Form 10-Q
Table of Contents

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 September 30, 2016

Commission File Number 001-33653

 

LOGO

(Exact name of Registrant as specified in its charter)

 

Ohio   31-0854434

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

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 755,613,518 shares of the Registrant’s common stock, without par value, outstanding as of October 31, 2016.


Table of Contents

LOGO

FINANCIAL CONTENTS

 

Part I. Financial Information

  

Glossary of Abbreviations and Acronyms

     2   

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 2)

  

Selected Financial Data

     3   

Overview

     4   

Non-GAAP Financial Measures

     9   

Recent Accounting Standards

     12   

Critical Accounting Policies

     12   

Statements of Income Analysis

     13   

Balance Sheet Analysis

     22   

Business Segment Review

     28   

Risk Management—Overview

     35   

Credit Risk Management

     36   

Market Risk Management

     50   

Liquidity Risk Management

     54   

Operational Risk Management

     56   

Compliance Risk Management

     56   

Capital Management

     57   

Off-Balance Sheet Arrangements

     59   

Quantitative and Qualitative Disclosures about Market Risk (Item 3)

     60   

Controls and Procedures (Item 4)

     60   

Condensed Consolidated Financial Statements and Notes (Item 1)

  

Balance Sheets (unaudited)

     61   

Statements of Income (unaudited)

     62   

Statements of Comprehensive Income (unaudited)

     63   

Statements of Changes in Equity (unaudited)

     64   

Statements of Cash Flows (unaudited)

     65   

Notes to Condensed Consolidated Financial Statements (unaudited)

     66   

Part II. Other Information

  

Legal Proceedings (Item 1)

     122   

Risk Factors (Item 1A)

     122   

Unregistered Sales of Equity Securities and Use of Proceeds (Item 2)

     122   

Exhibits (Item 6)

     122   

Signatures

     124   

Certifications

  

FORWARD-LOOKING STATEMENTS

This report contains statements that we believe are “forward-looking statements” 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. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. They usually can be identified by the use of forward-looking language such as “will likely result,” “may,” “are expected to,” “is anticipated,” “potential,” “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. You should not place undue reliance on these statements, as they are subject to risks and uncertainties, including but not limited to the risk factors set forth in our most recent Annual Report on Form 10-K as updated by our Quarterly Reports on Form 10-Q. When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements we may make. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to us. 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 or real estate market conditions, either nationally or in the states in which Fifth Third, one or more acquired entities and/or the combined company do business, weaken or 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 and adequate sources of funding and liquidity 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 Dodd-Frank Wall Street Reform and Consumer Protection 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 from Fifth Third’s investment in, relationship with, and nature of the operations of Vantiv, LLC; (21) loss of income from any sale or potential sale of businesses (22) difficulties in separating the operations of any branches or other assets divested; (23) losses or adverse impacts on the carrying values of branches and long-lived assets in connection with their sales or anticipated sales; (24) inability to achieve expected benefits from branch consolidations and planned sales within desired timeframes, if at all; (25) ability to secure confidential information and deliver products and services through the use of computer systems and telecommunications networks; and (26) the impact of reputational risk created by these developments on such matters as business generation and retention, funding and liquidity.

 

1


Table of Contents

Glossary of Abbreviations and Acronyms

 

Fifth Third Bancorp provides the following list of abbreviations and acronyms as a tool for the reader that are used in Management’s Discussion and Analysis of Financial Condition and Results of Operations, the Condensed Consolidated Financial Statements and the Notes to Condensed Consolidated Financial Statements.

 

 

ALCO: Asset Liability Management Committee

 

 

GSE: United States Government Sponsored Enterprise

ALLL: Allowance for Loan and Lease Losses

 

HAMP: Home Affordable Modification Program

AOCI: Accumulated Other Comprehensive Income

 

HARP: Home Affordable Refinance Program

ARM: Adjustable Rate Mortgage

 

HFS: Held for Sale

ASF: Available Stable Funding

 

HQLA: High Quality Liquid Assets

ASU: Accounting Standards Update

 

IPO: Initial Public Offering

ATM: Automated Teller Machine

 

IRC: Internal Revenue Code

BCBS: Basel Committee on Banking Supervision

 

IRLC: Interest Rate Lock Commitment

BHC: Bank Holding Company

 

ISDA: International Swaps and Derivatives Association, Inc.

BOLI: Bank Owned Life Insurance

 

LCR: Liquidity Coverage Ratio

BPO: Broker Price Opinion

 

LIBOR: London Interbank Offered Rate

bps: Basis Points

 

LLC: Limited Liability Company

CCAR: Comprehensive Capital Analysis and Review

 

LTV: Loan-to-Value

CDC: Fifth Third Community Development Corporation

 

MD&A: Management’s Discussion and Analysis of Financial

CET1: Common Equity Tier 1

 

Condition and Results of Operations

CFE: Collateralized Financing Entity

 

MSA: Metro Statistical Area

CFPB: Consumer Financial Protection Bureau

 

MSR: Mortgage Servicing Right

C&I: Commercial and Industrial

 

N/A: Not Applicable

CRA: Community Reinvestment Act

 

NII: Net Interest Income

DCF: Discounted Cash Flow

 

NM: Not Meaningful

DFA: Dodd-Frank Wall Street Reform & Consumer Protection Act

 

NSFR: Net Stable Funding Ratio

DIF: Deposit Insurance Fund

 

OAS: Option-Adjusted Spread

DTCC: Depository Trust & Clearing Corporation

 

OCI: Other Comprehensive Income (Loss)

ERISA: Employee Retirement Income Security Act

 

OREO: Other Real Estate Owned

ERM: Enterprise Risk Management

 

OTTI: Other-Than-Temporary Impairment

ERMC: Enterprise Risk Management Committee

 

PCA: Prompt Corrective Action

EVE: Economic Value of Equity

 

PMI: Private Mortgage Insurance

FASB: Financial Accounting Standards Board

 

RSF: Required Stable Funding

FDIC: Federal Deposit Insurance Corporation

 

SARs: Stock Appreciation Rights

FFIEC: Federal Financial Institutions Examination Council

 

SBA: Small Business Administration

FHA: Federal Housing Administration

 

SEC: United States Securities and Exchange Commission

FHLB: Federal Home Loan Bank

 

TBA: To Be Announced

FHLMC: Federal Home Loan Mortgage Corporation

 

TDR: Troubled Debt Restructuring

FICO: Fair Isaac Corporation (credit rating)

 

TILA: Truth in Lending Act

FINRA: Financial Industry Regulatory Authority

 

TRA: Tax Receivable Agreement

FNMA: Federal National Mortgage Association

 

TruPS: Trust Preferred Securities

FRB: Federal Reserve Bank

 

U.S.: United States of America

FTE: Fully Taxable Equivalent

 

U.S. GAAP: United States Generally Accepted Accounting

FTP: Funds Transfer Pricing

 

Principles

FTS: Fifth Third Securities

 

VA: United States Department of Veteran Affairs

GDP: Gross Domestic Product

 

VIE: Variable Interest Entity

GNMA: Government National Mortgage Association

 

VRDN: Variable Rate Demand Note

 

2


Table of Contents

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 2)

 

The following is Management’s Discussion and Analysis of Financial Condition and Results of Operations 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. The Bancorp’s banking subsidiary is referred to as the Bank.

TABLE 1: Selected Financial Data

 

 
       

    For the three months ended      
                 September 30,                 

     %           

    For the nine months ended      
                 September 30,                 

     %     
($ in millions, except for per share data)       2016   2015      Change            2016   2015      Change     

 

 

Income Statement Data

                     

Net interest income (U.S. GAAP)

  $   907         901             $   2,712         2,636          

Net interest income (FTE)(a)(b)

    913         906               2,730         2,650          

Noninterest income

    840         713        18         2,075         1,900          

Total revenue(a)

    1,753         1,619               4,805         4,550          

Provision for loan and lease losses

    80         156        (49)        289         305        (5)   

Noninterest expense

    973         943               2,942         2,814          

Net income attributable to Bancorp

    516         381        35         1,175         1,056        11    

Net income available to common shareholders

    501         366        37         1,123         1,004        12    

 

 

Common Share Data

                     

Earnings per share – basic

  $   0.66         0.46        43       $   1.46         1.24        18    

Earnings per share – diluted

    0.65         0.45        44         1.45         1.22        19    

Cash dividends declared per common share

    0.13         0.13               0.39         0.39          

Book value per share

    20.44         18.22        12         20.44         18.22        12    

Market value per share

    20.46         18.91               20.46         18.91          

 

 

Financial Ratios

                     

Return on average assets

    1.44  %   1.07        35         1.10  %   1.01          

Return on average common equity

    12.8         10.0        28         9.8         9.3          

Return on average tangible common equity(b)

    15.2         12.0        27         11.7         11.1          

Dividend payout ratio

    19.7         28.3        (30)        26.7         31.5        (15)   

Average total Bancorp shareholders’ equity as a percent of average assets

    11.83         11.24               11.67         11.35          

Tangible common equity as a percent of tangible assets(b)(h)

    8.78         8.32               8.78         8.32          

Net interest margin(a)(b)

    2.88         2.89               2.88         2.88          

Efficiency(a)(b)

    55.5         58.2        (5)        61.2         61.8        (1)   

 

 

Credit Quality

                     

Net losses charged-off

  $   107         188        (43)      $   289         366        (21)   

Net losses charged-off as a percent of average portfolio loans and leases

    0.45  %   0.80        (44)        0.41  %   0.53        (23)   

ALLL as a percent of portfolio loans and leases

    1.37         1.35               1.37         1.35          

Allowance for credit losses as a percent of portfolio loans and leases(c)

    1.54         1.49               1.54         1.49          

Nonperforming portfolio assets as a percent of portfolio loans and leases and OREO

    0.75         0.65        15         0.75         0.65        15    

 

 

Average Balances

                     

Loans and leases, including held for sale

  $   94,417         94,329             $   94,434         92,919          

Total securities and other short-term investments

    31,675         30,102               31,763         29,905          

Total assets(j)

    142,726         140,706               142,410         139,439          

Transaction deposits(d)

    94,855         94,660               94,821         95,100          

Core deposits(e)

    98,875         98,717               98,854         99,151          

Wholesale funding(f)(j)

    22,236         21,685               22,418         19,638        14    

Bancorp shareholders’ equity

    16,883         15,815               16,615         15,826          

 

 

Regulatory Capital and Liquidity Ratios

                     

CET1 capital(g)

    10.17  %   9.40(i)               10.17  %   9.40(i)          

Tier I risk-based capital(g)

    11.27         10.49(i)               11.27         10.49(i)          

Total risk-based capital(g)

    14.88         13.68(i)               14.88         13.68(i)          

Tier I leverage(g)

    9.80         9.38(i)               9.80         9.38(i)          

CET1 capital (fully phased-in)(b)(g)

    10.09         9.30(i)               10.09         9.30(i)          

Modified LCR

    115         N/A           N/A         115         N/A           N/A    

 

 
(a)

Amounts presented on an FTE basis. The FTE adjustment for the three months ended September 30, 2016 and 2015 was $6 and $5, respectively, and for the nine months ended September 30, 2016 and 2015 was $18 and $14, respectively.

(b)

These are non-GAAP measures. For further information, refer to the Non-GAAP Financial Measures section of MD&A.

(c)

The allowance for credit losses is the sum of the ALLL and the reserve for unfunded commitments.

(d)

Includes demand deposits, interest checking deposits, savings deposits, money market deposits and foreign office deposits.

(e)

Includes transaction deposits and other time deposits.

(f)

Includes certificates $100,000 and over, other deposits, federal funds purchased, other short-term borrowings and long-term debt.

(g)

Under the U.S. banking agencies’ Basel III Final Rule, assets and credit equivalent amounts of off-balance sheet exposures are calculated according to the standardized approach for risk-weighted assets. The resulting values are added together in the Bancorp’s total risk-weighted assets.

(h)

Excludes unrealized gains and losses.

(i)

Ratios not restated for the adoption of the amended guidance of ASU 2015-03 “Simplifying the Presentation of Debt Issuance Costs.” Refer to Note 3 of the Notes to Condensed Consolidated Financial Statements for further information.

(j)

Upon adoption of ASU 2015-03 on January 1, 2016, the September 30, 2015 Condensed Consolidated Balance Sheet was adjusted to reflect the reclassification of $33 of average debt issuance costs from average other assets to average long-term debt. For further information, refer to Note 3 of the Notes to Condensed Consolidated Financial Statements.

 

3


Table of Contents

Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

OVERVIEW

Fifth Third Bancorp is a diversified financial services company headquartered in Cincinnati, Ohio. At September 30, 2016, the Bancorp had $143.3 billion in assets and operated 1,191 full-service banking centers, including 94 Bank Mart® locations, open seven days a week, inside select grocery stores, and 2,497 ATMs in ten states throughout the Midwestern and Southeastern regions of the U.S. The Bancorp reports on four business segments: Commercial Banking, Branch Banking, Consumer Lending and Wealth and Asset Management. The Bancorp also has an approximate 18% interest in Vantiv Holding, LLC. The carrying value of the Bancorp’s investment in Vantiv Holding, LLC was $404 million at September 30, 2016.

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 as well as the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2015. Each of these items could have an impact on the Bancorp’s financial condition, results of operations and cash flows. In addition, refer to the Glossary of Abbreviations and Acronyms in this report for a list of terms included as a tool for the reader of this quarterly report on Form 10-Q. The abbreviations and acronyms identified therein are used throughout this MD&A, as well as the Condensed Consolidated Financial Statements and Notes to the Condensed Consolidated Financial Statements.

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. The FTE basis for presenting net interest income is a non-GAAP measure. For further information, refer to the Non-GAAP Financial Measures section of MD&A.

The Bancorp’s revenues are dependent on both net interest income and noninterest income. For the three months ended September 30, 2016, net interest income on an FTE basis and noninterest income provided 52% and 48% of total revenue, respectively. For the nine months ended September 30, 2016, 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 U.S. from customers domiciled in the U.S. Revenue from foreign countries and external customers domiciled in foreign countries was immaterial to the Condensed Consolidated Financial Statements for both the three and nine months ended September 30, 2016. 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 of MD&A, 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, other 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 loss on its loan and lease portfolio, as a result of changing expected cash flows caused by borrower credit events, such as, loan defaults and inadequate collateral due to a weakened economy within the Bancorp’s footprint.

Noninterest income is derived from service charges on deposits, corporate banking revenue, wealth and asset management revenue, card and processing revenue, mortgage banking net revenue, securities gains, net and other noninterest income. Noninterest expense includes personnel costs, net occupancy expense, technology and communication costs, card and processing expense, equipment expense and other noninterest expense.

Branch Consolidations and Sales Activity

The Bancorp monitors changing customer preferences associated with the channels it uses for banking transactions to evaluate the efficiency, competitiveness and quality of the customer service experience in its consumer distribution network. As part of this ongoing assessment, the Bancorp may determine that it is no longer fully committed to maintaining full-service branches at certain of its existing banking center locations. Similarly, the Bancorp may also determine that it is no longer fully committed to building banking centers on certain parcels of land which had previously been held for future branch expansion. On June 16, 2015, the Bancorp’s Board of Directors authorized management to pursue a plan to further develop its distribution strategy, including a plan to consolidate and/or sell certain operating branch locations and certain parcels of undeveloped land that had been acquired by the Bancorp for future branch expansion (the “Branch Consolidation and Sales Plan”). In addition, the Bancorp announced on September 13, 2016 that it had identified an additional 44 branch locations and 5 parcels of undeveloped land that it planned to consolidate or sell.

On January 29, 2016, the Bancorp closed the previously announced sale in the St. Louis MSA to Great Southern Bank and recorded a gain on the sale of $8 million which was recorded in other noninterest income in the Condensed Consolidated Statements of Income. Additionally, on April 22, 2016, the Bancorp closed the previously announced sale in the Pittsburgh MSA to First National Bank of Pennsylvania and recorded a gain on the sale of $11 million which was recorded in other noninterest income in the Condensed Consolidated Statements of Income. Both transactions were part of the Branch Consolidation and Sales Plan.

 

4


Table of Contents

Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

As of September 30, 2016, the Bancorp had 72 branch locations and 37 parcels of undeveloped land that had been acquired for future branch expansion that it intended to consolidate or sell. These branch locations and parcels of undeveloped land, which include unsold properties from the Branch Consolidation and Sales Plan as well as properties included in the September 13, 2016 announcement, represent $45 million, $17 million and $2 million of land and improvements, buildings and equipment, respectively, included in bank premises and equipment in the Condensed Consolidated Balance Sheets as of September 30, 2016, of which $34 million, $10 million and $1 million, respectively, were classified as held for sale. The Bancorp expects to receive approximately $72 million in annual savings from operating expenses upon completion of the Branch Consolidation and Sales Plan and the consolidation and/or sale of properties included in the September 13, 2016 announcement. For further information, refer to Note 7 of the Notes to Condensed Consolidated Financial Statements.

On September 29, 2016, the Bancorp closed on the sale of an office complex. The sale also included all of the Bancorp’s rights, title and interest as a landlord under existing leases in the complex. Under the terms of the transaction, the Bancorp received proceeds of approximately $31 million and entered into a lease agreement whereby the Bancorp leased-back approximately 25% of the office complex. In conjunction with the transaction, which qualified as a sale-leaseback under U.S. GAAP, the Bancorp retired assets with a net book value of approximately $10 million, recognized a deferred gain of $10 million, which will be amortized as a reduction of rent expense over the 15 year lease term, and recorded a gain on the transaction of $11 million which was recorded in other noninterest income in the Condensed Consolidated Statements of Income.

Vantiv, Inc. TRA Transactions

On July 27, 2016, the Bancorp entered into an agreement with Vantiv, Inc. under which a portion of its TRAs with Vantiv, Inc. was terminated and settled in full for consideration of a cash payment in the amount of $116 million from Vantiv, Inc. Under the agreement, the Bancorp terminated and settled certain TRA cash flows it expected to receive in the years 2019 to 2035, totaling an estimated $331 million. The Bancorp recognized a pre-tax gain of $116 million in other noninterest income in the Condensed Consolidated Statements of Income from this settlement in the third quarter of 2016.

Additionally, the agreement provides that Vantiv, Inc. may be obligated to pay up to a total of approximately $171 million to the Bancorp to terminate and settle certain remaining TRA cash flows, totaling an estimated $394 million, upon the exercise of certain call options by Vantiv, Inc. or certain put options by the Bancorp. If the associated call options or put options are exercised, 10% of the obligations would be settled with respect to each quarter in 2017 and 15% of the obligations would be settled with respect to each quarter in 2018. The Bancorp recognized a pre-tax gain of $164 million in other noninterest income in the Condensed Consolidated Statements of Income in the third quarter of 2016 associated with these options.

This agreement does not impact the TRA payments expected to be recognized in the fourth quarter of 2016 and the fourth quarter of 2017 which are expected to be received in the first quarter of 2017 and the first quarter of 2018, respectively.

Accelerated Share Repurchase Transactions

During the nine months ended September 30, 2016, the Bancorp entered into or settled a number of accelerated share repurchase transactions. As part of these transactions, the Bancorp entered into forward contracts in which the final number of shares delivered at settlement was based generally on a discount to the average daily volume weighted-average price of the Bancorp’s common stock during the term of the repurchase agreements. For more information on the accelerated share repurchase program, refer to Note 15 of the Notes to Condensed Consolidated Financial Statements. For a summary of the Bancorp’s accelerated share repurchase transactions that were entered into or settled during the nine months ended September 30, 2016, refer to Table 2.

TABLE 2: Summary of Accelerated Share Repurchase Transactions

 

 
Repurchase Date  

Amount

($ in millions)

    Shares Repurchased on
Repurchase Date
    Shares Received from Forward
Contract Settlement
    Total Shares
Repurchased
    Settlement Date     

 

 

December 14, 2015

  $                              215        9,248,482        1,782,477              11,030,959        January 14, 2016   

March 4, 2016

    240        12,623,762        1,868,379        14,492,141        April 11, 2016   

August 5, 2016

    240        10,979,548        1,099,205        12,078,753        November 7, 2016   

 

 

Open Market Share Repurchase Transactions

Between June 17, 2016 and June 20, 2016, the Bancorp repurchased 1,436,100 shares, or approximately $26 million, of its outstanding common stock through open market repurchase transactions.

Senior and Subordinated Notes Offerings

On March 15, 2016, the Bank issued and sold $1.5 billion in aggregate principal amount of unsecured bank notes. The bank notes consisted of $750 million of 2.30% senior fixed-rate notes, with a maturity of three years, due on March 15, 2019; and $750 million of 3.85% subordinated fixed-rate notes, with a maturity of ten years, due on March 15, 2026. These bank notes will be redeemable by the Bank, in whole or in part, on or after the date that is 30 days prior to the maturity date at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest up to, but excluding, the redemption date.

On June 14, 2016, the Bank issued and sold $1.3 billion of 2.25% unsecured senior fixed-rate notes, with a maturity of five years, due on June 14, 2021. These bank notes will be redeemable by the Bank, in whole or in part, on or after the date that is 30 days prior to the maturity date at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest up to, but excluding, the redemption date.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

On September 2, 2016, the Bank submitted a redemption notice to the Issuing and Paying Agent to redeem $1.0 billion of 1.15% senior fixed-rate notes and $750 million of senior floating-rate notes at three-month LIBOR plus 51 bps. Pursuant to the terms and conditions of the notes, the Bank redeemed the notes on October 19, 2016, which was 30 days prior to their scheduled maturity on November 18, 2016.

On September 27, 2016, the Bank issued and sold $1.0 billion in aggregate principal amount of unsecured senior bank notes, with a maturity of three years, due on September 27, 2019. The bank notes consisted of $750 million of 1.625% senior fixed-rate notes and $250 million of senior floating-rate notes at three-month LIBOR plus 59 bps. The Bancorp entered into interest rate swaps to convert the fixed-rate notes to a floating-rate, which resulted in an effective interest rate of three-month LIBOR plus 53 bps. These bank notes will be redeemable by the Bank, in whole or in part, on or after the date that is 30 days prior to the maturity date at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest up to, but excluding, the redemption date.

Legislative and Regulatory Developments

During the first quarter of 2016, the FDIC issued a final rule implementing a 4.5 bps surcharge on the quarterly FDIC insurance assessments of insured depository institutions with total consolidated assets of $10 billion or more. The surcharge will take effect at the same time the FDIC is required to lower the regular FDIC insurance assessments by approximately 2 bps under a rule adopted by the FDIC in 2011, which is triggered by the DIF reserve ratio reaching 1.15% of insured deposits. In August of 2016, the FDIC announced the DIF reserve ratio reached 1.17% of insured deposits as of June 30, 2016. Therefore, on July 1, 2016, the Bancorp became subject to the FDIC surcharge and reduced regular FDIC insurance assessments. The surcharges will continue through the quarter that the DIF reserve ratio first reaches or exceeds 1.35% of insured deposits, but not later than December 31, 2018. If the reserve ratio does not reach 1.35% by December 31, 2018, the FDIC will impose a shortfall assessment on March 31, 2019, on insured depository institutions with total consolidated assets of $10 billion or more. The FDIC projects the surcharges will be sufficient to raise the DIF reserve ratio to 1.35% in 2018. Fifth Third estimates the announced changes to the FDIC assessments will result in a net increase in its FDIC insurance expense of approximately $23 million on an annual basis.

The FRB launched the 2016 stress testing program and CCAR on January 28, 2016, with submissions of stress test results and capital plans to the FRB due on April 5, 2016, which the Bancorp submitted as required.

On June 29, 2016, the Bancorp announced the results of its capital plan submitted to the FRB as part of the 2016 CCAR. For BHCs that proposed capital distributions in their plans, the FRB either objected to the plan or provided a non-objection whereby the FRB permitted the proposed capital distributions. The FRB indicated to the Bancorp that it did not object to the following capital actions for the period beginning July 1, 2016 and ending June 30, 2017:

   

The potential increase in the quarterly common stock dividend to $0.14 in the fourth quarter of 2016;

   

The potential repurchase of common shares in an amount up to $660 million, which includes $84 million in repurchases related to share issuances under employee benefit plans;

   

The additional ability to repurchase shares in the amount of any realized after-tax gains from the sale of Vantiv, Inc. common stock, if executed;

   

The additional ability to repurchase shares in the amount of any realized after-tax gains from the termination and settlement of any portion of the TRA with Vantiv, Inc., if executed.

For more information on the 2016 CCAR results refer to the Capital Management subsection of the Risk Management section of MD&A.

Fifth Third offers qualified deposit customers a deposit advance product if they choose to avail themselves of this product to meet short-term, small-dollar financial needs. Fifth Third’s deposit advance product is designed to fully comply with the applicable federal and state laws and use of this product is subject to strict eligibility requirements and advance restriction guidelines to limit dependency on this product as a borrowing source. The Bancorp’s deposit advance balances are included in other consumer loans and leases in the Loans and Leases subsection of the Balance Sheet Analysis section of MD&A and in Table 8 in the Statements of Income Analysis section of MD&A. On January 17, 2014, given developments in industry practice, Fifth Third announced that it would no longer enroll new customers in its deposit advance product and expected to phase out the service to existing customers by the end of 2014. To avoid a disruption to its existing customers during the extension period while the banking industry awaits further regulatory guidance on the deposit advance product, on November 3, 2014, Fifth Third announced changes to its current deposit advance product for existing customers beginning January 1, 2015, including a lower transaction fee, an extended repayment period and a reduced maximum advance period. On June 2, 2016, the CFPB issued proposed rules to create additional consumer protections for certain consumer credit products such as payday loans, vehicle title loans and certain high-cost installment loans. Fifth Third is continuing to offer the service to existing deposit advance product customers and will address how best to meet customers’ need for a small dollar, short-term credit product when the rules are finalized.

In December 2013, the U.S. banking agencies issued final rules to implement section 619 of the DFA, known as the Volcker Rule, which places limitations on banking organizations’ ability to (i) engage in short-term proprietary trading and (ii) own, sponsor or have certain relationships with certain private equity funds, hedge funds, and other private funds (collectively “covered funds”). On July 7, 2016, the FRB announced a third extension of the conformance period, providing the industry until July 21, 2017, to conform investments in and relationships with covered funds that were in place prior to December 31, 2013. The extension does not apply to investments in and relationships with a covered fund made after December 31, 2013 or to short-term proprietary trading activities. The Volcker Rule prohibits banking organizations from engaging in short-term proprietary trading of certain securities, derivatives, commodity futures and options on these instruments for their own account. The Volcker Rule also restricts banking organizations from owning, sponsoring or having certain relationships with covered funds, as well as holding certain collateralized loan obligations that are deemed to contain ownership interests. The Volcker Rule provides several exclusions and exemptions for certain activities, such as underwriting, market making, hedging, trading in certain government obligations and organizing and offering a private fund.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Fifth Third does not sponsor any private funds that, under the Volcker Rule, it is prohibited from sponsoring. At September 30, 2016, the Bancorp had approximately $147 million in interests and approximately $30 million in binding commitments to invest in private equity funds that are affected by the Volcker Rule. The Bancorp recognized $9 million of OTTI primarily associated with certain nonconforming investments affected by the Volcker Rule during the third quarter of 2016. Refer to Note 22 of the Notes to Condensed Consolidated Financial Statements for further information.

On October 10, 2014, the U.S. Banking Agencies published final rules implementing a quantitative liquidity requirement consistent with the LCR standard established by the BCBS for large internationally active banking organizations, generally those with $250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposure. In addition, a modified LCR requirement was implemented for BHCs with $50 billion or more in total consolidated assets but that are not internationally active, such as Fifth Third. The Modified LCR became effective January 1, 2016 and requires BHCs to calculate its LCR on a monthly basis. Refer to the Liquidity Risk Management subsection of the Risk Management section of MD&A for further discussion on these ratios.

The FRB conducted a regularly scheduled examination covering 2011 through 2013 to determine the Bank’s compliance with the CRA. This CRA examination resulted in a rating of “Needs to Improve.” The Bank believes that the “Needs to Improve” rating reflects legacy issues that have been remediated during the intervening three years. While the Bank’s CRA rating is “Needs to Improve” the Bancorp and the Bank face limitations and conditions on certain activities, including the commencement of new activities and merger with or acquisitions of other financial institutions. The Bank’s next CRA examination is expected to commence during the fourth quarter of 2016.

Earnings Summary

The Bancorp’s net income available to common shareholders for the third quarter of 2016 was $501 million, or $0.65 per diluted share, which was net of $15 million in preferred stock dividends. The Bancorp’s net income available to common shareholders for the third quarter of 2015 was $366 million, or $0.45 per diluted share, which was net of $15 million in preferred stock dividends. The Bancorp’s net income available to common shareholders for the nine months ended September 30, 2016 was $1.1 billion, or $1.45 per diluted share, which was net of $52 million in preferred stock dividends. For the nine months ended September 30, 2015, the Bancorp’s net income available to common shareholders was $1.0 billion, or $1.22 per diluted share, which was net of $52 million in preferred stock dividends. Pre-provision net revenue was $774 million and $1.8 billion for the three and nine months ended September 30, 2016, respectively, compared to $671 million and $1.7 billion for the same periods in 2015. Pre-provision net revenue is a non-GAAP measure. For further information, refer to the Non-GAAP Financial Measures section of MD&A.

Net interest income on an FTE basis (non-GAAP) was $913 million and $2.7 billion for the three and nine months ended September 30, 2016, respectively, an increase of $7 million and $80 million compared to the same periods in the prior year. Net interest income was positively impacted by increases in average taxable securities and yields on average loans and leases. Additionally, net interest income was positively impacted by the decision of the Federal Open Market Committee in December 2015 to raise the target range of the federal funds rate 25 bps. The nine months ended September 30, 2016 also included the positive impact of an increase in average loans and leases. These positive impacts were partially offset by increases in average long-term debt coupled with decreases in the net interest rate spread. Net interest margin on an FTE basis (non-GAAP) was 2.88% for both the three and nine months ended September 30, 2016 compared to 2.89% and 2.88%, respectively, for the same periods in the prior year.

Noninterest income increased $127 million for the three months ended September 30, 2016 compared to the same period in the prior year primarily due to an increase in other noninterest income. Noninterest income increased $175 million for the nine months ended September 30, 2016 compared to the same period in the prior year primarily due to increases in other noninterest income and corporate banking revenue partially offset by a decrease in mortgage banking net revenue. Other noninterest income increased $123 million and $174 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods included the impact of a $280 million gain, which was recognized during the third quarter of 2016, from the termination and settlement of gross cash flows from existing Vantiv, Inc. TRAs and the expected obligation to terminate and settle the remaining Vantiv, Inc. TRA cash flows upon the exercise of put or call options. The increase for both periods also included the impact of impairment charges on bank premises and equipment of $28 million and $31 million that were recognized during the three and nine months ended September 30, 2016, respectively, compared to impairment charges of $2 million and $104 million which were recognized during the three and nine months ended September 30, 2015, respectively.

The increase in other noninterest income for both periods was partially offset by a negative valuation adjustment on the stock warrant associated with Vantiv Holding, LLC of $2 million for the three months ended September 30, 2016 compared to a positive valuation adjustment of $130 million for the three months ended September 30, 2015. The nine months ended September 30, 2016 included positive valuation adjustments on the stock warrant of $64 million compared to $215 million for the nine months ended September 30, 2015. Additionally, the increase in other noninterest income for the three and nine months ended September 30, 2016 was partially offset by the recognition of $9 million of OTTI on certain private equity investments in the third quarter of 2016. Refer to Note 22 of the Notes to Condensed Consolidated Financial Statements for further information.

The nine months ended September 30, 2016 also included the impact of gains of $19 million on the sale of certain branches and the $11 million gain on the sale of the agent bankcard loan portfolio during the second quarter of 2016. Additionally, the increase in other noninterest income for the nine months ended September 30, 2016 was partially offset by $61 million of negative valuation adjustments related to the Visa total return swap compared to $27 million for the nine months ended September 30, 2015 as well as by the impact of a $37 million gain on the sale of residential mortgage loans classified as TDRs during the first quarter of 2015.

Mortgage banking net revenue decreased $55 million for the nine months ended September 30, 2016 compared to the same period in the prior year primarily due to a decrease in net mortgage servicing revenue partially offset by an increase in origination fees and gains on loan sales. Corporate banking revenue increased $50 million for the nine months ended September 30, 2016 compared to the same period in the prior year primarily driven by increases in lease remarketing fees and syndication fees partially offset by decreases in foreign exchange fees and business lending fees.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Noninterest expense increased $30 million and $128 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily due to increases in personnel costs (salaries, wages and incentives plus employee benefits) technology and communications and other noninterest expense partially offset by a decrease in card and processing expense. Personnel costs increased $19 million and $85 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods was driven by increased base compensation, primarily due to personnel additions in risk and compliance and information technology, and increased variable compensation. The increase for the nine months ended September 30, 2016 was also driven by higher retirement and severance costs related to the Bancorp’s voluntary early retirement program. Technology and communications expense increased $6 million and $13 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year driven by increased investment in information technology associated with regulatory and compliance initiatives, system maintenance and other growth initiatives.

Other noninterest expense increased $21 million for the three months ended September 30, 2016 compared to the same period in the prior year primarily due to increases in the provision for the reserve for unfunded commitments, impairment on affordable housing investments and FDIC insurance and other taxes. Other noninterest expense increased $58 million for the nine months ended September 30, 2016 compared to the same period in the prior year primarily due to increases in the provision for the reserve for unfunded commitments, FDIC insurance and other taxes, impairment on affordable housing investments, losses and adjustments and operating lease expense partially offset by a decrease in loan and lease expense.

Card and processing expense decreased $10 million and $13 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily due to the impact of renegotiated service contracts.

For more information on net interest income, noninterest income and noninterest expense refer to the Statements of Income Analysis section of MD&A.

Credit Summary

The provision for loan and lease losses was $80 million and $289 million for the three and nine months ended September 30, 2016, respectively, compared to $156 million and $305 million for the same periods in 2015. Net losses charged-off as a percent of average portfolio loans and leases decreased to 0.45% during the three months ended September 30, 2016 compared to 0.80% during the same period in the prior year and decreased to 0.41% for the nine months ended September 30, 2016 compared to 0.53% for the same period in the prior year. At September 30, 2016, nonperforming portfolio assets as a percent of portfolio loans and leases and OREO increased to 0.75% compared to 0.70% at December 31, 2015. For further discussion on credit quality refer to the Credit Risk Management subsection of the Risk Management section of MD&A.

Capital Summary

The Bancorp’s capital ratios exceed the “well-capitalized” guidelines as defined by the PCA requirements of the U.S. banking agencies. As of September 30, 2016, as calculated under the Basel III transition provisions, the CET1 capital ratio was 10.17%, the Tier I risk-based capital ratio was 11.27%, the Total risk-based capital ratio was 14.88% and the Tier I leverage ratio was 9.80%.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

NON-GAAP FINANCIAL MEASURES

The following are non-GAAP measures which are important to the reader of the Condensed Consolidated Financial Statements but should be supplemental to primary U.S. GAAP measures.

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.

The following table reconciles the non-GAAP financial measures of net interest income on an FTE basis, net interest margin and the efficiency ratio to U.S. GAAP:

TABLE 3: Non-GAAP Financial Measures - Net Interest Income on an FTE Basis, Net Interest Margin and Efficiency Ratio

 

 
     For the three months ended
September 30,
       For the nine months ended    
September 30,    
 
($ in millions)    2016      2015        2016        2015  

 

 

Net interest income (U.S. GAAP)

   $ 907         901           2,712           2,636       

Add: FTE adjustment

     6         5           18           14       

 

 

Net interest income on an FTE basis (1)

   $ 913         906           2,730           2,650       

Net interest income on an FTE basis (annualized) (2)

     3,632         3,594           3,640           3,533       

Noninterest income (3)

   $ 840         713           2,075           1,900       

Noninterest expense (4)

     973         943           2,942           2,814       

Average interest-earning assets (5)

     126,092         124,431           126,197           122,824       

Ratios:

               

Net interest margin (2) / (5)

     2.88  %       2.89           2.88           2.88       

Efficiency ratio (4) / (1) + (3)

     55.5         58.2           61.2           61.8       

 

 

The following table reconciles the non-GAAP financial measure of income before income taxes on an FTE basis to U.S. GAAP:

TABLE 4: Non-GAAP Financial Measure - Income Before Income Taxes on an FTE Basis

 

 
     For the three months ended
September 30,
       For the nine months ended    
September 30,    
 
($ in millions)    2016      2015        2016      2015      

 

 

Income before income taxes (U.S. GAAP)

   $ 694         515           1,556         1,417       

Add: FTE adjustment

     6         5           18         14       

 

 

Income before income taxes on an FTE basis

   $ 700         520           1,574         1,431       

 

 

Pre-provision net revenue is net interest income plus noninterest income minus noninterest expense. The Bancorp believes this measure is important because it provides a ready view of the Bancorp’s pre-tax earnings before the impact of provision expense.

The following table reconciles the non-GAAP financial measure of pre-provision net revenue to U.S. GAAP:

TABLE 5: Non-GAAP Financial Measure - Pre-Provision Net Revenue

 

 
     For the three months ended
September 30,
     For the nine months ended    
September 30,    
 
($ in millions)    2016      2015      2016      2015      

 

 

Net interest income (U.S. GAAP)

   $ 907         901         2,712         2,636        

Add: Noninterest income

     840         713         2,075         1,900        

Less: Noninterest expense

     (973      (943      (2,942      (2,814)       

 

 

Pre-provision net revenue

   $ 774         671         1,845         1,722        

 

 

The Bancorp believes return on average tangible common equity is an important measure for comparative purposes with other financial institutions, but is not defined under U.S. GAAP, and therefore is considered a non-GAAP financial measure. This measure is useful for evaluating the performance of a business as it calculates the return available to common shareholders without the impact of intangible assets and their related amortization.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

The following table reconciles the non-GAAP financial measure of return on average tangible common equity to U.S. GAAP:

TABLE 6: Non-GAAP Financial Measure - Return on Average Tangible Common Equity

 

 
     For the three months ended
September 30,
     For the nine months ended    
September 30,    
 
($ in millions)    2016     2015      2016      2015      

 

 

Net income available to common shareholders (U.S. GAAP)

   $ 501        366         1,123         1,004        

Add: Intangible amortization, net of tax

     -        -         1         1        

 

 

Tangible net income available to common shareholders

   $ 501        366         1,124         1,005        

Tangible net income available to common shareholders (annualized) (1)

     1,993        1,452         1,499         1,340        

Average Bancorp shareholders’ equity (U.S. GAAP)

   $ 16,883        15,815         16,615         15,826        

Less: Average preferred stock

     (1,331     (1,331      (1,331      (1,331)       

Average goodwill

     (2,416     (2,416      (2,416      (2,416)       

Average intangible assets and other servicing rights

     (10     (14      (10      (15)       

 

 

Average tangible common equity (2)

   $ 13,126        12,054         12,858         12,064        

Return on average tangible common equity (1) / (2)

     15.2   %      12.0         11.7         11.1        

 

 

The Bancorp considers various measures when evaluating capital utilization and adequacy, including the tangible equity ratio, tangible common equity ratio and tangible book value per share, in addition to capital ratios defined by the U.S. banking agencies. These calculations are intended to complement the capital ratios defined by the U.S. banking agencies 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. These ratios are not formally defined by U.S. GAAP or codified in the federal banking regulations and, therefore, are considered to be non-GAAP financial measures. Additionally, the Bancorp became subject to the Basel III Final Rule on January 1, 2015 which defined various regulatory capital ratios including the CET1 ratio. The CET1 capital ratio has transition provisions that will be phased out over time. The Bancorp is presenting the CET1 capital ratio on a fully phased-in basis for comparative purposes with other organizations. The Bancorp considers the fully phased-in CET1 ratio a non-GAAP measure since it is not the CET1 ratio in effect for the periods presented. Since analysts and the U.S. banking agencies 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 encourages readers to consider its Condensed Consolidated Financial Statements in their entirety and not to rely on any single financial measure.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

The following table reconciles non-GAAP capital ratios to U.S. GAAP:

TABLE 7: Non-GAAP Financial Measures - Capital Ratios

As of ($ in millions)    September 30,  
2016          
    December 31,
2015        
 

Total Bancorp Shareholders’ Equity (U.S. GAAP)

   $ 16,776         15,839     

Less:  Preferred stock

     (1,331)        (1,331)    

Goodwill

     (2,416)        (2,416)    

Intangible assets and other servicing rights

     (10)        (13)    

Tangible common equity, including unrealized gains / losses (1)

     13,019         12,079     

Less:  AOCI

     (755)        (197)    

Tangible common equity, excluding unrealized gains / losses (2)

     12,264         11,882     

Add:  Preferred stock

     1,331         1,331     

Tangible equity (3)

   $ 13,595         13,213     

Total Assets (U.S. GAAP)

   $ 143,279         141,048   (f) 

Less:  Goodwill

     (2,416)        (2,416)    

Intangible assets and other servicing rights

     (10)        (13)    

AOCI, before tax

     (1,162)        (303)    

Tangible assets, excluding unrealized gains / losses (4)

   $ 139,691         138,316     

Common shares outstanding (5)

     756         785     

Ratios:

    

Tangible equity as a percentage of tangible assets (3) / (4)(d)

     9.73      9.55     

Tangible common equity as a percentage of tangible assets (2) / (4)(d)

     8.78         8.59     

Tangible book value per share (1) / (5)

     17.22         15.39     

Basel III Final Rule - Transition to Fully Phased-In

                

CET1 capital (transitional)

   $ 12,299         11,917     

Less: Adjustments to CET1 capital from transitional to fully phased-in(a)

     (4)        (8)    

CET1 capital (fully phased-in) (6)

     12,295         11,909     

Risk-weighted assets (transitional)(b)

     120,954         121,290   (e) 

Add: Adjustments to risk-weighted assets from transitional to fully phased-in(c)

     929         1,178     

Risk-weighted assets (fully phased-in) (7)

   $               121,883         122,468   (e) 

CET1 capital ratio under Basel III Final Rule (fully phased-in) (6) / (7)

     10.09      9.72   (e) 
(a)

Primarily relates to disallowed intangible assets (other than goodwill and MSRs, net of associated deferred tax liabilities).

(b)

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.

(c)

Primarily relates to higher risk weighting for MSRs.

(d)

Excludes unrealized gains and losses.

(e)

Balances not restated for the adoption of the amended guidance of ASU 2015-03 “Simplifying the Presentation of Debt Issuance Costs.” Refer to Note 3 of the Notes to Condensed Consolidated Financial Statements for further information.

(f)

Upon adoption of ASU 2015-03 on January 1, 2016, the December 31, 2015 Condensed Consolidated Balance Sheet was adjusted to reflect the reclassification of $34 of debt issuance costs from other assets to long-term debt. For further information, refer to Note 3 of the Notes to Condensed Consolidated Financial Statements for further information.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

RECENT ACCOUNTING STANDARDS

Note 3 of the Notes to Condensed Consolidated Financial Statements provides a discussion of the significant new accounting standards applicable to the Bancorp and the expected impact of significant accounting standards issued, but not yet required to be adopted.

CRITICAL ACCOUNTING POLICIES

The 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 Bancorp’s financial position, 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, goodwill and legal contingencies. These accounting policies are discussed in detail in the Critical Accounting Policies section of the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2015. No material changes were made to the valuation techniques or models during the nine months ended September 30, 2016.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

STATEMENTS OF INCOME ANALYSIS

Net Interest Income

Net interest income is the interest earned on loans and leases (including yield-related fees), securities and other short-term investments less the interest paid for core deposits (includes transaction deposits and other time deposits) and wholesale funding (includes certificates $100,000 and over, other deposits, federal funds purchased, other 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 yield 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 8 and 9 present the components of net interest income, net interest margin and net interest rate spread for the three and nine months ended September 30, 2016 and 2015, as well as the relative impact of changes in the balance sheet and changes in interest rates on net interest income. 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 and other securities included in other assets.

Net interest income on an FTE basis (non-GAAP) was $913 million and $2.7 billion for the three and nine months ended September 30, 2016, respectively, an increase of $7 million and $80 million compared to the same periods in the prior year. Net interest income was positively impacted by increases in average taxable securities of $1.5 billion and $3.5 billion for the three and nine months ended September 30, 2016, respectively, and increases in yields on average loans and leases of 10 bps and 5 bps for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. Additionally, net interest income was positively impacted by the decision of the Federal Open Market Committee in December 2015 to raise the target range of the federal funds rate 25 bps. The nine months ended September 30, 2016 also included the positive impact of an increase in average loans and leases of $1.5 billion compared to the same period in the prior year. These positive impacts were partially offset by increases in average long-term debt of $1.4 billion and $1.2 billion for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year coupled with decreases in the net interest rate spread to 2.66% and 2.68% during the three and nine months ended September 30, 2016, respectively, from 2.71% and 2.70% in the same periods in the prior year. The decreases in the net interest rate spread were due to a 12 bps and 9 bps increase in the rates paid on average interest-bearing liabilities for the three and nine months ended September 30, 2016, respectively, partially offset by a 7 bps increase in yields on average interest-earning assets for both the three and nine months ended September 30, 2016 compared to the same periods in the prior year.

Net interest margin on an FTE basis (non-GAAP) was 2.88% for both the three and nine months ended September 30, 2016 compared to 2.89% and 2.88% for the three and nine months ended September 30, 2015, respectively. The decrease from the three months ended September 30, 2015 was driven primarily by the aforementioned decrease in net interest rate spread coupled with an increase of $1.7 billion in average interest-earning assets partially offset by an increase in average free funding balances. The nine months ended September 30, 2016 was positively impacted by an increase in average free funding balances compared to the same period in the prior year offset by an increase of $3.4 billion in average interest-earning assets as well as the aforementioned decrease in net interest rate spread. The increase in average free funding balances for both periods was driven by an increase in average demand deposits of $687 million and $881 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year as well as an increase in average shareholders’ equity of $1.1 billion and $784 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year.

Interest income on an FTE basis from loans and leases (non-GAAP) increased $22 million and $78 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The increase for the three months ended September 30, 2016 was driven by an increase in yields on average loans and leases of 10 bps compared to the same period in the prior year primarily due to an increase in yields on average commercial and industrial loans. The increase for the nine months ended September 30, 2016 was primarily due to an increase in average loans and leases coupled with an increase in yields on average loans and leases. Average loans and leases increased $1.5 billion for the nine months ended September 30, 2016 compared to the same period in the prior year driven primarily by increases in average residential mortgage loans, average commercial construction loans and average commercial and industrial loans partially offset by a decrease in average automobile loans. Yields on average loans and leases increased 5 bps for the nine months ended September 30, 2016 compared to the same period in the prior year primarily driven by an increase in yields on average commercial and industrial loans. For more information on the Bancorp’s loan and lease portfolio, refer to the Loans and Leases subsection of the Balance Sheet Analysis section of MD&A. Interest income from investment securities and other short-term investments increased $10 million and $69 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily as a result of the aforementioned increases in average taxable securities.

Interest expense on core deposits increased $7 million for both the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. These increases were primarily due to increases in the cost of average interest-bearing core deposits to 26 bps for both the three and nine months ended September 30, 2016 from 22 bps and 24 bps for the three and nine months ended September 30, 2015, respectively. The increase in the cost of average interest-bearing core deposits for both periods was primarily due to increases in the cost of average interest checking deposits. The increase for the three months ended September 30, 2016 compared to the same period in the prior year was also due to an increase in the cost of average money market deposits. Refer to the Deposits subsection of the Balance Sheet Analysis section of MD&A for additional information on the Bancorp’s deposits.

Interest expense on average wholesale funding increased $18 million and $60 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The increases for the three and nine months ended September 30, 2016 were primarily due to increases of 24 bps and 25 bps, respectively, in the rates paid on average long-term debt coupled with the aforementioned increases in average long-term debt.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Refer to the Borrowings subsection of the Balance Sheet Analysis section of MD&A for additional information on the Bancorp’s borrowings. During both the three and nine months ended September 30, 2016, average wholesale funding represented 26% of average interest-bearing liabilities compared to 25% and 23% during the three and nine months ended September 30, 2015, respectively. For more information on the Bancorp’s interest rate risk management, including estimated earnings sensitivity to changes in market interest rates, refer to the Market Risk Management section of MD&A.

TABLE 8: Condensed Average Balance Sheets and Analysis of Net Interest Income on an FTE Basis

For the three months ended   September 30, 2016     September 30, 2015     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

  $ 43,125        356        3.28  %    $ 43,162        339        3.11  %    $ (2)         19          17   

  Commercial mortgage loans

    6,891        57        3.31        7,038        56        3.17        (1)         2          1   

  Commercial construction loans

    3,848        33        3.43        2,966        23        3.13        8          2          10   

  Commercial leases

    3,963        26        2.64        3,847        27        2.72        -          (1)         (1

Total commercial loans and leases

    57,827        472        3.25        57,013        445        3.09        5          22          27   

  Residential mortgage loans

    15,346        136        3.51        13,976        128        3.63        12          (4)         8   

  Home equity

    7,918        75        3.76        8,521        78        3.61        (6)         3          (3

  Automobile loans

    10,508        72        2.71        11,881        79        2.62        (10)         3          (7

  Credit card

    2,165        56        10.34        2,277        60        10.38        (4)         -          (4

  Other consumer loans and leases

    653        11        6.90        661        10        6.81        1          -          1   

Total consumer loans and leases

    36,590        350        3.80        37,316        355        3.78        (7)         2          (5

Total loans and leases

  $ 94,417        822        3.46  %    $ 94,329        800        3.36  %    $ (2)         24          22   

Securities:

                 

  Taxable

    29,772        238        3.18        28,251        229        3.23        12          (3)         9   

  Exempt from income taxes(b)

    76        1        4.91        52        1        5.20        -          -          -   

Other short-term investments

    1,827        2        0.44        1,799        1        0.23        -          1          1   

Total interest-earning assets

  $     126,092        1,063        3.36  %    $     124,431        1,031        3.29  %    $ 10          22          32   

  Cash and due from banks

    2,289            2,503             

  Other assets

    15,644            15,064  (d)           

  Allowance for loan and lease losses

    (1,299                     (1,292                                        

Total assets

  $ 142,726                      $ 140,706  (d)                                         

Liabilities and Equity:

                 

Interest-bearing liabilities:

                 

  Interest checking deposits

  $ 24,475        14        0.23  %    $ 25,590        11        0.18  %    $ -          3          3   

  Savings deposits

    14,232        2        0.04        14,868        2        0.05        -          -          -   

  Money market deposits

    19,706        13        0.27        18,253        10        0.21        -          3          3   

  Foreign office deposits

    524        -        0.17        718        -        0.14        -          -          -   

  Other time deposits

    4,020        13        1.24        4,057        12        1.19        1          -          1   

Total interest-bearing core deposits

    62,957        42        0.26        63,486        35        0.22        1          6          7   

  Certificates $100,000 and over

    2,768        8        1.28        2,924        9        1.16        (2)         1          (1

  Other deposits

    749        1        0.41        222        -        0.16        1          -          1   

  Federal funds purchased

    446        -        0.40        1,978        -        0.14        (1)         1          -   

  Other short-term borrowings

    2,171        2        0.30        1,897        1        0.13        -          1          1   

  Long-term debt

    16,102        97        2.40        14,664  (d)      80        2.16        8          9          17   

Total interest-bearing liabilities

  $ 85,193        150        0.70  %    $ 85,171  (d)      125        0.58  %    $ 7          18          25   

Demand deposits

    35,918            35,231             

Other liabilities

    4,704                        4,458                                           

Total liabilities

  $ 125,815          $ 124,860  (d)           

Total equity

  $ 16,911                      $ 15,846                                           

Total liabilities and equity

  $ 142,726                      $ 140,706  (d)                                         

Net interest income (FTE)(c)

    $ 913          $ 906        $ 3          4          7   

Net interest margin (FTE)(c)

        2.88  %          2.89  %       

Net interest rate spread (FTE)

        2.66            2.71         

Interest-bearing liabilities to interest-earning assets

  

            67.56                        68.45                           
(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 were $6 and $5 for the three months ended September 30, 2016 and 2015, respectively.

(c)

Net interest income (FTE) and net interest margin (FTE) are non-GAAP measures. For further information, refer to the Non-GAAP Financial Measures section of MD&A.

(d)

Upon adoption of ASU 2015-03 on January 1, 2016, the September 30, 2015 Condensed Consolidated Balance Sheet was adjusted to reflect the reclassification of $33 of average debt issuance costs from average other assets to average long-term debt. For further information, refer to Note 3 of the Notes to Condensed Consolidated Financial Statements.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

TABLE 9: Condensed Average Balance Sheets and Analysis of Net Interest Income on an FTE Basis   
For the nine months ended    September 30, 2016     September 30, 2015     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

   $ 43,376        1,057         3.25  %    $ 42,399        995         3.14  %    $ 25           37           62   

  Commercial mortgage loans

     6,878        169         3.29        7,144        172         3.22        (7)          4           (3

  Commercial construction loans

     3,567        91         3.39        2,574        61         3.17        25           5           30   

  Commercial leases

     3,914        79         2.71        3,780        80         2.82        2           (3)          (1

Total commercial loans and leases

     57,735        1,396         3.23        55,897        1,308         3.13        45           43           88   

  Residential mortgage loans

     14,866        397         3.57        13,624        378         3.71        34           (15)          19   

  Home equity

     8,072        229         3.79        8,658        236         3.64        (16)          9           (7

  Automobile loans

     10,892        219         2.68        11,905        236         2.65        (20)          3           (17

  Credit card

     2,213        174         10.48        2,298        177         10.31        (6)          3           (3

  Other consumer loans and leases

     656        32         6.51        537        34         8.45        7           (9)          (2

Total consumer loans and leases

     36,699        1,051         3.82        37,022        1,061         3.83        (1)          (9)          (10

Total loans and leases

   $ 94,434        2,447         3.46  %    $ 92,919        2,369         3.41  %    $ 44           34           78   

Securities:

                      

  Taxable

     29,798        705         3.16        26,251        635         3.24        85           (15)          70   

  Exempt from income taxes(b)

     80        2         4.43        57        2         5.08        -           -           -   

Other short-term investments

     1,885        6         0.43        3,597        7         0.25        (4)          3           (1

Total interest-earning assets

   $ 126,197        3,160         3.35  %    $ 122,824        3,013         3.28  %    $ 125           22           147   

  Cash and due from banks

     2,284             2,655                

  Other assets

     15,218             15,264 (d)              

  Allowance for loan and lease losses

     (1,289                      (1,304                                           

Total assets

   $ 142,410                       $ 139,439 (d)                                            

Liabilities and Equity:

                      

Interest-bearing liabilities:

                      

  Interest checking deposits

   $ 24,974        42         0.23  %    $ 26,452        38         0.19  %    $ (3)          7           4   

  Savings deposits

     14,469        5         0.05        15,065        7         0.06        (1)          (1)          (2

  Money market deposits

     19,203        37         0.26        17,942        34         0.25        2           1           3   

  Foreign office deposits

     497        1         0.16        844        1         0.16        -           -           -   

  Other time deposits

     4,033        38         1.23        4,051        36         1.20                1           2   

Total interest-bearing core deposits

     63,176        123         0.26        64,354        116         0.24        (1)          8           7   

  Certificates $100,000 and over

     2,801        27         1.28        2,722        24         1.19        1           2           3   

  Other deposits

     407        1         0.41        75        -         0.16        1           -           1   

  Federal funds purchased

     582        2         0.38        832        -         0.13        1           1           2   

  Other short-term borrowings

     3,160        8         0.36        1,736        2         0.12        1           5           6   

  Long-term debt

     15,468        269         2.33        14,273 (d)      221         2.08        20           28           48   

Total interest-bearing liabilities

   $ 85,594        430         0.67  %    $ 83,992 (d)      363         0.58  %    $ 23           44           67   

Demand deposits

     35,678             34,797                

Other liabilities

     4,492                         4,788                                              

Total liabilities

   $     125,764           $     123,577 (d)              

Total equity

   $ 16,646                       $ 15,862                                              

Total liabilities and equity

   $ 142,410                       $ 139,439 (d)                                            

Net interest income (FTE)(c)

     $ 2,730           $ 2,650         $ 102           (22)          80   

Net interest margin (FTE)(c)

          2.88  %           2.88  %         

Net interest rate spread (FTE)

          2.68             2.70           

Interest-bearing liabilities to interest-earning assets

  

     67.83                         68.38                             
(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 were $18 and $14 for the nine months ended September 30, 2016 and 2015, respectively.

(c)

Net interest income (FTE) and net interest margin (FTE) are non-GAAP measures. For further information, refer to the Non-GAAP Financial Measures section of MD&A.

(d)

Upon adoption of ASU 2015-03 on January 1, 2016, the September 30, 2015 Condensed Consolidated Balance Sheet was adjusted to reflect the reclassification of $33 of average debt issuance costs from average other assets to average long-term debt. For further information, refer to Note 3 of the Notes to Condensed Consolidated Financial Statements.

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 previously discussed in the Critical Accounting Policies section of the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2015. 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 and leases actually removed from the Condensed Consolidated Balance Sheets are referred to as charge-offs. Net charge-offs include current period charge-offs less recoveries on previously charged-off loans and leases.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

The provision for loan and lease losses was $80 million and $289 million for the three and nine months ended September 30, 2016, respectively, compared to $156 million and $305 million during the same periods in the prior year. The decrease in provision expense for both periods was primarily due to the impact of the restructuring of a student loan backed commercial credit originated in 2007 during the third quarter of 2015 partially offset by prolonged softness in commodity prices, slow global economic growth and appreciation of the U.S. dollar. The ALLL was $1.3 billion at both September 30, 2016 and December 31, 2015. At both September 30, 2016 and December 31, 2015, the ALLL as a percent of portfolio loans and leases was 1.37%.

Refer to the Credit Risk Management subsection of the Risk Management section of MD&A 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 and lease 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 $127 million and $175 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year.

The following table presents the components of noninterest income:

TABLE 10: Components of Noninterest Income

          For the three months ended
September 30,
                For the nine months ended
September 30,
        
($ in millions)        2016      2015     % Change          2016      2015     % Change  

Service charges on deposits

  $     143            145           (1)       $     417            419           -     

Corporate banking revenue

      111            104           7            330            280           18     

Wealth and asset management revenue

      101            103           (2)           304            315           (3)    

Card and processing revenue

      79            77           3            240            225           7     

Mortgage banking net revenue

      66            71           (7)           219            274           (20)    

Other noninterest income

      336            213           58            552            378           46     

Securities gains, net

        4            -           100              13            9           44     

Total noninterest income

  $     840            713           18        $     2,075            1,900           9     

Service charges on deposits

Service charges on deposits decreased $2 million for both the three and nine months ended September 30, 2016 compared to the same periods in the prior year. The decrease for the three and nine months ended September 30, 2016 compared to the same periods in the prior year was due to a $3 million and $8 million, respectively, decrease in consumer deposit fees driven by a decrease in consumer checking fees partially offset by a $1 million and $6 million, respectively, increase in commercial deposit fees driven by new customer acquisition.

Corporate banking revenue

Corporate banking revenue increased $7 million and $50 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The increase for both the three and nine months ended September 30, 2016 compared to the same periods in the prior year was primarily driven by increases in lease remarketing fees and syndication fees. The increase for the nine months ended September 30, 2016 was partially offset by decreases in foreign exchange fees and letter of credit fees. The increase in lease remarketing fees of $5 million and $35 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year included an $11 million gain on certain commercial lease terminations partially offset by $6 million of impairment charges related to certain operating lease equipment that were recognized during the third quarter of 2016. The increase in lease remarketing fees for the nine months ended September 30, 2016 compared to the same period in the prior year also included the impact of $36 million of impairment charges related to operating lease equipment that was recognized during the nine months ended September 30, 2015. Syndication fees increased $4 million and $31 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year as a result of increased activity in the market. Foreign exchange fees decreased $11 million for the nine months ended September 30, 2016 compared to the same period in the prior year primarily driven by lower volume coupled with lower volatility. Letter of credit fees decreased $7 million for the nine months ended September 30, 2016 compared to the same period in the prior year primarily driven by a decrease in outstanding VRDNs.

Wealth and asset management revenue

Wealth and asset management revenue (formerly investment advisory revenue) decreased $2 million and $11 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The decrease for both the three and nine months ended September 30, 2016 compared to the same periods in the prior year was primarily due to decreases of $4 million and $13 million, respectively, in transactional securities and brokerage fees driven by lower sales and trading volume. These decreases were partially offset by a $2 million increase in private client service fees and institutional fees for both the three and nine months ended September 30, 2016 compared to the same periods in the prior year. The Bancorp had approximately $314 billion and $297 billion in total assets under care at September 30, 2016 and 2015, respectively, and managed $27 billion and $25 billion in assets for individuals, corporations and not-for-profit organizations at September 30, 2016 and 2015, respectively.

Card and processing revenue

Card and processing revenue increased $2 million and $15 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily driven by an increase in the number of actively used cards and customer spend volume.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Mortgage banking net revenue

Mortgage banking net revenue decreased $5 million and $55 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year.

The following table presents the components of mortgage banking net revenue:

TABLE 11: Components of Mortgage Banking Net Revenue

 

 
        For the three months ended
September 30,
    For the nine months ended
September 30,
 
($ in millions)       2016     2015     2016     2015  

 

 

Origination fees and gains on loan sales

  $     61        46              156        134         

Net mortgage servicing revenue:

         

  Gross mortgage servicing fees

      49        54              151        169         

  MSR amortization

      (35     (37)             (96     (110)        

  Net valuation adjustments on MSRs and free-standing derivatives purchased to economically hedge MSRs

      (9     8              8        81         

 

 

Net mortgage servicing revenue

      5        25              63        140         

 

 

Mortgage banking net revenue

  $     66        71              219        274         

 

 

Origination fees and gains on loan sales increased $15 million and $22 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year driven by an increase in saleable residential mortgage loan originations. Residential mortgage loan originations increased to $2.9 billion and $7.3 billion during the three and nine months ended September 30, 2016, respectively, compared to $2.3 billion and $6.6 billion during the same periods in the prior year.

Net mortgage servicing revenue is comprised of gross mortgage servicing fees and related MSR amortization as well as valuation adjustments on MSRs and mark-to-market adjustments on both settled and outstanding free-standing derivative financial instruments used to economically hedge the MSR portfolio. Net mortgage servicing revenue decreased $20 million and $77 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The decreases for the three and nine months ended September 30, 2016 compared to the same periods in the prior year were driven by decreases of $17 million and $73 million in net valuation adjustments, respectively, as well as decreases of $5 million and $18 million in gross mortgage servicing fees, respectively. These decreases were partially offset by decreases in MSR amortization of $2 million and $14 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year.

The following table presents the components of net valuation adjustments on the MSR portfolio and the impact of the non-qualifying hedging strategy:

TABLE 12: Components of Net Valuation Adjustments on MSRs

 

 
            For the three months ended        
September 30,
        For the nine months ended      
September 30,
 
($ in millions)       2016     2015     2016     2015  

 

 

Changes in fair value and settlement of free-standing derivatives purchased to economically hedge the MSR portfolio

  $     (16     85              133        119         

(Provision for) recovery of MSR impairment

      7        (77)             (125     (38)        

 

 

Net valuation adjustments on MSR and free-standing derivatives purchased to economically hedge MSRs

  $     (9     8              8        81         

 

 

Mortgage rates increased during the three months ended September 30, 2016. Actual prepayment speeds also increased during the three months ended September 30, 2016, but were associated with the interest rate decline at the end of the second quarter of 2016 as there is a natural lag between interest rate movements and prepayments. The increase in mortgage rates caused modeled prepayment speeds to decrease, which led to a recovery of temporary impairment on servicing rights during the period. Mortgage rates decreased during the nine months ended September 30, 2016. Mortgage rates were also lower during both the three and nine months ended September 30, 2015 which caused actual prepayments on the servicing portfolio to increase. Lower mortgage rates caused modeled prepayment speeds to increase, which led to temporary impairment on servicing rights during the periods.

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 11 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. Refer to Note 12 of the Notes to Condensed Consolidated Financial Statements for more information on the free-standing derivatives used to economically hedge the MSR portfolio.

The Bancorp’s total residential loans serviced at September 30, 2016 and 2015 were $70.2 billion and $74.5 billion, respectively, with $54.6 billion and $60.3 billion, respectively, of residential mortgage loans serviced for others.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Other noninterest income

The following table presents the components of other noninterest income:

TABLE 13: Components of Other Noninterest Income

              For the three months ended    
September 30,
        For the nine months ended    
September 30,
 
($ in millions)        2016     2015     2016     2015  

Income from the TRA associated with Vantiv, Inc.

  $     280        -            280        -       

Operating lease income

      27        22            76        66       

Valuation adjustments on the warrant associated with Vantiv Holding, LLC

      (2     130            64        215       

Equity method income from interest in Vantiv Holding, LLC

      21        17            51        42       

BOLI income

      12        12            39        37       

Cardholder fees

      12        11            33        33       

Gains on sale of branches

      -        -            19        -       

Consumer loan and lease fees

      7        6            17        18       

Banking center income

      5        6            15        16       

Insurance income

      3        3            9        11       

Net gains (losses) on loan sales

      1        (1)           8        40       

Private equity investment income

      (5     12            5        21       

Loss on swap associated with the sale of Visa, Inc. class B shares

      (12     (8)           (61     (27)      

Net losses on disposition and impairment of bank premises and equipment

      (17     (1)           (14     (102)      

Other, net

        4        4            11        8       

Total other noninterest income

  $     336        213            552        378       

Other noninterest income increased $123 million during the three months ended September 30, 2016 compared to the same period in the prior year primarily due to an increase in the income from the TRA associated with Vantiv, Inc. partially offset by decreases in positive valuation adjustments on the warrant associated with Vantiv Holding, LLC and private equity investment income as well as an increase in net losses on disposition and impairment of bank premises and equipment. Other noninterest income increased $174 million during the nine months ended September 30, 2016 compared to the same period in the prior year primarily due to increases in the income from the TRA associated with Vantiv, Inc. and gains on sale of branches as well as a decrease in the net losses on disposition and impairment of bank premises and equipment. These increases were partially offset by decreases in positive valuation adjustments on the warrant associated with Vantiv Holding, LLC, net gains on loan sales and private equity investment income as well as an increase in the loss on the swap associated with the sale of Visa, Inc. class B shares.

The increase for both periods included the impact of a $280 million gain, which was recognized during the third quarter of 2016, from the termination and settlement of gross cash flows from existing Vantiv, Inc. TRAs and the expected obligation to terminate and settle the remaining Vantiv, Inc. TRA cash flows upon the exercise of put or call options. The increase for the three and nine months ended September 30, 2016 compared to the same periods in the prior year also included the impact of impairment charges of $28 million and $31 million, respectively, included in net losses on disposition and impairment of bank premises and equipment, compared to impairment charges of $2 million and $104 million which were recognized during the three and nine months ended September 30, 2015, respectively. The impairment charges for both the three and nine months ended September 30, 2016 were partially offset by a gain of $11 million on the sale-leaseback of an office complex during the third quarter of 2016. For further information, refer to Note 7 of the Notes to Condensed Consolidated Financial Statements.

Gains on sale of branches of $19 million for the nine months ended September 30, 2016 included an $11 million gain on the sale of the Bancorp’s retail operations in the Pittsburgh MSA to First National Bank of Pennsylvania during the second quarter of 2016 and an $8 million gain on the sale of the Bancorp’s retail operations in the St. Louis MSA to Great Southern Bank during the first quarter of 2016.

The Bancorp recognized a negative valuation adjustment on the stock warrant associated with Vantiv Holding, LLC of $2 million and a positive valuation adjustment of $130 million for the three months ended September 30, 2016 and 2015, respectively. The nine months ended September 30, 2016 and 2015 included positive valuation adjustments on the stock warrant associated with Vantiv Holding, LLC of $64 million and $215 million, respectively. The fair value of the stock warrant is calculated using the Black-Scholes option-pricing model, which utilizes several key inputs (Vantiv, Inc. stock price, strike price of the warrant and several unobservable inputs). The negative valuation adjustment for the three months ended September 30, 2016 was primarily due to a decrease of 1% in Vantiv, Inc.’s share price from June 30, 2016 to September 30, 2016. The positive valuation adjustment for the three months ended September 30, 2015 was primarily due to an increase of 18% in Vantiv, Inc.’s share price from June 30, 2015 to September 30, 2015. The positive valuation adjustments for the nine months ended September 30, 2016 and 2015 were primarily due to increases of 19% and 32%, respectively, in Vantiv, Inc.’s share price from December 31, 2015 to September 30, 2016 and from December 31, 2014 to September 30, 2015. The changes in the valuation adjustments for the three and nine months ended September 30, 2016 compared to the same periods in the prior year included the impact of the sale and exercise of a portion of the warrant during the fourth quarter of 2015. For additional information on the valuation of the warrant, refer to Note 22 of the Notes to Condensed Consolidated Financial Statements.

Private equity investment income decreased $17 million and $16 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The decrease for both periods was primarily driven by the recognition of $9 million of OTTI on certain private equity investments in the third quarter of 2016. Refer to Note 22 of the Notes to Condensed Consolidated Financial Statements for further information.

 

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Net gains on loan sales decreased $32 million for the nine months ended September 30, 2016 compared to the same period in the prior year as the prior period included the impact of a $37 million gain on the sale of residential mortgage loans classified as TDRs during the first quarter of 2015 which was partially offset by the $11 million gain on the sale of the agent bankcard loan portfolio during the second quarter of 2016.

During the nine months ended September 30, 2016, the Bancorp recognized a $61 million negative valuation adjustment related to the Visa total return swap compared to $27 million during the nine months ended September 30, 2015. The adjustment for the nine months ended September 30, 2016 was primarily attributable to the decision of the U.S. Court of Appeals for the Second Circuit to vacate and reverse the district court’s approval of the settlement of an interchange antitrust class action litigation matter on June 30, 2016. For additional information on the valuation of the swap associated with the sale of Visa, Inc. Class B shares and the related litigation matters, refer to Note 16, Note 17 and Note 22 of the Notes to Condensed Consolidated Financial Statements.

Noninterest Expense

Noninterest expense increased $30 million and $128 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily due to increases in personnel costs (salaries, wages and incentives plus employee benefits), technology and communications expense and other noninterest expense partially offset by a decrease in card and processing expense.

The following table presents the components of noninterest expense:

TABLE 14: Components of Noninterest Expense

            For the three months ended  
September 30,
                   For the nine months ended  
September 30,
         
($ in millions)        2016     2015      % Change          2016     2015      % Change  

Salaries, wages and incentives

  $     400        387         3        $     1,209        1,139         6     

Employee benefits

      78        72         8            263        248         6     

Net occupancy expense

      73        77         (5)           226        238         (5)    

Technology and communications

      62        56         11            178        165         8     

Card and processing expense

      30        40         (25)           101        114         (11)    

Equipment expense

      29        31         (6)           89        92         (3)    

Other noninterest expense

        301        280         8              876        818         7     

Total noninterest expense

  $     973        943         3        $     2,942        2,814         5     

Efficiency ratio on an FTE basis(a)

        55.5  %      58.2                     61.2  %      61.8            
(a)

This is a non-GAAP measure. For further information, refer to the Non-GAAP Financial Measures section of MD&A.

Personnel costs increased $19 million and $85 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods was driven by increased base compensation, primarily due to personnel additions in risk and compliance and information technology, and increased variable compensation. The increase for the nine months ended September 30, 2016 was also driven by higher retirement and severance costs related to the Bancorp’s voluntary early retirement program. Full-time equivalent employees totaled 18,072 at September 30, 2016 compared to 18,311 at September 30, 2015.

Technology and communications expense increased $6 million and $13 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year driven by increased investment in information technology associated with regulatory and compliance initiatives, system maintenance and other growth initiatives.

Card and processing expense decreased $10 million and $13 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily due to the impact of renegotiated service contracts.

 

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The following table presents the components of other noninterest expense:

TABLE 15: Components of Other Noninterest Expense

 

 
         For the three months ended 
September 30,
     For the nine months ended 
September 30,
 
($ in millions)       2016      2015     2016      2015  

 

 

Impairment on affordable housing investments

  $     42         37             128         112        

FDIC insurance and other taxes

      33         28             95         72        

Marketing

      30         32             81         87        

Loan and lease

      30         30             81         90        

Operating lease

      22         18             64         54        

Losses and adjustments

      8         9             51         38        

Professional service fees

      14         21             43         49        

Data processing

      14         12             37         34        

Postal and courier

      12         11             35         34        

Travel

      11         13             34         40        

Recruitment and education

      10         9             28         24        

Provision for the reserve for unfunded commitments

      11         2             24         -        

Donations

      9         5             15         15        

Insurance

      4         4             11         13        

Supplies

      4         4             11         12        

Other, net

      47         45             138         144        

 

 

Total other noninterest expense

  $     301         280             876         818        

 

 

Other noninterest expense increased $21 million for the three months ended September 30, 2016 compared to the same period in the prior year primarily due to increases in the provision for the reserve for unfunded commitments, impairment on affordable housing investments and FDIC insurance and other taxes. The provision for the reserve for unfunded commitments increased $9 million for the three months ended September 30, 2016 compared to the same period in the prior year primarily due to an increase in estimated loss rates related to unfunded commitments. Impairment on affordable housing investments increased $5 million for the three months ended September 30, 2016 compared to the same period in the prior year primarily due to incremental losses resulting from previous growth in the portfolio. FDIC insurance and other taxes increased $5 million for the three months ended September 30, 2016 compared to the three months ended September 30, 2015 primarily due to the implementation of the FDIC surcharge in the third quarter of 2016. For further information on the FDIC surcharge, refer to the Legislative and Regulatory Developments subsection of the Overview section of MD&A.

Other noninterest expense increased $58 million for the nine months ended September 30, 2016 compared to the same period in the prior year primarily due to increases in the provision for the reserve for unfunded commitments, FDIC insurance and other taxes, impairment on affordable housing investments, losses and adjustments and operating lease expense partially offset by a decrease in loan and lease expense. The provision for the reserve for unfunded commitments increased $24 million for the nine months ended September 30, 2016 compared to the same period in the prior year primarily due to an increase in estimated loss rates related to unfunded commitments. FDIC insurance and other taxes increased $23 million for the nine months ended September 30, 2016 compared to the same period in the prior year primarily due to the implementation of the FDIC surcharge in the third quarter of 2016 as well as an increase in the FDIC insurance assessment base and a favorable settlement of a tax liability related to prior years during the first quarter of 2015. Impairment on affordable housing investments increased $16 million for the nine months ended September 30, 2016 compared to the same period in the prior year primarily due to incremental losses resulting from previous growth in the portfolio. Losses and adjustments increased $13 million for the nine months ended September 30, 2016 compared to the same period in the prior year primarily due to the impact of favorable legal settlements for the nine months ended September 30, 2015. Additionally, operating lease expense increased $10 million for the nine months ended September 30, 2016 compared to the same period in the prior year. The decrease in loan and lease expense of $9 million for the nine months ended September 30, 2016 compared to the same period in the prior year included lower loan closing and appraisal costs driven by a decline in automobile loan originations.

The Bancorp continues to focus on efficiency initiatives as part of its core emphasis on operating leverage and expense control. The efficiency ratio was 55.5% and 61.2% for the three and nine months ended September 30, 2016, respectively, compared to 58.2% and 61.8% for the three and nine months ended September 30, 2015, respectively. The efficiency ratio is a non-GAAP measure. For further information, refer to the Non-GAAP Financial Measures section of MD&A.

Applicable Income Taxes

The following table presents the Bancorp’s income before income taxes, applicable income tax expense and effective tax rate:

TABLE 16: Applicable Income Taxes

 

 
          For the three months ended  
September 30,
      For the nine months ended  
September 30,
 
($ in millions)       2016     2015     2016      2015  

 

 

Income before income taxes

  $     694         515            1,556         1,417       

Applicable income tax expense

      178         134            385         367       

Effective tax rate

      25.6      26.0            24.6         25.9       

 

 

Applicable income tax expense for all periods includes the benefit from tax-exempt income, tax-advantaged investments and 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 IRC, the New Markets Tax Credit program established under Section 45D of the IRC 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.

 

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The decrease in the effective tax rate for the nine months ended September 30, 2016 compared to the same period in the prior year was primarily related to gains on sales of certain leveraged leases that are exempt from federal taxation partially offset by Vantiv, Inc. related gains.

The Bancorp establishes a deferred tax asset for stock-based awards granted to its employees and directors. When the actual tax deduction for these stock-based awards is less than the expense previously recognized for financial reporting and where the Bancorp has not accumulated an excess tax benefit for previously exercised or released stock-based awards, the Bancorp is required to recognize a non-cash charge to income tax expense upon the write-off of the deferred tax asset previously established for these stock-based awards. Based on the Bancorp’s stock price at September 30, 2016, the Bancorp believes it will recognize a $7 million non-cash charge to income tax expense over the next twelve months related to stock-based awards, primarily in the second quarter of 2017. However, the Bancorp cannot predict its stock price or whether its employees will exercise other stock-based awards with lower exercise prices in the future. Therefore, it is possible the Bancorp may recognize a non-cash charge to income tax expense greater than or less than $7 million over the next twelve months.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

BALANCE SHEET ANALYSIS

Loans and Leases

The Bancorp classifies its commercial loans and leases based upon primary purpose and consumer loans and leases based upon product or collateral. Table 17 summarizes end of period loans and leases, including loans held for sale and Table 18 summarizes average total loans and leases, including loans held for sale.

TABLE 17: Components of Loans and Leases (including loans held for sale)

          September 30, 2016      December 31, 2015  
As of ($ in millions)        Carrying Value      % of Total          Carrying Value      % of Total    

Commercial loans and leases:

            

Commercial and industrial loans

  $     42,829          46         $ 42,151          46       

Commercial mortgage loans

      6,860          7           6,991          7       

Commercial construction loans

      3,905          4           3,214          3       

Commercial leases

        3,995          4           3,854          4       

Total commercial loans and leases

        57,589          61           56,210          60       

Consumer loans and leases:

            

Residential mortgage loans

      15,597          17           14,424          15       

Home equity

      7,864          8           8,336          9       

Automobile loans

      10,349          11           11,497          12       

Credit card

      2,169          2           2,360          3       

Other consumer loans and leases

        643          1           658          1       

Total consumer loans and leases

        36,622          39           37,275          40       

Total loans and leases

  $     94,211          100         $ 93,485          100       

Total portfolio loans and leases (excluding loans held for sale)

  $     93,151                 $ 92,582             

Loans and leases, including loans held for sale, increased $726 million, or 1%, from December 31, 2015. The increase from December 31, 2015 was the result of a $1.4 billion, or 2%, increase in commercial loans and leases, partially offset by a $653 million, or 2%, decrease in consumer loans and leases.

Commercial loans and leases increased from December 31, 2015 primarily due to increases in commercial construction loans, commercial and industrial loans and commercial leases, partially offset by a decrease in commercial mortgage loans. Commercial construction loans increased $691 million, or 21%, from December 31, 2015 primarily as a result of an increase in new loan origination activity resulting from an increase in demand and targeted marketing efforts. Commercial and industrial loans increased $678 million, or 2%, from December 31, 2015 primarily as a result of increases in new loan origination activity and line utilization. Commercial leases increased $141 million, or 4%, from December 31, 2015 primarily as a result of an increase in syndication and participation origination activity. Commercial mortgage loans decreased $131 million, or 2%, from December 31, 2015 primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns.

Consumer loans and leases decreased from December 31, 2015 primarily due to decreases in automobile loans, home equity and credit card, partially offset by an increase in residential mortgage loans. Automobile loans decreased $1.1 billion, or 10%, from December 31, 2015 and home equity decreased $472 million, or 6%, from December 31, 2015 as payoffs exceeded new loan production. Credit card decreased $191 million, or 8%, from December 31, 2015 primarily due to the sale of the agent bankcard loan portfolio during the second quarter of 2016 and seasonal trends from the paydown of year-end balances which were higher due to holiday spending. Residential mortgage loans increased $1.2 billion, or 8%, from December 31, 2015 primarily due to the continued retention of certain conforming ARMs and certain other fixed-rate loans originated during the nine months ended September 30, 2016.

TABLE 18: Components of Average Loans and Leases (including loans held for sale)

          September 30, 2016      September 30, 2015  
For the three months ended ($ in millions)        Carrying Value      % of Total          Carrying Value      % of Total    

Commercial loans and leases:

            

Commercial and industrial loans

  $     43,125          46         $ 43,162          46       

Commercial mortgage loans

      6,891          7           7,038          7       

Commercial construction loans

      3,848          4           2,966          3       

Commercial leases

        3,963          4           3,847          4       

Total commercial loans and leases

        57,827          61           57,013          60       

Consumer loans and leases:

            

Residential mortgage loans

      15,346          17           13,976          15       

Home equity

      7,918          8           8,521          9       

Automobile loans

      10,508          11           11,881          13       

Credit card

      2,165          2           2,277          2       

Other consumer loans and leases

        653          1           661          1       

Total consumer loans and leases

        36,590          39           37,316          40       

Total average loans and leases

  $     94,417          100         $ 94,329          100       

Total average portfolio loans and leases (excluding loans held for sale)

  $     93,511                 $ 93,373             

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Average loans and leases, including loans held for sale, increased $88 million from September 30, 2015 as a result of an $814 million, or 1%, increase in average commercial loans and leases, partially offset by a $726 million, or 2%, decrease in average consumer loans and leases.

Average commercial loans and leases increased from September 30, 2015 primarily due to increases in average commercial construction loans and average commercial leases, partially offset by a decrease in average commercial mortgage loans. Average commercial construction loans increased $882 million, or 30%, from September 30, 2015 primarily as a result of an increase in new loan origination activity resulting from an increase in demand and targeted marketing efforts. Average commercial leases increased $116 million, or 3%, from September 30, 2015 primarily as a result of an increase in syndication and participation origination activity. Average commercial mortgage loans decreased $147 million, or 2%, from September 30, 2015 primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns.

Average consumer loans and leases decreased from September 30, 2015 primarily due to decreases in average automobile loans, average home equity and average credit card, partially offset by an increase in average residential mortgage loans. Average automobile loans decreased $1.4 billion, or 12%, from September 30, 2015 and average home equity decreased $603 million, or 7%, from September 30, 2015 as payoffs exceeded new loan production. Average credit card decreased $112 million, or 5%, primarily due to the sale of the agent bankcard loan portfolio during the second quarter of 2016. Average residential mortgage loans increased $1.4 billion, or 10%, from September 30, 2015 primarily driven by the continued retention of certain conforming ARMs and certain other fixed-rate loans.

Investment Securities

The Bancorp uses investment securities as a means of managing interest rate risk, providing liquidity support and providing collateral for pledging purposes. Total investment securities were $31.2 billion and $29.5 billion at September 30, 2016 and December 31, 2015, respectively. The taxable investment securities portfolio had an effective duration of 4.0 years at September 30, 2016 compared to 5.1 years at December 31, 2015.

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. At September 30, 2016, the Bancorp’s investment portfolio consisted primarily of AAA-rated available-for-sale securities. Securities classified as below investment grade were immaterial at both September 30, 2016 and December 31, 2015. 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.

The following table provides a summary of OTTI by security type:

TABLE 19: Components of OTTI by Security Type

                For the three months ended
      September 30,
           For the nine months ended       
September 30,       
 
($ in millions)        2016        2015               2016                           2015          

Available-for-sale and other debt securities

  $     (2              (7)                         (5)       

Available-for-sale equity securities

        -                   (1)                         -        

Total OTTI(a)

  $     (2                (8)                         (5)       
(a)

Included in securities gains, net, in the Condensed Consolidated Statements of Income.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

The following table summarizes the end of period components of investment securities:

TABLE 20: Components of Investment Securities

As of ($ in millions)        September 30,    
    2016    
     December 31,      
2015      
 

Available-for-sale and other securities (amortized cost basis):

     

U.S. Treasury and federal agencies securities

   $ 866                  1,155                

Obligations of states and political subdivisions securities

     49                  50                

Mortgage-backed securities:

     

Agency residential mortgage-backed securities(a)

     14,671                  14,811                

Agency commercial mortgage-backed securities

     8,449                  7,795                

Non-agency commercial mortgage-backed securities

     2,683                  2,801                

Asset-backed securities and other debt securities

     2,069                  1,363                

Equity securities(b)

     699                  703                

Total available-for-sale and other securities

   $         29,486                  28,678                

Held-to-maturity securities (amortized cost basis):

     

Obligations of states and political subdivisions securities

   $ 55                  68                

Asset-backed securities and other debt securities

     1                  2                

Total held-to-maturity securities

   $ 56                  70                

Trading securities (fair value):

     

U.S. Treasury and federal agencies securities

   $ 9                  19                

Obligations of states and political subdivisions securities

     42                  9                

Agency residential mortgage-backed securities

     13                  6                

Asset-backed securities and other debt securities

     30                  19                

Equity securities

     337                  333                

Total trading securities

   $ 431                  386                
(a)

Includes interest-only mortgage-backed securities of $33 and $50 as of September 30, 2016 and December 31, 2015, respectively, recorded at fair value with fair value changes recorded in securities gains, net in the Condensed Consolidated Statements of Income.

(b)

Equity securities consist of FHLB, FRB and DTCC restricted stock holdings of $248, $357 and $1, respectively, at September 30, 2016 and $248, $355, and $1, respectively, at December 31, 2015, that are carried at cost, and certain mutual fund and equity security holdings.

On an amortized cost basis, available-for-sale and other securities increased $808 million, or 3%, from December 31, 2015 primarily due to increases in asset-backed securities and other debt securities and agency commercial mortgage-backed securities partially offset by a decrease in U.S. Treasury and federal agencies securities.

On an amortized cost basis, available-for-sale and other securities were 23% of total interest-earning assets at both September 30, 2016 and December 31, 2015. The estimated weighted-average life of the debt securities in the available-for-sale and other securities portfolio was 5.6 years at September 30, 2016 compared to 6.4 years at December 31, 2015. In addition, at September 30, 2016, the available-for-sale and other securities portfolio had a weighted-average yield of 3.35%, compared to 3.19% at December 31, 2015.

Information presented in Table 21 is on a weighted-average life basis, anticipating future prepayments. Yield information is presented on an FTE basis and is computed using amortized cost balances. Maturity and yield calculations for the total available-for-sale and other securities portfolio exclude equity securities that have no stated yield or maturity. Total net unrealized gains on the available-for-sale and other securities portfolio were $1.2 billion at September 30, 2016 compared to $366 million at December 31, 2015. The increase from December 31, 2015 was primarily due to a decrease in interest rates during the nine months ended September 30, 2016. The fair value of investment securities is impacted by interest rates, credit spreads, market volatility and liquidity conditions. The fair value of investment securities generally increases when interest rates decrease or when credit spreads contract.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

TABLE 21: Characteristics of Available-for-Sale and Other Securities

As of September 30, 2016 ($ in millions)      Amortized Cost     Fair Value     Weighted-Average
Life (in years)
    Weighted-Average    
Yield    
 

U.S. Treasury and federal agencies securities:

       

Average life of 1 year or less

  $ 790                 803              0.4                 4.12 %           

Average life 1 – 5 years

    76                 78              4.3                 1.80              

Total

  $ 866                 881              0.8                 3.92 %           

Obligations of states and political subdivisions securities:(a)

       

Average life of 1 year or less

    15                 15              -                 0.11              

Average life 5 – 10 years

    34                 37              6.5                 3.93              

Total

  $ 49                 52              4.6                 2.79 %           

Agency residential mortgage-backed securities:

       

Average life of 1 year or less

    53                 53              0.8                 4.44              

Average life 1 – 5 years

    10,053                 10,383              3.8                 3.65              

Average life 5 – 10 years

    4,361                 4,538              6.0                 3.39              

Average life greater than 10 years

    204                 214              11.5                 2.99              

Total

  $ 14,671                 15,188              4.5                 3.56 %           

Agency commercial mortgage-backed securities:

       

Average life 1 – 5 years

    1,606                 1,690              3.7                 3.10              

Average life 5 – 10 years

    6,539                 6,943              7.7                 3.01              

Average life greater than 10 years

    304                 317              12.0                 2.99              

Total

  $ 8,449                 8,950              7.1                 3.03 %           

Non-agency commercial mortgage-backed securities:

       

Average life of 1 year or less

    112                 113              0.7                 4.18              

Average life 1 – 5 years

    294                 305              3.1                 3.43              

Average life 5 – 10 years

    2,277                 2,416              7.6                 3.34              

Total

  $ 2,683                 2,834              6.8                 3.39 %           

Asset-backed securities and other debt securities:

       

Average life of 1 year or less

    203                 207              0.2                 2.58              

Average life 1 – 5 years

    790                 800              3.1                 3.11              

Average life 5 – 10 years

    237                 237              7.8                 2.77              

Average life greater than 10 years

    839                 839              13.3                 2.62              

Total

  $ 2,069                 2,083              7.5                 2.82 %           

Equity securities

    699                 701                         

Total available-for-sale and other securities

  $ 29,486                 30,689              5.6                 3.35 %           
(a)

Taxable-equivalent yield adjustments included in the above table are 0.00%, 2.14% and 1.49% for securities with an average life of 1 year or less, 5-10 years and in total, respectively.

Deposits

The Bancorp’s deposit balances represent an important source of funding and revenue growth opportunity. The Bancorp continues 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% and 71% of the Bancorp’s asset funding base at September 30, 2016 and December 31, 2015, respectively.

TABLE 22: Components of Deposits

           September 30, 2016     December 31, 2015  
As of ($ in millions)         Balance        % of Total     Balance        % of Total  

Demand

 

$

     35,625           34          $ 36,267           35       

Interest checking

       24,483           24            26,768           26       

Savings

       14,019           14            14,601           14       

Money market

       19,910           20            18,494           18       

Foreign office

         518           1            464           -       

Transaction deposits

       94,555           93            96,594           93       

Other time

         3,971           4            4,019           4       

Core deposits

       98,526           97            100,613           97       

Certificates $100,000 and over(a)

         2,745           3            2,592           3       

Total deposits

 

$

     101,271           100          $     103,205           100       
(a)

Includes $1,267 and $1,449 of certificates $250,000 and over at September 30, 2016 and December 31, 2015, respectively.

Core deposits decreased $2.1 billion, or 2%, from December 31, 2015 driven primarily by a decrease of $2.0 billion, or 2%, in transaction deposits. The decrease from December 31, 2015 included the sale of $511 million of deposits as part of the branches sold in the St. Louis MSA and Pittsburgh MSA during 2016. Transaction deposits decreased from December 31, 2015 primarily due to decreases in interest checking deposits, demand deposits and savings deposits, partially offset by an increase in money market deposits. Interest checking deposits decreased $2.3 billion, or 9%, from December 31, 2015 driven primarily by lower balances per account for commercial customers. Demand deposits decreased $642 million, or 2%, from December 31, 2015 driven primarily by consumer customer seasonality. Money market deposits increased $1.4 billion, or 8%, from December 31, 2015 driven primarily by a promotional product offering during 2016 which drove balance migration from savings deposits, which decreased $582 million, or 4%, compared to December 31, 2015. Money market deposits also increased due to higher balances for existing customers. Certificates $100,000 and over increased $153 million, or 6%, from December 31, 2015 primarily due to the issuance of institutional certificates of deposit during the nine months ended September 30, 2016.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

The following table presents the components of average deposits for the three months ended:

TABLE 23: Components of Average Deposits

           September 30, 2016         September 30, 2015     
($ in millions)         Balance        % of Total      Balance        % of Total  

Demand

 

$

     35,918           34           $ 35,231           34       

Interest checking

       24,475           24             25,590           25       

Savings

       14,232           14             14,868           15       

Money market

       19,706           19             18,253           18       

Foreign office

         524           1             718           1       

Transaction deposits

       94,855           92             94,660           93       

Other time

         4,020           4             4,057           4       

Core deposits

       98,875           96             98,717           97       

Certificates $100,000 and over(a)

       2,768           3             2,924           3       

Other

         749           1             222           -       

Total average deposits

 

$

     102,392           100           $     101,863           100       
(a)

Includes $1,270 and $1,389 of average certificates $250,000 and over for the three months ended September 30, 2016 and 2015, respectively.

On an average basis, core deposits increased $158 million from September 30, 2015 primarily due to an increase of $195 million in average transaction deposits. The increase in average transaction deposits was driven by increases in average money market deposits and average demand deposits, partially offset by decreases in average interest checking deposits, average savings deposits and average foreign office deposits. Average money market deposits and average demand deposits increased $1.5 billion, or 8%, and $687 million, or 2%, respectively, from September 30, 2015 due to the acquisition of new commercial customers and higher average customer balances per commercial customer account. Average money market deposits also increased due to a promotional product offering which drove balance migration from savings deposits, which decreased $636 million, or 4%, compared to September 30, 2015. Average interest checking deposits and average foreign office deposits decreased $1.1 billion, or 4%, and $194 million, or 27%, respectively, from September 30, 2015 primarily due to a decrease in average commercial customer balances per account. Average other deposits increased $527 million from September 30, 2015 primarily due to an increase in Eurodollar trade deposits. Average certificates $100,000 and over decreased $156 million, or 5%, from September 30, 2015 primarily due to the maturity and run-off of institutional certificates of deposit since September 30, 2015.

Contractual maturities

The contractual maturities of certificates $100,000 and over as of September 30, 2016 are summarized in the following table:

TABLE 24: Contractual Maturities of Certificates $100,000 and Over

 

 

($ in millions)

  

 

 

Next 3 months

   $ 493    

3-6 months

     135    

6-12 months

     341    

After 12 months

     1,776    

Total certificates $100,000 and over

   $         2,745    

The contractual maturities of other time deposits and certificates $100,000 and over as of September 30, 2016 are summarized in the following table:

TABLE 25: Contractual Maturities of Other Time Deposits and Certificates $100,000 and Over

 

 

($ in millions)

  

 

 

Next 12 months

   $ 2,302    

13-24 months

     1,864    

25-36 months

     810    

37-48 months

     1,307    

49-60 months

     415    

After 60 months

     18    

Total other time deposits and certificates $100,000 and over

   $         6,716    

Borrowings

The Bancorp accesses a variety of other short-term and long-term funding sources. Borrowings with original maturities of one year or less are classified as short-term and include federal funds purchased and other short-term borrowings. Table 26 summarizes the end of period components of total borrowings. As of September 30, 2016, total borrowings as a percent of interest-bearing liabilities were 24% compared to 21% at December 31, 2015.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

TABLE 26: Components of Borrowings

As of ($ in millions)    September 30, 2016      December 31, 2015   

Federal funds purchased

   $ 126               151            

Other short-term borrowings

     3,494               1,507            

Long-term debt

     16,890               15,810 (a)        

Total borrowings

   $                20,510                              17,468            
(a)

Upon adoption of ASU 2015-03 on January 1, 2016, the December 31, 2015 Condensed Consolidated Balance Sheet was adjusted to reflect the reclassification of $34 of debt issuance costs from other assets to long-term debt. For further information, refer to Note 3 of the Notes to Condensed Consolidated Financial Statements.

Total borrowings increased $3.0 billion, or 17%, from December 31, 2015 primarily due to increases in other short-term borrowings and long-term debt. Other short-term borrowings increased $2.0 billion from December 31, 2015 primarily driven by an increase of $2.0 billion in FHLB short-term borrowings. The level of other short-term borrowings can fluctuate significantly from period to period depending on funding needs and which sources are used to satisfy those needs. For further information on the components of other short-term borrowings, refer to Note 13 of the Notes to Condensed Consolidated Financial Statements. Long-term debt increased $1.1 billion from December 31, 2015 primarily driven by issuances during the nine months ended September 30, 2016 of $2.8 billion of unsecured senior fixed-rate bank notes, $250 million of unsecured senior floating-rate bank notes and $750 million of unsecured subordinated fixed-rate bank notes, partially offset by the maturity of $1.7 billion of unsecured senior bank notes and $1.1 billion of paydowns on long-term debt associated with automobile loan securitizations. For additional information regarding automobile securitizations and long-term debt, refer to Note 10 and Note 14, respectively, of the Notes to Condensed Consolidated Financial Statements.

The following table presents average borrowings for the three months ended:

TABLE 27: Components of Average Borrowings

($ in millions)    September 30, 2016     September 30, 2015      

Federal funds purchased

   $ 446              1,978             

Other short-term borrowings

     2,171              1,897             

Long-term debt

     16,102              14,664 (a)        

Total average borrowings

   $                18,719                             18,539             
(a)

Upon adoption of ASU 2015-03 on January 1, 2016, the September 30, 2015 Condensed Consolidated Balance Sheet was adjusted to reflect the reclassification of $33 of average debt issuance costs from average other assets to average long-term debt. For further information, refer to Note 3 of the Notes to Condensed Consolidated Financial Statements.

Total average borrowings increased $180 million, or 1%, compared to September 30, 2015, primarily due to an increase in average long-term debt partially offset by a decrease in average federal funds purchased. The increase in average long-term debt of $1.4 billion was primarily driven by the issuance of asset-backed securities by a consolidated VIE of $750 million related to an automobile loan securitization in the fourth quarter of 2015 and the previously mentioned unsecured note issuances during 2016. The impact of these issuances was partially offset by the aforementioned maturity of unsecured senior bank notes and paydowns on long-term debt associated with automobile loan securitizations since the third quarter of 2015. Average federal funds purchased decreased $1.5 billion compared to September 30, 2015. The level of average federal funds purchased can fluctuate significantly from period to period depending on funding needs and which sources are used to satisfy those needs. Information on the average rates paid on borrowings is discussed in the Net Interest Income subsection of the Statements of Income Analysis section of MD&A. In addition, refer to the Liquidity Risk Management subsection of the Risk Management section of MD&A 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)

 

 

BUSINESS SEGMENT REVIEW

The Bancorp reports on four business segments: Commercial Banking, Branch Banking, Consumer Lending and Wealth and Asset Management (formerly Investment Advisors). Additional information on each business segment is included in Note 23 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’s accounting practices or businesses change. In the second quarter of 2016, the Investment Advisors segment name was changed to Wealth and Asset Management to better reflect the services provided by the business segment.

The Bancorp manages interest rate risk centrally at the corporate level and employs an FTP methodology at the business segment level. This methodology insulates the business segments from interest rate volatility, enabling them to focus on serving customers through loan and deposit products. The FTP system assigns charge rates and credit rates to classes of assets and liabilities, respectively, based on expected duration and the U.S. swap curve. Matching duration allocates interest income and interest expense to each business 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 Wealth and Asset Management, 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 interest-bearing liabilities and by the review of the estimated durations for the indeterminate-lived deposits. The credit rate provided for demand deposit accounts is reviewed annually based upon the account type, its estimated duration and the corresponding federal funds, U.S. swap curve or swap rate. The credit rates for several deposit products were reset January 1, 2016 to reflect the current market rates and updated market assumptions. These rates were generally higher than those in place during 2015, thus net interest income for deposit-providing businesses was positively impacted during 2016. FTP charge rates on assets were affected by the prevailing level of interest rates and by the duration and repricing characteristics of the portfolio. As overall market rates increased, the FTP charge increased for asset-generating businesses, thus negatively affecting net interest income during 2016. Credit rates for deposit products and charge rates for loan products may be reset periodically in response to changes in market conditions.

During the first quarter of 2016, the Bancorp refined its methodology for allocating provision expense to the business segments to include charges or benefits associated with changes in criticized commercial loan levels in addition to actual net charge-offs experienced by the loans and leases owned by each business segment. The results of operations and financial position for the three and nine months ended September 30, 2015 were adjusted to reflect this change. Provision expense attributable to loan and lease growth and changes in ALLL factors are captured in General Corporate and Other. The financial results of the business segments include allocations for shared services and headquarters expenses. 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.

The results of operations and financial position for the three and nine months ended September 30, 2015 were adjusted to reflect changes in internal expense allocation methodologies.

The following table summarizes net income by business segment:

TABLE 28: Net Income by Business Segment

           For the three months ended 
September 30,
         For the nine months ended 
September 30,
($ in millions)        2016          2015                  2016             2015         

Income Statement Data

              

Commercial Banking

  $   279     121             715           492       

Branch Banking

    91     98             330           190       

Consumer Lending

       13             18           100       

Wealth and Asset Management

    23     14             73           40       

General Corporate and Other

      120     135               35           228       

Net income

    516     381             1,171           1,050       

Less: Net income attributable to noncontrolling interests

         -               (4)           (6)      

Net income attributable to Bancorp

    516     381             1,175           1,056       

Dividends on preferred stock

      15     15               52           52       

Net income available to common shareholders

  $              501     366                          1,123           1,004       

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Commercial Banking

Commercial Banking offers credit intermediation, 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 29: Commercial Banking

            For the three months ended 
September 30,
         For the nine months ended 
September 30,
($ in millions)         2016      2015                  2016     2015           

Income Statement Data

             

Net interest income (FTE)(a)

  $    462    418               1,385   1,221         

Provision for (benefit from) loan and lease losses

     (18)   195               119   271         

Noninterest income:

             

Corporate banking revenue

     110    104               328   276         

Service charges on deposits

     75    72               218   212         

Other noninterest income

     43    52               137   142         

Noninterest expense:

             

Personnel costs

     69    73               222   228         

Other noninterest expense

       280    261                 843   803         

Income before income taxes (FTE)

     359    117               884   549         

Applicable income tax expense (benefit)(a)(b)

       80    (4)                169   57         

Net income

  $    279    121                 715   492         

Average Balance Sheet Data

             

Commercial loans and leases, including held for sale

  $    54,798          53,824               54,648         52,705         

Demand deposits

     20,798    20,712               20,612   20,476         

Interest checking deposits

     8,284    8,996               8,543   9,170         

Savings and money market deposits

     6,655    6,838               6,692   6,479         

Other time deposits and certificates $100,000 and over

     1,008    1,161               1,065   1,256         

Foreign office deposits

       523    717                 496   839         
(a)

Includes FTE adjustments of $6 and $5 for the three months ended September 30, 2016 and 2015, respectively, and $18 and $14 for the nine months ended September 30, 2016 and 2015, respectively. This is a non-GAAP measure.

(b)

Applicable income tax expense for all periods includes the tax benefit from tax-exempt income, tax-advantaged investments and tax credits, partially offset by the effect of certain nondeductible expenses. Refer to the Applicable Income Taxes section of MD&A for additional information.

Net income was $279 million for the three months ended September 30, 2016 compared to net income of $121 million for the three months ended September 30, 2015. Net income was $715 million for the nine months ended September 30, 2016 compared to net income of $492 million for the nine months ended September 30, 2015. The increase for both the three and nine months ended September 30, 2016 was driven by an increase in net interest income and a decrease in the provision for loan and lease losses partially offset by an increase in noninterest expense. The increase for the nine months ended September 30, 2016 was also driven by an increase in noninterest income.

Net interest income on an FTE basis increased $44 million and $164 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The increase in net interest income for both periods was primarily driven by an increase in FTP credit rates on core deposits and an increase in average commercial loan and lease balances as well as an increase in their yields of 22 bps and 15 bps for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The increase in net interest income for both periods was partially offset by an increase in FTP charge rates on loans and leases.

Provision for loan and lease losses decreased $213 million and $152 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The decrease for both periods was primarily due to a $102 million charge-off during the third quarter of 2015 associated with the restructuring of a student loan backed commercial credit originated in 2007 as well as a decrease in criticized commercial loans during the three and nine months ended September 30, 2016. The decrease for the nine months ended September 30, 2016 compared to the same period in the prior year was partially offset by an increase in charge-offs of commercial and industrial loans, primarily in the energy portfolio related to oil field services loans. Net charge-offs as a percent of average portfolio loans and leases decreased to 43 bps for the three months ended September 30, 2016 compared to 101 bps for the same period in the prior year and decreased to 37 bps for the nine months ended September 30, 2016 compared to 53 bps for the same period in the prior year.

Noninterest income was flat and increased $53 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The increase for the nine months ended September 30, 2016 was primarily driven by an increase in corporate banking revenue of $52 million driven by increases in lease remarketing fees and syndication fees partially offset by decreases in foreign exchange fees and business lending fees. This increase was partially offset by a decrease in other noninterest income of $5 million primarily driven by the recognition of $9 million of OTTI on certain private equity investments in the third quarter of 2016.

Noninterest expense increased $15 million and $34 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily as a result of an increase in other noninterest expense. The increase in other noninterest expense for both periods was primarily driven by increases in corporate overhead allocations and impairment on affordable housing investments. The increase for the nine months ended September 30, 2016 was partially offset by a decrease in loan and lease expense.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Average commercial loans increased $974 million and $1.9 billion for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily due to increases in average commercial and industrial loans, average commercial construction loans and average commercial leases partially offset by a decrease in average commercial mortgage loans. Average commercial and industrial loans increased $1.0 billion for the nine months ended September 30, 2016 compared to the same period in the prior year and average commercial construction loans increased $886 million and $987 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily as a result of an increase in new loan origination activity resulting from an increase in demand and targeted marketing efforts. Average commercial leases increased $120 million and $136 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily as a result of an increase in syndication and participation origination activity. Average commercial mortgage loans decreased $53 million and $195 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns.

Average core deposits decreased $1.0 billion and $626 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The decrease for the three months ended September 30, 2016 was primarily driven by decreases in average interest checking deposits, average foreign deposits and average savings and money market deposits which decreased $712 million, $194 million and $183 million, respectively, compared to the same period in the prior year. The decrease for the nine months ended September 30, 2016 was primarily driven by decreases in average interest checking deposits and average foreign deposits which decreased $627 million and $343 million, respectively, compared to the same period in the prior year. This decrease was partially offset by an increase in average savings and money market deposits of $213 million for the nine months ended September 30, 2016 compared to the same period in the prior year.

Branch Banking

Branch Banking provides a full range of deposit and loan products to individuals and small businesses through 1,191 full-service banking centers. Branch Banking offers depository and loan products, such as checking and savings accounts, home equity loans and lines of credit, credit cards and loans for automobiles and other personal financing needs, as well as products designed to meet the specific needs of small businesses, including cash management services.

The following table contains selected financial data for the Branch Banking segment:

TABLE 30: Branch Banking

             For the three months ended
September 30,
            For the nine months ended
September 30,
 
($ in millions)           2016     2015             2016      2015  

Income Statement Data

              

Net interest income

  $           414        395                  1,272         1,148          

Provision for loan and lease losses

       34        37                  104         116          

Noninterest income:

              

Service charges on deposits

       68        73                  198         206          

Card and processing revenue

       64        60                  190         176          

Wealth and asset management revenue

       35        40                  107         120          

Other noninterest income

       (4     24                  71         (34)         

Noninterest expense:

              

Personnel costs

       130        130                  392         397          

Net occupancy and equipment expense

       59        63                  177         186          

Card and processing expense

       29        38                  98         108          

Other noninterest expense

             184        173                        556         516          

Income before income taxes

       141        151                  511         293          

Applicable income tax expense

             50        53                        181         103          

Net income

  $           91        98                        330         190          

Average Balance Sheet Data

              

Consumer loans, including held for sale

  $           13,428        14,269                  13,658         14,449          

Commercial loans, including held for sale

       1,849        1,963                  1,896         1,994          

Demand deposits

       13,300        12,771                  13,283         12,561          

Interest checking deposits

       9,699        9,003                  9,597         9,096          

Savings and money market deposits

       26,084        25,155                  25,783         25,448          

Other time deposits and certificates $100,000 and over

             5,225        5,202                        5,221         5,141          

Net income was $91 million for the three months ended September 30, 2016 compared to net income of $98 million for the three months ended September 30, 2015. The decrease was driven by a decrease in noninterest income partially offset by an increase in net interest income and decreases in the provision for loan and lease losses and noninterest expense. Net income was $330 million for the nine months ended September 30, 2016 compared to $190 million for the same period in the prior year. The increase was driven by increases in net interest income and noninterest income as well as a decrease in the provision for loan and lease losses, partially offset by an increase in noninterest expense.

Net interest income increased $19 million and $124 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods was primarily driven by an increase in FTP credit rates on core deposits partially offset by a decrease in interest income on residential mortgage loans, home equity loans, credit card loans and other consumer loans driven by a decline in average balances. Additionally, net interest income for both periods was negatively impacted by an increase in FTP charge rates on loans and leases.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Provision for loan and lease losses decreased $3 million and $12 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily due to improved credit trends. Net charge-offs as a percent of average portfolio loans and leases decreased to 93 bps and 90 bps for the three and nine months ended September 30, 2016, respectively, compared to 97 bps for both the three and nine months ended September 30, 2015.

Noninterest income decreased $34 million and increased $98 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The decrease for the three months ended September 30, 2016 was primarily driven by decreases in other noninterest income, service charges on deposits and wealth and asset management revenue. Other noninterest income decreased $28 million for the three months ended September 30, 2016 compared to the same period in the prior year primarily driven by impairment charges on bank premises and equipment of $28 million recognized during the three months ended September 30, 2016 compared to $2 million recognized during the three months ended September 30, 2015. Service charges on deposits decreased $5 million for the three months ended September 30, 2016 compared to the same period in the prior year primarily due to a decrease in consumer deposit fees driven by a decrease in consumer checking fees. Wealth and asset management revenue decreased $5 million for the three months ended September 30, 2016 compared to the same period in the prior year primarily due to a decrease in transactional securities and brokerage fees driven by lower sales and trading volume. The increase for the nine months ended September 30, 2016 was due to an increase in other noninterest income of $105 million primarily driven by impairment charges on bank premises and equipment of $31 million recognized during the nine months ended September 30, 2016 compared to $104 million recognized during the nine months ended September 30, 2015. Additionally, the increase in other noninterest income for the nine months ended September 30, 2016 included a gain of $19 million on the sale of certain branches in the St. Louis and Pittsburgh MSAs in the first and second quarters of 2016 as well as a gain of $11 million on the sale of the agent bankcard loan portfolio during the second quarter of 2016.

Noninterest expense decreased $2 million and increased $16 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The decrease for the three months ended was driven by decreases in card and processing expense and net occupancy and equipment expense partially offset by an increase in other noninterest expense. The increase for the nine months ended September 30, 2016 was primarily driven by an increase in other noninterest expense partially offset by decreases in card and processing expense and net occupancy and equipment expense. Card and processing expense decreased $9 million and $10 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily due to the impact of renegotiated service contracts. Net occupancy and equipment expense decreased $4 million and $9 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily due to a decrease in rent expense driven by a reduction in the number of full-service banking centers and ATM locations. Other noninterest expense increased $11 million and $40 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily driven by an increase in corporate overhead allocations.

Average consumer loans decreased $841 million and $791 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The decrease for both periods was primarily driven by a decrease in average home equity loans of $477 million and $473 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year and a decrease in average residential mortgage loans of $273 million and $262 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year as payoffs exceeded new loan production. Average commercial loans decreased $114 million and $98 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The decrease for both periods was primarily driven by a decrease in average commercial mortgage loans of $83 million and $66 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year and a decrease in average commercial and industrial loans of $25 million for both the three and nine months ended September 30, 2016 compared to the same periods in the prior year as payoffs exceeded new loan production.

Average core deposits increased $2.1 billion and $1.5 billion for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods was primarily driven by growth in average savings and money market deposits of $929 million and $335 million, respectively, growth in average interest checking deposits of $696 million and $501 million, respectively, and growth in average demand deposits of $529 million and $722 million, respectively, for the three and nine months ended September 30, 2016 compared to the same periods in the prior year. The growth in average savings and money market deposits, average interest checking deposits and average demand deposits was driven by an increase in average balances per customer account and acquisition of new customers.

 

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Consumer Lending

Consumer Lending includes the Bancorp’s residential mortgage, home equity, automobile and other indirect lending activities. Lending activities include the origination, retention and servicing of residential mortgage and home equity loans or lines of credit, sales and securitizations of those loans, pools of loans or lines of credit and all associated hedging activities. Indirect lending activities include extending loans to consumers through correspondent lenders and automobile dealers.

The following table contains selected financial data for the Consumer Lending segment:

TABLE 31: Consumer Lending

             For the three months ended
September 30,
            For the nine months ended
September 30,
 
($ in millions)           2016      2015             2016      2015  

Income Statement Data

               

Net interest income

  $           63         62                 185         187         

Provision for loan and lease losses

       12         11                 32         33         

Noninterest income:

               

Mortgage banking net revenue

       64         69                 214         268         

Other noninterest income

       7         7                 20         59         

Noninterest expense:

               

Personnel costs

       48         47                 147         139         

Other noninterest expense

             69         60                       211         186         

Income before income taxes

       5         20                 29         156         

Applicable income tax expense

             2         7                       11         56         

Net income

  $           3         13                       18         100         

Average Balance Sheet Data

               

Residential mortgage loans, including held for sale

  $           10,795         9,393                 10,304         9,089         

Home equity

       348         414                 365         433         

Automobile loans

       9,967         11,381                 10,366         11,401         

Other consumer loans, including held for sale

             -         3                       -         14         

Net income was $3 million for the three months ended September 30, 2016 compared to net income of $13 million for the three months ended September 30, 2015. Net income was $18 million for the nine months ended September 30, 2016 compared to net income of $100 million for the nine months ended September 30, 2015. The decrease for both periods was primarily driven by a decrease in noninterest income as well as an increase in noninterest expense.

Net interest income increased $1 million and decreased $2 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The increase for the three months ended September 30, 2016 compared to the same period in the prior year was primarily driven by an increase in FTP credit rates on demand deposits. The decrease for the nine months ended September 30, 2016 compared to the same period in the prior year was primarily driven by an increase in FTP charge rates on loans and leases partially offset by an increase in FTP credit rates on demand deposits. Net interest income for both periods was impacted by an increase in average residential mortgage loan balances partially offset by a decline in average automobile loan balances.

Provision for loan and lease losses increased $1 million for the three months ended September 30, 2016 compared to the same period in the prior year primarily due to an increase in net charge-offs on automobile loans partially offset by a decline in net charge-offs on residential mortgage loans and home equity loans. The provision for loan and lease losses decreased $1 million for the nine months ended September 30, 2016 compared to the same period in the prior year primarily due to a decline in net charge-offs on residential mortgage loans and home equity loans partially offset by an increase in net charge-offs on automobile loans. Net charge-offs as a percent of average portfolio loans and leases increased to 23 bps for the three months ended September 30, 2016 compared to 22 bps for the same period in the prior year and decreased to 21 bps for the nine months ended September 30, 2016 compared to 22 bps for the same period in the prior year.

Noninterest income decreased $5 million and $93 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The decrease for the three months ended September 30, 2016 was driven by a decrease in mortgage banking net revenue of $5 million from the same period in the prior year primarily driven by a $20 million decrease in net mortgage servicing revenue partially offset by an increase of $15 million in mortgage origination fees and gains on loan sales. The decrease for the nine months ended September 30, 2016 was driven by decreases in mortgage banking net revenue and other noninterest income. Mortgage banking net revenue decreased $54 million for the nine months ended September 30, 2016 compared to the same period in the prior year primarily driven by a $76 million decrease in net mortgage servicing revenue partially offset by a $22 million increase in mortgage origination fees and gains on loan sales. Refer to the Noninterest Income subsection of the Statements of Income Analysis of MD&A for additional information on the fluctuations in mortgage banking net revenue. Other noninterest income decreased $39 million for the nine months ended September 30, 2016 from the same period in the prior year primarily due to a $37 million gain on the sale of residential mortgage loans held for sale classified as TDRs in the first quarter of 2015.

Noninterest expense increased $10 million and $33 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year driven by increases in other noninterest expense and personnel costs. Other noninterest expense increased $9 million and $25 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily driven by increases in operational losses and corporate overhead allocations. Personnel costs increased $1 million and $8 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily driven by increases in base compensation and variable compensation.

 

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Average consumer loans and leases decreased $81 million and increased $98 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. Average residential mortgage loans, including held for sale, increased $1.4 billion and $1.2 billion for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily driven by the continued retention of certain conforming ARMs and certain other fixed-rate loans. Average automobile loans decreased $1.4 billion and $1.0 billion for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year as payoffs exceeded new loan production.

Wealth and Asset Management

Wealth and Asset Management provides a full range of investment alternatives for individuals, companies and not-for-profit organizations. Wealth and Asset Management is made up of four main businesses: FTS, an indirect wholly-owned subsidiary of the Bancorp; ClearArc Capital, Inc., an indirect wholly-owned subsidiary of the Bancorp; Fifth Third Private Bank; and Fifth Third Institutional Services. FTS offers full-service retail brokerage services to individual clients and broker dealer services to the institutional marketplace. ClearArc Capital, Inc. provides asset management services. Fifth Third Private Bank offers holistic strategies to affluent clients in wealth planning, investing, insurance and wealth protection. Fifth Third Institutional Services provides advisory services for institutional clients including states and municipalities.

The following table contains selected financial data for the Wealth and Asset Management segment:

TABLE 32: Wealth and Asset Management

            For the three months ended            For the nine months ended  
          September 30,           September 30,  
($ in millions)          2016       2015            2016       2015  

Income Statement Data

           

Net interest income

    $        40        33                 127        91          

Provision for loan and lease losses

      -        -                 1        3          

Noninterest income:

           

Wealth and asset management revenue

      98        100                 294        306          

Other noninterest income

      1        2                 8        9          

Noninterest expense:

           

Personnel costs

      41        42                 127        127          

Other noninterest expense

            62        70                       190        215          

Income before income taxes

      36        23                 111        61          

Applicable income tax expense

            13        9                       38        21          

Net income

  $          23        14                       73        40          

Average Balance Sheet Data

           

Loans and leases, including held for sale

  $          3,148        2,982                 3,109        2,732          

Core deposits

            8,159        8,944                       8,459        9,489          

Net income was $23 million for the three months ended September 30, 2016 compared to net income of $14 million for the same period in the prior year. Net income was $73 million for the nine months ended September 30, 2016 compared to $40 million for the nine months ended September 30, 2015. The increases for both periods were driven primarily by increases in net interest income as well as decreases in noninterest expense partially offset by decreases in noninterest income.

Net interest income increased $7 million and $36 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods was primarily due to an increase in FTP credit rates on core deposits and an increase in interest income on loans and leases driven by an increase in average balances and higher yields on average commercial and industrial loans and average other consumer loans and leases. The increase in net interest income for both periods was partially offset by an increase in FTP charge rates on loans and leases and the increase for the nine months ended was also partially offset by an increase in FTP charges due to an increase in average loan balances.

Provision for loan and lease losses was flat and decreased $2 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year.

Noninterest income decreased $3 million and $13 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The decrease for both periods was primarily due to a $2 million and $12 million decrease in wealth and asset management revenue for the three and nine months ended September 30, 2016, respectively, driven by a decrease of $4 million and $14 million in transactional securities and brokerage fees as a result of lower sales and trading volume. The decrease for both periods was partially offset by a $2 million increase in private client service fees and institutional fees compared to the same periods in the prior year.

Noninterest expense decreased $9 million and $25 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The decrease for both periods was primarily driven by decreases in other noninterest expense of $8 million and $25 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily due to a decrease in corporate overhead allocations partially offset by an increase in operational losses.

Average loans and leases increased $166 million and $377 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily due to increases in average residential mortgage loans and average other consumer loans driven by increases in new loan origination activity.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Average core deposits decreased $785 million and $1.0 billion for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year primarily due to a decline in average interest checking balances partially offset by an increase in average savings and money market deposits.

General Corporate and Other

General Corporate and Other includes the unallocated portion of the investment securities portfolio, securities gains and losses, certain non-core deposit funding, unassigned equity, unallocated provision expense or a benefit from the reduction of the ALLL, the payment of preferred stock dividends and certain support activities and other items not attributed to the business segments.

Net interest income for the three months ended September 30, 2016 was a negative $66 million compared to negative $2 million for the same period in the prior year. Net interest income for the nine months ended September 30, 2016 was a negative $239 million compared to net interest income of $3 million for the same period in the prior year. The decreases for both periods were primarily driven by an increase in FTP credits on deposits allocated to business segments due to increases in FTP credit rates and average deposits as well as an increase in interest expense on long-term debt. The decreases in net interest income were partially offset by an increase in interest income on taxable securities and an increase in the benefit related to the FTP charges on loans and leases. The provision for loan and lease losses for the three and nine months ended September 30, 2016 was $52 million and $33 million, respectively, compared to a benefit of $87 million and $118 million for the three and nine months ended September 30, 2015, respectively, due to decreases in the allocation of provision expense to the business segments.

Noninterest income increased $164 million and $116 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods included the impact of a $280 million gain recognized during the third quarter of 2016 from the termination and settlement of gross cash flows from existing Vantiv, Inc. TRAs and the expected obligation to terminate and settle the remaining Vantiv, Inc. TRA cash flows upon the exercise of put or call options. Additionally, equity method earnings from the Bancorp’s interest in Vantiv Holding, LLC increased $4 million and $9 million compared to the three and nine months ended September 30, 2015, respectively. The increase in noninterest income was partially offset by negative valuation adjustments related to the Visa total return swap of $12 million and $61 million for the three and nine months ended September 30, 2016, respectively, compared with $8 million and $27 million, respectively, for the same periods in the prior year. In addition, the negative valuation adjustment on the stock warrant associated with Vantiv Holding, LLC was $2 million for the three months ended September 30, 2016 compared to the positive valuation adjustment of $130 million during the three months ended September 30, 2015. The positive valuation adjustments on the stock warrant associated with Vantiv Holding, LLC were $64 million for the nine months ended September 30, 2016 compared to the positive valuation adjustments of $215 million during the nine months ended September 30, 2015. The increase in noninterest income for the three and nine months ended September 30, 2016 also included a gain of $11 million on the sale-leaseback of an office complex during the third quarter of 2016.

Noninterest expense was $35 million and $79 million for the three and nine months ended September 30, 2016, respectively, compared to $24 million and $23 million for the same periods in the prior year. The increase for both periods was primarily due to increases in personnel costs and the provision for the reserve for unfunded commitments partially offset by an increase in corporate overhead allocations from General Corporate and Other to the other business segments.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

RISK MANAGEMENT – OVERVIEW

Managing risk is an essential component of successfully operating a financial services company. The Bancorp’s risk management approach includes processes for identifying, assessing, managing, monitoring and reporting risks. The ERM division, led by the Bancorp’s Chief Risk Officer, ensures the consistency and adequacy of the Bancorp’s risk management approach within the structure of the Bancorp’s operating model. Management within the lines of business and support functions assess and manage risks associated with their activities and determine if actions need to be taken to strengthen risk management or reduce risk given their risk profile. They are responsible for considering risk when making business decisions and for integrating risk management into business processes. In addition, the Internal Audit division provides an independent assessment of the Bancorp’s internal control structure and related systems and processes.

The assumption of risk requires robust and active risk management practices that comprise an integrated and comprehensive set of activities, measures and strategies that apply to the entire organization. The Bancorp has established a Risk Appetite Framework, approved by the Board, that provides the foundations of corporate risk capacity, risk appetite and risk tolerances. The Bancorp’s risk capacity is represented by its available financial resources. Risk capacity sets an absolute limit on risk-assumption in the Bancorp’s annual and strategic plans. The Bancorp understands that not all financial resources may persist as viable loss buffers over time. Further, consideration must be given to regulatory capital buffers required per Capital Policy Targets that would reduce risk capacity. Those factors take the form of capacity adjustments to arrive at an Operating Risk Capacity which represents the operating risk level the Bancorp can assume while maintaining its solvency standard. The Bancorp’s policy currently discounts its Operating Risk Capacity by a minimum of 5% to provide a buffer; as a result, the Bancorp’s risk appetite is limited by policy to, at most, 95% of its Operating Risk Capacity.

Economic capital is the amount of unencumbered financial resources required to support the Bancorp’s risks. The Bancorp measures economic capital under the assumption that it expects to maintain debt ratings at strong investment grade levels over time. The Bancorp’s capital policies require that the Operating Risk Capacity less the aforementioned buffer exceed the calculated economic capital required in its business.

Risk appetite is the aggregate amount of risk the Bancorp is willing to accept in pursuit of its strategic and financial objectives. By establishing boundaries around risk taking and business decisions, and by incorporating the needs and goals of its shareholders, regulators, rating agencies and customers, the Bancorp’s risk appetite is aligned with its priorities and goals. Risk tolerance is the maximum amount of risk applicable to each of the eight specific risk categories included in its Enterprise Risk Management Framework. This is expressed primarily in qualitative terms; however certain risk types also have quantitative metrics that are used to measure the Bancorp’s level of risk against its risk tolerances. The Bancorp’s risk appetite and risk tolerances are supported by risk targets and risk limits. Those limits are used to monitor the amount of risk assumed at a granular level. On a quarterly basis, the Risk and Compliance Committee of the Board reviews current assessments of each of the eight risk types relative to the established tolerance. Information supporting these assessments, including policy limits, key risk indicators and qualitative factors, is also reported to the Risk and Compliance Committee of the Board. Any results outside of tolerance require the development of an action plan that describes actions to be taken to return the measure to within the tolerance.

The risks faced by the Bancorp include, but are not limited to, credit, market, liquidity, operational, regulatory compliance, legal, reputational and strategic. Each of these risks is managed through the Bancorp’s risk program which includes the following key functions:

   

ERM is responsible for developing and overseeing the implementation of risk programs and reporting that facilitate a broad integrated view of risk. The department also leads the continual fostering of a strong risk management culture and the framework, policies and committees that support effective risk governance;

   

Credit Risk Management is responsible for overseeing the safety and soundness of the commercial and consumer loan portfolio within an independent portfolio management framework that supports the Bancorp’s loan growth strategies and underwriting practices, ensuring portfolio optimization and appropriate risk controls. Credit Risk Management is also responsible for the economic capital program and quantitative analytics to support the commercial portfolio and risk rating models, ALLL methodology and analytics needed to assess credit risk and develop mitigation strategies related to that risk. The department also provides oversight, reporting and monitoring of commercial and consumer underwriting and credit administration processes;

   

Operational Risk Management works with lines of business and regional management to maintain processes to monitor and manage all aspects of operational risk, including vendors and information security to ensure consistency in application of operational risk programs;

   

Bank Protection oversees and manages fraud prevention and detection and provides investigative and recovery services for the Bancorp;

   

Capital Markets Risk Management is responsible for instituting, monitoring, and reporting appropriate trading limits within the Capital Markets groups and monitoring liquidity, interest rate risk and risk tolerances resulting from management of Fifth Third’s overall balance sheet;

   

Compliance Risk Management provides independent oversight to ensure that an enterprise-wide framework, including processes and procedures, are in place to comply with applicable laws, regulations, rules and other regulatory requirements; internal policies and procedures; and principles of integrity and fair dealing applicable to the Bancorp’s activities and functions. The Bancorp focuses on managing regulatory compliance risk in accordance with the Bancorp’s integrated risk management framework, which ensures consistent processes for identifying, assessing, managing, monitoring and reporting risks; and

   

The ERM division creates and maintains other functions, committees or processes as are necessary to effectively oversee risk management throughout the Bancorp.

Risk management oversight and governance is provided by the Risk and Compliance Committee of the Board of Directors and through multiple management committees whose membership includes a broad cross-section of line-of-business, regional market and support representatives. The Risk and Compliance Committee of the Board of Directors consists of five outside directors and has the responsibility for the oversight of risk management for the Bancorp, as well as for the Bancorp’s overall aggregate risk profile. The Risk and Compliance Committee of the Board of Directors has approved the formation of key management governance committees that are responsible for evaluating risks and controls.

 

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The primary committee responsible for the oversight of risk management is the ERMC. Committees accountable to the ERMC, which support the core risk programs, are the Corporate Credit Committee, the Operational Risk Committee, the Management Compliance Committee, the Asset/Liability Committee and the Enterprise Marketing Committee. Other committees accountable to the ERMC oversee the ALLL, capital, model risk and regulatory change management functions. There is also a risk assessment process applicable to every line of business to ensure an appropriate standard readiness assessment is performed before launching a new or changing product or initiative. Significant risk policies approved by the management governance committees are also reviewed and approved by the Risk and Compliance Committee of the Board of Directors.

Credit Risk Review is an independent function responsible for evaluating the sufficiency of underwriting, documentation and approval processes for consumer and commercial credits, the accuracy of risk grades assigned to commercial credit exposure, nonaccrual status, specific reserves and monitoring for charge-offs. Credit Risk Review reports directly to the Risk and Compliance Committee of the Board of Directors and administratively to the Chief Auditor.

CREDIT RISK MANAGEMENT

The objective of the Bancorp’s credit risk management strategy is to quantify and manage credit risk on an aggregate portfolio basis, as well as to limit the risk of loss resulting from the failure of a borrower or counterparty to honor its financial or contractual obligations to the Bancorp. The Bancorp’s credit risk management strategy is based on three core principles: conservatism, diversification and monitoring. The Bancorp believes that effective credit risk management begins with conservative lending practices. These practices include conservative exposure and counterparty limits and conservative underwriting, documentation and collection standards. The Bancorp’s credit risk management strategy also emphasizes diversification on a geographic, industry and customer level as well as ongoing portfolio monitoring and timely management reviews of large credit exposures and credits experiencing deterioration of credit quality. Credit officers with the authority to extend credit are delegated specific authority amounts, the utilization of which is closely monitored. Underwriting activities are centrally managed, and ERM manages the policy and the authority delegation process directly. The Credit Risk Review function provides independent and objective assessments of the quality of underwriting and documentation, the accuracy of risk grades and the charge-off, nonaccrual and reserve analysis process. The Bancorp’s credit review process and overall assessment of the adequacy of the allowance for credit losses is based on quarterly assessments of the probable estimated losses inherent in the loan and lease portfolio. The Bancorp uses these assessments to promptly identify potential problem loans or leases within the portfolio, maintain an adequate reserve and take any necessary charge-offs. The Bancorp defines potential problem loans and leases as those rated substandard that do not meet the definition of a nonaccrual loan or a restructured loan. Refer to Note 6 of the Notes to Condensed Consolidated Financial Statements for further information on the Bancorp’s credit grade categories, which are derived from standard regulatory rating definitions.

The following tables provide a summary of potential problem portfolio loans and leases:

 

TABLE 33: Potential Problem Portfolio Loans and Leases                                  
As of September 30, 2016 ($ in millions)          Carrying  
Value  
       Unpaid  
Principal  
Balance  
       Exposure    

Commercial and industrial loans

    $        1,186           1,188           1,829   

Commercial mortgage loans

      115           115           117   

Commercial leases

            36           36           36   

Total potential problem portfolio loans and leases

    $        1,337           1,339           1,982   
TABLE 34: Potential Problem Portfolio Loans and Leases                                  
As of December 31, 2015 ($ in millions)          Carrying  
Value  
       Unpaid  
Principal  
Balance  
       Exposure    

Commercial and industrial loans

    $        1,383           1,384           1,922   

Commercial mortgage loans

      170           171           172   

Commercial construction loans

      6           6           7   

Commercial leases

            36           36           39   

Total potential problem portfolio loans and leases

    $        1,595           1,597           2,140   

In addition to the individual review of larger commercial loans that exhibit probable or observed credit weaknesses, the commercial credit review process includes the use of two risk grading systems. The risk grading system currently utilized for reserve analysis purposes encompasses ten categories. The Bancorp also maintains a dual risk rating system for credit approval and pricing, portfolio monitoring and capital allocation that includes a “through-the-cycle” rating philosophy for assessing a borrower’s creditworthiness. The dual risk rating system includes thirteen probabilities of default grade categories and an additional six grade categories for estimating losses given an event of default. The probability of default and loss given default evaluations are not separated in the ten-category risk rating system. The Bancorp has completed significant validation and testing of the dual risk rating system as a commercial credit risk management tool. The Bancorp is assessing the necessary modifications to the dual risk rating system outputs to develop a U.S. GAAP compliant ALLL model and will evaluate the use of modified dual risk ratings for purposes of determining the Bancorp’s ALLL as part of the Bancorp’s adoption of ASU 2016-13 “Measurement of Credit Losses on Financial Instruments,” which will be effective for the Bancorp on January 1, 2020. Scoring systems, various analytical tools and portfolio performance monitoring are used to assess the credit risk in the Bancorp’s homogenous consumer and small business loan portfolios.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

Economic Overview

Economic growth continues to improve, and GDP is expected to maintain its modest expansionary pattern. The U.S. job market and wages are slowly but steadily improving. Household spending continues to be the strongest driver of the U.S. economy. Tepid business investment and lackluster global economic growth continue to be the weights keeping economic growth in check. Inflation continues to run below the FRB’s stated objective, but has increased over the past several months. Energy prices and the dollar have stabilized and are moving in a pattern that may continue the improvement in inflation and manufacturing. Housing prices have largely stabilized and are increasing in many markets. However, overall current economic and competitive conditions are causing weaker than desired qualified loan growth that combined with a weakness in global economic conditions and a relatively low interest rate environment, may directly or indirectly impact the Bancorp’s growth and profitability. In the U.S., loan growth has continued to slow. Economic weakness in developed economies continues, growth has slowed in China and other developing economies and the British vote to exit the European Union has created market volatility and additional economic uncertainty. The FRB noted asymmetric risks to the downside in their latest assessment of the risks to their economic outlook. With regard to commercial real estate, the credit market has become somewhat more selective even though market data and vacancies remain positive.

Commercial Portfolio

The Bancorp’s credit risk management strategy seeks to minimize concentrations of risk through diversification. The Bancorp has commercial loan concentration limits based on industry, lines of business within the commercial segment, geography and credit product type. The risk within the commercial loan and lease portfolio is managed and monitored through an underwriting process utilizing detailed origination policies, continuous loan level reviews, monitoring of industry concentration and product type limits and continuous portfolio risk management reporting.

The Bancorp provides loans to a variety of customers ranging from large multi-national firms to middle market businesses, sole proprietors and high net worth individuals. The origination policies for commercial and industrial loans outline the risks and underwriting requirements for loans to businesses in various industries. Included in the policies are maturity and amortization terms, collateral and leverage requirements, cash flow coverage measures and hold limits. The Bancorp aligns credit and sales teams with specific industry expertise to better monitor and manage different industry segments of the portfolio.

The origination policies for commercial real estate outline the risks and underwriting requirements for owner and nonowner-occupied and construction lending. Included in the policies are maturity and amortization terms, maximum LTVs, minimum debt service coverage ratios, construction loan monitoring procedures, appraisal requirements, pre-leasing requirements (as applicable), sensitivity and pro-forma analysis requirements and interest rate sensitivity. The Bancorp requires a valuation of real estate collateral, which may include third-party appraisals, be performed at the time of origination and renewal in accordance with regulatory requirements and on an as needed basis when market conditions justify. Although the Bancorp does not back test these collateral value assumptions, the Bancorp maintains an appraisal review department to order and review third-party appraisals in accordance with regulatory requirements. Collateral values on criticized assets with relationships exceeding $1 million are reviewed quarterly to assess the appropriateness of the value ascribed in the assessment of charge-offs and specific reserves.

The Bancorp assesses all real estate and non-real estate collateral securing a loan and considers all cross-collateralized loans in the calculation of the LTV ratio. The following tables provide detail on the most recent LTV ratios for commercial mortgage loans greater than $1 million, excluding impaired commercial mortgage loans individually evaluated. The Bancorp does not typically aggregate the LTV ratios for commercial mortgage loans less than $1 million.

 

TABLE 35: Commercial Mortgage Loans Outstanding by LTV, Loans Greater Than $1 Million  
As of September 30, 2016 ($ in millions)    LTV > 100%       LTV 80-100%      LTV < 80%  

Commercial mortgage owner-occupied loans

   $               114              193               1,997       

Commercial mortgage nonowner-occupied loans

     106              166               2,298       

Total

   $ 220              359               4,295       
TABLE 36: Commercial Mortgage Loans Outstanding by LTV, Loans Greater Than $1 Million  
As of December 31, 2015 ($ in millions)    LTV > 100%     LTV 80-100%      LTV < 80%  

Commercial mortgage owner-occupied loans

   $ 119              216               2,063       

Commercial mortgage nonowner-occupied loans

     120              194               2,032       

Total

   $ 239              410               4,095       

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

 

 

The following table provides detail on commercial loans and leases by industry classification (as defined by the North American Industry Classification System), by loan size and by state, illustrating the diversity and granularity of the Bancorp’s commercial loans and leases as of:

 

TABLE 37: Commercial Loan and Lease Portfolio (excluding loans held for sale)  
      September 30, 2016     December 31, 2015  
($ in millions)    Outstanding      Exposure       Nonaccrual     Outstanding      Exposure      Nonaccrual  

By Industry:

                

Manufacturing

   $ 10,524              20,259         52         10,572             20,422         70      

Real estate

     7,207              11,816         24         6,494             10,293         40      

Financial services and insurance

     6,053              12,176                5,896             13,021         3      

Healthcare

     4,660              6,608         34         4,676             6,879         22      

Business services

     4,513              6,922         50         4,471             6,765         96      

Retail trade

     4,032              7,649         13         3,764             7,391         8      

Wholesale trade

     3,759              6,596         19         4,082             7,254         23      

Transportation and warehousing

     3,134              4,555                3,111             4,619         1      

Communication and information

     3,119              5,091                2,913             5,052         2      

Accommodation and food

     2,917              4,596                2,507             4,104         6      

Construction

     1,869              3,372         11         1,871             3,403         8      

Entertainment and recreation

     1,626              2,900                1,210             2,066         4      

Mining

     1,330              2,376         211         1,499             2,695         36      

Utilities

     1,123              2,748                1,217             2,854         -      

Other services

     799              1,025         24         864             1,188         10      

Public administration

     467              513                495             562         -      

Agribusiness

     265              423                368             527         4      

Individuals

     73              97                139             187         2      

Other

     13              18                7             6         6      

Total

   $        57,483              99,740         460  (a)      56,156             99,288         341      

By Loan Size:

                

Less than $200,000

     1 %         1                1             1         7      

$200,000 - $1 million

     3              3                4             3         10      

$1 million - $5 million

     9              7         20         10             8         25      

$5 million - $10 million

     7              6         21         8 &