DBRS Comments on Fifth Third Bancorp’s 3Q11 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 3Q11 earnings. The trend on all ratings remains Stable. Fifth Third recorded a strong third quarter, reporting net income available to common shareholders of $373 million that increased 14% or $45 million from the prior quarter and 112% from the same period a year ago.

FITB’s 3Q11 results reflect the Company’s solid financial fundamentals, improving earnings capacity, and resilience in a difficult economy. Despite the low interest rate environment underpinned by slow growth, Fifth Third reported a higher return on assets of 1.34% in the third quarter that was supported by lower credit costs and solid revenue generation. The adjusted pre-provision net revenue (PPNR, adjusted for nonrecurring items) of $633 million grew 8.8% sequentially benefiting from a 4% QoQ increase in net interest income and a 1% QoQ growth in fee income, primarily from mortgage banking activities. The benefit of revenue growth was partially offset by an increase in noninterest expense that climbed 5% to $946 million compared to unusually low levels in the prior quarter. Continued improvement in credit metrics resulted in a 23% sequential decline in provision for loan losses to $87 million.

While overall loan growth was low, there were positive signs in the trends for different loan categories particularly as C&I loans were up 3% QoQ. With continued runoff in some of its loan categories coupled with low utilization rates, however, overall loan growth remains a challenge. Fifth Third’s average loans grew moderately by 1% QoQ to $78.6 billion, as stronger C&I loan growth was partially offset by continued runoff in the commercial real estate (CRE) loans. Consumer loans balances, that comprised 44% of total loans, also grew in the quarter, increasing 1% or $374 million QoQ. In aggregate, runoffs in average CRE (-4.1%) and home equity (-1.4%) books were approximately $669 million.

The trend in net interest income was also positive with increases in earning assets and net interest margin (NIM). The Company’s net interest income grew $33 million or 4% over the prior quarter to $902 million with results reflecting growth in loans and in investment securities. Net interest margin (NIM) grew 3 basis points (bps) to 3.65% in the quarter as a result of the loan growth that more than offset the lower yields on loans and securities. Management anticipates NIM to expand single bps in 4Q11 from lower deposit cost and liquidity runoff.

Highlighting the quarter’s improved fee income results of $665 million (up 1% sequentially) were 10% sequential growth in mortgage banking net revenue and 7% growth in deposit service charges. These contributions were partially offset by the negative impacts from valuation adjustments of liability related to the Visa total return swap and from Vantiv puts and warrants valuation. Securities gains of $26 million in the quarter also contributed to noninterest income growth. Card and processing revenue declined 12% to $78 million in the quarter, driven by increased redemption on debit and credit rewards programs. Based on the new regulatory guidance, the Company anticipates the Durbin Amendment (effective as of October 1, 2011) to result in approximately 50% or a $30 million decline in interchange fees per quarter (based on 3Q11 volumes) beginning in 4Q11. Fifth Third plans to mitigate two-thirds of the impact by the middle of 2012 through product offerings and other changes.

In the quarter, operating leverage on an adjusted basis was negative, reversing a positive trend. Noninterest expense of $946 million grew $45 million over the prior quarter, largely due to the $28 million of expense associated with the termination of certain current and planned FHLB borrowings and hedging transactions. On an adjusted basis, expenses increased 2% to $918 million in 3Q11 due to a $5 million or an 18% increase in card and processing expense partially offset by a 12% reduction in employee benefits expense. Management continues to drive to control expenses while coping with still elevated credit costs and increased regulatory demands.

Credit quality continued to reflect positive trends with all credit metrics improving across all key categories, including delinquencies, nonperforming assets (NPAs), and net charge-offs (NCOs) that were at record lows since 4Q07. NPAs of $2.1 billion (including $197 million of held for sale loans) declined $123 million or 5.4% sequentially to 2.44% of total loans plus OREO. NPAs levels were the lowest since 2007 and benefited from declining inflows that declined 25% sequentially to $418 million. Florida and Michigan continued to represent the most challenged geographies with NPAs in these states accounting for 41% of total commercial and consumer NPAs. NCOs of $262 million or 1.32% of average loans were also the lowest since 4Q07, having declined $42 million or 14% QoQ. The biggest improvement stemmed from Florida and Michigan, with sequential declines in charge-offs of 24% and 28%, respectively. Management anticipates trends to be relatively stable in both the consumer and commercial portfolio, with charge-offs running at approximately 150 bps for 2011.

Reflecting its confidence in its asset quality improvement, the Company released $175 million of reserves over the quarter. This still left its allowance for loan losses at $2.4 billion or 3.08% of total loans, 125% of NPAs, and 235% of annualized NCOs, providing a sizeable cushion to absorb prospective losses.

DBRS is mindful of Fifth Third’s $1.8 billion in consumer TDRs. Of the total, $1.6 billion remains on accrual status with $1.3 billion being current. Of the accruing TDRs, approximately 85% has been restructured over six months ago and exhibit successful seasoning. In 3Q11, $215 million or about 12% were on nonaccrual status. DBRS notes that recently modified vintages exhibited lower redefault rates and comprised a larger proportion of the aggregate TDRs.

Fifth Third’s financial fundamentals and capital position remained strong in 3Q11 with Tier 1 common equity ratio improving 13 bps QoQ to 9.33%. Reflecting growth in both retained earnings and assets, the Company’s Tangible Common Equity to tangible assets ratio was 8.63%, consistent to the prior quarter. Given its solid capital position, Fifth Third raised its dividend by 33% to $0.08 per share in 3Q11 and announced that it plans to work towards returning more capital to its shareholders in 2012. Fifth Third anticipates that its Basel III Tier 1 common ratio would be 9.8%, which would already be 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.

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 under Related Research.