DBRS Comments on Fifth Third Bancorp’s 2Q11 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 2Q11 financial results. The trend on all ratings remains Stable. Fifth Third recorded a strong second quarter, reporting net income available to common shareholders of $328 million that increased $240 million, or 3.7 times, from the prior quarter.

Pre-provision net revenue (PPNR) of $619 million grew 14% sequentially benefiting from a 12% quarter-over-quarter (QoQ) increase in its non-interest income from stronger mortgage-related revenues, partially offset by a 2% decline in net interest income. Expenses declined 2% QoQ to $901 million also benefiting bottom line results. As a result of improved earnings trends and 3.9% QoQ growth in revenue, Fifth Third achieved positive operating leverage in 2Q11; an indicator of financial health. With solid financial fundamentals, Fifth Third continued to exhibit franchise strength by continuing to increase revenue, achieve loan and deposit growth, and improve credit metrics.

The Company’s financial profile in the quarter was indicative of the broader trends for banks within the economy. All credit metrics continued to improve, with non-performing assets (NPAs), net charge-offs (NCOs), and total delinquencies (early delinquencies and 90 days past due loans) down sequentially to the lowest levels since the beginning of the credit crisis for most metrics. NPAs of $2.3 billion (including $176 million of held for sale loans) declined $78 million, or 3%, sequentially to 2.66% of total loans plus OREO, partially offset by non-accruing restructured loans and leases that grew 11.5% QoQ to $399 million. NPAs levels were the lowest since 2007 attributable to declining inflows that were 55% below peak levels at 3Q09. NCOs at $304 million or 1.56% of average loans were the lowest since 1Q08 and declined $63 million, or 17%, QoQ. Moreover, total delinquencies declined 9% sequentially to its lowest level since 2006. Florida and Michigan continue to represent a disproportional amount of stressed credits comprising 9% and 15%, respectively, of total loans and 22% and 17%, respectively, of total NCOs. Management anticipates total charge-offs to be below 125 basis points (bps) of loans by the year-end 2011.

Reflecting its confidence in asset quality improvements, the Company released $191 million of reserves over the quarter, resulting in an allowance for loan losses of $2.6 billion, or 3.35% of total loans, 125% of NPAs, and 214% of annualized NCOs.

DBRS is mindful of Fifth Third’s $1.8 billion in consumer TDRs. Of the total, $1.6 billion is in accrual status with $1.3 billion being current. Despite higher redefault rates on loans of older vintages, vintages from 2008 onward reflected a 12 month default frequency in the 25% range. Positively, recently modified vintages exhibited lower redefault rates and comprised a larger proportion of the aggregate TDRs.

Moreover, the Company’s exposures to mortgage putbacks have experienced some volatility in demand requests and repurchase losses. Although repurchase losses have remained flat at $22 to $23 million for the past 3 quarters and are expected to remain somewhat elevated in the near-term, outstanding counterparty claims are trending downward for the fourth consecutive quarter. DBRS notes that at 2Q11, 98% of the outstanding balances on sold loans and 87% of the outstanding claims relate to agency loans. In DBRS’s view, the Company’s $80 million level of repurchase reserves, if maintained, appears adequate given the characteristics of their exposure.

With continued runoff in some of its loan categories coupled with low utilization rates, loan growth remains a challenge, in spite of modest growth in 2Q11. Fifth Third’s commercial loans comprised approximately 56% of total loans and commercial real estate (CRE) balances, representing approximately $12.0 billion, or 28%, of commercial loans, continued to runoff at a pace of 3% sequentially. Positively, commercial and industrial (C&I) loans grew $578 million, or 2%, from 1Q11, benefiting from strong production in health care, manufacturing and wholesale sectors despite high levels of pay downs. Consumer loans increased $141 million QoQ, driven by growth in the residential mortgage book of $372 million and automobile loans of $118 million compared to 1Q11. Home equity loans continued to runoff and declined $232 million, or 2%, QoQ to $11 billion and credit card balances declined 1% sequentially to $1.8 billion as consumers continue to deleverage. Fifth Third anticipates growth in 2H11 for C&I, mortgage, and auto loans, partially offset by attrition in CRE loans that will likely be a drag on the overall loan growth.

In 2Q11, loan yields contracted 13 bps, partially offset by a 2 bps decline on interest bearing liabilities as deposits (which fund 100% of loans) grew and resulted in a net interest income decline of 1.7% to $869 million. Consequently, net interest margin (NIM) compressed 9 bps to 3.62% and was indicative of lower mortgage warehouse balances, lower LIBOR rates and loan spreads, and a flatter yield curve. NIM is expected to increase modestly in the single bp range in 2H11 from lower deposit cost and liquidity runoff.

Fee income of $656 million was $72 million stronger compared to 1Q11, driven by a 58% increase in mortgage-related revenue, an 11% growth in corporate banking revenue, and a 10% increase in card and processing revenue. Based on the new regulatory guidance, the Company anticipates a decline of approximately $30 million in interchange fees per quarter beginning in 4Q11 of which Fifth Third plans to mitigate one-third to one-half by the fourth quarter through product offerings and changes.

In 2Q11, Fifth Third’s financial fundamentals and solid capital position were strengthened. The Company’s Tier 1 common equity at 9.20% grew 21 bps over the quarter and Tier 1 risk-based and total capital ratios stood at 11.93% and 16.03%, respectively, at 2Q11. Fifth Third anticipates it Basel III Tier 1 common ratio to be 9.6%, likely well above the level required by the 2019 final phase-in date.

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.
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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: Roger Lister
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.