 million in 4Q10 and declined 79% from $39 million a year ago.

DBRS views Fifth Third’s credit quality trends positively with nonperforming assets (NPAs), NPLs, NPL inflows, other real estate owned (OREO), 90+ day delinquencies and charge-offs down over the quarter (excluding charge-offs from collateral related to a single credit relationship). Credit metrics trended favorably with NPAs modestly down at 2.73% of total loans plus OREO, compared to 2.79% in the prior quarter. NCOs increased $11 million sequentially to $367 million or 1.92% of average loans (compared to 1.86% in 4Q10), driven by the single credit charge-off. The Company noted that most of its operating markets are improving, while Florida still remains challenging. Asset quality in Michigan, particularly in real estate, has significantly improved despite some headwinds. Nevertheless, the two states accounted for 41% of NPAs in the commercial and consumer portfolios, while NPAs in those two states were down $48 million sequentially.

Despite a broad-based improvement in asset quality, Fifth Third’s loan loss provision expense stayed relatively flat but conservative, increasing 1% to $168 million. DBRS notes that reserve levels remain adequate at 3.62% of total loans or 132% of nonperforming assets (excluding accruing restructured loans and nonaccruals in loans held for sale) despite a $215 million sequential decline in the allowance for loan losses.

Fifth Third maintains solid capital, funding and liquidity positions that provide the Company with ample loss absorption capacity. The Company’s estimated Tier 1 common equity of 9.00% grew 150 bps over the quarter. Meanwhile, post-TARP repayment Tier 1 risk-based and total capital ratios stood at 12.21% and 16.29%, respectively, at 1Q11. Maintaining these strong capital levels will position Fifth Third for a successful transition to Basel III requirements. On one hand the Company expects organic capital generation to increase its capital ratios further, however, Management also noted that raising the dividend in the first quarter was the first step to returning more capital to its shareholders and the Company will continue to evaluate the dividend level as the year progresses. In 1Q11, average core deposits increased 1% sequentially with strong transaction deposit growth. DBRS also noted that Fifth Third’s core deposits funded nearly 100% of average loans (excluding HFS).

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other methodologies used include the Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments, and Rating Bank Preferred Shares and Equivalent Hybrids, all of which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the company documents, the Federal Deposit Insurance Corporation and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: William Schwartz
Approver: Alan G. Reid
Initial Rating Date: 27 July 2005
Most Recent Rating Update: 26 March 2010

For additional information on this rating, please refer to the linking document below.