DBRS Comments on Fifth Third Bancorp’s 4Q12 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 4Q12 results. The Company reported net income attributable to common shareholders of $390 million, up 10% from $354 million in 3Q12. Highlights of the quarter included sustained loan growth, significantly higher core fee income, and improved asset quality.

Fifth Third’s 4Q12 earnings included multiple non-core items, similar to the prior quarter. Specifically, the Company reported a $157 million pre-tax gain on the sale of Vantiv shares, a $19 million (pre-tax) negative valuation adjustment on the Vantiv warrant, a $15 million (pre-tax) charge related to the valuation of the Visa total return swap and a $2 million (pre-tax) net gain on investment securities. Furthermore, 4Q12 noninterest expense included $134 million (pre-tax) of debt extinguishment costs associated with the termination of FHLB debt, $13 million (pre-tax) in charges to increase litigation reserves, and an additional $29 million (pre-tax) charge to increase the mortgage representations and warranty reserve. Despite these numerous non-core items, Fifth Third’s performance for the quarter was solid.

Excluding the abovementioned items, Fifth Third’s DBRS-calculated adjusted income before provision and taxes (IBPT) increased by 7.1% QoQ to $664 million. The increase was driven by a solid 4.9% increase in adjusted revenue, which generated positive operating leverage as it more than offset the 3.6% increase in adjusted expense. Higher adjusted revenue reflected a substantial 12.1% increase in adjusted noninterest income, partially offset by a 0.4% decline in net interest income.

Higher linked-quarter noninterest income was bolstered by a sizable 29% increase in mortgage banking income, a 13% increase in corporate banking revenue and a 5% increase in service charges on deposits. Higher mortgage banking income was driven by higher gains on mortgages sold, elevated servicing fees, and lower negative asset valuation adjustments. Meanwhile, improved corporate banking revenue was driven by higher syndication fees, business lending fees, and derivative fees. Finally, service charges on deposits improved due to seasonal increases in consumer overdrafts and the initial benefit from transitioning to new deposit product offerings.

Spread income declined $4 million to $903 million (FTE), as margin pressure more than offset growth in average earning assets (up 2.0%). Indeed, the Company’s net interest margin (NIM) narrowed by 7 bps to 3.49%, primarily reflecting $10 million of non-recurrent revenues generated in 3Q12. Positively, NIM benefited from FHLB prepayments in 4Q12 and the full quarter impact of the Trups repayment, which occurred in 3Q12. DBRS notes that the low rate environment continues to place pressure on Fifth Third’s margin and as such, management anticipates NIM to narrow modestly and range between 3.35% and 3.40% for 2013.

Importantly, the Company continued to exhibit loan growth. Specifically, total average loans (excluding loans held for sale) grew by 1% sequentially, reflecting a 4% increase in commercial & industrial loans, a 2% increase in residential mortgage loans, a 1% increase in automobile loans, and a 3% increase in credit card loans. Partially offsetting the loan growth in other segments, commercial real estate and construction loans continue to decline.

4Q12 noninterest expense increased 16% QoQ to $1.2 billion, mostly reflecting the already mentioned non-core expense items. On a core basis (adjusted), expense grew a still elevated 3.6%, largely reflecting higher compensation related expenses, primarily driven by performance incentives and a $6 million annual pension settlement expense.

Overall, credit costs recorded in noninterest expense totaled $68 million, up from $59 million in 3Q12, mostly reflecting $44 million ($36 million in 3Q12) in provisions for mortgage repurchases. The higher mortgage representation and warranty expense reflected additional information from Freddie Mac regarding its selection criteria for future repurchases and file requests that are not unique to Fifth Third.

Despite the challenging business environment, Fifth Third’s asset quality remains sound and continued to improve. Specifically, non-performing assets (NPAs, excluding nonaccrual loans held for sale) declined 11.0% QoQ to $1.3 billion and represented a manageable 1.49% of total loans plus OREO. Lower NPA’s reflected decreases across most loan types, except for home equity loans, which were slightly up QoQ. Meanwhile, NCOs declined $9 million to $147 million and represented a moderate 70 bps of average loans. The Company remains well reserved, as its allowance for loan losses represented 2.16% of total loans and 144% of NPAs. Furthermore, DBRS notes that Fifth Third’s 4Q12 provisions for loan loss reserves represented a moderate 11% of its IBPT, reflecting the Company’s healthy coverage of credit costs.

In DBRS’s view, Fifth Third’s capitalization remains sound with a Tier 1 Common equity ratio of 9.51% (estimated), a Tier 1 risk-based capital ratio of 10.65%, and a tangible common equity ratio of 8.83% (excluding unrealized gains on securities). DBRS notes that Fifth Third’s capitalization reflects the repurchase of approximately $225 million in common shares during 4Q12. Finally, Fifth Third anticipates its estimated Basel III Tier 1 common equity ratio to be approximately 8.8% signaling its compliance with a requirement that is scheduled to go into full effect in 2019.

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

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]