DBRS Comments on Fifth Third Bancorp’s 3Q12 Earnings – Senior at A (low); Ratings Unchanged

DBRS, Inc. (DBRS) has today commented that its 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 3Q12 results.

Reflecting some noise, tepid loan growth and a material increase to its mortgage and warranty reserve, Fifth Third’s 3Q12 earnings available to common shareholders decreased 5.9% to $354 million from $376 million for 2Q12. Specifically, lower QoQ earnings were driven by a 7.4% increase in non-interest expense, partially offset by an 8.4% decrease in provisions for loan loss reserves. Meanwhile total revenues were relatively flat, QoQ.

The Company’s 3Q12 results reflect the difficult operating environment, which has dampened loan growth and pressured margins. Although Fifth Third continues to exhibit sustained average loan growth, it has slowed and will likely remain tepid over the near term. Nonetheless, the Company’s asset quality continues to improve, reflecting lower levels of nonperforming assets (NPAs) and net charge-offs (NCOs).

Earnings were somewhat noisy QoQ and reflected multiple non-core items. During 3Q12, the Company reported a $26 million (pre-tax) debt extinguishment expense related to the redemption of trust preferred securities, a $16 million (pre-tax) negative valuation adjustment on Vantiv warrants, $11 million in pre-tax income on the sale of certain Fifth Third funds, $5 million in benefits related to affordable housing investments, and $2 million in net securities gains.

On a core basis, excluding the above mentioned items, Fifth Third’s DBRS-calculated adjusted income before provision and taxes decreased by 4.8%, driven by a 5.9% increase in adjusted expense, partially offset by a 1.8% increase in adjusted revenue.

Higher expenses drove the QoQ swing in earnings. On a core basis, the bulk of the increase in non-interest expense reflected a $22 million increase in the Company’s mortgage representation and warranty reserve.

Overall, total revenues were flat QoQ, reflecting an $8 million, or 0.9% increase in net interest income, mostly offset by a $7 million or 1.0% decrease in non-interest income. Modestly higher spread income was attributable to a stable net interest margin (NIM) at 3.56% and slightly lower levels of interest earning assets (down 0.3%). DBRS notes that Fifth Third’s net interest income and NIM benefited from $10 million of revenues primarily generated from non-recurrent hedging ineffectiveness from the redeemed trust preferred securities, and income related to an auto securitization cleanup. This benefit bolstered NIM by 4 basis points. DBRS notes that the low rate environment continues to place pressure on Fifth Third’s margin. Indeed, management expects the Company’s NIM to narrow by roughly 10 bps in 4Q12.

As with many banks, loan growth continues to be a struggle for Fifth Third, which reported a modest 0.4% increase in average loans (including held for sale) during 3Q12. Meanwhile, pre-investment in the second quarter of anticipated third quarter portfolio cash flows led to lower levels of securities in 3Q12.

Fifth Third’s fee revenues reflected a sizable 9.3% QoQ increase in mortgage banking income. The increase reflected higher gain on sale margins, partially offset by MSR valuation adjustments. Most other core fee income components were slightly down QoQ.

Despite the difficult business environment, Fifth Third’s asset quality continues to improve. Specifically, NPAs declined 11.3% QoQ to $1.5 billion and represented 1.73% of total loans plus OREO. Meanwhile, NCOs declined $25 million to $156 million or a moderate 75 bps of average loans. The Company remains well reserved, as its allowance for loan losses represented 2.32% of total loans and 133% of NPAs.

Capitalization remains sound with a Tier 1 Common equity ratio of 9.67% (estimated), a Tier 1 risk-based capital ratio of 10.85% (estimated) and a tangible common equity ratio of 9.1% (excluding unrealized gains on securities). Finally, Fifth Third anticipates its estimated Basel III Tier 1 common equity ratio to be approximately 9.0%.

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 DBRS Criteria – Intrinsic and Support Assessments, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments, and Rating Bank Preferred Shares and Equivalent Hybrids. All can be found on the DBRS website under Methodologies.

The sources of information used for this rating include 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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Mark Nolan
Approver: Roger Lister
Initial Rating Date: 27 July 2005
Most Recent Rating Update: 9 December 2011

For additional information on this rating, please refer to the linking document under Related Research.