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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2011
Commission File Number 001-33653
(Exact name of Registrant as specified in its charter)
| Ohio | 31-0854434 | |
| (State or other jurisdiction | (I.R.S. Employer | |
| of incorporation or organization) | Identification Number) |
Fifth Third Center
Cincinnati, Ohio 45263
(Address of principal executive offices)
Registrant’s telephone number, including area code: (800) 972-3030
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer | x | Accelerated filer | ¨ | |||||
| Non-accelerated filer |
¨ | (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
There were 919,818,137 shares of the Registrant’s common stock, without par value, outstanding as of June 30, 2011.
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This report may contain forward-looking statements about Fifth Third Bancorp and/or the company as combined acquired entities within the meaning of Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended, and Rule 3b-6 promulgated thereunder, that involve inherent risks and uncertainties. This report may contain certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of Fifth Third Bancorp and/or the combined company including statements preceded by, followed by or that include the words or phrases such as “will likely result,” “may,” “are expected to,” “is anticipated,” “estimate,” “forecast,” “projected,” “intends to,” or may include other similar words or phrases such as “believes,” “plans,” “trend,” “objective,” “continue,” “remain,” or similar expressions, or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” or similar verbs. There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements. Factors that might cause such a difference include, but are not limited to: (1) general economic conditions and weakening in the economy, specifically the real estate market, either nationally or in the states in which Fifth Third, one or more acquired entities and/or the combined company do business, are less favorable than expected; (2) deteriorating credit quality; (3) political developments, wars or other hostilities may disrupt or increase volatility in securities markets or other economic conditions; (4) changes in the interest rate environment reduce interest margins; (5) prepayment speeds, loan origination and sale volumes, charge-offs and loan loss provisions; (6) Fifth Third’s ability to maintain required capital levels and adequate sources of funding and liquidity; (7) maintaining capital requirements may limit Fifth Third’s operations and potential growth; (8) changes and trends in capital markets; (9) problems encountered by larger or similar financial institutions may adversely affect the banking industry and/or Fifth Third; (10) competitive pressures among depository institutions increase significantly; (11) effects of critical accounting policies and judgments; (12) changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board (FASB) or other regulatory agencies; (13) legislative or regulatory changes or actions, or significant litigation, adversely affect Fifth Third, one or more acquired entities and/or the combined company or the businesses in which Fifth Third, one or more acquired entities and/or the combined company are engaged, including the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act); (14) ability to maintain favorable ratings from rating agencies; (15) fluctuation of Fifth Third’s stock price; (16) ability to attract and retain key personnel; (17) ability to receive dividends from its subsidiaries; (18) potentially dilutive effect of future acquisitions on current shareholders’ ownership of Fifth Third; (19) effects of accounting or financial results of one or more acquired entities; (20) difficulties in separating Vantiv, LLC, formerly Fifth Third Processing Solutions, LLC from Fifth Third; (21) loss of income from any sale or potential sale of businesses that could have an adverse effect on Fifth Third’s earnings and future growth; (22) ability to secure confidential information through the use of computer systems and telecommunications networks; and (23) the impact of reputational risk created by these developments on such matters as business generation and retention, funding and liquidity. Additional information concerning factors that could cause actual results to differ materially from those expressed or implied in the forward-looking statements is available in the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2010, filed with the United States Securities and Exchange Commission (SEC). Copies of this filing are available at no cost on the SEC’s Web site at www.sec.gov or on the Fifth Third Web site at www.53.com. Fifth Third undertakes no obligation to release revisions to these forward-looking statements or reflect events or circumstances after the date of this report.
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Fifth Third Bancorp provides the following list of acronyms as a tool for the reader. The acronyms identified below are used in Management’s Discussion and Analysis of Financial Condition and Results of Operations, the Condensed Consolidated Financial Statements and in the Notes to Condensed Consolidated Financial Statements.
| ALCO: Asset Liability Management Committee ALLL: Allowance for Loan and Lease Losses ARM: Adjustable Rate Mortgage BOLI: Bank Owned Life Insurance bp: Basis point(s) CDC: Fifth Third Community Development Corporation CPP: Capital Purchase Program DCF: Discounted Cash Flow DDA: Demand Deposit Account ERISA: Employee Retirement Income Security Act ERM: Enterprise Risk Management ERMC: Enterprise Risk Management Committee EVE: Economic Value of Equity FASB: Financial Accounting Standards Board FDIC: Federal Deposit Insurance Corporation FHLB: Federal Home Loan Bank FHLMC: Federal Home Loan Mortgage Corporation FICO: Fair Isaac Corporation (credit rating) FNMA: Federal National Mortgage Association FRB: Federal Reserve Bank FTAM: Fifth Third Asset Management, Inc. FTE: Fully Taxable Equivalent FTP: Funds Transfer Pricing FTPS: Fifth Third Processing Solutions FTS: Fifth Third Securities |
GNMA: Government National Mortgage Association IFRS: International Financial Reporting Standards IPO: Initial Public Offering IRS: Internal Revenue Service LIBOR: London InterBank Offered Rate LTV: Loan-to-Value MD&A: Management’s Discussion and Analysis of Financial Condition and Results of Operations MSR: Mortgage Servicing Right NII: Net Interest Income OCI: Other Comprehensive Income OREO: Other Real Estate Owned OTTI: Other-Than-Temporary Impairment PMI: Private Mortgage Insurance SEC: United States Securities and Exchange Commission SCAP: Supervisory Capital Assessment Program TARP: Troubled Asset Relief Program TDR: Troubled Debt Restructuring TLGP: Temporary Liquidity Guarantee Program TSA: Transition Service Agreement U.S. GAAP: Accounting principles generally accepted in the United States of America VIE: Variable Interest Entity VRDN: Variable Rate Demand Note |
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Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 2)
The following is MD&A of certain significant factors that have affected Fifth Third Bancorp’s (the “Bancorp” or “Fifth Third”) financial condition and results of operations during the periods included in the Condensed Consolidated Financial Statements, which are a part of this filing. Reference to the Bancorp incorporates the parent holding company and all consolidated subsidiaries.
TABLE 1: Selected Financial Data
| For the three months | For the six months | |||||||||||||||||||||||
| ended June 30, | ended June 30, | |||||||||||||||||||||||
| ($ in millions, except per share data) |
2011 | 2010 | % Change | 2011 | 2010 | % Change | ||||||||||||||||||
| Income Statement Data |
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| Net interest income(a) |
$ | 869 | 887 | (2 | ) | $ | 1,752 | 1,788 | (2 | ) | ||||||||||||||
| Noninterest income |
656 | 620 | 6 | 1,240 | 1,247 | (1 | ) | |||||||||||||||||
| Total revenue(a) |
1,525 | 1,507 | 1 | 2,992 | 3,035 | (1 | ) | |||||||||||||||||
| Provision for loan and lease losses |
113 | 325 | (65 | ) | 281 | 915 | (69 | ) | ||||||||||||||||
| Noninterest expense |
901 | 935 | (4 | ) | 1,819 | 1,891 | (4 | ) | ||||||||||||||||
| Net income attributable to Bancorp |
337 | 192 | 75 | 602 | 182 | 231 | ||||||||||||||||||
| Net income available to common shareholders |
328 | 130 | 153 | 417 | 57 | 625 | ||||||||||||||||||
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| Common Share Data |
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| Earnings per share, basic |
$ | 0.36 | 0.16 | 125 | $ | 0.46 | 0.07 | 557 | ||||||||||||||||
| Earnings per share, diluted |
0.35 | 0.16 | 119 | 0.46 | 0.07 | 557 | ||||||||||||||||||
| Cash dividends per common share |
0.06 | 0.01 | 500 | 0.12 | 0.02 | 500 | ||||||||||||||||||
| Book value per share |
13.23 | 12.65 | 5 | 13.23 | 12.65 | 5 | ||||||||||||||||||
| Market value per share |
12.75 | 12.29 | 4 | 12.75 | 12.29 | 4 | ||||||||||||||||||
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| Financial Ratios (%) |
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| Return on assets |
1.22 | 0.68 | 79 | 1.09 | 0.32 | 241 | ||||||||||||||||||
| Return on average common equity |
11.0 | 5.2 | 112 | 7.2 | 1.2 | 500 | ||||||||||||||||||
| Return on average tangible common equity(b) |
14.0 | 7.4 | 89 | 9.3 | 3.9 | 138 | ||||||||||||||||||
| Average equity as a percent of average assets |
11.1 | 12.0 | (8 | ) | 11.4 | 12.0 | (5 | ) | ||||||||||||||||
| Tangible common equity(b) |
8.64 | 6.55 | 32 | 8.64 | 6.55 | 32 | ||||||||||||||||||
| Net interest margin(a) |
3.62 | 3.57 | 1 | 3.66 | 3.60 | 2 | ||||||||||||||||||
| Efficiency(a) |
59.1 | 62.1 | (5 | ) | 60.8 | 62.3 | (2 | ) | ||||||||||||||||
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| Credit Quality |
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| Net losses charged off |
$ | 304 | 434 | (30 | ) | $ | 671 | 1,016 | (34 | ) | ||||||||||||||
| Net losses charged off as a percent of average loans and leases |
1.56 | 2.26 | (31 | ) | 1.74 | 2.64 | (34 | ) | ||||||||||||||||
| ALLL as a percent of loans and leases |
3.35 | 4.85 | (31 | ) | 3.35 | 4.85 | (31 | ) | ||||||||||||||||
| Allowance for credit losses as a percent of loans and leases(c) |
3.61 | 5.18 | (30 | ) | 3.61 | 5.18 | (30 | ) | ||||||||||||||||
| Nonperforming assets as a percent of loans, leases and other assets, including other real estate owned(d) |
2.66 | 3.87 | (31 | ) | 2.66 | 3.87 | (31 | ) | ||||||||||||||||
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| Average Balances |
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| Loans and leases, including held for sale |
$ | 79,153 | 78,807 | — | $ | 79,265 | 79,468 | — | ||||||||||||||||
| Total securities and other short-term investments |
17,192 | 20,891 | (18 | ) | 17,241 | 20,726 | (17 | ) | ||||||||||||||||
| Total assets |
111,200 | 112,613 | (1 | ) | 111,023 | 113,021 | (2 | ) | ||||||||||||||||
| Transaction deposits(e) |
71,506 | 65,508 | 9 | 70,838 | 64,859 | 9 | ||||||||||||||||||
| Core deposits(f) |
78,244 | 76,844 | 2 | 77,887 | 76,555 | 2 | ||||||||||||||||||
| Wholesale funding(g) |
16,433 | 18,977 | (13 | ) | 16,430 | 19,591 | (16 | ) | ||||||||||||||||
| Bancorp shareholders’ equity |
12,365 | 13,563 | (9 | ) | 12,706 | 13,541 | (6 | ) | ||||||||||||||||
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| Regulatory Capital Ratios (%) |
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| Tier I capital |
11.93 | 13.65 | (12 | ) | 11.93 | 13.65 | (12 | ) | ||||||||||||||||
| Total risk-based capital |
16.03 | 17.99 | (11 | ) | 16.03 | 17.99 | (11 | ) | ||||||||||||||||
| Tier I leverage |
11.03 | 12.24 | (10 | ) | 11.03 | 12.24 | (10 | ) | ||||||||||||||||
| Tier I common equity(b) |
9.20 | 7.17 | 28 | 9.20 | 7.17 | 28 | ||||||||||||||||||
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| (a) | Amounts presented on an FTE basis. The FTE adjustment for the three months ended June 30, 2011 and 2010 was $5 and for the six months ended June 30, 2011 and 2010 was $9. |
| (b) | The return on average tangible common equity, tangible common equity and Tier I common equity ratios are non-GAAP measures. For further information, see the Non-GAAP Financial Measures section of the MD&A. |
| (c) | The allowance for credit losses is the sum of the ALLL and the reserve for unfunded commitments. |
| (d) | Excludes nonaccrual loans held for sale. |
| (e) | Includes demand, interest checking, savings, money market and foreign office deposits. |
| (f) | Includes transaction deposits plus other time deposits. |
| (g) | Includes certificates $100 thousand and over, other deposits, federal funds purchased, short-term borrowings and long-term debt. |
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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Fifth Third Bancorp is a diversified financial services company headquartered in Cincinnati, Ohio. At June 30, 2011, the Bancorp had $111 billion in assets, operated 15 affiliates with 1,316 full-service Banking Centers, including 103 Bank Mart® locations open seven days a week inside select grocery stores, and 2,456 Jeanie® ATMs in 12 states throughout the Midwestern and Southeastern regions of the United States. The Bancorp reports on four business segments: Commercial Banking, Branch Banking, Consumer Lending and Investment Advisors. The Bancorp also has a 49% interest in Vantiv, LLC, formerly Fifth Third Processing Solutions, LLC.
This overview of MD&A highlights selected information in the financial results of the Bancorp and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources and critical accounting policies and estimates, you should carefully read this entire document. Each of these items could have an impact on the Bancorp’s financial condition, results of operations and cash flows. In addition, see the Glossary of Terms on page 3 of this report for a list of acronyms included as a tool for the reader of this quarterly report on Form 10-Q. The acronyms identified therein are used throughout this MD&A, as well as the Condensed Consolidated Financial Statements and Notes to Condensed Consolidated Financial Statements.
The Bancorp believes that banking is first and foremost a relationship business where the strength of the competition and challenges for growth can vary in every market. The Bancorp believes its affiliate operating model provides a competitive advantage by emphasizing individual relationships. Through its affiliate operating model, individual managers at all levels within the affiliates are given the opportunity to tailor financial solutions for their customers.
The Bancorp’s revenues are dependent on both net interest income and noninterest income. For the three months ended June 30, 2011, net interest income, on an FTE basis, and noninterest income provided 57% and 43% of total revenue, respectively. The Bancorp derives the majority of its revenues within the United States from customers domiciled in the United States. Revenue from foreign countries and external customers domiciled in foreign countries is immaterial to the Bancorp’s Condensed Consolidated Financial Statements. Changes in interest rates, credit quality, economic trends and the capital markets are primary factors that drive the performance of the Bancorp. As discussed later in the Risk Management section, risk identification, measurement, monitoring, control and reporting are important to the management of risk and to the financial performance and capital strength of the Bancorp.
Net interest income is the difference between interest income earned on assets such as loans, leases and securities, and interest expense incurred on liabilities such as deposits, short-term borrowings and long-term debt. Net interest income is affected by the general level of interest rates, the relative level of short-term and long-term interest rates, changes in interest rates and changes in the amount and composition of interest-earning assets and interest-bearing liabilities. Generally, the rates of interest the Bancorp earns on its assets and pays on its liabilities are established for a period of time. The change in market interest rates over time exposes the Bancorp to interest rate risk through potential adverse changes to net interest income and financial position. The Bancorp manages this risk by continually analyzing and adjusting the composition of its assets and liabilities based on their payment streams and interest rates, the timing of their maturities and their sensitivity to changes in market interest rates. Additionally, in the ordinary course of business, the Bancorp enters into certain derivative transactions as part of its overall strategy to manage its interest rate and prepayment risks. The Bancorp is also exposed to the risk of losses on its loan and lease portfolio as a result of changing expected cash flows caused by loan defaults and inadequate collateral due to a weakened economy within the Bancorp’s footprint.
Net interest income, net interest margin and the efficiency ratio are presented in MD&A on an FTE basis. The FTE basis adjusts for the tax-favored status of income from certain loans and securities held by the Bancorp that are not taxable for federal income tax purposes. The Bancorp believes this presentation to be the preferred industry measurement of net interest income as it provides a relevant comparison between taxable and non-taxable amounts.
Noninterest income is derived primarily from service charges on deposits, corporate banking revenue, mortgage banking net revenue, fiduciary and investment management fees and card and processing revenue. Noninterest expense is primarily driven by personnel costs and occupancy expenses, costs incurred in the origination of loans and leases and insurance premiums paid to the FDIC.
Redemption of Trust Preferred Securities
On March 18, 2011, the Bancorp announced that the Federal Reserve Board did not object to the Bancorp’s capital plan submitted under the Federal Reserve’s Comprehensive Capital Analysis and Review. Pursuant to this plan, during June of 2011 the Bancorp redeemed certain trust preferred securities, totaling $452 million, which related to the Fifth Third Capital Trust VII, First National Bankshares Statutory Trust I and R&G Capital Trust II, LLT.
Legislative Developments
On July 21, 2010, the Dodd-Frank Act was signed into law. This act implements changes to the financial services industry and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The legislation establishes a Bureau of Consumer Financial Protection responsible for implementing and enforcing compliance with consumer financial laws, changes the methodology for determining deposit insurance assessments, gives the Federal Reserve the ability to regulate and limit interchange rates charged to merchants for the use of debit cards, and excludes certain instruments currently included in determining Tier I regulatory capital. This act calls for federal regulatory agencies to adopt hundreds of new rules and conduct multiple studies over the next several years in order
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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
to implement its provisions. While the total impact of this legislation on Fifth Third is not currently known, the impact is expected to be substantial and may have an adverse impact on Fifth Third’s financial performance and growth opportunities.
Earnings Summary
The Bancorp’s net income available to common shareholders for the second quarter of 2011 was $328 million, or $0.35 per diluted share, which was net of $9 million in preferred stock dividends. For the second quarter of 2010, the Bancorp’s net income available to common shareholders was $130 million, or $0.16 per diluted share, which was net of $62 million in preferred stock dividends. The Bancorp’s net income available to common shareholders for the six months ended June 30, 2011 was $417 million, or $0.46 per diluted share, which was net of $185 million in preferred stock dividends. The preferred stock dividends for the six months ended June 30, 2011 included $153 million in discount accretion resulting from the Bancorp’s repurchase of Series F preferred stock. For the six months ended June 30, 2010, the Bancorp’s net income available to common shareholders was $57 million, or $0.07 per diluted share, which was net of $125 million in preferred stock dividends.
Net interest income (FTE) decreased two percent in the second quarter of 2011 to $869 million, compared to $887 million in the same period last year. The decrease from the second quarter of 2010 was primarily due to a 32 bp decrease in the average yield on loans and leases from the second quarter of 2010, as well as a $3.4 billion, or three percent, decline in total average interest-earnings assets. Partially offsetting these items was a 23 bp decrease in the average rate paid on interest-bearing liabilities primarily driven by a mix shift from higher cost term deposits to lower cost deposit products, coupled with a five percent decrease in average interest-bearing liabilities. Net interest income (FTE) was $1.8 billion for the six months ended June 30, 2011 and 2010. Net interest income for the six months ended June 30, 2011 compared to the same period in the prior year was impacted by a 14 bp decrease in average yield on average interest earning assets and a $3.7 billion decrease in average interest bearing assets offset by 25 bp decrease in the average rate paid on interest bearing liabilities and a $4.6 billion decrease in average interest bearing liabilities. Net interest income for the three and six months ended June 30, 2011 included $10 million and $23 million, respectively, in accretion of discounts on loans and deposits from acquisitions during 2008 compared to $17 million and $38 million for the three and six months ended June 30, 2010. Excluding these items, net interest income decreased $11 million from the second quarter of 2010 and $21 million from the six months ended June 30, 2010. Net interest margin increased to 3.62% and 3.66% for the three and six months ended June 30, 2011, respectively compared to 3.57% and 3.60% for the same periods in the prior year.
Noninterest income increased six percent to $656 million in the second quarter of 2011 compared to the same period last year. Noninterest income was $1.2 billion for the six months ended June 30, 2011 and 2010. The increase from the second quarter of 2010 was primarily due to an increase in mortgage banking net revenue and investment advisory revenue partially offset by a decrease in service charges on deposits. Mortgage banking net revenue increased $48 million, or 42%, primarily due to an increase in gains on net valuation adjustments on MSRs and MSR derivatives partially offset by a decline in origination fees and gains on loan sales. Investment advisory revenue increased $8 million, or 10%, due to improved market conditions and expansion of the sales force. Service charges on deposits decreased $23 million, or 16%, primarily due to the impact of Regulation E.
Noninterest expense decreased four percent to $901 million in the second quarter of 2011 and decreased four percent to $1.8 billion for the six months ended June 30, 2011 compared to the same periods in the prior year. The decrease from the second quarter of 2010 and the six months ended June 30, 2010 was primarily due to decreases of $16 million and $34 million, respectively, in FDIC insurance and other taxes, $14 million and $30 million, respectively, in the provision for unfunded commitments and letters of credit, and $4 million and $33 million, respectively in the provision for representation and warranty reserves related to residential mortgage loans sold to third parties. Partially offsetting this activity was an increase in personnel expenses of $15 million compared to the second quarter of 2010 and $47 million compared to the six months ended June 30, 2010.
The Bancorp does not originate subprime mortgage loans, does not hold credit default swaps and does not hold asset-backed securities backed by subprime mortgage loans in its securities portfolio. However, the Bancorp has exposure to disruptions in the capital markets and weakened economic conditions. Throughout 2010 and into 2011, the Bancorp continued to be affected by high unemployment rates, weakened housing markets, particularly in the upper Midwest and Florida, and a challenging credit environment. Credit trends, however, continued to show signs of moderation and, as a result, the provision for loan and lease losses decreased 65% to $113 million and 69% to $281 million for the three and six months ended June 30, 2011 compared to $325 million and $915 million, respectively, for the same periods in 2010. In addition, net charge-offs as a percent of average loans and leases decreased to 1.56% during the second quarter of 2011 compared to 2.26% during the second quarter of 2010 and decreased to 1.74% for the six months ended June 30, 2011 compared to 2.64% for the six months ended June 30, 2010. At June 30, 2011, nonperforming assets as a percent of loans, leases and other assets, including OREO (excluding nonaccrual loans held for sale) decreased to 2.66%, compared to 2.79% at December 31, 2010 and 3.87% at June 30, 2010. For further discussion on credit quality, see the Credit Risk Management section.
The Bancorp’s capital ratios exceed the “well-capitalized” guidelines as defined by the Board of Governors of the Federal Reserve System. As of June 30, 2011, the Tier I capital ratio was 11.93%, the Tier I leverage ratio was 11.03% and the total risk-based capital ratio was 16.03%. For additional information on the Bancorp’s capital ratios, see the Capital Management section.
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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
The Bancorp considers various measures when evaluating capital utilization and adequacy, including the return on average tangible common equity ratio, tangible equity ratio, tangible common equity ratio and tier I common equity ratio, in addition to capital ratios defined by banking regulators. These calculations are intended to complement the capital ratios defined by banking regulators for both absolute and comparative purposes. Because U.S. GAAP does not include capital ratio measures, the Bancorp believes there are no comparable U.S. GAAP financial measures to these ratios. Tier I common equity is not formally defined by U.S. GAAP or codified in the federal banking regulations and, therefore, is considered to be a non-GAAP financial measure. Since analysts and banking regulators may assess the Bancorp’s capital adequacy using these ratios, the Bancorp believes they are useful to provide investors the ability to assess its capital adequacy on the same basis.
The Bancorp believes these non-GAAP measures are important because they reflect the level of capital available to withstand unexpected market conditions. Additionally, presentation of these measures allows readers to compare certain aspects of the Bancorp’s capitalization to other organizations. However, because there are no standardized definitions for these ratios, the Bancorp’s calculations may not be comparable with other organizations, and the usefulness of these measures to investors may be limited. As a result, the Bancorp encourages readers to consider its Condensed Consolidated Financial Statements in their entirety and not to rely on any single financial measure.
The following table reconciles non-GAAP financial measures to U.S. GAAP as of or for the three months ended:
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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
| TABLE 2: Non-GAAP Financial Measures | ||||||||||||
| June
30, 2011 |
December 31, 2010 |
June 30, 2010 |
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| As of ($ in millions) |
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| Net income available to common shareholders (U.S. GAAP) |
$ | 328 | 270 | 130 | ||||||||
| Add: Intangible amortization, net of tax |
4 | 7 | 7 | |||||||||
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| Tangible net income available to common shareholders |
332 | 277 | 137 | |||||||||
| Tangible net income available to common shareholders (annualized) (1) |
1,332 | 1,099 | 550 | |||||||||
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| Average Bancorp shareholders’ equity (U.S. GAAP) |
12,365 | 14,007 | 13,563 | |||||||||
| Less: Average preferred stock |
(398 | ) | (3,648 | ) | (3,626 | ) | ||||||
| Average goodwill |
(2,417 | ) | (2,417 | ) | (2,417 | ) | ||||||
| Average intangible assets |
(52 | ) | (67 | ) | (88 | ) | ||||||
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| Average tangible common equity (2) |
9,498 | 7,875 | 7,432 | |||||||||
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| Total Bancorp shareholders’ equity (U.S. GAAP) |
$ | 12,572 | 14,051 | 13,701 | ||||||||
| Less: Preferred stock |
(398 | ) | (3,654 | ) | (3,631 | ) | ||||||
| Goodwill |
(2,417 | ) | (2,417 | ) | (2,417 | ) | ||||||
| Intangible assets |
(49 | ) | (62 | ) | (83 | ) | ||||||
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| Tangible common equity, including unrealized gains / losses |
9,708 | 7,918 | 7,570 | |||||||||
| Less: Accumulated other comprehensive income |
(396 | ) | (314 | ) | (440 | ) | ||||||
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| Tangible common equity, excluding unrealized gains / losses (3) |
9,312 | 7,604 | 7,130 | |||||||||
| Add: Preferred stock |
398 | 3,654 | 3,631 | |||||||||
|
|
|
|
|
|
|
|||||||
| Tangible equity (4) |
9,710 | 11,258 | 10,761 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total assets (U.S. GAAP) |
$ | 110,805 | 111,007 | 112,025 | ||||||||
| Less: Goodwill |
(2,417 | ) | (2,417 | ) | (2,417 | ) | ||||||
| Intangible assets |
(49 | ) | (62 | ) | (83 | ) | ||||||
| Accumulated other comprehensive income, before tax |
(609 | ) | (483 | ) | (677 | ) | ||||||
|
|
|
|
|
|
|
|||||||
| Tangible assets, excluding unrealized gains / losses (5) |
$ | 107,730 | 108,045 | 108,848 | ||||||||
|
|
|
|
|
|
|
|||||||
| Total Bancorp shareholders’ equity (U.S. GAAP) |
$ | 12,572 | 14,051 | 13,701 | ||||||||
| Less: Goodwill and certain other intangibles |
(2,536 | ) | (2,546 | ) | (2,537 | ) | ||||||
| Accumulated other comprehensive income |
(396 | ) | (314 | ) | (440 | ) | ||||||
| Add: Qualifying trust preferred securities |
2,312 | 2,763 | 2,763 | |||||||||
| Other |
20 | 11 | (25 | ) | ||||||||
|
|
|
|
|
|
|
|||||||
| Tier I capital |
11,972 | 13,965 | 13,462 | |||||||||
| Less: Preferred stock |
(398 | ) | (3,654 | ) | (3,631 | ) | ||||||
| Qualifying trust preferred securities |
(2,312 | ) | (2,763 | ) | (2,763 | ) | ||||||
| Qualified noncontrolling interest in consolidated subsidiaries |
(30 | ) | (30 | ) | — | |||||||
|
|
|
|
|
|
|
|||||||
| Tier I common equity (6) |
$ | 9,232 | 7,518 | 7,068 | ||||||||
|
|
|
|
|
|
|
|||||||
| Risk-weighted assets (7) (a) |
$ | 100,320 | 100,561 | 98,604 | ||||||||
| Ratios: |
||||||||||||
| Return on average tangible common equity (1) / (2) |
14.02 | % | 13.95 | 7.40 | ||||||||
| Tangible equity (4) / (5) |
9.01 | % | 10.42 | 9.89 | ||||||||
| Tangible common equity (3) / (5) |
8.64 | 7.04 | 6.55 | |||||||||
| Tier I common equity (6) / (7) |
9.20 | 7.48 | 7.17 | |||||||||
| (a) | Under the banking agencies’ risk-based capital guidelines, assets and credit equivalent amounts of derivatives and off-balance sheet exposures are assigned to broad risk categories. The aggregate dollar amount in each risk category is multiplied by the associated risk weight of the category. The resulting weighted values are added together, along with the measure for market risk, resulting in the Bancorp’s total risk-weighted assets. |
8
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Note 3 of the Notes to Condensed Consolidated Financial Statements provides a complete discussion of the significant new accounting standards recently adopted by the Bancorp and the expected impact of significant accounting standards issued, but not yet required to be adopted.
The Bancorp’s Condensed Consolidated Financial Statements are prepared in accordance with U.S. GAAP. Certain accounting policies require management to exercise judgment in determining methodologies, economic assumptions and estimates that may materially affect the value of the Bancorp’s assets or liabilities and results of operations and cash flows. The Bancorp’s critical accounting policies include the accounting for the ALLL, reserve for unfunded commitments, income taxes, valuation of servicing rights, fair value measurements and goodwill. These accounting policies are discussed in detail in Management’s Discussion and Analysis - Critical Accounting Policies in the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2010. No material changes have been made to the valuation techniques or models during the six months ended June 30, 2011.
9
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Net Interest Income
Net interest income is the interest earned on securities, loans and leases (including yield-related fees) and other interest-earning assets less the interest paid for core deposits (includes transaction deposits and other time deposits) and wholesale funding (includes certificates of deposit $100,000 and over, other deposits, federal funds purchased, short-term borrowings and long-term debt). The net interest margin is calculated by dividing net interest income by average interest-earning assets. Net interest rate spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. Net interest margin is typically greater than net interest rate spread due to the interest income earned on those assets that are funded by noninterest-bearing liabilities, or free funding, such as demand deposits or shareholders’ equity.
Tables 3 and 4 present the components of net interest income, net interest margin and net interest rate spread for the three and six months ended June 30, 2011 and 2010. Nonaccrual loans and leases and loans held for sale have been included in the average loan and lease balances. Average outstanding securities balances are based on amortized cost with any unrealized gains or losses on available-for-sale securities included in other assets.
Net interest income was $869 million for the second quarter of 2011, a decrease of $18 million from the second quarter of 2010. Net interest income was $1,752 million for the six months ended June 30, 2011 a decrease of $36 million from the six months ended June 30, 2010. Included within net interest income are amounts related to the accretion of discounts on acquired loans and deposits, primarily as a result of the second quarter 2008 acquisition of First Charter Corporation, which increased net interest income $10 million and $23 million during the three and six months ended June 30, 2011, respectively, compared to $17 million and $38 million during the three and six months ended June 30, 2010, respectively. The original purchase accounting discount reflected the high discount rate in the market at the time of the acquisition; the total loan discounts are being accreted into net interest income over the remaining period to maturity of the loans acquired. Based upon the remaining period to maturity, and excluding the impact of prepayments, the Bancorp anticipates recognizing approximately $14 million in additional net interest income during the remainder of 2011 as a result of the amortization and accretion of premiums and discounts on acquired loans and deposits. Exclusive of the impact of these items, net interest income decreased $11 million compared to the second quarter of 2010 and $21 million from the six months ended June 30, 2010.
For the three and six months ended June 30, 2011, net interest income was adversely impacted by lower yields on both the commercial and consumer loan portfolios partially offset by an increase in average consumer loans and a decrease in interest expense compared to the three and six months ended June 30, 2010, respectively. Yields on the commercial and consumer loan portfolio have decreased throughout 2011 as the result of low interest rates during 2011. Average consumer loans increased primarily as the result of increases in average residential mortgage loans and automobile loans compared to the three and six months ended June 30, 2010. The decreases in interest expense was primarily the result of a $3.9 billion and $4.6 billion decrease in average interest bearing liabilities for the three and six months ended June 30, 2010, respectively, coupled with a mix shift to lower cost core deposits as well as the benefit of lower rates offered on savings account balances. The decrease in average interest bearing liabilities was the result of migration from certificates of deposit into demand accounts due to low interest rates during 2011. The shift in funding composition partially offset by the decrease in yields on loans and leases resulted in an increase in the net interest rate spread to 3.37% and 3.41% for the three and six months ended June 30, 2011, respectively, compared to 3.28% and 3.30% for the three and six months ended June 30, 2010, respectively.
Net interest margin increased to 3.62% and 3.66% for the three and six months ended June 30, 2011, respectively, compared to 3.57% and 3.60% for the three and six months ended June 30, 2010, respectively. Net interest margin was impacted by the amortization and accretion of premiums and discounts on acquired loans and deposits that increased net interest margin approximately 4 bp and 8 bp during the three and six months ended June 30, 2011, respectively, compared to a 6 bp and 14 bp increase during the three and six months ended June 30, 2010, respectively. Exclusive of these amounts, net interest margin increased 7 bp for the second quarter of 2011 and 12 bp for the six months ended June 30, 2011 compared to the same periods in the prior year. The increase from both periods in 2010 was driven by the previously mentioned shift in funding composition to lower cost core deposits, an increase in free-funding balances and an increase in the net interest rate spread.
Total average interest-earning assets for the three and six months ended June 30, 2011 decreased three percent and four percent from the three and six months ended June 30, 2010, respectively. The decrease from the three months ended June 30, 2010 was the result of a two percent decline in average commercial loans and an 18% decrease in the average investment portfolio partially offset by the three percent increase in average consumer loans and leases. The decrease from the six months ended June 30, 2010 was the result of a three percent decrease in average commercial loans and a 17% decrease in the average investment portfolio partially offset by a three percent increase in average consumer loans.
Interest income from loans and leases decreased $58 million, or six percent, compared to second quarter of 2010 and $106 million, or six percent, compared to the six months ended June 30, 2010. The decrease from the three and six months ended June 30, 2010 was primarily the result of a 32 bp and 26 bp decrease in average yields, respectively, partially offset by a three percent increase in average consumer loans compared to both periods. Yields across much of the loan and lease portfolio decreased as the result of lower interest rates on newly originated loans and a decline in interest rates on automobile loans due to increased competition. Exclusive of the amortization and accretion of premiums and discounts on acquired loans, interest income from loans and leases decreased $51 million and $91 million compared to the
10
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
three and six months ended June 30, 2010. Interest income from investment securities and short-term investments decreased $13 million, or eight percent, compared to the three months ended June 30, 2010 primarily due to an 18% decrease in average balances. Interest income from investment securities and short-term investments decreased $48 million, or 14%, compared to the six months ended June 30, 2010 primarily due to a 17% decrease in the average balance and a 12 bp decrease on the yield of taxable securities.
Average core deposits increased $1.4 billion, or two percent, compared to the second quarter of 2010 and increased $1.3 billion, or two percent, compared to the six months ended June 30, 2010. The increase from both periods was primarily due to an increase in average savings, average demand deposits and average foreign office deposits, partially offset by a decrease in average time deposits. The cost of average core deposits decreased to 39 bp and 42 bp for the three and six months ended June 30, 2011, respectively, from 67 bp and 69 bp for the three and six months ended June 30, 2010. This decrease was primarily the result of a mix shift to lower cost core deposits and a 27 bp and 26 bp decrease in rates on average savings deposits compared to the three and six months ended June 30, 2010, respectively.
For the three months ended June 30, 2011, interest expense on wholesale funding decreased $2 million, or two percent, compared to the three months ended June 30, 2010, primarily as a result of a $2.5 billion decrease in the average balance partially offset by a 30 bp increase in the rate. During the six months ended June 30, 2011, interest expense on wholesale funding decreased $19 million, or nine percent, compared to the six months ended June 30, 2010 primarily as the result of a $3.2 billion decrease in the average balance partially offset by a 20 bp increase in rate. Both periods in 2011 were impacted by the repayment of $1.0 billion of long-term debt during the fourth quarter of 2010 and the Bancorp’s redemption of $452 million of trust preferred securities, classified as long term debt, during June of 2011 partially offset by the issuance of $1.0 billion in long-term debt, that carries a 3.625% rate of interest, during the first quarter of 2011. During the three and six months ended June 30, 2011, wholesale funding represented 23% of interest-bearing liabilities compared to 25%, respectively, during the three and six months ended June 30, 2010. Refer to the Borrowings section of MD&A for additional information on the Bancorp’s change in average long-term debt. For more information on the Bancorp’s interest rate risk management, including estimated earnings sensitivity to changes in market interest rates, see the Market Risk Management section of MD&A.
11
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
TABLE 3: Condensed Average Balance Sheets and Analysis of Net Interest Income
| For the three months ended |
June 30, 2011 | June 30, 2010 | Attribution of Change in Net Interest Income (a) |
|||||||||||||||||||||||||||||||||
| ($ in millions) |
Average Balance |
Revenue/ Cost |
Average Yield Rate |
Average Balance |
Revenue/ Cost |
Average Yield Rate |
Volume | Yield/Rate | Total | |||||||||||||||||||||||||||
| Assets |
||||||||||||||||||||||||||||||||||||
| Interest-earning assets: |
||||||||||||||||||||||||||||||||||||
| Loans and leases:(b) |
||||||||||||||||||||||||||||||||||||
| Commercial and industrial loans |
$ | 27,970 | $ | 304 | 4.35 | % | $ | 26,179 | $ | 310 | 4.75 | % | $ | 21 | (27 | ) | (6 | ) | ||||||||||||||||||
| Commercial mortgage |
10,491 | 105 | 4.00 | 11,772 | 120 | 4.10 | (12 | ) | (3 | ) | (15 | ) | ||||||||||||||||||||||||
| Commercial construction |
1,950 | 15 | 3.01 | 3,258 | 25 | 3.15 | (9 | ) | (1 | ) | (10 | ) | ||||||||||||||||||||||||
| Commercial leases |
3,349 | 34 | 4.06 | 3,336 | 38 | 4.51 | — | (4 | ) | (4 | ) | |||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Subtotal – commercial |
43,760 | 458 | 4.19 | 44,545 | 493 | 4.44 | — | (35 | ) | (35 | ) | |||||||||||||||||||||||||
| Residential mortgage loans |
10,655 | 120 | 4.54 | 9,390 | 112 | 4.77 | 14 | (6 | ) | 8 | ||||||||||||||||||||||||||
| Home equity |
11,144 | 109 | 3.91 | 12,102 | 121 | 4.01 | (9 | ) | (3 | ) | (12 | ) | ||||||||||||||||||||||||
| Automobile loans |
11,188 | 134 | 4.81 | 10,170 | 154 | 6.01 | 13 | (33 | ) | (20 | ) | |||||||||||||||||||||||||
| Credit card |
1,834 | 45 | 9.91 | 1,859 | 50 | 10.91 | (1 | ) | (4 | ) | (5 | ) | ||||||||||||||||||||||||
| Other consumer loans/leases |
572 | 31 | 22.02 | 742 | 25 | 13.65 | (7 | ) | 13 | 6 | ||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Subtotal – consumer |
35,393 | 439 | 4.99 | 34,263 | 462 | 5.40 | 10 | (33 | ) | (23 | ) | |||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Total loans and leases |
79,153 | 897 | 4.54 | 78,808 | 955 | 4.86 | 10 | (68 | ) | (58 | ) | |||||||||||||||||||||||||
| Securities: |
||||||||||||||||||||||||||||||||||||
| Taxable |
15,115 | 150 | 3.97 | 16,451 | 161 | 3.93 | (11 | ) | — | (11 | ) | |||||||||||||||||||||||||
| Exempt from income taxes(b) |
96 | 2 | 6.41 | 154 | 3 | 6.98 | (1 | ) | — | (1 | ) | |||||||||||||||||||||||||
| Other short-term investments |
1,981 | 1 | 0.25 | 4,285 | 2 | 0.20 | (1 | ) | — | (1 | ) | |||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Total interest-earning assets |
96,345 | 1,050 | 4.37 | 99,698 | 1,121 | 4.51 | (3 | ) | (68 | ) | (71 | ) | ||||||||||||||||||||||||
| Cash and due from banks |
2,356 | 2,163 | ||||||||||||||||||||||||||||||||||
| Other assets |
15,298 | 14,550 | ||||||||||||||||||||||||||||||||||
| Allowance for loan and lease losses |
(2,799 | ) | (3,798 | ) | ||||||||||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||||||||||
| Total assets |
$ | 111,200 | $ | 112,613 | ||||||||||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||||||||||
| Liabilities and Equity |
||||||||||||||||||||||||||||||||||||
| Interest-bearing liabilities: |
||||||||||||||||||||||||||||||||||||
| Interest checking |
$ | 18,701 | $ | 12 | 0.26 | % | $ | 18,652 | $ | 14 | 0.30 | % | $ | — | (2 | ) | (2 | ) | ||||||||||||||||||
| Savings |
21,817 | 18 | 0.33 | 19,446 | 30 | 0.60 | 3 | (15 | ) | (12 | ) | |||||||||||||||||||||||||
| Money market |
5,009 | 4 | 0.29 | 4,679 | 5 | 0.42 | — | (1 | ) | (1 | ) | |||||||||||||||||||||||||
| Foreign office deposits |
3,805 | 3 | 0.29 | 3,325 | 3 | 0.36 | — | — | — | |||||||||||||||||||||||||||
| Other time deposits |
6,738 | 40 | 2.40 | 11,336 | 76 | 2.70 | (28 | ) | (8 | ) | (36 | ) | ||||||||||||||||||||||||
| Certificates - $100,000 and over |
3,955 | 20 | 2.05 | 6,354 | 34 | 2.13 | (13 | ) | (1 | ) | (14 | ) | ||||||||||||||||||||||||
| Other deposits |
2 | — | 0.02 | 5 | — | 0.10 | — | — | — | |||||||||||||||||||||||||||
| Federal funds purchased |
344 | — | 0.11 | 264 | — | 0.17 | — | — | — | |||||||||||||||||||||||||||
| Other short-term borrowings |
1,605 | 1 | 0.16 | 1,478 | 1 | 0.21 | — | — | — | |||||||||||||||||||||||||||
| Long-term debt |
10,527 | 83 | 3.16 | 10,876 | 71 | 2.64 | (2 | ) | 14 | 12 | ||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Total interest-bearing liabilities |
72,503 | 181 | 1.00 | 76,415 | 234 | 1.23 | (40 | ) | (13 | ) | (53 | ) | ||||||||||||||||||||||||
| Demand deposits |
22,174 | 19,406 | ||||||||||||||||||||||||||||||||||
| Other liabilities |
4,129 | 3,229 | ||||||||||||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||||||||||
| Total liabilities |
98,806 | 99,050 | ||||||||||||||||||||||||||||||||||
| Total equity |
12,394 | 13,563 | ||||||||||||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||||||||||
| Total liabilities and equity |
$ | 111,200 | $ | 112,613 | ||||||||||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||||||||||
| Net interest income |
$ | 869 | $ | 887 | $ | 37 | (55 | ) | (18 | ) | ||||||||||||||||||||||||||
| Net interest margin |
3.62 | % | 3.57 | % | ||||||||||||||||||||||||||||||||
| Net interest rate spread |
3.37 | 3.28 | ||||||||||||||||||||||||||||||||||
| Interest-bearing liabilities to interest-earning assets |
75.25 | 76.65 | ||||||||||||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||||||||||
| (a) | Changes in interest not solely due to volume or yield/rate are allocated in proportion to the absolute dollar amount of change in volume and yield/rate. |
| (b) | The FTE adjustments included in the above table are $5 for the three months ended June 30, 2011 and 2010. |
12
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
TABLE 4: Condensed Average Balance Sheets and Analysis of Net Interest Income
| For the six months ended |
June 30, 2011 | June 30, 2010 | Attribution of Change in Net Interest Income (a) |
|||||||||||||||||||||||||||||||||
| ($ in millions) |
Average Balance |
Revenue/ Cost |
Average Yield Rate |
Average Balance |
Revenue/ Cost |
Average Yield Rate |
Volume | Yield/Rate | Total | |||||||||||||||||||||||||||
| Assets |
||||||||||||||||||||||||||||||||||||
| Interest-earning assets: |
||||||||||||||||||||||||||||||||||||
| Loans and leases:(b) |
||||||||||||||||||||||||||||||||||||
| Commercial and industrial loans |
$ | 27,689 | $ | 605 | 4.40 | % | $ | 26,239 | $ | 609 | 4.68 | % | $ | 33 | (37 | ) | (4 | ) | ||||||||||||||||||
| Commercial mortgage |
10,652 | 214 | 4.06 | 11,804 | 243 | 4.15 | (24 | ) | (5 | ) | (29 | ) | ||||||||||||||||||||||||
| Commercial construction |
2,017 | 31 | 3.08 | 3,518 | 53 | 3.03 | (23 | ) | 1 | (22 | ) | |||||||||||||||||||||||||
| Commercial leases |
3,356 | 69 | 4.12 | 3,402 | 76 | 4.53 | — | (7 | ) | (7 | ) | |||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Subtotal – commercial |
43,714 | 919 | 4.24 | 44,963 | 981 | 4.40 | (14 | ) | (48 | ) | (62 | ) | ||||||||||||||||||||||||
| Residential mortgage loans |
10,695 | 244 | 4.60 | 9,434 | 233 | 4.98 | 29 | (18 | ) | 11 | ||||||||||||||||||||||||||
| Home equity |
11,259 | 220 | 3.94 | 12,219 | 243 | 4.01 | (18 | ) | (5 | ) | (23 | ) | ||||||||||||||||||||||||
| Automobile loans |
11,130 | 273 | 4.95 | 10,178 | 309 | 6.13 | 27 | (63 | ) | (36 | ) | |||||||||||||||||||||||||
| Credit card |
1,843 | 93 | 10.17 | 1,899 | 102 | 10.83 | (3 | ) | (6 | ) | (9 | ) | ||||||||||||||||||||||||
| Other consumer loans/leases |
624 | 62 | 20.14 | 775 | 49 | 12.73 | (11 | ) | 24 | 13 | ||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Subtotal – consumer |
35,551 | 892 | 5.06 | 34,505 | 936 | 5.47 | 24 | (68 | ) | (44 | ) | |||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Total loans and leases |
79,265 | 1,811 | 4.61 | 79,468 | 1,917 | 4.87 | 10 | (116 | ) | (106 | ) | |||||||||||||||||||||||||
| Securities: |
||||||||||||||||||||||||||||||||||||
| Taxable |
15,135 | 298 | 3.96 | 16,843 | 341 | 4.08 | (30 | ) | (13 | ) | (43 | ) | ||||||||||||||||||||||||
| Exempt from income taxes(b) |
147 | 3 | 5.31 | 165 | 6 | 7.03 | (1 | ) | (2 | ) | (3 | ) | ||||||||||||||||||||||||
| Other short-term investments |
1,959 | 2 | 0.25 | 3,718 | 4 | 0.19 | (3 | ) | 1 | (2 | ) | |||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Total interest-earning assets |
96,506 | 2,114 | 4.42 | 100,194 | 2,268 | 4.56 | (24 | ) | (130 | ) | (154 | ) | ||||||||||||||||||||||||
| Cash and due from banks |
2,313 | 2,205 | ||||||||||||||||||||||||||||||||||
| Other assets |
15,098 | 14,407 | ||||||||||||||||||||||||||||||||||
| Allowance for loan and lease losses |
(2,894 | ) | (3,785 | ) | ||||||||||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||||||||||
| Total assets |
$ | 111,023 | $ | 113,021 | ||||||||||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||||||||||
| Liabilities and Equity |
||||||||||||||||||||||||||||||||||||
| Interest-bearing liabilities: |
||||||||||||||||||||||||||||||||||||
| Interest checking |
$ | 18,621 | $ | 25 | 0.27 | % | $ | 19,090 | $ | 28 | 0.29 | % | $ | (1 | ) | (2 | ) | (3 | ) | |||||||||||||||||
| Savings |
21,572 | 40 | 0.38 | 18,960 | 60 | 0.64 | 7 | (27 | ) | (20 | ) | |||||||||||||||||||||||||
| Money market |
5,072 | 8 | 0.30 | 4,651 | 10 | 0.44 | 1 | (3 | ) | (2 | ) | |||||||||||||||||||||||||
| Foreign office deposits |
3,693 | 6 | 0.30 | 3,043 | 5 | 0.35 | 1 | — | 1 | |||||||||||||||||||||||||||
| Other time deposits |
7,049 | 83 | 2.38 | 11,696 | 158 | 2.73 | (57 | ) | (18 | ) | (75 | ) | ||||||||||||||||||||||||
| Certificates - $100,000 and over |
4,090 | 41 | 2.02 | 6,700 | 71 | 2.14 | (26 | ) | (4 | ) | (30 | ) | ||||||||||||||||||||||||
| Other deposits |
2 | — | 0.03 | 6 | — | 0.05 | — | — | — | |||||||||||||||||||||||||||
| Federal funds purchased |
327 | — | 0.12 | 242 | — | 0.15 | — | — | — | |||||||||||||||||||||||||||
| Other short-term borrowings |
1,622 | 2 | 0.18 | 1,464 | 2 | 0.22 | — | — | — | |||||||||||||||||||||||||||
| Long-term debt |
10,389 | 157 | 3.05 | 11,179 | 146 | 2.64 | (11 | ) | 22 | 11 | ||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Total interest-bearing liabilities |
72,437 | 362 | 1.01 | 77,031 | 480 | 1.26 | (86 | ) | (32 | ) | (118 | ) | ||||||||||||||||||||||||
| Demand deposits |
21,880 | 19,115 | ||||||||||||||||||||||||||||||||||
| Other liabilities |
3,970 | 3,334 | ||||||||||||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||||||||||
| Total liabilities |
98,287 | 99,480 | ||||||||||||||||||||||||||||||||||
| Total equity |
12,736 | 13,541 | ||||||||||||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||||||||||
| Total liabilities and equity |
$ | 111,023 | $ | 113,021 | ||||||||||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||||||||||
| Net interest income |
$ | 1,752 | $ | 1,788 | $ | 62 | (98 | ) | (36 | ) | ||||||||||||||||||||||||||
| Net interest margin |
3.66 | % | 3.60 | % | ||||||||||||||||||||||||||||||||
| Net interest rate spread |
3.41 | 3.30 | ||||||||||||||||||||||||||||||||||
| Interest-bearing liabilities to interest-earning assets |
75.06 | 76.88 | ||||||||||||||||||||||||||||||||||
| (a) | Changes in interest not solely due to volume or yield/rate are allocated in proportion to the absolute dollar amount of change in volume and yield/rate. |
| (b) | The FTE adjustments included in the above table are $9 for the six months ended June 30, 2011 and 2010. |
13
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Provision for Loan and Lease Losses
The Bancorp provides as an expense an amount for probable loan and lease losses within the loan and lease portfolio that is based on factors discussed in the Critical Accounting Policies section of the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2010. The provision is recorded to bring the ALLL to a level deemed appropriate by the Bancorp to cover losses inherent in the portfolio. Actual credit losses on loans and leases are charged against the ALLL. The amount of loans actually removed from the Condensed Consolidated Balance Sheets is referred to as charge-offs. Net charge-offs include current period charge-offs less recoveries on previously charged-off loans and leases.
The provision for loan and lease losses was $113 million and $281 million for the three and six months ended June 30, 2011, respectively, compared to $325 million and $915 million during the comparable periods in 2010. The decrease in provision expense compared to the same prior year periods was due to decreases in nonperforming loans and leases, improved delinquency metrics in commercial and consumer loans and leases, and improvement in underlying loss trends. As of June 30, 2011, the ALLL as a percent of loans and leases decreased to 3.35%, from 4.85% at June 30, 2010.
Refer to the Credit Risk Management section as well as Note 6 of the Notes to Condensed Consolidated Financial Statements for more detailed information on the provision for loan and lease losses, including an analysis of loan portfolio composition, nonperforming assets, net charge-offs, and other factors considered by the Bancorp in assessing the credit quality of the loan and lease portfolio and the ALLL.
Noninterest Income
Noninterest income increased $36 million, or six percent, for the second quarter of 2011 compared to the second quarter of 2010 and decreased $7 million, or one percent, for the six months ended June 30, 2011 compared to the same period in the prior year. The components of noninterest income for the three and six months ended June 30, 2011 and 2010 are as follows:
TABLE 5: Noninterest Income
| For the three months | For the six months | |||||||||||||||||||||||
| ended June 30, | Percent | ended June 30, | Percent | |||||||||||||||||||||
| ($ in millions) |
2011 | 2010 | Change | 2011 | 2010 | Change | ||||||||||||||||||
| Mortgage banking net revenue |
$ | 162 | 114 | 42 | $ | 264 | 266 | (1 | ) | |||||||||||||||
| Service charges on deposits |
126 | 149 | (16 | ) | 250 | 291 | (14 | ) | ||||||||||||||||
| Investment advisory revenue |
95 | 87 | 10 | 193 | 177 | 9 | ||||||||||||||||||
| Corporate banking revenue |
95 | 93 | 2 | 181 | 174 | 4 | ||||||||||||||||||
| Card and processing revenue |
89 | 84 | 5 | 169 | 158 | 8 | ||||||||||||||||||
| Other noninterest income |
83 | 85 | (2 | ) | 164 | 160 | 3 | |||||||||||||||||
| Securities gains, net |
6 | 8 | (25 | ) | 14 | 21 | (33 | ) | ||||||||||||||||
| Securities gains, net, non-qualifying hedges on mortgage servicing rights |
— | — | NM | 5 | — | NM | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total noninterest income |
$ | 656 | 620 | 6 | $ | 1,240 | 1,247 | (1 | ) | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| NM: Not meaningful | ||||||||||||||||||||||||
Mortgage banking net revenue increased $48 million during the three months ended June 30, 2011 compared to the three months ended June 30, 2010 and decreased $2 million during the six months ended June 30, 2011 compared to the six months ended June 30, 2010. The components of mortgage banking net revenue are as follows:
TABLE 6: Components of Mortgage Banking Net Revenue
| For the three months ended June 30, |
For the six months ended June 30, |
|||||||||||||||
| ($ in millions) |
2011 | 2010 | 2011 | 2010 | ||||||||||||
| Origination fees and gains on loan sales |
$ | 64 | 89 | $ | 126 | 160 | ||||||||||
| Net servicing revenue: |
||||||||||||||||
| Servicing fees |
58 | 54 | 116 | 107 | ||||||||||||
| Servicing rights amortization |
(25 | ) | (25 | ) | (53 | ) | (49 | ) | ||||||||
| Net valuation adjustments on servicing rights and free-standing derivatives entered into to economically hedge MSR |
65 | (4 | ) | 75 | 48 | |||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Net servicing revenue |
98 | 25 | 138 | 106 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Mortgage banking net revenue |
$ | 162 | 114 | $ | 264 | 266 | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
Origination fees and gains on loan sales decreased $25 million and $34 million for the three and six months ended June 30, 2011 compared to the three and six months ended June 30, 2010. The decrease from both periods in the prior year was primarily the result of an 18% and three percent decrease in loan originations from the three and six months ended June 30, 2010, respectively, and a decrease in margins on sold loans. Residential mortgage loan originations decreased to $3.1 billion during the second quarter of 2011 compared to $3.8 billion during the second quarter of 2010 and decreased to $7.1 billion during the six months ended June 30, 2011 from $7.3 billion during the six months
14
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
ended June 30, 2010. The decrease in originations from both periods is primarily due to a decrease in refinancing activity as many customers have taken advantage of the low interest rate environment in prior periods.
Net servicing revenue is comprised of gross servicing fees and related servicing rights amortization as well as valuation adjustments on MSRs and mark-to-market adjustments on both settled and outstanding free-standing derivative financial instruments. Net servicing revenue increased $73 million and $32 million for the three and six months ended June 30, 2011 compared to the three and six months ended June 30, 2010 driven primarily by an increase of $69 million and $27 million, respectively, in net valuation adjustments. The net valuation adjustment of $65 million during the second quarter of 2011 included $129 million in gains from derivatives economically hedging the MSRs partially offset by $64 million in temporary impairment on the MSR portfolio. The net valuation adjustment of $75 million for the six months ended June 30, 2011 included $102 million in gains from derivatives economically hedging the MSR portfolio partially offset by $27 million of temporary impairment on the MSR portfolio. Refinancing activity in recent years has resulted in prepayments being less sensitive to lower mortgage rates due to customers taking advantage of lower rates in those earlier periods as well as the impact of tighter underwriting standards. The net MSR/hedge position has benefited from the positive carry of the hedge and the widening spread between mortgage and swap rates. The Bancorp’s total residential loans serviced as of June 30, 2011, December 31, 2010, and June 30, 2010 was $66.8 billion, $63.2 billion, and $61.0 billion, respectively, with $56.0 billion, $54.2 billion, and $51.3 billion, respectively, of residential mortgage loans serviced for others.
Servicing rights are deemed impaired when a borrower’s loan rate is distinctly higher than prevailing rates. Impairment on servicing rights is reversed when the prevailing rates return to a level commensurate with the borrower’s loan rate. Further detail on the valuation of MSRs can be found in Note 9 of the Notes to Condensed Consolidated Financial Statements. The Bancorp maintains a non-qualifying hedging strategy to manage a portion of the risk associated with changes in the valuation on the MSR portfolio. See Note 10 of the Notes to Condensed Consolidated Financial Statements for more information on the free-standing derivatives used to economically hedge the MSR portfolio.
In addition to the derivative positions used to economically hedge the MSR portfolio, the Bancorp acquires various securities as a component of its non-qualifying hedging strategy. Net gains on sales of these securities were $5 million for the six months ended June 30, 2011. There were no sales of securities related to the Bancorp’s non-qualifying hedging strategy during the second quarter of 2011 or the three and six months ended June 30, 2010.
Service charges on deposits decreased $23 million and $41 million for the three and six months ended June 30, 2011 compared to the three and six months ended June 30, 2010. Consumer deposit revenue decreased $26 million and $44 million for the three and six months ended June 30, 2011, respectively, compared to the same periods in the prior year primarily due to the impact of Regulation E and new overdraft policies that resulted in a decrease in overdraft occurrences. Regulation E became effective on July 1, 2010 for new accounts and August 15, 2010 for existing accounts. Regulation E is a FRB rule that prohibits financial institutions from charging consumers fees for paying overdrafts on ATMs and one-time debit card transactions unless a consumer consents, or opts in, to the overdraft service for those types of transactions. Commercial deposit revenue increased $2 million and $3 million for the three and six months ended June 30, 2011, respectively, compared to the same periods in the prior year. The increase from both periods in the prior year was primarily due to a decrease in earnings credits paid on customer balances as the result of a decrease in the crediting rate applied to balances. Commercial customers receive earnings credits to offset the fees charged for banking services on their deposit accounts such as account maintenance, lockbox, ACH transactions, wire transfers and other ancillary corporate treasury management services. Earnings credits are based on the customer’s average balance in qualifying deposits multiplied by the crediting rate. Qualifying deposits include demand deposits and interest-bearing checking accounts. The Bancorp has a standard crediting rate that is adjusted as necessary based on the competitive market conditions and changes in short-term interest rates.
Investment advisory revenue increased $8 million and $16 million for the three and six months ended June 30, 2011 compared to the three and six months ended June 30, 2010. The increases from both periods in the prior year was primarily due to improved market performance and sales force expansion that resulted in increased brokerage activity and assets under management and care. As of June 30, 2011, the Bancorp had approximately $276 billion in assets under care and managed $25 billion in assets for individuals, corporations and not-for-profit organizations.
Corporate banking revenue increased $2 million and $7 million for the three and six months ended June 30, 2011 compared to the three and six months ended June 30, 2010. The increase from both prior year periods was primarily the result of increases in syndication fees, business lending fees, and derivative sales partially offset by decreases in international income and institutional sales.
Card and processing revenue increased $5 million and $11 million for the three and six months ended June 30, 2011 compared to the three and six months ended June 30, 2010. The increase from both periods in the prior year was due to growth in debit and credit card transaction volumes.
15
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
The major components of other noninterest income are as follows:
TABLE 7: Components of Other Noninterest Income
| For the three months ended June 30, |
For the six months ended June 30, |
|||||||||||||||
| ($ in millions) |
2011 | 2010 | 2011 | 2010 | ||||||||||||
| Operating lease income |
$ | 14 | 15 | $ | 30 | 31 | ||||||||||
| BOLI income |
11 | 12 | 21 | 23 | ||||||||||||
| Cardholder fees |
9 | 8 | 18 | 19 | ||||||||||||
| Gain on loan sales |
8 | 6 | 25 | 31 | ||||||||||||
| Consumer loan and lease fees |
8 | 9 | 15 | 15 | ||||||||||||
| Banking center income |
7 | 5 | 14 | 10 | ||||||||||||
| TSA revenue |
5 | 13 | 16 | 26 | ||||||||||||
| Insurance income |
5 | 8 | 13 | 17 | ||||||||||||
| Loss on sale of OREO |
(26 | ) | (13 | ) | (28 | ) | (29 | ) | ||||||||
| Other |
42 | 22 | 40 | 17 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total other noninterest income |
$ | 83 | 85 | $ | 164 | 160 | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
Other noninterest income decreased $2 million, or two percent, in the second quarter of 2011 compared to the second quarter of 2010 and increased $4 million, or two percent, for the six months ended June 30, 2011 compared to the same period in the prior year. The decrease compared to the second quarter of 2010 was primarily due to a $13 million increase in the loss on sale of OREO, an $8 million decrease in TSA revenue and a $3 million decrease in insurance income partially offset by a $21 million increase in the valuation of warrants and put options issued as part of the Processing Business sale in 2009, recorded in the “other” caption. The increase compared to the six months ended June 30, 2010 was primarily due to the previously mentioned $21 million increase in valuation of warrants and put options partially offset by a $10 million decrease in TSA revenue and a $6 million decrease in gains on loan sales. As part of the Processing Business Sale in 2009, the Bancorp entered into a TSA that resulted in the Bancorp recognizing approximately $5 million and $16 million in revenue during the three and six months ended June 30, 2011, respectively, that were offset with expense from the TSA recorded in noninterest expense.
Net securities gains were $6 million and $14 million for the three and six months ended June 30, 2011, respectively, compared to $8 million and $21 million for the three and six months ended June 30, 2010, respectively.
Noninterest Expense
Total noninterest expense decreased $34 million, or four percent for the three months ended June 30, 2011, and $72 million, or four percent, for the six months ended June 30, 2011 compared to the three and six months ended June 30, 2010, respectively. The decrease from both periods in the prior year was primarily due to a decrease in other noninterest expense, partially offset by an increase in total personnel costs. The major components of noninterest expense are detailed in the following table.
TABLE 8: Noninterest Expense
| For the three months ended June 30, |
Percent | For the six months ended June 30, |
Percent | |||||||||||||||||||||
| ($ in millions) |
2011 | 2010 | Change | 2011 | 2010 | Change | ||||||||||||||||||
| Salaries, wages and incentives |
$ | 365 | 356 | 2 | $ | 716 | 686 | 4 | ||||||||||||||||
| Employee benefits |
79 | 73 | 9 | 176 | 159 | 11 | ||||||||||||||||||
| Net occupancy expense |
75 | 73 | 2 | 152 | 150 | 1 | ||||||||||||||||||
| Technology and communications |
48 | 45 | 6 | 93 | 90 | 3 | ||||||||||||||||||
| Card and processing expense |
29 | 31 | (8 | ) | 58 | 56 | 3 | |||||||||||||||||
| Equipment expense |
28 | 31 | (9 | ) | 57 | 60 | (6 | ) | ||||||||||||||||
| Other noninterest expense |
277 | 326 | (15 | ) | 567 | 690 | (18 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total noninterest expense |
$ | 901 | 935 | (4 | ) | $ | 1,819 | 1,891 | (4 | ) | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total personnel costs (salaries, wages and incentives plus employee benefits) increased three and six percent, respectively, for the three and six months ended June 30, 2011, compared to the same periods last year, due to an increase in base and incentive compensation driven by investments in the sales force beginning in mid-2010. Full time equivalent employees totalled 20,953 at June 30, 2011 compared to 20,479 at June 30, 2010.
16
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
The major components of other noninterest expense are as follows:
TABLE 9: Components of Other Noninterest Expense
| For the three months ended June 30, |
For the six months ended June 30, |
|||||||||||||||
| ($ in millions) |
2011 | 2010 | 2011 | 2010 | ||||||||||||
| FDIC insurance and other taxes |
$ | 50 | 66 | $ | 101 | 135 | ||||||||||
| Loan and lease |
48 | 47 | 94 | 95 | ||||||||||||
| Marketing |
31 | 27 | 53 | 48 | ||||||||||||
| Affordable housing investments impairment |
26 | 24 | 50 | 47 | ||||||||||||
| Losses and adjustments |
22 | 30 | 51 | 93 | ||||||||||||
| Travel |
14 | 13 | 26 | 24 | ||||||||||||
| Postal and courier |
12 | 12 | 25 | 24 | ||||||||||||
| Professional services fees |
12 | 11 | 26 | 21 | ||||||||||||
| Operating lease |
10 | 11 | 21 | 22 | ||||||||||||
| Recruitment and education |
8 | 8 | 15 | 15 | ||||||||||||
| Intangible asset amortization |
6 | 11 | 13 | 23 | ||||||||||||
| OREO |
6 | 7 | 18 | 14 | ||||||||||||
| Insurance |
1 | 11 | 13 | 25 | ||||||||||||
| Provision for unfunded commitments and letters of credit |
(14 | ) | (6 | ) | (30 | ) | 3 | |||||||||
| Other |
45 | 54 | 91 | 101 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total other noninterest expense |
$ | 277 | 326 | $ | 567 | 690 | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
Total other noninterest expense decreased $49 million and $123 million, respectively, for the three and six months ended June 30, 2011 compared to the same periods in the prior year. The decrease from both periods in the prior year was primarily due to decreases in FDIC insurance and other taxes, the provision for unfunded commitments and letters of credit, the provision for representation and warranty reserve related to residential mortgage loans sold to third-parties, insurance expense and expenses related to the TSA. FDIC insurance and other taxes decreased $16 million and $34 million, respectively, for the three and six months ended June 30, 2011 compared to same periods in the prior year due primarily to the FDIC’s implementation of amended regulations that revise the Federal Deposit Insurance Act as a result of the Dodd-Frank Act. The amended regulations modified the definition of an institution’s deposit insurance assessment base from domestic deposits to quarterly average total assets less quarterly average tangible equity as well as modified the assessment rate calculation; additionally, the six months ended June 30, 2010 included expenses due to the Bancorp’s participation in the FDIC’s TLGP transaction account guarantee program, which was exited during the first quarter of 2010. The provision for unfunded commitments and letters of credit was a benefit of $14 million and $30 million, respectively, for the three and six months ended June 30, 2011 compared to a benefit of $6 million and an expense of $3 million, respectively, for the three and six months ended June 30, 2010 due to lower estimates of inherent losses resulting from a decrease in delinquent loans as general economic conditions continued to show signs of moderation during 2011. The provision for representation and warranty claims, included in other losses and adjustments, decreased $4 million and $33 million, respectively, for the three and six months ended June 30, 2011 compared to the same periods in the prior year primarily due to a decrease in demand requests during 2011. Insurance expense decreased $10 million and $12 million, respectively, for the three and six months ended June 30, 2011 compared to the same periods in the prior year primarily due to the benefit recorded on the termination of a reinsurance agreement with a third-party during the second quarter of 2011. Refer to Note 12 of the Notes to Condensed Consolidated Financial Statements for additional information on the termination of the reinsurance agreement. TSA related expenses decreased to approximately $5 million and $16 million, respectively, for the three and six months ended June 30, 2011 compared to $16 million and $26 million in the same periods in the prior year due to Vantiv’s transition to their own supporting systems. The three and six months ended June 30, 2011 also include $6 million of gains, recorded in the “other” caption, as a result of the redemption of certain trust preferred securities during June of 2011.
The Bancorp continues to focus on efficiency initiatives as part of its core emphasis on operating leverage and expense control. The efficiency ratio (noninterest expense divided by the sum of net interest income (FTE) and noninterest income) was 59.1% and 60.8% for the three and six months ended June 30, 2011 compared to 62.1% and 62.3% for the three and six months ended June 30, 2010, respectively.
Applicable Income Taxes
The Bancorp’s income before income taxes, applicable income tax expense and effective tax rate are as follows:
TABLE 10: Applicable Income Taxes
| For the three months ended June 30, |
For the six months ended June 30, |
|||||||||||||||
| ($ in millions) |
2011 | 2010 | 2011 | 2010 | ||||||||||||
| Income before income taxes |
$ | 506 | 242 | 883 | 220 | |||||||||||
| Applicable income tax expense |
169 | 50 | 281 | 38 | ||||||||||||
| Effective tax rate |
33.3 | % | 20.5 | % | 31.8 | % | 17.3 | % | ||||||||
17
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Applicable income tax expense for all periods includes the tax benefit from tax-exempt income, tax-advantaged investments and general business tax credits, partially offset by the effect of certain nondeductible expenses. The tax credits are associated with the Low-Income Housing Tax Credit program established under Section 42 of the Internal Revenue Code (IRC), the New Markets Tax Credit program established under section 45D of the IRC and the Rehabilitation Investment Tax Credit program established under section 47 of the IRC and the Qualified Zone Academy Bond program established under Section 1397E of the IRC. The increase in the effective tax rate for the three months ended June 30, 2011 from the prior year quarter was primarily due to higher forecasted pre-tax income as well as an increase in the amount of non-cash charges relating to previously recognized tax benefits associated with stock-based awards that will not be realized. The increase in the effective tax rate for the six months ended June 30, 2011 from the prior year period was primarily due to higher forecasted pre-tax income as well as a $24 million tax benefit resulting from the settlement of certain uncertain tax positions with the IRS during the first quarter of 2010.
Deductibility of Executive Compensation
Certain sections of the Internal Revenue Code limit the deductibility of compensation paid to or earned by certain executive officers of a public company. This has historically limited the deductibility of certain executive compensation to $1 million per executive officer, and the Bancorp’s compensation philosophy has been to position pay to ensure deductibility. However, both the amount of the executive compensation that is deductible for certain executive officers and the allowable compensation vehicles changed as a result of the Bancorp’s participation in TARP. In particular, the Bancorp was not permitted to deduct compensation earned by certain executive officers in excess of $500,000 per executive officer as a result of the Bancorp’s participation in TARP. Therefore, a portion of the compensation earned by certain executive officers was not deductible by the Bancorp for the period in which the Bancorp participated in TARP. Subsequent to ending its participation in TARP, certain limitations on the deductibility of executive compensation will continue to apply to some forms of compensation earned while under TARP. The Bancorp’s Compensation Committee determined that the underlying executive compensation programs are appropriate and necessary to attract, retain and motivate senior executives, and that failing to meet these objectives creates more risk for the Bancorp and its value than the financial impact of losing the tax deduction. For the year ended 2010, the total tax impact for non-deductible compensation was $6 million.
18
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Loans and Leases
The Bancorp classifies its loans and leases based upon the primary purpose of the loan. Table 11 summarizes end of period loans and leases, including loans held for sale, and Table 12 summarizes average total loans and leases, including loans held for sale.
TABLE 11: Components of Total Loans and Leases (includes held for sale)
| June 30, 2011 | December 31, 2010 | June 30, 2010 | ||||||||||||||||||||||
| ($ in millions) |
Balance | % of Total | Balance | % of Total | Balance | % of Total | ||||||||||||||||||
| Commercial: |
||||||||||||||||||||||||
| Commercial and industrial loans |
$ | 28,155 | 36 | $ | 27,275 | 34 | $ | 26,011 | 33 | |||||||||||||||
| Commercial mortgage loans |
10,331 | 13 | 10,992 | 14 | 11,569 | 15 | ||||||||||||||||||
| Commercial construction loans |
1,805 | 2 | 2,111 | 3 | 3,042 | 4 | ||||||||||||||||||
| Commercial leases |
3,326 | 4 | 3,378 | 4 | 3,271 | 4 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Subtotal – commercial |
43,617 | 55 | 43,756 | 55 | 43,893 | 56 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Consumer: |
||||||||||||||||||||||||
| Residential mortgage loans |
10,838 | 14 | 10,857 | 14 | 9,672 | 12 | ||||||||||||||||||
| Home equity |
11,048 | 14 | 11,513 | 14 | 11,987 | 15 | ||||||||||||||||||
| Automobile loans |
11,315 | 14 | 10,983 | 14 | 10,285 | 13 | ||||||||||||||||||
| Credit card |
1,856 | 2 | 1,896 | 2 | 1,841 | 3 | ||||||||||||||||||
| Other consumer loans and leases |
478 | 1 | 702 | 1 | 704 | 1 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Subtotal – consumer |
35,535 | 45 | 35,951 | 45 | 34,489 | 44 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total loans and leases |
$ | 79,152 | 100 | $ | 79,707 | 100 | $ | 78,382 | 100 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total portfolio loans and leases (excludes loans held for sale) |
$ | 77,967 | $ | 77,491 | $ | 76,232 | ||||||||||||||||||
|
|
|
|
|
|
|
|||||||||||||||||||
Total loans and leases, including loans held for sale, decreased $555 million, or one percent, compared to December 31, 2010 , and increased $770 million, or one percent, from June 30, 2010. The decrease in total loans and leases from December 31, 2010 was the result of a $139 million decline in commercial loans and a $416 million decline in consumer loans. The increase in total loans and leases from June 30, 2010 was the result of a $1.0 billion increase in consumer loans partially offset by a $276 million decrease in commercial loans.
Total commercial loans and leases decreased $139 million from December 31, 2010 primarily due to declines in commercial mortgage loans and commercial construction loans, partially offset by an increase in commercial and industrial loans. Commercial mortgage loans decreased $661 million, or six percent, from December 31, 2010 as a result of tighter underwriting standards implemented in prior quarters in an effort to limit exposure to commercial real estate. Commercial construction loans decreased $306 million, or 14%, from December 31, 2010 due to runoff of non-owner occupied commercial real estate. The Bancorp decided to suspend lending on commercial non-owner occupied commercial real estate in 2008. Commercial and industrial loans increased $880 million, or three percent, from December 31, 2010, driven by an increase in new loan origination activity.
Total commercial loans and leases decreased $276 million, or one percent, compared to June 30, 2010 due primarily to decreases in commercial construction loans and commercial mortgage loans, partially offset by an increase in commercial and industrial loans. Commercial construction loans decreased $1.2 billion, or 41%, compared to June 30, 2010, primarily due to management’s strategy to suspend new lending on commercial non-owner occupied real estate beginning in 2008. Despite the inflow from completed construction projects, commercial mortgage loans decreased $1.2 billion, or 11%, compared to June 30, 2010, due to tighter underwriting standards on commercial real estate loans in an effort to limit exposure to commercial real estate. Commercial and industrial loans increased $2.1 billion, or eight percent, compared to June 30, 2010, driven by an increase in new loan origination activity, despite the $852 million decrease in loans originally issued to Vantiv, LLC, formerly Fifth Third Processing Solutions, LLC, in conjunction with the Processing Business Sale. Vantiv, LLC, refinanced the original $1.25 billion in loans into a larger syndicated structure in connection with an acquisition in the fourth quarter of 2010.
Total consumer loans and leases decreased $416 million, or one percent, from December 31, 2010 primarily due to declines in home equity loans and other consumer loans and leases partially offset by an increase in automobile loans. Home equity loans decreased $465 million, or four percent, compared to December 31, 2010, due to tighter underwriting standards implemented in prior quarters and decreased customer demand. Other consumer loans and leases, primarily made up of automobile leases as well as some student loans designated as held for sale, decreased $224 million, or 32%, compared to December 31, 2010 due to a decline in new originations driven by tighter underwriting standards implemented in prior quarters. Automobile loans increased $332 million, or three percent, compared to December 31, 2010, due to strong loan origination volumes through consistent and competitive pricing, enhanced customer service with our dealership network and disciplined sales execution. Residential mortgage loans and credit card loans remained relatively flat from December 31, 2010.
Total consumer loans and leases increased $1.0 billion, or three percent, compared to June 30, 2010 primarily due to increases in residential mortgage loans and automobile loans, partially offset by decreases in home equity loans and other consumer loans and leases. Residential mortgage loans and leases increased $1.2 billion, or 12%, from June 30, 2010, primarily due to management’s decision in the third quarter of
19
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
2010 to retain certain shorter term residential mortgage loans originated through the Bancorp’s retail branches. Automobile loans increased $1.0 billion, or 10 percent, from June 30, 2010, due to the previously mentioned strategic focus on increasing automobile lending during 2010 and throughout the first half of 2011. Home equity loans decreased $939 million, or 8%, compared to June 30, 2010 as a result of tighter underwriting standards and decreased customer demand. Other consumer loans and leases decreased $226 million, or 32%, compared to June 30, 2010 due to a decline in new originations driven by tighter underwriting standards.
TABLE 12: Components of Average Total Loans and Leases (includes held for sale)
| June 30, 2011 | December 31, 2010 | June 30, 2010 | ||||||||||||||||||||||
| ($ in millions) |
Balance | % of Total | Balance | % of Total | Balance | % of Total | ||||||||||||||||||
| Commercial: |
||||||||||||||||||||||||
| Commercial and industrial loans |
$ | 27,970 | 36 | $ | 26,509 | 34 | $ | 26,179 | 33 | |||||||||||||||
| Commercial mortgage loans |
10,491 | 13 | 11,276 | 14 | 11,772 | 15 | ||||||||||||||||||
| Commercial construction loans |
1,950 | 2 | 2,289 | 3 | 3,258 | 4 | ||||||||||||||||||
| Commercial leases |
3,349 | 4 | 3,314 | 4 | 3,336 | 5 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Subtotal – commercial |
43,760 | 55 | 43,388 | 55 | 44,545 | 57 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Consumer: |
||||||||||||||||||||||||
| Residential mortgage loans |
10,655 | 14 | 10,693 | 13 | 9,390 | 12 | ||||||||||||||||||
| Home equity |
11,144 | 14 | 11,655 | 15 | 12,102 | 15 | ||||||||||||||||||
| Automobile loans |
11,188 | 14 | 10,825 | 14 | 10,170 | 13 | ||||||||||||||||||
| Credit card |
1,834 | 2 | 1,844 | 2 | 1,859 | 2 | ||||||||||||||||||
| Other consumer loans and leases |
572 | 1 | 743 | 1 | 741 | 1 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Subtotal – consumer |
35,393 | 45 | 35,760 | 45 | 34,262 | 43 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total average loans and leases |
$ | 79,153 | 100 | $ | 79,148 | 100 | $ | 78,807 | 100 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total portfolio loans and leases (excludes loans held for sale) |
$ | 77,937 | $ | 76,236 | $ | 76,973 | ||||||||||||||||||
|
|
|
|
|
|
|
|||||||||||||||||||
Average total commercial loans and leases were relatively flat compared to December 31, 2010 and decreased $785 million, or two percent, compared to June 30, 2010. The decrease in average total commercial loans from June 30, 2010 was driven by tighter underwriting standards and lower demand for commercial mortgage loans, the suspension of lending on non-owner occupied commercial real estate in 2008, and the previously mentioned Vantiv, LLC, refinancing, partially offset by an increase in commercial and industrial originations.
Average total consumer loans and leases were relatively flat compared to December 31, 2010 and increased $1.1 billion, or three percent, compared to June 30, 2010. The increase in average total consumer loans and leases from June 30, 2010 was driven by increases in average residential mortgage loans and average automobile loans, partially offset by decreases in average home equity loans and average other consumer loans and leases. Average residential mortgage loans increased $1.3 billion, or 13%, average automobile loan balances increased $1.0 billion, or 10%, average home equity loans decreased $958 million, or eight percent, and other consumer loans and leases decreased $169 million, or 23%, from June 30, 2010 due to the reasons previously discussed.
Investment Securities
The Bancorp uses investment securities as a means of managing interest rate risk, providing liquidity support and providing collateral for pledging purposes. As of June 30, 2011 and December 31, 2010, total investment securities were $16.1 billion, compared to $16.6 billion at June 30, 2010.
Securities are classified as trading when bought and held principally for the purpose of selling them in the near term. Securities are classified as available-for-sale when, in management’s judgment, they may be sold in response to, or in anticipation of, changes in market conditions. Securities that management has the intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. The Bancorp’s management has evaluated the securities in an unrealized loss position in the available-for-sale and held-to-maturity portfolios for OTTI. See Note 4 of the Notes to Condensed Consolidated Financial Statements for further information on OTTI.
For all periods presented, the Bancorp’s investment portfolio consisted primarily of AAA-rated agency mortgage-backed securities, and did not hold asset-backed securities backed by subprime mortgage loans in its investment portfolio. Additionally, there was approximately $131 million of securities classified as below investment grade as of June 30, 2011, compared to $137 million as of December 31, 2010 and $142 million as of June 30, 2010.
20
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
TABLE 13: Components of Investment Securities
| ($ in millions) |
June 30, 2011 |
December 31, 2010 |
June 30, 2010 |
|||||||||
| Available-for-sale and other: (amortized cost basis) |
||||||||||||
| U.S. Treasury and Government agencies |
$ | 199 | 225 | 475 | ||||||||
| U.S. Government sponsored agencies |
2,141 | 1,564 | 1,692 | |||||||||
| Obligations of states and political subdivisions |
113 | 170 | 196 | |||||||||
| Agency mortgage-backed securities |
10,269 | 10,570 | 10,109 | |||||||||
| Other bonds, notes and debentures |
1,135 | 1,338 | 946 | |||||||||
| Other securities |
1,032 | 1,052 | 1,938 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total available-for-sale and other securities |
$ | 14,889 | 14,919 | 15,356 | ||||||||
|
|
|
|
|
|
|
|||||||
| Held-to-maturity: (amortized cost basis) |
||||||||||||
| Obligations of states and political subdivisions |
$ | 340 | 348 | 349 | ||||||||
| Other bonds, notes and debentures |
4 | 5 | 5 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total held-to-maturity |
$ | 344 | 353 | 354 | ||||||||
|
|
|
|
|
|
|
|||||||
| Trading: (fair value) |
||||||||||||
| Variable rate demand notes |
$ | 15 | 106 | 169 | ||||||||
| Other securities |
202 | 188 | 101 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total trading |
$ | 217 | 294 | 270 | ||||||||
|
|
|
|
|
|
|
|||||||
Available-for-sale securities on an amortized basis remained relatively flat compared to December 31, 2010 and decreased $467 million from June 30, 2010. The decrease from June 30, 2010 was due to a $906 million decrease in other securities partially offset by a $449 million increase in U.S. Government sponsored agency securities.
At June 30, 2011 and 2010, available-for-sale securities were 16% of total interest-earning assets, compared to 15% at December 31, 2010. The estimated weighted-average life of the debt securities in the available-for-sale portfolio was 4.5 years at June 30, 2011, compared to 4.4 years at December 31, 2010 and June 30, 2010. In addition, at June 30, 2011, the fixed-rate securities within the available-for-sale securities portfolio had a weighted-average yield of 4.28%, compared to 4.24% at December 31, 2010 and 4.41% at June 30, 2010.
Information presented in Table 14 is on a weighted-average life basis, anticipating future prepayments. Yield information is presented on an FTE basis and is computed using historical cost balances. Maturity and yield calculations for the total available-for-sale portfolio exclude equity securities that have no stated yield or maturity. Market rates declined slightly in the second quarter of 2011 from the fourth quarter of 2010, resulting in an increase in net unrealized gains on agency mortgage-backed securities to $471 million at June 30, 2011, compared to $403 million in December 31, 2010. Total net unrealized gains on the available-for-sale securities portfolio were $613 million at June 30, 2011, compared to $495 million at December 31, 2010 and $665 million at June 30, 2010.
21
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
TABLE 14: Characteristics of Available-for-Sale and Other Securities
| As of June 30, 2011 ($ in millions) |
Amortized Cost | Fair Value | Weighted-Average Life (in years) |
Weighted-Average Yield |
||||||||||||
| U.S. Treasury and Government agencies: |
||||||||||||||||
| Average life of one year or less |
$ | 51 | 50 | 0.7 | 0.95 | % | ||||||||||
| Average life 1 – 5 years |
49 | 51 | 1.2 | 1.44 | ||||||||||||
| Average life 5 – 10 years |
99 | 105 | 8.4 | 3.58 | ||||||||||||
| Average life greater than 10 years |
— | — | — | — | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total |
199 | 206 | 4.6 | 2.38 | ||||||||||||
| U.S. Government sponsored agencies: |
||||||||||||||||
| Average life of one year or less |
50 | 50 | 0.3 | 1.42 | ||||||||||||
| Average life 1 – 5 years |
388 | 392 | 4.2 | 2.55 | ||||||||||||
| Average life 5 – 10 years |
1,703 | 1,817 | 5.6 | 3.60 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total |
2,141 | 2,259 | 5.2 | 3.36 | ||||||||||||
| Obligations of states and political subdivisions:(a) |
||||||||||||||||
| Average life of one year or less |
23 | 23 | 0.2 | 7.39 | ||||||||||||
| Average life 1 – 5 years |
18 | 17 | 3.5 | 0.42 | ||||||||||||
| Average life 5 – 10 years |
61 | 63 | 6.9 | 2.53 | ||||||||||||
| Average life greater than 10 years |
11 | 12 | 11.3 | 5.02 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total |
113 | 115 | 5.4 | 3.45 | ||||||||||||
| Agency mortgage-backed securities: |
||||||||||||||||
| Average life of one year or less |
279 | 287 | 0.7 | 5.12 | ||||||||||||
| Average life 1 – 5 years |
7,406 | 7,823 | 3.6 | 4.65 | ||||||||||||
| Average life 5 – 10 years |
2,454 | 2,499 | 6.5 | 4.21 | ||||||||||||
| Average life greater than 10 years |
130 | 131 | 12.1 | 4.22 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total |
10,269 | 10,740 | 4.3 | 4.55 | ||||||||||||
| Other bonds, notes and debentures:(b) |
||||||||||||||||
| Average life of one year or less |
105 | 107 | 0.7 | 1.78 | ||||||||||||
| Average life 1 – 5 years |
750 | 758 | 2.9 | 3.87 | ||||||||||||
| Average life 5 – 10 years |
211 | 210 | 5.7 | 3.40 | ||||||||||||
| Average life greater than 10 years |
69 | 71 | 22.7 | 9.85 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total |
1,135 | 1,146 | 4.4 | 3.95 | ||||||||||||
| Other securities(c) |
1,032 | 1,036 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total available-for-sale and other securities |
$ | 14,889 | 15,502 | 4.5 | 4.28 | % | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| (a) | Taxable-equivalent yield adjustments included in the above table are 2.55%, 0.14%, 0.88%, 1.74% and 1.19% for securities with an average life of one year or less, 1-5 years, 5-10 years, greater than 10 years and in total, respectively. |
| (b) | Other bonds, notes, and debentures consist of non-agency mortgage backed securities, certain other asset backed securities (primarily automobile and commercial loan backed securities) and corporate bond securities. |
| (c) | Other securities consist of FHLB and FRB restricted stock holdings that are carried at par, FHLMC and FNMA preferred stock holdings and certain mutual fund holdings and equity security holdings. |
Trading securities decreased $77 million, or 26%, compared to December 31, 2010 and decreased $53 million, or 20%, compared to June 30, 2010. The decreases from December 31, 2010 and June 30, 2010 were driven by the sale of VRDNs, which were held by the Bancorp in its trading securities portfolio. These securities were purchased from the market through FTS who was also the remarketing agent. Rates on these securities declined in 2010 and, as a result, the Bancorp continued to sell the VRDNs, replacing them with higher-yielding agency mortgage-backed securities classified as available-for-sale. For more information on VRDNs, see Note 12 of the Notes to Condensed Consolidated Financial Statements.
Deposits
Deposit balances represent an important source of funding and revenue growth opportunity. The Bancorp is continuing to focus on core deposit growth in its retail and commercial franchises by improving customer satisfaction, building full relationships and offering competitive rates. Core deposits represented 69%, 70% and 68% of the Bancorp’s asset funding base at June 30, 2011, December 31, 2010 and June 30, 2010, respectively.
22
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
TABLE 15: Deposits
| June 30, 2011 | December 31, 2010 | June 30, 2010 | ||||||||||||||||||||||
| ($ in millions) |
Balance | % of Total |
Balance | % of Total |
Balance | % of Total |
||||||||||||||||||
| Demand |
$ | 22,589 | 28 | 21,413 | 26 | 19,256 | 23 | |||||||||||||||||
| Interest checking |
18,072 | 22 | 18,560 | 23 | 17,759 | 22 | ||||||||||||||||||
| Savings |
21,764 | 27 | 20,903 | 26 | 19,646 | 24 | ||||||||||||||||||
| Money market |
4,859 | 6 | 5,035 | 6 | 4,666 | 6 | ||||||||||||||||||
| Foreign office |
3,271 | 4 | 3,721 | 5 | 3,430 | 4 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Transaction deposits |
70,555 | 87 | 69,632 | 86 | 64,757 | 79 | ||||||||||||||||||
| Other time |
6,399 | 8 | 7,728 | 9 | 10,966 | 13 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Core deposits |
76,954 | 95 | 77,360 | 95 | 75,723 | 92 | ||||||||||||||||||
| Certificates - $100,000 and over |
3,642 | 5 | 4,287 | 5 | 6,389 | 8 | ||||||||||||||||||
| Other |
2 | — | 1 | — | 3 | — | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total deposits |
$ | 80,598 | 100 | 81,648 | 100 | 82,115 | 100 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Core deposits decreased $406 million, or one percent, compared to December 31, 2010, driven by a decrease in other time deposits, partially offset by an increase in transaction deposits. Other time deposits decreased $1.3 billion, or 17%, primarily as a result of continued runoff of CDs due to the low interest rate environment as customers have opted to maintain balances in more liquid transaction accounts. Transaction deposits increased $923 million, or one percent, primarily driven by an increase in demand deposits and saving deposits partially offset by a decrease in interest checking. Demand deposits increased $1.2 billion, or five percent, from December 31, 2010 due to commercial customers opting to hold money in demand deposit accounts rather than investing excess cash given current market conditions. Saving deposits increased $861 million, or four percent, primarily due to growth in the relationship savings program which offers customers double-interest bonus payments every month when an active checking account is held. These increases were partially offset by a decrease of $488 million, or three percent, in interest checking due to decreasing interest rates and seasonal decreases from year end balances
Core deposits increased $1.2 billion, or two percent, compared to June 30, 2010, driven by an increase in transaction deposits, partially offset by a decrease in other time deposits. The increase of $5.8 billion, or nine percent, in transaction deposits was driven primarily by increases in demand deposits and saving deposits. Demand deposits increased $3.3 billion, or 17%, due to an increase in new accounts from the relationship savings program, improved attrition levels, and growth from maturing certificate of deposits. Saving deposits increased $2.1 billion, or 11%, primarily due to the relationship savings program, an increase in new accounts in the Bancorp’s growth markets due to competitive interest rates, and growth due to maturing certificate of deposit accounts. The increase in transaction deposits was offset by a decrease of $4.6 billion, or 42%, in other time deposits, as customers maintained their balances in more liquid accounts as interest rates remained near historical lows.
Included in core deposits are foreign office deposits, which are Eurodollar sweep accounts for the Bancorp’s commercial customers. These accounts bear interest at rates slightly higher than money market accounts and unlike repurchase agreements the Bancorp does not have to pledge collateral. Foreign office deposits decreased $450 million, or 12%, from December 31, 2010 due to seasonality causing deposits to build up in the fourth quarter of 2010 and decrease over the first two quarters of 2011 along with a reduction in deposits due to decreasing interest rates.
The Bancorp uses certificates of deposit $100,000 and over, as a method to fund earning asset growth. At June 30, 2011, certificates $100,000 and over decreased $645 million, or 15%, compared to December 31, 2010, and decreased $2.7 billion, or 43%, compared to June 30, 2010, due to the reasons previously discussed.
23
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
The following table presents average deposits for the three months ending June 30, 2011, December 31, 2010, and June 30, 2010.
TABLE 16: Average Deposits
| June 30, 2011 | December 31, 2010 | June 30, 2010 | ||||||||||||||||||||||
| ($ in millions) |
Balance | % of Total |
Balance | % of Total |
Balance | % of Total |
||||||||||||||||||
| Demand |
$ | 22,174 | 27 | 21,066 | 26 | 19,406 | 23 | |||||||||||||||||
| Interest checking |
18,701 | 23 | 17,578 | 22 | 18,652 | 22 | ||||||||||||||||||
| Savings |
21,817 | 27 | 20,602 | 25 | 19,446 | 23 | ||||||||||||||||||
| Money market |
5,009 | 6 | 4,985 | 6 | 4,679 | 6 | ||||||||||||||||||
| Foreign office |
3,805 | 4 | 3,733 | 5 | 3,325 | 4 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Transaction deposits |
71,506 | 87 | 67,964 | 84 | 65,508 | 78 | ||||||||||||||||||
| Other time |
6,738 | 8 | 8,490 | 10 | 11,336 | 14 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Core deposits |
78,244 | 95 | 76,454 | 94 | 76,844 | 92 | ||||||||||||||||||
| Certificates - $100,000 and over |
3,955 | 5 | 4,858 | 6 | 6,354 | 8 | ||||||||||||||||||
| Other |
2 | — | 9 | — | 5 | — | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total average deposits |
$ | 82,201 | 100 | 81,321 | 100 | 83,203 | 100 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
On an average basis, core deposits increased $1.8 billion, or two percent, compared to the fourth quarter of 2010, and increased $1.4 billion, or two percent, compared to the second quarter of 2010 due to migration of higher priced certificates of deposit into transaction accounts, due to the impact of historically low rates and excess customer liquidity.
Borrowings
Total borrowings increased approximately $1.8 billion, or 16%, from December 31, 2010 and increased $472 million, or four percent, compared to June 30, 2010. The increase in total borrowings from December 31, 2010 was the result of increases in all components of borrowings. The increase in total borrowings compared to June 30, 2010 was driven by increases in federal funds purchased and other short-term borrowings, partially offset by a decrease in long-term debt. As of June 30, 2011, total borrowings as a percentage of interest-bearing liabilities was 19% compared to 16% at December 31, 2010 and 17% at June 30, 2010.
TABLE 17: Borrowings
| ($ in millions) |
June 30, 2011 | December 31, 2010 | June 30, 2010 | |||||||||
| Federal funds purchased |
$ | 403 | 279 | 240 | ||||||||
| Other short-term borrowings |
2,702 | 1,574 | 1,556 | |||||||||
| Long-term debt |
10,152 | 9,558 | 10,989 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total borrowings |
$ | 13,257 | 11,411 | 12,785 | ||||||||
|
|
|
|
|
|
|
|||||||
Long-term debt increased $594 million, or 6%, compared to December 31, 2010 primarily due to the issuance of $1.0 billion in senior notes in the first quarter of 2011 and an increase of approximately $320 million in structured repurchase agreements. These increases were offset primarily by the June 2011 redemption of $452 million of certain trust preferred securities, classified as long term debt. Federal funds purchased increased $124 million, or 44% compared to December 31, 2010, due to an increase in borrowings from the Bank’s correspondent banks. In order to meet its funding obligations, the Bancorp enters into repurchase agreements with customers, which are accounted for as collateralized financing transactions, where excess customer funds are borrowed overnight by the Bancorp, and later repurchased by the customers. Other short-term borrowings increased $1.1 billion, or 72%, compared to December 31, 2010, primarily due to an increase of $1.3 billion in short term FHLB borrowings in June of 2011.
Federal funds purchased increased $163 million, or 68%, compared to June 30, 2010, due to an increase in borrowings from the Bank’s correspondent banks. Other short-term borrowings increased $1.1 billion, or 74%, driven by an increase in FHLB borrowings partially offset by a reduction in derivative collateral due to market movements. Long-term debt decreased $837 million, or 8%, compared to June 30, 2010 due to the repayment of $1.0 billion in FHLB advances during the fourth quarter of 2010, the previously mentioned redemption of certain trust preferred securities during the second quarter of 2011, and continual paydowns in securitization conduits and trusts. These decreases were partially offset by the aforementioned $1.0 billion in senior notes issued in the first quarter of 2011 and increases in structured repurchase agreements.
24
Table of Contents
Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
The following table presents average borrowings for the three months ending June 30, 2011, December 31, 2010, and June 30, 2010.
TABLE 18: Average Borrowings
| ($ in millions) |
June 30, 2011 | December 31, 2010 | June 30, 2010 | |||||||||
| Federal funds purchased |
$ | 344 | 376 | 264 | ||||||||
| Other short-term borrowings |
1,605 | 1,728 | 1,478 | |||||||||
| Long-term debt |
10,527 | 10,298 | 10,876 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total average borrowings |
$ | 12,476 | 12,402 | 12,618 | ||||||||
|
|
|
|
|
|
|
|||||||
Average total borrowings increased $74 million, or one percent, compared to December 31, 2010, primarily due to an increase in long-term debt partially offset by a decrease in short-term borrowings. The increase in average long-term debt compared to December 31, 2010 was primarily the result of the aforementioned $1.0 billion senior note issued in the first quarter of 2011 and an increase in structured repurchase agreements. The increase was partially offset by the repayment of $1.0 billion of FHLB advances in the fourth quarter of 2010 and a reduction in commercial customer repurchase sweep agreements. Average total borrowings decreased $142 million, or one percent, compared to June 30, 2010 due to the previously mentioned activity during the fourth quarter of 2010 and the first and second quarters of 2011.
Information on the average rates paid on borrowings is discussed in the Statements of Income Analysis in MD&A. In addition, refer to the Liquidity Risk Management section for a discussion on the role of borrowings in the Bancorp’s liquidity management.
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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
The Bancorp reports on four business segments: Commercial Banking, Branch Banking, Consumer Lending and Investment Advisors. Additional detailed financial information on each business segment is included in Note 20 of the Notes to Condensed Consolidated Financial Statements.
Results of the Bancorp’s business segments are presented based on its management structure and management accounting practices. The structure and accounting practices are specific to the Bancorp; therefore, the financial results of the Bancorp’s business segments are not necessarily comparable with similar information for other financial institutions. The Bancorp refines its methodologies from time to time as management accounting practices are improved and businesses change.
The Bancorp manages interest rate risk centrally at the corporate level by employing a FTP methodology. This methodology insulates the business segments from interest rate volatility, enabling them to focus on serving customers through loan originations and deposit taking. The FTP system assigns charge rates and credit rates to classes of assets and liabilities, respectively, based on expected duration and the LIBOR swap curve. Matching duration allocates interest income and interest expense to each segment so its resulting net interest income is insulated from interest rate risk. In a rising rate environment, the Bancorp benefits from the widening spread between deposit costs and wholesale funding costs. However, the Bancorp’s FTP system credits this benefit to deposit-providing businesses, such as Branch Banking and Investment Advisors, on a duration-adjusted basis. The net impact of the FTP methodology is captured in General Corporate and Other.
The Bancorp adjusts the FTP charge and credit rates as dictated by changes in interest rates for various interest-earning assets and liabilities. The credit rate provided for DDA’s is reviewed annually based upon the account type, its estimated duration and the corresponding fed funds, LIBOR or swap rate. The credit rates for DDA’s were reset January 1, 2011 to reflect the current market rates. These rates were significantly lower than those in place during the first six months of 2010, thus net interest income for deposit providing businesses was negatively impacted during the first six months of 2011.
The business segments are charged provision expense based on the actual net charge-offs experienced by the loans owned by each segment. Provision expense attributable to loan growth and changes in factors in the ALLL are captured in General Corporate and Other. The financial results of the business segments include allocations for shared services and headquarters expenses. Even with these allocations, the financial results are not necessarily indicative of the business segments’ financial condition and results of operations as if they existed as independent entities. Additionally, the business segments form synergies by taking advantage of cross-sell opportunities and when funding operations, by accessing the capital markets as a collective unit. Net income (loss) by business segment is summarized in the following table.
TABLE 19: Business Segment Results
| For the three months ended June 30, |
For the six months ended June 30, |
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| ($ in millions) |
2011 | 2010 | 2011 | 2010 | ||||||||||||
| Commercial Banking |
$ | 86 | 116 | $ | 174 | 167 | ||||||||||
| Branch Banking |
52 | 58 | 70 | 99 | ||||||||||||
| Consumer Lending |
30 | (18 | ) | 5 | (10 | ) | ||||||||||
| Investment Advisors |
10 | 10 | 18 | 22 | ||||||||||||
| General Corporate & Other |
159 | 26 | 335 | (96 | ) | |||||||||||
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| Net income |
337 | 192 | 602 | 182 | ||||||||||||
| Less: Net income attributable to noncontrolling interest |
— | — | — | — | ||||||||||||
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| Net income attributable to Bancorp |
337 | 192 | 602 | 182 | ||||||||||||
| Dividends on preferred stock |
9 | 62 | 185 | 125 | ||||||||||||
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| Net income available to common shareholders |
$ | 328 | 130 | $ | 417 | 57 | ||||||||||
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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
Commercial Banking
Commercial Banking offers banking, cash management and financial services to large and middle-market businesses and government and professional customers. In addition to the traditional lending and depository offerings, Commercial Banking products and services include global cash management, foreign exchange and international trade finance, derivatives and capital markets services, asset-based lending, real estate finance, public finance, commercial leasing and syndicated finance. The following table contains selected financial data for the Commercial Banking segment.
TABLE 20: Commercial Banking
| For the three months ended June 30, |
For the six months ended June 30, |
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| ($ in millions) |
2011 | 2010 | 2011 | 2010 | ||||||||||||
| Income Statement Data |
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| Net interest income (FTE)(a) |
$ | 339 | 390 | $ | 671 | 767 | ||||||||||
| Provision for loan and lease losses |
147 | 188 | 299 | 466 | ||||||||||||
| Noninterest income: |
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| Corporate banking revenue |
90 | 89 | 172 | 165 | ||||||||||||
| Service charges on deposits |
52 | 47 | 101 | 95 | ||||||||||||
| Other noninterest income |
21 | 28 | 65 | 66 | ||||||||||||
| Noninterest expense: |
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| Salaries, incentives and benefits |
68 | 62 | 137 | 126 | ||||||||||||
| Other noninterest expense |
212 | 179 | 416 | 353 | ||||||||||||
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| Income before taxes |
75 | 125 | 157 | 148 | ||||||||||||
| Applicable income tax (benefit) expense |
(11 | ) | 9 | (17 | ) | (19 | ) | |||||||||
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| Net income |
$ | 86 | 116 | $ | 174 | 167 | ||||||||||
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| Average Balance Sheet Data |
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| Commercial loans |
$ | 38,046 | 38,499 | $ | 38,034 | 38,824 | ||||||||||
| Demand deposits |
12,068 | 10,813 | 12,024 | 10,668 | ||||||||||||
| Interest checking |
7,959 | 8,659 | 8,129 | 9,331 | ||||||||||||
| Savings and money market |
2,721 | 2,787 | 2,820 | 2,733 | ||||||||||||
| Certificates over $100,000 |
1,818 | 3,055 | 1,928 | 3,114 | ||||||||||||
| Foreign office deposits |
1,841 | 2,007 | 1,888 | 1,763 | ||||||||||||
| (a) | Includes FTE adjustments of $4 for the three months ended June 30, 2011 and 2010 and $8 and $7 for the six months ended June 30, 2011 and 2010, respectively. |
Net income was $86 million for the three months ended June 30, 2011, compared to net income of $116 million for the three months ended June 30, 2010. The decline in net income was the result of lower net interest income and higher noninterest expense, partially offset by a decline in the provision for loan and lease losses. For the six months ended June 30, 2011, net income was $174 million compared to $167 million for the same period of the prior year. The increase in net income was driven by a decrease in the provision for loan and lease losses, partially offset by lower net interest income and higher noninterest expense.
Net interest income decreased $51 million and $96 million for the three and six months ended June 30, 2011, respectively, compared to the same periods of the prior year. The decreases in net interest income for the three and six months ended June 30, 2011 compared to the same periods of the prior year were primarily driven by declines in the FTP credits for DDA accounts and decreases in interest income. The decreases in interest income were driven primarily by declines in average commercial loan balances as well as declines in yields of 20 bp and 8 bp, respectively.
Provision for loan and lease losses decreased $41 million and $167 million, respectively, for the three and six months ended June 30, 2011 compared to the same periods of the prior year as a result of improved credit trends across all commercial loan types. Net charge-offs as a percent of average loans and leases decreased to 155 bp for the three months ended June 30, 2011 compared to 196 bp for the same period of the prior year and decreased to 159 bp for the six months ended June 30, 2011 compared to 243 bp for the same period of the prior year.
Noninterest income remained relatively flat in the second quarter of 2011 compared to the second quarter of 2010. For the six months ended June 30, 2011, noninterest income increased $12 million compared to the same period of the prior year as increases in corporate banking revenue and service charges on deposits were partially offset by declines in other noninterest income. The increase in corporate banking revenue of $7 million was primarily driven by increased business lending and syndication fees, partially offset by decreases in international income and institutional sales. The increase in service charges on deposits of $6 million was primarily driven by a decrease in earnings credits paid on customer balances.
Noninterest expense increased $39 million and $74 million, respectively, for the three and six months ended June 30, 2011 compared to the same periods of the prior year as a result of increases in salaries, incentives and benefits and FDIC insurance expense. The increases in salaries, incentives and benefits of $6 million and $11 million, respectively, was the result of increased incentive compensation due to higher corporate banking net revenue, as well as additions to the sales force. FDIC insurance expense increased $4 million and $6 million,
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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)
respectively, for the three and six months ended June 30, 2011 compared to the same periods of the prior year due to a change in the methodology in determining FDIC insurance premiums to one based on total assets as opposed to the previous method that was based on total domestic deposits.
Average commercial loans decreased $453 million and $790 million for the three and six months ended June 30, 2011, respectively, compared to the same periods of the prior year, as declines in average commercial mortgage and commercial construction loan balances were partially offset by increased average commercial and industrial loans. Aver