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Form 10-K
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2016 ANNUAL REPORT

FINANCIAL CONTENTS

 

Glossary of Abbreviations and Acronyms

    30  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Selected Financial Data

    31  

Overview

    32  

Non-GAAP Financial Measures

    36  

Recent Accounting Standards

    39  

Critical Accounting Policies

    39  

Statements of Income Analysis

    42  

Business Segment Review

    50  

Fourth Quarter Review

    58  

Balance Sheet Analysis

    60  

Risk Management - Overview

    66  

Credit Risk Management

    67  

Market Risk Management

    81  

Liquidity Risk Management

    85  

Operational Risk Management

    86  

Compliance Risk Management

    87  

Capital Management

    87  

Off-Balance Sheet Arrangements

    90  

Contractual Obligations and Other Commitments

    91  

Management’s Assessment as to the Effectiveness of Internal Control over Financial Reporting

    92  

Reports of Independent Registered Public Accounting Firm

    93  

Financial Statements

 

Consolidated Balance Sheets

    95  

Consolidated Statements of Income

    96  

Consolidated Statements of Comprehensive Income

    97  

Consolidated Statements of Changes in Equity

    98  

Consolidated Statements of Cash Flows

    99  

 

Notes to Consolidated Financial Statements

  

Summary of Significant Accounting and Reporting Policies

     100  

Supplemental Cash Flow Information

     111  

Restrictions on Cash and Dividends

     111  

Investment Securities

     113  

Loans and Leases

     115  

Credit Quality and the Allowance for Loan and Lease Losses

     117  

Bank Premises and Equipment

     125  

Operating Lease Equipment

     126  

Goodwill

     126  

Intangible Assets

     126  

Variable Interest Entities

     127  

Sales of Receivables and Servicing Rights

     130  

Derivative Financial Instruments

     132  

Other Assets

     137  

Short-Term Borrowings

     138  

Annual Report on Form 10-K

     183  

Consolidated Ten Year Comparison

     210  

Directors and Officers

     211  

Corporate Information

  

Long-Term Debt

     139  

Commitments, Contingent Liabilities and Guarantees

     142  

Legal and Regulatory Proceedings

     146  

Related Party Transactions

     148  

Income Taxes

     151  

Retirement and Benefit Plans

     153  

Accumulated Other Comprehensive Income

     157  

Common, Preferred and Treasury Stock

     159  

Stock-Based Compensation

     160  

Other Noninterest Income and Other Noninterest Expense

     164  

Earnings Per Share

     165  

Fair Value Measurements

     166  

Regulatory Capital Requirements and Capital Ratios

     177  

Parent Company Financial Statements

     178  

Business Segments

     180  
 

 

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 the Risk Factors section in Item 1A in this Annual Report on Form 10-K. 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) changes in customer preferences or information technology systems; (12) effects of critical accounting policies and judgments; (13) changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board (FASB) or other regulatory agencies; (14) 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; (15) ability to maintain favorable ratings from rating agencies; (16) failure of models or risk management systems or controls; (17) fluctuation of Fifth Third’s stock price; (18) ability to attract and retain key personnel; (19) ability to receive dividends from its subsidiaries; (20) potentially dilutive effect of future acquisitions on current shareholders’ ownership of Fifth Third; (21) declines in the value of Fifth Third’s goodwill or other intangible assets; (22) effects of accounting or financial results of one or more acquired entities; (23) difficulties from Fifth Third’s investment in, relationship with, and nature of the operations of Vantiv Holding, LLC; (24) loss of income from any sale or potential sale of businesses (25) difficulties in separating the operations of any branches or other assets divested; (26) losses or adverse impacts on the carrying values of branches and long-lived assets in connection with their sales or anticipated sales; (27) inability to achieve expected benefits from branch consolidations and planned sales within desired timeframes, if at all; (28) ability to secure confidential information and deliver products and services through the use of computer systems and telecommunications networks; and (29) the impact of reputational risk created by these developments on such matters as business generation and retention, funding and liquidity.


Table of Contents

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 Consolidated Financial Statements and the Notes to Consolidated Financial Statements.

 

ALCO: Asset Liability Management Committee

ALLL: Allowance for Loan and Lease Losses

AOCI: Accumulated Other Comprehensive Income

ARM: Adjustable Rate Mortgage

ASF: Available Stable Funding

ASU: Accounting Standards Update

ATM: Automated Teller Machine

BCBS: Basel Committee on Banking Supervision

BHC: Bank Holding Company

BHCA: Bank Holding Company Act

BOLI: Bank Owned Life Insurance

BPO: Broker Price Opinion

bps: Basis Points

CCAR: Comprehensive Capital Analysis and Review

CDC: Fifth Third Community Development Corporation

CET1: Common Equity Tier 1

CFE: Collateralized Financing Entity

CFPB: United States Consumer Financial Protection Bureau

CFTC: Commodity Futures Trading Commission

C&I: Commercial and Industrial

CRA: Community Reinvestment Act

DCF: Discounted Cash Flow

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

DIF: Deposit Insurance Fund

DTCC: Depository Trust & Clearing Corporation

ERISA: Employee Retirement Income Security Act

ERM: Enterprise Risk Management

ERMC: Enterprise Risk Management Committee

EVE: Economic Value of Equity

FASB: Financial Accounting Standards Board

FDIA: Federal Deposit Insurance Act

FDIC: Federal Deposit Insurance Corporation

FFIEC: Federal Financial Institutions Examination Council

FHA: Federal Housing Administration

FHLB: Federal Home Loan Bank

FHLMC: Federal Home Loan Mortgage Corporation

FICO: Fair Isaac Corporation (credit rating)

FINRA: Financial Industry Regulatory Authority

FNMA: Federal National Mortgage Association

FRB: Federal Reserve Bank

FSOC: Financial Stability Oversight Council

FTE: Fully Taxable Equivalent

FTP: Funds Transfer Pricing

FTS: Fifth Third Securities

GDP: Gross Domestic Product

GNMA: Government National Mortgage Association

GSE: United States Government Sponsored Enterprise

HAMP: Home Affordable Modification Program

  

HARP: Home Affordable Refinance Program

HFS: Held for Sale

HQLA: High-Quality Liquid Assets

IPO: Initial Public Offering

IRC: Internal Revenue Code

IRLC: Interest Rate Lock Commitment

IRS: Internal Revenue Service

ISDA: International Swaps and Derivatives Association, Inc.

LCR: Liquidity Coverage Ratio

LIBOR: London Interbank Offered Rate

LLC: Limited Liability Company

LTV: Loan-to-Value

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

MSA: Metropolitan Statistical Area

MSR: Mortgage Servicing Right

N/A: Not Applicable

NASDAQ: National Association of Securities Dealers Automated Quotations

NII: Net Interest Income

NM: Not Meaningful

NSFR: Net Stable Funding Ratio

OAS: Option-Adjusted Spread

OCC: Office of the Comptroller of the Currency

OCI: Other Comprehensive Income

OREO: Other Real Estate Owned

OTTI: Other-Than-Temporary Impairment

PCA: Prompt Corrective Action

PMI: Private Mortgage Insurance

PSA: Performance Share Award

RSA: Restricted Stock Award

RSF: Required Stable Funding

RSU: Restricted Stock Unit

SAR: Stock Appreciation Right

SBA: Small Business Administration

SEC: United States Securities and Exchange Commission

TBA: To Be Announced

TDR: Troubled Debt Restructuring

TILA: Truth in Lending Act

TRA: Tax Receivable Agreement

TruPS: Trust Preferred Securities

U.S.: United States of America

U.S. GAAP: United States Generally Accepted Accounting Principles

VA: Department of Veterans Affairs

VIE: Variable Interest Entity

VRDN: Variable Rate Demand Note

 

30  Fifth Third Bancorp


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 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 years ended December 31 ($ in millions, except for per share data)    2016    2015      2014     2013     2012

 

Income Statement Data

            

Net interest income (U.S. GAAP)

   $              3,615      3,533        3,579       3,561     3,595

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

   3,640      3,554        3,600       3,581     3,613

Noninterest income

   2,696      3,003        2,473       3,227     2,999

Total revenue(a)

   6,336      6,557        6,073       6,808     6,612

Provision for loan and lease losses

   343      396        315       229     303

Noninterest expense

   3,903      3,775        3,709       3,961     4,081

Net income attributable to Bancorp

   1,564      1,712        1,481       1,836     1,576

Net income available to common shareholders

   1,489      1,637        1,414       1,799     1,541

 

Common Share Data

            

Earnings per share - basic

   $                1.95      2.03        1.68       2.05     1.69

Earnings per share - diluted

   1.93      2.01        1.66       2.02     1.66

Cash dividends declared per common share

   0.53      0.52        0.51       0.47     0.36

Book value per share

   19.82      18.48        17.35       15.85     15.10

Market value per share

   26.97      20.10        20.38       21.03     15.20

 

Financial Ratios

            

Return on average assets

   1.10%      1.22(j)        1.12 (j)      1.48 (j)    1.34(j)

Return on average common equity

   9.8      11.3        10.0       13.1     11.6

Return on average tangible common equity(b)

   11.6      13.5        12.2       16.0     14.3

Dividend payout ratio

   27.2      25.6        30.3       22.9     21.3

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

   11.67      11.33(j)        11.59 (j)      11.56 (j)    11.65(j)

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

   8.87      8.59        8.43       8.63     8.83

Net interest margin(a)(b)

   2.88      2.88        3.10       3.32     3.55

Efficiency(a)(b)

   61.6      57.6        61.1       58.2     61.7

 

Credit Quality

            

Net losses charged-off

   $                 362      446        575       501     704

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

   0.39%      0.48        0.64       0.58     0.85

ALLL as a percent of portfolio loans and leases

   1.36      1.37        1.47       1.79     2.16

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

   1.54      1.52        1.62       1.97     2.37

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

   0.80      0.70        0.82       1.10     1.49

 

Average Balances

            

Loans and leases, including held for sale

   $            94,320      93,339        91,127       89,093     84,822

Total securities and other short-term investments

   31,965      30,245        24,866       18,861     16,814

Total assets

   142,266      140,078(j)        131,909 (j)      123,704 (j)    117,562(j)

Transaction deposits(d)

   95,371      95,244        89,715       82,915     78,116

Core deposits(e)

   99,381      99,295        93,477       86,675     82,422

Wholesale funding(f)

   21,813      20,210(j)        19,154 (j)      17,769 (j)    16,926(j)

Bancorp shareholders’ equity

   16,597      15,865        15,290       14,302     13,701

 

Regulatory Capital and Liquidity Ratios    Basel III  Transitional(g)      Basel I(h)(k)
  

 

    

 

 

CET1 capital

   10.39%      9.82(k)        N/A       N/A     N/A

Tier I risk-based capital

   11.50      10.93(k)        10.83        10.43      10.69 

Total risk-based capital

   15.02      14.13(k)        14.33        14.17      14.47 

Tier I leverage

   9.90      9.54(k)        9.66        9.73      10.15 

CET1 capital (fully phased-in)(b)

   10.29      9.72(k)        N/A       N/A     N/A

Modified LCR

   128      N/A        N/A       N/A     N/A

 

(a)

Amounts presented on an FTE basis. The FTE adjustment for the years ended December 31, 2016, 2015, 2014, 2013 and 2012 was $25, $21, $21, $20 and $18, 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)

These capital ratios were calculated under the Supervisory Agencies general risk-based capital rules (Basel I) which were in effect prior to January 1, 2015.

(i)

Excludes unrealized gains and losses.

(j)

Upon adoption of ASU 2015-03 on January 1, 2016, the Consolidated Balance Sheets for the years ended 2015, 2014, 2013 and 2012 were adjusted to reflect the reclassification of $33, $34, $28 and $52, respectively, of average debt issuance costs from average other assets to average long-term debt. For further information, refer to Note 1 of the Notes to Consolidated Financial Statements.

(k)

Ratios not restated for the adoption of the amended guidance of ASU 2015-03 “Simplifying the Presentation of Debt Issuance Costs.” Refer to Note 1 of the Notes to Consolidated Financial Statements for further information.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

OVERVIEW

 

This overview of MD&A highlights selected information in the financial results of the Bancorp and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources and critical accounting policies and estimates, you should carefully read this entire document. Each of these items could have an impact on the Bancorp’s financial condition, results of operations and cash flows. In addition, 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 annual report on Form 10-K. The abbreviations and acronyms identified therein are used throughout this MD&A, as well as the Consolidated Financial Statements and Notes to 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 year ended December 31, 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 United States. Revenue from foreign countries and external customers domiciled in foreign countries was immaterial to the Consolidated Financial Statements. Changes in interest rates, credit quality, economic trends and the capital markets are primary factors that drive the performance of the Bancorp. As discussed later in the Risk Management section 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, short-term borrowings and long-term debt. Net interest income is affected by the general level of interest rates, the relative level of short-term and long-term interest rates, changes in interest rates and changes in the amount and composition of interest-earning assets and interest-bearing liabilities. Generally, the rates of interest the Bancorp earns on its assets and pays on its liabilities are established for a period of time. The change in market interest rates over time exposes the Bancorp to interest rate risk through potential adverse changes to net interest income and financial position. The Bancorp manages this risk by continually analyzing and adjusting the composition of its assets and liabilities based on their payment streams and interest rates, the timing of their maturities and their sensitivity to changes in market interest rates. Additionally, in the ordinary course of business, the Bancorp enters into certain derivative transactions as part of its overall strategy to manage its interest rate and prepayment risks. The Bancorp is also exposed to the risk of losses on its loan and lease portfolio as a result of changing expected cash flows caused by 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.

Vantiv, Inc. and Vantiv Holding, LLC Transactions

On July 27, 2016, the Bancorp entered into an agreement with Vantiv, Inc. under which a portion of its TRA 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 gain of $116 million in other noninterest income in the Consolidated Statements of Income from this settlement in 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 gain of $164 million in other noninterest income in the Consolidated Statements of Income in 2016 associated with these options. This agreement did not impact the TRA payments recognized in the fourth quarter of 2016 and is not expected to impact the TRA payment expected in the fourth quarter of 2017.

During the fourth quarter of 2016, the Bancorp exercised its right to purchase approximately 7.8 million Class C Units underlying the warrant at the $15.98 strike price. This exercise was settled on a net basis for approximately 5.7 million Class C Units, which were then exchanged for approximately 5.7 million shares of Vantiv, Inc. Class A Common Stock of which 4.8 million shares were sold in a secondary offering and 0.9 million shares were repurchased by Vantiv, Inc. The Bancorp recognized a gain of $9 million in other noninterest income in the Consolidated Statements of Income in 2016 on the exercise of the remaining warrant in Vantiv Holding, LLC.

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 to sell 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 in other noninterest income.

 

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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 in other noninterest income. Both transactions were part of the Branch Consolidation and Sales Plan.

As of December 31, 2016, the Bancorp had 64 branch locations and 35 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 $39 million, $16 million and $1 million of land and improvements, buildings and equipment, respectively, included in bank premises and equipment in the Consolidated Balance Sheets as of December 31, 2016, of which $29 million, $9 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. Approximately $60 million of the $72 million in total estimated annual savings are attributable to branches that were closed prior to December 31, 2016. For further information, refer to Note 7 of the Notes to 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 is being amortized as a reduction of rent expense over the 15 year lease term, and recorded a gain on the transaction of $11 million in other noninterest income.

NorthStar Strategy

In the third quarter of 2016, the Bancorp launched the NorthStar Strategy, a three-year plan designed to achieve the Bancorp’s

vision to be the One Bank people most value and trust and deliver strong, consistent returns through longer term economic cycles.

The strategy is designed to impact every line of business, every employee and, most importantly, every customer. The Bancorp is focused on:

   

Building a differentiated brand and corporate reputation by improving the customer experience, increasing brand equity and delivering on the Bancorp’s $30 billion community commitment.

   

Delivering a better, more differentiated value proposition by investing in our sales and service channels and expanding on our products, solutions and expertise.

   

Generating returns on average tangible common equity (non-GAAP) of 12% to 14%, a return on average assets of 1.1% to 1.3% and an efficiency ratio below 60% by the end of 2019.

   

Achieving risk and operational excellence.

The Bancorp has implemented several initiatives to assist in achieving these goals, including the following: our partnership with GreenSky, upgrades to our mortgage and teller systems, expansion of credit card and treasury management products, focused growth in asset-based lending and our commercial verticals and acceleration of our automation and robotics initiatives.

Accelerated Share Repurchase Transactions

During the years ended December 31, 2016 and 2015, 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 23 of the Notes to Consolidated Financial Statements. For a summary of the Bancorp’s accelerated share repurchase transactions that were entered into or settled during the years ended December 31, 2016 and 2015, 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      

 

October 23, 2014

     180        8,337,875        794,245        9,132,120      January 8, 2015

January 27, 2015

     180        8,542,713        1,103,744        9,646,457      April 28, 2015

April 30, 2015

     155        6,704,835        842,655        7,547,490      July 31, 2015

August 3, 2015

     150        6,039,792        1,346,314        7,386,106      September 3, 2015

September 9, 2015

     150        6,538,462        1,446,613        7,985,075      October 23, 2015

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

December 20, 2016

     155        4,843,750        1,044,362        5,888,112      February 6, 2017

 

 

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 due on March 15, 2019; and $750 million of 3.85% subordinated fixed-rate notes 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 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.

On September 27, 2016, the Bank issued and sold $1.0 billion in aggregate principal amount of unsecured senior bank notes due on September 27, 2019.

 

 

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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

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. During the fourth quarter of 2016, the FRB began a CRA examination of the Bank. For further information, refer to the Regulation and Supervision subsection of Part I, Item 1 of the Annual Report on Form 10-K.

 

 

TABLE 3: CONDENSED CONSOLIDATED STATEMENTS OF INCOME                                      

 

 
For the years ended December 31 ($ in millions, except per share data)    2016     2015         2014          2013         2012            

 

 

Interest income (FTE)

 

   $       4,218       4,049       4,051        3,993       4,125    

Interest expense

     578       495       451        412       512    

 

 

Net Interest Income (FTE)

 

     3,640       3,554       3,600        3,581       3,613    

Provision for loan and lease losses

     343       396       315        229       303    

 

 

Net Interest Income After Provision for Loan and Lease Losses (FTE)

 

     3,297       3,158       3,285        3,352       3,310    

Noninterest income

 

     2,696       3,003       2,473        3,227       2,999    

Noninterest expense

     3,903       3,775       3,709        3,961       4,081    

 

 

Income Before Income Taxes (FTE)

 

     2,090       2,386       2,049        2,618       2,228    

Fully taxable equivalent adjustment

 

     25       21       21        20       18    

Applicable income tax expense

     505       659       545        772       636    

 

 

Net Income

 

     1,560       1,706       1,483        1,826       1,574    

Less: Net income attributable to noncontrolling interests

     (4     (6     2        (10     (2  

 

 

Net Income Attributable to Bancorp

 

     1,564       1,712       1,481        1,836       1,576    

Dividends on preferred stock

     75       75       67        37       35    

 

 

Net Income Available to Common Shareholders

   $ 1,489       1,637       1,414        1,799       1,541    

 

 

Earnings per share - basic

 

   $ 1.95       2.03       1.68        2.05       1.69    

Earnings per share - diluted

   $ 1.93       2.01       1.66        2.02       1.66    

 

 

Cash dividends declared per common share

   $ 0.53       0.52       0.51        0.47       0.36    

 

 

 

Earnings Summary

The Bancorp’s net income available to common shareholders for the year ended December 31, 2016 was $1.5 billion, or $1.93 per diluted share, which was net of $75 million in preferred stock dividends. The Bancorp’s net income available to common shareholders for the year ended December 31, 2015 was $1.6 billion, or $2.01 per diluted share, which was net of $75 million in preferred stock dividends. Pre-provision net revenue was $2.4 billion and $2.8 billion for the years ended December 31, 2016 and 2015, respectively. 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 $3.6 billion for both the years ended December 31, 2016 and 2015. Net interest income was positively impacted by increases in average taxable securities of $3.1 billion and average loans and leases of $981 million for the year ended December 31, 2016 compared to the year ended December 31, 2015. Additionally, net interest income was positively impacted by the decision of the Federal Open Market Committee to raise the target range of the federal funds rate 25 bps to 50 bps in 2015 and 25 bps to 75 bps in 2016. These positive impacts were partially offset by an increase in average long-term debt of $750 million coupled with a decrease in the net interest rate spread to 2.66% during the year ended December 31, 2016 from 2.69% during the year ended December 31, 2015. Net interest margin on an FTE basis (non-GAAP) was 2.88% for the both years ended December 31, 2016 and 2015, respectively.

        Noninterest income decreased $307 million from the year ended December 31, 2015 primarily due to decreases in other noninterest income and mortgage banking net revenue partially offset by an increase in corporate banking revenue. Other noninterest income decreased $291 million from the year ended December 31, 2015. The decrease included the impact of a gain of $331 million on the sale of Vantiv, Inc. shares in the fourth quarter of 2015. The Bancorp recognized positive valuation adjustments on the stock warrant associated with Vantiv Holding, LLC of $64 million and $236 million for the years ended December 31, 2016 and 2015, respectively. In addition to valuation adjustments, during the fourth quarter of 2015, the Bancorp recognized a gain of $89 million on both the sale and exercise of a portion of the warrant associated with Vantiv Holding, LLC compared with a gain of $9 million on the sale of the remaining warrant in Vantiv Holding, LLC during 2016. These decreases were partially offset by an increase in income from the TRAs associated with Vantiv, Inc. of $233 million during the year ended December 31, 2016 compared to the same period in the prior year and a decrease in net losses on disposition and impairment of bank premises and equipment of $88 million during the year ended December 31, 2016 compared with the same period in the prior year. Mortgage banking net revenue decreased $63 million from the year ended December 31, 2015 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 $48 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily driven by increases in syndication fees and lease remarketing fees, partially offset by decreases in letter of credit fees and foreign exchange fees.

 

 

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Noninterest expense increased $128 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily due to increases in personnel costs, technology and communications expense and other noninterest expense partially offset by decreases in net occupancy expense and card and processing expense. Personnel costs increased $103 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 driven by an increase in base compensation, variable compensation, and higher retirement and severance costs related to the Bancorp’s voluntary early retirement program. Technology and communications expense increased $10 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 driven primarily by increased investment in information technology associated with regulatory and compliance initiatives, system maintenance and other growth initiatives. Other noninterest expense increased $64 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily due to increases in FDIC insurance and other taxes, impairment on affordable housing investments, the provision for the reserve for unfunded commitments, losses and adjustments and operating lease expense. These increases were partially offset by decreases in travel expense, professional service fees and loan and lease expense. Card and processing expense decreased $21 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 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 $343 million and $396 million for the years ended December 31, 2016 and 2015, respectively. Net losses charged-off as a percent of average portfolio loans and leases decreased to 0.39% during the year ended December 31, 2016 compared to 0.48% during the year ended December 31, 2015. At December 31, 2016, nonperforming portfolio assets as a percent of portfolio loans and leases and OREO increased to 0.80% 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 December 31, 2016, as calculated under the Basel III transition provisions, the CET1 capital ratio was 10.39%, the Tier I risk-based capital ratio was 11.50%, the Total risk-based capital ratio was 15.02% and the Tier I leverage ratio was 9.90%.

 

 

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NON-GAAP FINANCIAL MEASURES

 

The following are non-GAAP measures which are important to the reader of the 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 4: NON-GAAP FINANCIAL MEASURES - NET INTEREST INCOME ON AN FTE BASIS, NET INTEREST MARGIN AND
EFFICIENCY RATIO
 

 

 
For the years ended December 31 ($ in millions)    2016          2015              

 

 

Net interest income (U.S. GAAP)

   $             3,615        3,533     

 

Add: FTE adjustment

     25        21     

 

 

Net interest income on an FTE basis (1)

   $ 3,640        3,554     

Noninterest income (2)

 

   $ 2,696        3,003     

Noninterest expense (3)

 

     3,903        3,775     

Average interest-earning assets (4)

     126,285        123,584     

Ratios:

 

        

Net interest margin (1) / (4)

 

     2.88       2.88     

Efficiency ratio (3) / (1) + (2)

     61.6         57.6     

 

 

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

 
TABLE 5: NON-GAAP FINANCIAL MEASURE - INCOME BEFORE INCOME TAXES ON AN FTE BASIS  

 

 
For the years ended December 31 ($ in millions)    2016          2015              

 

 

Income before income taxes (U.S. GAAP)

 

   $ 2,065         2,365     

Add: FTE adjustment

     25         21     

 

 

Income before income taxes on an FTE basis

   $ 2,090         2,386     

 

 

 

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 6: NON-GAAP FINANCIAL MEASURE - PRE-PROVISION NET REVENUE                    

 

For the years ended December 31 ($ in millions)    2016              2015            

 

Net interest income (U.S. GAAP)

 

   $             3,615           3,533    

Add: Noninterest income

 

     2,696           3,003    

Less: Noninterest expense

     (3,903)          (3,775  

 

Pre-provision net revenue

   $ 2,408           2,761    

 

 

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

 

TABLE 7: NON-GAAP FINANCIAL MEASURE - RETURN ON AVERAGE TANGIBLE COMMON EQUITY        

 

 
For the years ended December 31 ($ in millions)         2016      2015              

 

 

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

   $ 1,489        1,637    

Add: Intangible amortization, net of tax

     1        2    

 

 

Tangible net income available to common shareholders (1)

   $ 1,490        1,639    

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

   $           16,597        15,865    

Less: Average preferred stock

     (1,331      (1,331  

Average goodwill

     (2,416      (2,416  

Average intangible assets and other servicing rights

     (10      (14  

 

 

Average tangible common equity (2)

   $ 12,840        12,104    

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

     11.6   %       13.5    

 

 

 

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 Consolidated Financial Statements in their entirety and not to rely on any single financial measure.

 

 

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

 

TABLE 8: NON-GAAP FINANCIAL MEASURES - CAPITAL RATIOS             

 

 
As of December 31 ($ in millions)          2016     2015                     

 

 

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

   $               16,205       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)

     12,448       12,079       

Less:   AOCI

     (59     (197     

 

 

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

     12,389       11,882       

Add:   Preferred stock

     1,331       1,331       

 

 

Tangible equity (3)

   $ 13,720       13,213       

 

 

Total Assets (U.S. GAAP)

   $ 142,177       141,048     (e)   

Less:   Goodwill

     (2,416     (2,416     

  Intangible assets and other servicing rights

     (10     (13     

  AOCI, before tax

     (91     (303     

 

 

Tangible assets, excluding unrealized gains / losses (4)

   $ 139,660       138,316       

 

 

Common shares outstanding (shares in millions) (5)

     750       785       

Ratios:

         

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

     9.82  %      9.55       

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

     8.87       8.59       

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

   $ 16.60       15.39       

Basel III Final Rule - Transition to Fully Phased-In

         

 

 

CET1 capital (transitional)

   $ 12,426       11,917       

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

     (4     (8     

 

 

CET1 capital (fully phased-in) (6)

     12,422       11,909       

 

 

Risk-weighted assets (transitional)(b)

     119,632       121,290     (d)   

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

     1,115       1,178       

 

 

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

   $ 120,747       122,468     (d)   

 

 

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

     10.29  %      9.72     (d)   

 

 
(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)

Balances not restated for the adoption of the amended guidance of ASU 2015-03 “Simplifying the Presentation of Debt Issuance Costs.” Refer to Note 1 of the Notes to Consolidated Financial Statements for further information.

(e)

Upon adoption of ASU 2015-03 on January 1, 2016, the December 31, 2015 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 1 of the Notes to Consolidated Financial Statements.

 

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RECENT ACCOUNTING STANDARDS

 

Note 1 of the Notes to Consolidated Financial Statements provides a discussion of the significant new accounting standards adopted

by the Bancorp during 2016 and the expected impact of significant accounting standards issued, but not yet required to be adopted.

 

 

CRITICAL ACCOUNTING POLICIES

 

The Bancorp’s 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. No material changes were made to the valuation techniques or models described below during the year ended December 31, 2016.

ALLL

The Bancorp disaggregates its portfolio loans and leases into portfolio segments for purposes of determining the ALLL. The Bancorp’s portfolio segments include commercial, residential mortgage and consumer. The Bancorp further disaggregates its portfolio segments into classes for purposes of monitoring and assessing credit quality based on certain risk characteristics. For an analysis of the Bancorp’s ALLL by portfolio segment and credit quality information by class, refer to Note 6 of the Notes to Consolidated Financial Statements.

The Bancorp maintains the ALLL to absorb probable loan and lease losses inherent in its portfolio segments. The ALLL is maintained at a level the Bancorp considers to be adequate and is based on ongoing quarterly assessments and evaluations of the collectability and historical loss experience of loans and leases. Credit losses are charged and recoveries are credited to the ALLL. Provisions for loan and lease losses are based on the Bancorp’s review of the historical credit loss experience and such factors that, in management’s judgment, deserve consideration under existing economic conditions in estimating probable credit losses. The Bancorp’s strategy for credit risk management includes a combination of conservative exposure limits significantly below legal lending limits and conservative underwriting, documentation and collections standards. The strategy also emphasizes diversification on a geographic, industry and customer level, regular credit examinations and quarterly management reviews of large credit exposures and loans experiencing deterioration of credit quality.

The Bancorp’s methodology for determining the ALLL requires significant management judgement and is based on historical loss rates, current credit grades, specific allocation on loans modified in a TDR and impaired commercial credits above specified thresholds and other qualitative adjustments. Allowances on individual commercial loans, TDRs and historical loss rates are reviewed quarterly and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience. An unallocated allowance is maintained to recognize the imprecision in estimating and measuring losses when evaluating allowances for pools of loans.

        Larger commercial loans included within aggregate borrower relationship balances exceeding $1 million that exhibit probable or observed credit weaknesses, as well as loans that have been modified in a TDR, are subject to individual review for impairment. The Bancorp considers the current value of collateral, credit quality of any guarantees, the guarantor’s liquidity and willingness to cooperate, the loan structure and other factors when evaluating whether an individual loan is impaired. Other factors

may include the industry and geographic region of the borrower, size and financial condition of the borrower, cash flow and leverage of the borrower and the Bancorp’s evaluation of the borrower’s management. When individual loans are impaired, allowances are determined based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral and other sources of cash flow, as well as an evaluation of legal options available to the Bancorp. Allowances for impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, fair value of the underlying collateral or readily observable secondary market values. The Bancorp evaluates the collectability of both principal and interest when assessing the need for a loss accrual.

Historical credit loss rates are applied to commercial loans that are not impaired or are impaired, but smaller than the established threshold of $1 million and thus not subject to specific allowance allocations. The loss rates are derived from migration analyses for several portfolio stratifications, which track the historical net charge-off experience sustained on loans according to their internal risk grade. The risk grading system utilized for allowance analysis purposes encompasses ten categories.

Homogenous loans and leases in the residential mortgage and consumer portfolio segments are not individually risk graded. Rather, standard credit scoring systems and delinquency monitoring are used to assess credit risks and allowances are established based on the expected net charge-offs. Loss rates are based on the trailing twelve month net charge-off history by loan category. Historical loss rates may be adjusted for certain prescriptive and qualitative factors that, in management’s judgment, are necessary to reflect losses inherent in the portfolio. The prescriptive loss rate factors include adjustments for delinquency trends, LTV trends and refreshed FICO score trends.

The Bancorp also considers qualitative factors in determining the ALLL. These include adjustments for changes in policies or procedures in underwriting, monitoring or collections, economic conditions, portfolio mix, lending and risk management personnel, results of internal audit and quality control reviews, collateral values and geographic concentrations. The Bancorp considers home price index trends when determining the collateral value qualitative factor.

The Bancorp’s primary market areas for lending are the Midwestern and Southeastern regions of the U.S. When evaluating the adequacy of allowances, consideration is given to these regional geographic concentrations and the closely associated effect changing economic conditions have on the Bancorp’s customers. Refer to the Allowance for Credit Losses subsection of the Risk Management section of MD&A for a discussion on the Bancorp’s ALLL sensitivity analysis.

Reserve for Unfunded Commitments

The reserve for unfunded commitments is maintained at a level believed by management to be sufficient to absorb estimated probable losses related to unfunded credit facilities and is included in other liabilities in the Consolidated Balance Sheets. The determination of the adequacy of the reserve is based upon an evaluation of the unfunded credit facilities, including an assessment of historical commitment utilization experience, credit risk grading and historical loss rates based on credit grade migration. This process takes into consideration the same risk elements that are analyzed in the determination of the adequacy of the Bancorp’s ALLL, as previously discussed.

 

 

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Net adjustments to the reserve for unfunded commitments are included in other noninterest expense in the Consolidated Statements of Income.

Income Taxes

The income tax laws of the jurisdictions in which the Bancorp operates are complex and may be subject to different interpretations. The Bancorp evaluates and assesses the relative risks and appropriate tax treatment of transactions and filing positions after considering statutes, regulations, judicial precedent and other information. The Bancorp maintains tax accruals consistent with its evaluation of these items.

Changes in the estimate of tax accruals occur periodically due to changes in tax rates, interpretation of tax laws and regulations, and other guidance issued by tax authorities and the status of examinations conducted by tax authorities, as well as the expiration of statutes of limitations. These changes may significantly impact the Bancorp’s tax accruals, deferred taxes and income tax expense and may significantly impact the operating results of the Bancorp.

Deferred taxes are determined using the balance sheet method. Under this method, the net deferred tax asset or liability is calculated based on the difference between the book and tax bases of the assets and liabilities using enacted tax rates and laws. Significant management judgment is required to determine the realizability of deferred tax assets. Deferred tax assets are recognized when management believes that it is more likely than not that the deferred tax assets will be realized. Where management has determined that it is not more likely than not that certain deferred tax assets will be realized, a valuation allowance is maintained. For additional information on income taxes, refer to Note 20 of the Notes to Consolidated Financial Statements.

Valuation of Servicing Rights

When the Bancorp sells loans through either securitizations or individual loan sales in accordance with its investment policies, it often obtains servicing rights. Servicing rights resulting from loan sales are initially recorded at fair value and subsequently amortized in proportion to, and over the period of, estimated net servicing revenue. Servicing rights are assessed for impairment monthly, based on fair value, with temporary impairment recognized through a valuation allowance and other-than-temporary impairment recognized through a write-off of the servicing asset and related valuation allowance. Significant management judgement is necessary to identify key economic assumptions used in measuring any potential impairment of the servicing rights including the prepayment speeds of the underlying loans, the weighted-average life, the OAS spread and the weighted-average coupon rate, as applicable. The primary risk of material changes to the value of the servicing rights resides in the potential volatility in the economic assumptions used, particularly the prepayment speeds. The Bancorp monitors risk and adjusts its valuation allowance as necessary to adequately reserve for impairment in the servicing portfolio. In order to assist in this assessment, the Bancorp obtains external valuations of the MSR portfolio from third parties and participates in peer surveys that provide additional confirmation of the

reasonableness of key assumptions utilized in the internal OAS model. For purposes of measuring impairment, the MSRs are stratified into classes based on the financial asset type (fixed-rate vs. adjustable-rate) and interest rates. For additional information on servicing rights, refer to Note 12 of the Notes to Consolidated Financial Statements.

Fair Value Measurements

The Bancorp measures certain financial assets and liabilities at fair value in accordance with U.S. GAAP, which defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Valuation techniques the Bancorp uses to measure fair value include the market approach, income approach and cost approach. The market approach uses prices or relevant information generated by market transactions involving identical or comparable assets or liabilities. The income approach involves discounting future amounts to a single present amount and is based on current market expectations about those future amounts. The cost approach is based on the amount that currently would be required to replace the service capacity of the asset.

U.S. GAAP establishes a fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the instrument’s fair value measurement. For additional information on the fair value hierarchy and fair value measurements, refer to Note 1 of the Notes to Consolidated Financial Statements.

The Bancorp’s fair value measurements involve various valuation techniques and models, which involve inputs that are observable, when available. Valuation techniques and parameters used for measuring assets and liabilities are reviewed and validated by the Bancorp on a quarterly basis. Additionally, the Bancorp monitors the fair values of significant assets and liabilities using a variety of methods including the evaluation of pricing runs and exception reports based on certain analytical criteria, comparison to previous trades and overall review and assessments for reasonableness. The level of management judgement necessary to determine fair value varies based upon the methods used in the determination of fair value. Financial instruments that are measured at fair value using quoted prices in active markets (Level 1) require minimal judgement. The valuation of financial instruments when quoted market prices are not available (Levels 2 and 3) may require significant management judgement to assess whether quoted prices for similar instruments exist, the impact of changing market conditions including reducing liquidity in the capital markets, and, the use of estimates surrounding significant unobservable inputs. Table 8 provides a summary of the fair value of financial instruments carried at fair value on a recurring basis and the amounts of financial instruments valued using Level 3 inputs.

 

 

TABLE 9: FAIR VALUE SUMMARY         

 

 
As of ($ in millions)                December 31, 2016                                December 31, 2015                  
     Balance             Level 3                   Balance      Level 3               

 

 

Assets carried at fair value

   $                32,872       156         31,364        444     

As a percent of total assets

     23  %      -         22        -     

Liabilities carried at fair value

   $ 687       96         967        64     

As a percent of total liabilities

     1  %      -         1        -     

 

 

 

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Refer to Note 27 of the Notes to Consolidated Financial Statements for further information on fair value measurements including a description of the valuation methodologies used for significant financial instruments.

Goodwill

Business combinations entered into by the Bancorp typically include the acquisition of goodwill. U.S. GAAP requires goodwill to be tested for impairment at the Bancorp’s reporting unit level on an annual basis, which for the Bancorp is September 30, and more frequently if events or circumstances indicate that there may be impairment. Refer to Note 1 of the Notes to Consolidated Financial Statements for a discussion on the methodology used by the Bancorp to assess goodwill for impairment.

Impairment exists when a reporting unit’s carrying amount of goodwill exceeds its implied fair value. In testing goodwill for impairment, U.S. GAAP permits the Bancorp to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. In this qualitative assessment, the Bancorp evaluates events and circumstances which may include, but are not limited to, the general economic environment, banking industry and market conditions, the overall financial performance of the Bancorp, the performance of the Bancorp’s common stock, the key financial performance metrics of the Bancorp’s reporting units and events affecting the reporting units to determine if it is not more likely than not that the fair value of a reporting unit is less than its carrying amount. If the two-step impairment test is required or the decision to bypass the qualitative assessment is elected, the Bancorp would be required to perform the first step (Step 1) of the goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds its fair value, Step 2 of the goodwill impairment test is performed to measure the amount of impairment loss, if any.

The fair value of a reporting unit is the price that would be received to sell the unit as a whole in an orderly transaction between market participants at the measurement date. As none of the Bancorp’s reporting units are publicly traded, individual reporting unit fair value determinations cannot be directly correlated to the Bancorp’s stock price. The determination of the fair value of a reporting unit is a subjective process that involves the use of estimates and judgments, particularly related to cash flows, the appropriate discount rates and an applicable control premium. The Bancorp employs an income-based approach, utilizing the reporting unit’s forecasted cash flows (including a terminal value approach to estimate cash flows beyond the final year of the forecast) and the reporting unit’s estimated cost of equity as the discount rate. Significant management judgment is necessary in the preparation of each reporting unit’s forecasted cash flows surrounding expectations for earnings projections, growth and credit loss expectations and actual results may differ from forecasted results. Additionally, the Bancorp determines its market capitalization based on the average of the closing price of the Bancorp’s stock during the month including the measurement date, incorporating an additional control premium, and compares this market-based fair value measurement to the aggregate fair value of the Bancorp’s reporting units in order to corroborate the results of the income approach.

When required to perform Step 2, the Bancorp compares the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount exceeds the implied fair value, an impairment loss equal to that excess amount is recognized. A recognized impairment loss cannot exceed the carrying amount of that goodwill and cannot be reversed in future periods even if the fair value of the reporting unit subsequently recovers.

During Step 2, the Bancorp determines the implied fair value of goodwill for a reporting unit by assigning the fair value of the reporting unit to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination. Significant management judgement is necessary in the identification and valuation of unrecognized intangible assets and the valuation of the reporting unit’s recorded assets and liabilities. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. This assignment process is only performed for purposes of testing goodwill for impairment. The Bancorp does not adjust the carrying values of recognized assets or liabilities (other than goodwill, if appropriate), nor does it recognize previously unrecognized intangible assets in the Consolidated Financial Statements as a result of this assignment process. Refer to Note 9 of the Notes to Consolidated Financial Statements for further information regarding the Bancorp’s goodwill.

Legal Contingencies

The Bancorp and its subsidiaries are parties to numerous claims and lawsuits as well as threatened or potential actions or claims concerning matters arising from the conduct of its business activities. The outcome of claims or litigation and the timing of ultimate resolution are inherently difficult to predict and significant judgment may be required in the determination of both the probability of loss and whether the amount of the loss is reasonably estimable. The Bancorp’s estimates are subjective and are based on the status of legal and regulatory proceedings, the merit of the Bancorp’s defenses and consultation with internal and external legal counsel. An accrual for a potential litigation loss is established when information related to the loss contingency indicates both that a loss is probable and that the amount of loss can be reasonably estimated. Refer to Note 18 of the Notes to Consolidated Financial Statements for further information regarding the Bancorp’s legal proceedings.

 

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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 10 and 11 present the components of net interest income, net interest margin and net interest rate spread for the years ended December 31, 2016, 2015 and 2014, 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 securities included in other assets.

Net interest income on an FTE basis (non-GAAP) was $3.6 billion for both the years ended December 31, 2016 and 2015. Net interest income was positively impacted by increases in average taxable securities of $3.1 billion and average loans and leases of $981 million for the year ended December 31, 2016 compared to the year ended December 31, 2015. Additionally, net interest income was positively impacted by the decision of the Federal Open Market Committee to raise the target range of the federal funds rate 25 bps to 50 bps in December 2015 and 25 bps to 75 bps in December 2016. These positive impacts were partially offset by an increase in average long-term debt of $750 million coupled with a decrease in the net interest rate spread to 2.66% during the year ended December 31, 2016 from 2.69% during the year ended December 31, 2015. The decrease in the net interest rate spread was driven by a 9 bps increase on rates paid on average interest-bearing liabilities partially offset by a 6 bps increase in yields on average interest-earning assets.

Net interest margin on an FTE basis (non-GAAP) was 2.88% for both the years ended December 31, 2016 and 2015. Net interest margin was positively impacted by an increase in average free funding balances partially offset by the aforementioned decrease in net interest rate spread coupled with an increase of $2.7 billion in average interest-earning assets. The increase in average free funding balances was driven by increases in average demand deposits and average shareholders’ equity of $698 million and $727 million, respectively, for the year ended December 31, 2016 compared to the year ended December 31, 2015.

Interest income on an FTE basis (non-GAAP) from loans and leases increased $86 million compared to the year ended December 31, 2015 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 $981 million during the year ended December 31, 2016 compared to the year ended December 31, 2015 and was primarily driven by increases in average residential mortgage loans, average commercial construction loans and average commercial and industrial loans partially offset by decreases in average automobile loans and average home equity. Yields on average loans and leases increased 5 bps during the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily as a result of increases in yields on average commercial construction loans, average commercial and industrial loans and average home equity loans partially offset by a decrease in yields on average credit cards which included the impact of a $16 million reduction in interest income related to refunds to be offered to certain bankcard customers. 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 $83 million compared to the year ended December 31, 2015. The increase was primarily the result of the previously mentioned increase in average taxable securities, partially offset by a decrease of $14 million in dividends on FRB stock, due to the amended provisions of the Federal Reserve Act governing dividend payments to FRB stockholders.

Interest expense on core deposits increased $15 million for the year ended December 31, 2016 compared to the year ended December 31, 2015. This increase was primarily due to increases in the cost of average interest-bearing core deposits to 26 bps for the year ended December 31, 2016 compared to 24 bps for the year ended December 31, 2015. The increase in the cost of average interest-bearing core deposits was primarily due to an increase in the cost of average interest checking and 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 $68 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily due to an increase of 26 bps in the rates paid on average long-term debt coupled with the aforementioned increase in average long-term debt. Refer to the Borrowings subsection of the Balance Sheet Analysis section of MD&A for additional information on the Bancorp’s borrowings. Average wholesale funding represented 26% and 24% of average interest-bearing liabilities during the years ended December 31, 2016 and 2015, respectively. For more information on the Bancorp’s interest rate risk management, including estimated earnings sensitivity to changes in market interest rates, see the Market Risk Management subsection of the Risk Management section of MD&A.

 

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

TABLE 10: CONSOLIDATED AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME ON AN FTE BASIS  

 

 
For the years ended December 31    2016     2015     2014  

 

   

 

 

   

 

 

 
                   Average                  Average                  Average       
     Average      Revenue/      Yield/     Average     Revenue/      Yield/     Average     Revenue/      Yield/       
($ in millions)    Balance      Cost      Rate     Balance     Cost      Rate     Balance     Cost      Rate       

 

 

Assets:

                      

Interest-earning assets:

                      

Loans and leases:(a)

                      

Commercial and industrial loans

   $         43,184        1,413        3.27   $         42,594       1,334        3.13   $         41,178       1,346        3.27%  

Commercial mortgage loans

     6,899        229        3.32       7,121       227        3.19       7,745       260        3.36     

Commercial construction loans

     3,648        125        3.42       2,717       86        3.17       1,492       51        3.44     

Commercial leases

     3,916        105        2.69       3,796       106        2.78       3,585       108        3.01     

 

 

Total commercial loans and leases

     57,647        1,872        3.25       56,228       1,753        3.12       54,000       1,765        3.27     

 

 

Residential mortgage loans

     15,101        535        3.54       13,798       509        3.69       13,344       518        3.88     

Home equity

     7,998        302        3.78       8,592       312        3.63       9,059       336        3.71     

Automobile loans

     10,708        290        2.71       11,847       315        2.66       12,068       334        2.77     

Credit card

     2,205        214        9.69       2,303       237        10.27       2,271       227        9.98     

Other consumer loans and leases

     661        44        6.56       571       45        8.00       385       138        35.99     

 

 

Total consumer loans and leases

     36,673        1,385        3.78       37,111       1,418        3.82       37,127       1,553        4.18     

 

 

Total loans and leases

   $ 94,320        3,257        3.45   $ 93,339       3,171        3.40   $ 91,127       3,318        3.64%  

Securities:

                      

Taxable

     30,019        950        3.16       26,932       867        3.22       21,770       722        3.32     

Exempt from income taxes(a)

     80        3        4.51       55       3        5.23       53       3        4.94     

Other short-term investments

     1,866        8        0.44       3,258       8        0.25       3,043       8        0.26     

 

 

Total interest-earning assets

   $ 126,285        4,218        3.34   $ 123,584       4,049        3.28   $ 115,993       4,051        3.49%  

Cash and due from banks

     2,303             2,608            2,892       

Other assets

     14,963             15,179 (c)           14,505  (c)      

Allowance for loan and lease losses

     (1,285)             (1,293)            (1,481)       

 

 

Total assets

   $ 142,266           $ 140,078 (c)         $ 131,909  (c)      

 

 

Liabilities and Equity:

                      

Interest-bearing liabilities:

                      

Interest checking deposits

   $ 25,143        58        0.23   $ 26,160       50        0.19   $ 25,382       56        0.22%  

Savings deposits

     14,346        7        0.05       14,951       9        0.06       16,080       16        0.10     

Money market deposits

     19,523        53        0.27       18,152       44        0.24       14,670       51        0.35     

Foreign office deposits

     497        1        0.16       817       1        0.16       1,828       5        0.29     

Other time deposits

     4,010        49        1.24       4,051       49        1.20       3,762       40        1.06     

 

 

Total interest-bearing core deposits

     63,519        168        0.26       64,131       153        0.24       61,722       168        0.27     

Certificates $100,000 and over

     2,735        36        1.30       2,869       33        1.16       3,929       34        0.85     

Other deposits

     333        1        0.41       57       -        0.16       -       -        0.02     

Federal funds purchased

     506        2        0.39       920       1        0.13       458       -        0.09     

Other short-term borrowings

     2,845        10        0.36       1,721       2        0.12       1,873       2        0.10     

Long-term debt

     15,394        361        2.35       14,644 (c)      306        2.09       12,894  (c)      247        1.91     

 

 

Total interest-bearing liabilities

   $ 85,332        578        0.68   $ 84,342 (c)      495        0.59   $ 80,876  (c)      451        0.56%  

Demand deposits

     35,862             35,164            31,755       

Other liabilities

     4,445             4,672            3,950       

 

 

Total liabilities

   $ 125,639           $ 124,178 (c)         $ 116,581  (c)      

Total equity

   $ 16,627           $ 15,900          $ 15,328       

 

 

Total liabilities and equity

   $ 142,266           $ 140,078 (c)         $ 131,909  (c)      

 

 

Net interest income (FTE)(b)

      $ 3,640          $ 3,554          $ 3,600     

Net interest margin (FTE)(b)

           2.88          2.88          3.10%  

Net interest rate spread (FTE)(b)

           2.66            2.69            2.94     

Interest-bearing liabilities to interest-earning assets

           67.57            68.25 (c)           69.73(c)   

 

 
(a)

The FTE adjustments included in the above table were $25 for the year ended December 31, 2016 and $21 for both the years ended December 31, 2015 and 2014.

(b)

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

(c)

Upon adoption of ASU 2015-03 on January 1, 2016, the December 31, 2015 and 2014 Consolidated Balance Sheets were adjusted to reflect the reclassification of $33 and $34, respectively, of average debt issuance costs from average other assets to average long-term debt. For further information, refer to Note 1 of the Notes to Consolidated Financial Statements.

 

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TABLE 11: CHANGES IN NET INTEREST INCOME ATTRIBUTABLE TO VOLUME AND YIELD/RATE(a)  

 

 
For the years ended December 31    2016 Compared to 2015      2015 Compared to 2014          

 

    

 

 

 
($ in millions)    Volume        Yield/Rate      Total      Volume          Yield/Rate      Total          

 

 

Assets:

                 

Interest-earning assets:

                 

Loans and leases:

                 

Commercial and industrial loans

   $ 19          60          79          45          (57)         (12)      

Commercial mortgage loans

     (7)         9          2          (21)         (12)         (33)      

Commercial construction loans

     32          7          39          39          (4)         35       

Commercial leases

     3          (4)         (1)         6          (8)         (2)      

 

 

Total commercial loans and leases

     47          72          119          69          (81)         (12)      

 

 

Residential mortgage loans

     47          (21)         26          17          (26)         (9)      

Home equity

     (22)         12          (10)         (17)         (7)         (24)      

Automobile loans

     (31)         6          (25)         (5)         (14)         (19)      

Credit card

     (10)         (13)         (23)         3          7          10       

Other consumer loans and leases

     8          (9)         (1)         47          (140)         (93)      

 

 

Total consumer loans and leases

     (8)         (25)         (33)         45          (180)         (135)      

 

 

Total loans and leases

   $ 39          47          86          114          (261)         (147)      

Securities:

                 

Taxable

     98          (15)         83          167          (22)         145       

Other short-term investments

     (4)         4          -          -          -          -       

 

 

Total change in interest income

   $                 133          36          169          281          (283)         (2)      

 

 

Liabilities:

                 

Interest-bearing liabilities:

                 

Interest checking deposits

   $ (3)         11          8          2          (8)         (6)      

Savings deposits

     -          (2)         (2)         (1)         (6)         (7)      

Money market deposits

     4          5          9          10          (17)         (7)      

Foreign office deposits

     -          -          -          (2)         (2)         (4)      

Other time deposits

     (1)         1          -          3          6          9       

 

 

Total interest-bearing core deposits

     -          15          15          12          (27)         (15)      

Certificates $100,000 and over

     (1)         4          3          (11)         10          (1)      

Other deposits

     1          -          1          -          -          -       

Federal funds purchased

     -          1          1          1          -          1       

Other short-term borrowings

     2          6          8          -          -          -       

Long-term debt

     15          40          55          35          24          59       

 

 

Total change in interest expense

   $ 17          66          83          37          7          44       

 

 

Total change in net interest income

   $ 116          (30)         86          244          (290)         (46)      

 

 
(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.

 

Provision for Loan and Lease Losses

The Bancorp provides as an expense an amount for probable losses within the loan and lease portfolio that is based on factors previously discussed in the Critical Accounting Policies section of MD&A. 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 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.

The provision for loan and lease losses was $343 million for the year ended December 31, 2016 compared to $396 million for the same period in the prior year. The decrease in provision expense for the year ended December 31, 2016 compared to the

prior year was primarily due to the decrease in the level of commercial criticized assets, which reflected improvement in the national economy and stabilization of commodity prices, and a decrease in outstanding loan balances. The ALLL declined $19 million from December 31, 2015 to $1.3 billion at December 31, 2016. At December 31, 2016, the ALLL as a percent of portfolio loans and leases decreased to 1.36%, compared to 1.37% at December 31, 2015.

Refer to the Credit Risk Management subsection of the Risk Management section of MD&A as well as Note 6 of the Notes to Consolidated Financial Statements for more detailed information on the provision for loan and lease losses, including an analysis of loan portfolio composition, nonperforming assets, net charge-offs and other factors considered by the Bancorp in assessing the credit quality of the loan and lease portfolio and the ALLL.

 

 

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Noninterest Income

Noninterest income decreased $307 million for the year ended December 31, 2016 compared to the year ended December 31, 2015. The following table presents the components of noninterest income:

 

TABLE 12: COMPONENTS OF NONINTEREST INCOME                                             

 

 
For the years ended December 31 ($ in millions)      2016         2015        2014        2013        2012      

 

 

Service charges on deposits

     $           558          563          560          549          522      

Corporate banking revenue

       432          384          430          400          413      

Wealth and asset management revenue

       404          418          407          393          374      

Card and processing revenue

       319          302          295          272          253      

Mortgage banking net revenue

       285          348          310          700          845      

Other noninterest income

       688          979          450          879          574      

Securities gains, net

       10          9          21          21          15      

Securities gains, net - non-qualifying hedges on mortgage service rights

       -          -          -          13          3      

 

 

Total noninterest income

     $ 2,696          3,003          2,473          3,227          2,999      

 

 

 

Service charges on deposits

Service charges on deposits decreased $5 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 due primarily to a $10 million decrease in consumer deposit fees driven by a decrease in consumer checking fees, partially offset by a $5 million increase in commercial deposit fees driven by new customer acquisition.

Corporate banking revenue

Corporate banking revenue increased $48 million for the year ended December 31, 2016 compared to the year ended December 31, 2015. The increase from the prior year was primarily driven by increases in syndication fees and lease remarketing fees. The increase was partially offset by decreases in letter of credit fees and foreign exchange fees. Syndication fees increased $32 million compared to the year ended December 31, 2015 as a result of increased activity in the market and gains in specialized business segments. Lease remarketing fees increased $30 million for the year ended December 31, 2016 from the prior year and included the impact of $16 million in gains on certain leveraged lease terminations. Additionally, the increase included the impact of impairment charges of $20 million related to certain operating lease equipment that were recognized during the year ended December 31, 2016 compared to $36 million recognized during the year ended December 31, 2015. Letter of credit fees decreased $10 million for the year ended December 31, 2016 compared to the prior year primarily driven by a decrease in outstanding VRDNs. Foreign exchange fees decreased $8 million

during the year ended December 31, 2016 compared to the prior year primarily driven by lower volume coupled with lower currency volatility.

Wealth and asset management revenue

Wealth and asset management revenue (formerly investment advisory revenue) decreased $14 million for the year ended December 31, 2016 compared to the year ended December 31, 2015. The decrease from the prior year was primarily due to a decrease of $16 million in securities and brokerage fees driven by lower transactional fees partially offset by an increase in managed account fee-based business. The decrease was partially offset by a $2 million increase in private client service fees and institutional fees for the year ended December 31, 2016 compared to the year ended December 31, 2015. The Bancorp’s Trust, Brokerage and Insurance businesses had approximately $315 billion and $297 billion in total assets under care as of December 31, 2016 and 2015, respectively, and managed $31 billion and $29 billion in assets for individuals, corporations and not-for-profit organizations as of December 31, 2016 and 2015, respectively.

Card and processing revenue

Card and processing revenue increased $17 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily driven by an increase in the number of actively used cards and customer spend volume.

 

Mortgage banking net revenue

Mortgage banking net revenue decreased $63 million for the year ended December 31, 2016 compared to the year ended December 31, 2015.

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

 

TABLE 13: COMPONENTS OF MORTGAGE BANKING NET REVENUE                           

 

 
For the years ended December 31 ($ in millions)      2016         2015         2014       

 

 

Origination fees and gains on loan sales

     $           186           171           153       

Net mortgage servicing revenue:

              

Gross mortgage servicing fees

       199           222           246       

MSR amortization

       (131)          (139)          (119)      

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

       31           94           30       

 

 

Net mortgage servicing revenue

       99           177           157       

 

 

Mortgage banking net revenue

     $ 285           348           310       

 

 

 

Origination fees and gains on loan sales increased $15 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 driven by an increase in saleable residential mortgage loan originations. Residential mortgage loan originations increased to $10.0 billion for the year ended December 31, 2016 from $8.3 billion for the year ended December 31, 2015.

 

        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.

 

 

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Net mortgage servicing revenue decreased $78 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 driven primarily by a decrease of $63 million in net valuation adjustments, as well as a decrease in gross mortgage servicing fees of $23 million. The decrease was partially

offset by a decrease in MSR amortization of $8 million for the year ended December 31, 2016 compared to 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 for the years ended December 31:

 

TABLE 14: COMPONENTS OF NET VALUATION ADJUSTMENTS ON MSRs                     

 

 
($ in millions)    2016        2015        2014         

 

 

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

   $                 24        90        95       

Recovery of (provision for) MSR impairment

     7        4        (65)      

 

 

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

   $ 31        94        30       

 

 

 

Mortgage rates increased during the year ended December 31, 2016 which caused modeled prepayment speeds to decrease, leading to a recovery of temporary impairment on the servicing rights during the year. Mortgage rates increased during the year ended December 31, 2015 which caused the modeled prepayment speeds to decrease, which led to a recovery of temporary impairment on the servicing rights during the year.

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 12 of the Notes to 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 13 of the Notes to Consolidated Financial Statements for more information on the free-standing derivatives used to economically hedge the MSR portfolio.

In addition to the derivative positions used to economically hedge the MSR portfolio, the Bancorp may acquire various securities as a component of its non-qualifying hedging strategy. The Bancorp did not hold or sell securities related to the non-qualifying hedging strategy during the years ended December 31, 2016 and 2015.

The Bancorp’s total residential loans serviced at December 31, 2016 and 2015 were $69.3 billion and $73.4 billion, respectively, with $53.6 billion and $59.0 billion, respectively, of residential mortgage loans serviced for others.

 

 

Other noninterest income

The following table presents the components of other noninterest income:

 

TABLE 15: COMPONENTS OF OTHER NONINTEREST INCOME                     

 

 
For the years ended December 31 ($ in millions)    2016           2015           2014           

 

 

Income from the TRA associated with Vantiv, Inc.

   $            313         80         23       

Operating lease income

     102         89         84       

Equity method income from interest in Vantiv Holding, LLC

     66         63         48       

Valuation adjustments on the warrant associated with Vantiv Holding, LLC

     64         236         31       

BOLI income

     53         48         44       

Cardholder fees

     46         43         45       

Consumer loan and lease fees

     23         23         25       

Banking center income

     20         21         30       

Gain on sale of certain retail branch operations

     19                -       

Private equity investment income

     11         28         27       

Insurance income

     11         14         13       

Net gains on loan sales

     10         38         -       

Gain on sale and exercise of the warrant associated with Vantiv Holding, LLC.

            89         -       

Gain on sale of Vantiv, Inc. shares

            331         125       

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

     (56)        (37)        (38)      

Net losses on disposition and impairment of bank premises and equipment

     (13)        (101)        (19)      

Other, net

     10         14         12       

 

 

Total other noninterest income

   $ 688         979         450       

 

 

 

Other noninterest income decreased $291 million for the year ended December 31, 2016 compared to the year ended December 31, 2015. The decrease included the impact of a gain of $331 million on the sale of Vantiv, Inc. shares in the fourth quarter of 2015, decreases in positive valuation adjustments on the warrant associated with Vantiv Holding, LLC, a decrease in the gain on the sale and exercise of the warrant associated with Vantiv Holding, LLC, decreases in 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. These decreases were partially offset by increases in the income from the

TRA associated with Vantiv, Inc. and a decrease in the net losses on disposition and impairment of bank premises and equipment as well as gains on sales of certain retail branch operations and an increase in operating lease income.

        The Bancorp recognized positive valuation adjustments on the stock warrant associated with Vantiv Holding, LLC of $64 million and $236 million for the years ended December 31, 2016 and 2015, respectively. The fair value of the stock warrant was 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).

 

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The positive valuation adjustments for years ended December 31, 2016 and 2015 were primarily due to increases of 24% and 40%, respectively, in Vantiv, Inc.’s share price from December 31, 2015 to November 22, 2016 and from December 31, 2014 to December 31, 2015, respectively. In addition to valuation adjustments, during the fourth quarter of 2015, the Bancorp recognized a gain of $89 million on both the sale and exercise of a portion of the warrant associated with Vantiv Holding, LLC. During the fourth quarter of 2016, the Bancorp recognized a gain of $9 million on the exercise of the remaining warrant in Vantiv Holding, LLC. For additional information on the valuation of the warrant, refer to Note 27 of the Notes to Consolidated Financial Statements.

Net gains on loan sales decreased $28 million for the year ended December 31, 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.

Private equity investment income decreased $17 million for the year ended December 31, 2016, compared to same period in the prior year primarily driven by the recognition of $9 million of OTTI on certain private equity investments in the third quarter of 2016. Refer to Note 27 of the Notes to Consolidated Financial Statements for further information.

During the year ended December 31, 2016, the Bancorp recognized $56 million of negative valuation adjustments related to the Visa total return swap compared to $37 million during same period in the prior year. The adjustments for the year ended December 31, 2016 were 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 17, Note 18 and Note 27 of the Notes to Consolidated Financial Statements.

Income from the TRAs associated with Vantiv, Inc. increased $233 million during the year ended December 31, 2016 compared to the same period in the prior year. This increase was primarily driven by a $280 million gain recognized in 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. During the fourth quarter of 2015, the Bancorp recognized a $49 million gain from the payment from Vantiv, Inc. to terminate a portion of the TRA. Additionally, the Bancorp recognized a gain of $33 million associated with the annual TRA payment during the fourth quarter of 2016 compared to a $31 million gain during the same period in the prior year.

Net losses on disposition and impairment of bank premises and equipment decreased $88 million during the year ended December 31, 2016 compared with the same period in the prior year. This decrease was driven by impairment charges of $32 million during the year ended December 31, 2016 compared to impairment charges of $109 million recognized during the year ended December 31, 2015. The impairment charges for the year ended December 31, 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 Consolidated Financial Statements.

Gains on sales of certain retail branch operations of $19 million for the year ended December 31, 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.

Operating lease income increased $13 million primarily as a result of an increase in syndication and participation origination activity.

 

 

Noninterest Expense

Noninterest expense increased $128 million for the year ended December 31, 2016 compared to the year ended December 31, 2015, primarily due to increases in personnel costs (salaries, wages and incentives plus employee benefits), technology and communications and other noninterest expense partially offset by decreases in net occupancy expense and card and processing expense. The following table presents the components of noninterest expense:

 

TABLE 16: COMPONENTS OF NONINTEREST EXPENSE                                           

 

 
For the years ended December 31 ($ in millions)      2016          2015            2014            2013            2012          

 

 

Salaries, wages and incentives

     $         1,612        1,525          1,449          1,581          1,607      

Employee benefits

       339        323          334          357          371      

Net occupancy expense

       299        321          313          307          302      

Technology and communications

       234        224          212          204          196      

Card and processing expense

       132        153          141          134          121      

Equipment expense

       118        124          121          114          110      

Other noninterest expense

       1,169        1,105          1,139          1,264          1,374      

 

 

Total noninterest expense

     $ 3,903        3,775          3,709          3,961          4,081      

 

 

Efficiency ratio on an FTE basis(a)

       61.6       57.6          61.1          58.2          61.7      

 

 
(a)

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

 

Personnel costs increased $103 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 driven by an increase in base compensation, primarily due to personnel additions in risk and compliance and information technology, and increased variable compensation, as well as higher retirement and severance costs related to the Bancorp’s voluntary early retirement program. Full-time equivalent employees totaled 17,844 at December 31, 2016 compared to 18,261 at December 31, 2015.

        Technology and communications expense increased $10 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 driven primarily by increased investment in information technology associated with regulatory and compliance initiatives, system maintenance and other growth initiatives.

Net occupancy expense decreased $22 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily due to a decrease in rent expense driven by a reduction in the number of full-service banking centers and ATM locations.

 

 

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Card and processing expense decreased $21 million for the year ended December 31, 2016 compared to the year ended December 31,

2015 primarily due to the impact of renegotiated service contracts.

 

 

The following table presents the components of other noninterest expense:

 

TABLE 17: COMPONENTS OF OTHER NONINTEREST EXPENSE                           

 

 
For the years ended December 31 ($ in millions)      2016            2015            2014           

 

 

Impairment on affordable housing investments

     $              168          145          135       

FDIC insurance and other taxes

       126          99          89       

Loan and lease

       110          118          119       

Marketing

       104          110          98       

Operating lease

       86          74          67       

Losses and adjustments

       73          55          188       

Professional service fees

       61          70          72       

Data processing

       51          45          41       

Postal and courier

       46          45          47       

Travel

       45          54          52       

Recruitment and education

       37          33          28       

Provision for (benefit from) the reserve for unfunded commitments

       23          4          (27)      

Donations

       23          29          18       

Insurance

       15          17          16       

Supplies

       14          16          15       

Other, net

       187          191          181       

 

 

Total other noninterest expense

     $ 1,169          1,105          1,139       

 

 

 

Other noninterest expense increased $64 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily due to increases in FDIC insurance and other taxes, impairment on affordable housing investments, the provision for the reserve for unfunded commitments, losses and adjustments and operating lease expense partially offset by decreases in travel expense, professional service fees and loan and lease expense.

FDIC insurance and other taxes increased $27 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 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 $23 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily due to incremental losses resulting from previous growth in the portfolio. For further information, refer to Note 11 of the Notes to Consolidated Financial Statements. The provision for the reserve for unfunded commitments increased $19 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily due to an increase in estimated loss rates related to unfunded

commitments. Losses and adjustments increased $18 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily due to the impact of favorable legal settlements for the year ended December 31, 2015 partially offset by a decrease in legal settlements and reserve expense for the year ended December 31, 2016. Operating lease expense increased $12 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily due to an increase in the volume of leases. Travel expense and professional service fees both decreased $9 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily due to overall expense control. Loan and lease expense decreased $8 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily due to 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 on an FTE basis was 61.6% for the year ended December 31, 2016 compared to 57.6% for the year ended December 31, 2015. The efficiency ratio on an FTE basis is a non-GAAP measure. For further information, refer to the Non-GAAP Financial Measures section of MD&A.

 

Applicable Income Taxes

Applicable income tax expense for all periods includes the benefit from tax-exempt income, tax-advantaged investments, certain gains on sales of leveraged leases that are exempt from federal taxation 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.

        The effective tax rates for the years ended December 31, 2016 and 2015 were primarily impacted by $182 million and $178 million, respectively, in tax credits and $56 million and $39 million of tax benefits from tax exempt income in 2016 and 2015, respectively.

The decrease in the effective tax rate from the year ended December 31, 2015 to the year ended December 31, 2016 was primarily related to a decrease in income before taxes, the increase in tax exempt income, and a change in the estimated deductibility of a prior expense.

        During 2016, the Bancorp adopted ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting”, effective as of January 1, 2016. Consistent with existing U.S. GAAP and ASU 2016-09, the Bancorp establishes a deferred tax asset and recognizes a corresponding deferred tax benefit for stock-based awards granted to its employees and directors based on enacted tax rates and the expense recorded for financial reporting purposes. The actual tax deduction for these stock-based awards is determined when the stock-based awards are settled or expired and the tax deductions will typically be greater than or less than the expense previously recognized for financial reporting.

 

 

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Among other requirements, ASU 2016-09 requires that the tax consequences for the difference between the expense recognized for financial reporting and the Bancorp’s actual tax deduction for the stock-based awards be recognized through income tax expense in the interim periods in which they occur. Prior to the adoption of ASU 2016-09, the tax consequences for the difference between the expense recognized for financial reporting and the actual tax deduction for stock-based awards was recognized either through additional paid-in-capital when the Bancorp accumulated “excess tax benefits” from stock based

awards or through income tax expense when the Bancorp depleted its accumulated “excess tax benefits” from stock-based awards.

The Bancorp cannot predict its stock price or whether and when its employees will exercise stock-based awards in the future. As of December 31, 2016, the Bancorp does not believe it will be necessary to recognize a material impact to tax expense over the next twelve months related to the settlement of stock-based awards. However, the amount of income tax expense or benefit recognized upon settlement may vary significantly from expectations based on the Bancorp’s stock price and the number of SARs exercised by employees.

 

 

The Bancorp’s income before income taxes, applicable income tax expense and effective tax rate are as follows:

 

TABLE 18: APPLICABLE INCOME TAXES                                           

 

 
For the years ended December 31 ($ in millions)      2016      2015        2014        2013        2012      

 

 

Income before income taxes

     $         2,065        2,365          2,028          2,598          2,210      

Applicable income tax expense

       505        659          545          772          636      

Effective tax rate

       24.4      27.8          26.9          29.7          28.8      

 

 

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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 30 of the Notes to 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. By employing an FTP methodology, the business segments are insulated from most benchmark interest rate volatility, enabling them to focus on serving customers through the origination of loans and acceptance of deposits. The FTP methodology assigns charge rates and credit rates to classes of assets and liabilities, respectively, based on the estimated amount and timing of cash flows for each transaction. Assigning the FTP rate based on matching the duration of cash flows allocates interest income and interest expense to each business segment so its resulting net interest income is insulated from future changes in benchmark interest rates. The Bancorp’s FTP methodology also allocates the contribution to net interest income of the asset-generating and deposit-providing businesses on a duration-adjusted basis to better attribute the driver of the performance. As the asset and liability durations are not perfectly matched, the residual impact of the FTP methodology is captured in General Corporate and Other. The charge and credit rates are determined using the FTP rate curve, which is based on an estimate of Fifth Third’s marginal borrowing cost in the wholesale funding markets. The FTP curve is constructed using the U.S. swap curve, brokered CD pricing and unsecured debt pricing.

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 behavioural assumptions, such as prepayment rates on interest-earning assets and the estimated durations for indeterminate-lived deposits. Key assumptions, including the credit rates provided for deposit accounts, are reviewed annually. Credit rates for deposit products and charge rates for loan products may be reset more frequently in response to changes in market conditions. 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 business segments 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 business segments during 2016.

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 years ended December 31, 2015 and 2014 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 years ended December 31, 2015 and 2014 were adjusted to reflect changes in internal expense allocation methodologies.

 

The following table summarizes net income (loss) by business segment:

 

TABLE 19: NET INCOME (LOSS) BY BUSINESS SEGMENT                           

 

 
For the years ended December 31 ($ in millions)      2016          2015         2014       

 

 

Income Statement Data

              

Commercial Banking

     $ 995           718           884       

Branch Banking

       431           297           350       

Consumer Lending

       20           111           (69)      

Wealth and Asset Management

       93           58           58       

General Corporate and Other

       21           522           260       

 

 

Net income

       1,560           1,706           1,483       

Less: Net income attributable to noncontrolling interests

       (4)          (6)          2       

 

 

Net income attributable to Bancorp

       1,564           1,712           1,481       

Dividends on preferred stock

       75           75           67       

 

 

Net income available to common shareholders

     $         1,489           1,637           1,414       

 

 

 

50  Fifth Third Bancorp


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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 20: COMMERCIAL BANKING                           

 

 
For the years ended December 31 ($ in millions)      2016         2015         2014        

 

 

Income Statement Data

              

Net interest income (FTE)(a)

     $ 1,839          1,646          1,648      

Provision for loan and lease losses

       76          298          141      

Noninterest income:

              

Corporate banking revenue

       430          378          429      

Service charges on deposits

       292          284          280      

Other noninterest income

       185          191          171      

Noninterest expense:

              

Personnel costs

       296          303          304      

Other noninterest expense

       1,130          1,066          977      

 

 

Income before income taxes (FTE)

       1,244          832          1,106      

Applicable income tax expense(a)(b)

       249          114          222      

 

 

Net income

     $ 995          718          884      

 

 

Average Balance Sheet Data

              

Commercial loans and leases, including held for sale

     $       54,597          53,010          50,718      

Demand deposits

       20,735          20,677          18,381      

Interest checking deposits

       8,582          9,069          7,995      

Savings and money market deposits

       6,686          6,652          5,792      

Other time deposits and certificates $100,000 and over

       1,046          1,230          1,399      

Foreign office deposits

       496          813          1,817      

 

 
(a)

Includes FTE adjustments of $25 for the year ended December 31, 2016 and $21 for both the years ended December 31, 2015 and 2014.

(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.

 

Comparison of the year ended 2016 with 2015

Net income was $995 million for the year ended December 31, 2016 compared to net income of $718 million for the year ended December 31, 2015. The increase in net income was driven by increases in net interest income and noninterest income and a decrease in the provision for loan and lease losses partially offset by an increase in noninterest expense.

Net interest income on an FTE basis increased $193 million from the year ended December 31, 2015 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 17 bps for the year ended December 31, 2016 compared to the prior year. These increases in net interest income for the year ended December 31, 2016 were partially offset by an increase in FTP charge rates on loans and leases.

Provision for loan and lease losses decreased $222 million from the year ended December 31, 2015. The decrease was primarily due to a decrease in criticized commercial loans during the year ended December 31, 2016 as well as 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. Net charge-offs as a percent of average portfolio loans and leases decreased to 33 bps for the year ended December 31, 2016 compared to 45 bps for the year ended December 31, 2015.

Noninterest income increased $54 million from the year ended December 31, 2015 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 letter of credit fees and foreign exchange fees.

Noninterest expense increased $57 million from the year ended December 31, 2015 primarily as a result of an increase in other noninterest expense. The increase in other noninterest expense was primarily driven by increases in corporate overhead allocations, impairment on affordable housing investments and operating lease expense partially offset by a decrease in loan and lease expense.

Average commercial loans increased $1.6 billion from the year ended December 31, 2015 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 $657 million from the year ended December 31, 2015 primarily as a result of an increase in new origination activity resulting from an increase in demand and line utilization in the first half of the year. Average commercial construction loans increased $926 million from the year ended December 31, 2015 primarily as a result of increased demand and draw levels continuing to outpace attrition. Average commercial leases increased $121 million from the year ended December 31, 2015 primarily as a result of an increase in syndication and participation origination activity. Average commercial mortgage loans decreased $117 million from the year ended December 31, 2015 primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns.

Average core deposits decreased $717 million from the year ended December 31, 2015. The decrease was primarily driven by decreases in average interest checking deposits and average foreign deposits which decreased $487 million and $317 million, respectively, from the year ended December 31, 2015.

 

 

51  Fifth Third Bancorp


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Comparison of the year ended 2015 with 2014

Net income was $718 million for the year ended December 31, 2015 compared to net income of $884 million for the year ended December 31, 2014. The decrease in net income was the result of increases in the provision for loan and leases losses and noninterest expense coupled with a decrease in noninterest income.

Net interest income decreased $2 million from the year ended December 31, 2014 primarily driven by a decline in yields of 19 bps on average commercial loans and leases and increases in FTP charges on loans and leases driven by an increase in average balances. These decreases for the year ended December 31, 2015 were partially offset by increases in FTP credits on core deposits driven by increases in average balances.

Provision for loan and lease losses increased $157 million from the year ended December 31, 2014 primarily due to an increase in criticized commercial loans. The increase also included 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. The year ended December 31, 2014 included net charge-offs related to certain impaired commercial and industrial loans in the first and third quarters of 2014. Net charge-offs as a percent of average portfolio loans and leases decreased to 45 bps for the year ended December 31, 2015 compared to 46 bps for the year ended December 31, 2014.

Noninterest income decreased $27 million from the year ended December 31, 2014 due primarily to a decrease in corporate banking revenue partially offset by an increase in other noninterest income. Corporate banking revenue decreased $51 million from the year ended December 31, 2015 primarily driven by decreases in syndication fees and lease remarketing fees. The decrease in syndication fees was the result of decreased activity in the market and the Bancorp’s reduced leveraged loan appetite. The decrease in lease remarketing fees included the impact of impairment charges of $36 million related to certain operating lease equipment that was recognized during the year ended December 31, 2015. Refer to Note 8 of the Notes to Consolidated Financial Statements for additional information. The decrease in corporate banking revenue for the year ended December 31, 2015 was partially offset by higher institutional sales revenue. Other noninterest income

increased $20 million from the year ended December 31, 2015 primarily driven by increases in gains on loan sales.

Noninterest expense increased $88 million from the year ended December 31, 2014 driven by an increase in other noninterest expense. The increase in other noninterest expense was primarily driven by increases in corporate overhead allocations, operating lease expense and impairment on affordable housing investments.

Average commercial loans increased $2.3 billion from the year ended December 31, 2014 primarily due to increases in average commercial and industrial loans and average commercial construction loans partially offset by a decrease in average commercial mortgage loans. Average commercial and industrial loans and average commercial construction loans increased $1.4 billion and $1.2 billion, respectively, from the year ended December 31, 2014 primarily as a result of an increase in new loan origination activity resulting from an increase in demand and targeted marketing efforts. Average commercial mortgage loans decreased $552 million from the year ended December 31, 2014 primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns.

Average core deposits increased $3.2 billion from the year ended December 31, 2014. The increase was the result of growth in average demand deposits, average interest checking deposits and average savings and money market deposits which increased $2.3 billion, $1.1 billion and $860 million, respectively, from the year ended December 31, 2014. The increase was partially offset by a decrease in average foreign deposits of $1.0 billion from the year ended December 31, 2014.

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.

 

 

52  Fifth Third Bancorp


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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

 

TABLE 21: BRANCH BANKING                     

 

 
For the years ended December 31 ($ in millions)    2016      2015       2014      

 

 

Income Statement Data

        

Net interest income

   $ 1,669        1,555        1,573      

Provision for loan and lease losses

     138        151        171      

Noninterest income:

        

Service charges on deposits

     265        277        278      

Card and processing revenue

     253        236        227      

Wealth and asset management revenue

     140        157        152      

Other noninterest income

     97        (18      69      

Noninterest expense:

        

Personnel costs

     520        524        539      

Net occupancy and equipment expense

     234        248        246      

Card and processing expense

     128        145        133      

Other noninterest expense

     739        681        669      

 

 

Income before income taxes

     665        458        541      

Applicable income tax expense

     234        161        191      

 

 

Net income

   $ 431        297        350      

 

 

Average Balance Sheet Data

        

Consumer loans, including held for sale

   $        13,572        14,374        14,978      

Commercial loans, including held for sale

     1,870        2,021        2,175      

Demand deposits

     13,332        12,715        11,781      

Interest checking deposits

     9,659        9,128        9,071      

Savings and money market deposits

     25,974        25,342        24,065      

Other time deposits and certificates $100,000 and over

     5,205        5,161        4,690      

 

 

 

Comparison of the year ended 2016 with 2015

Net income was $431 million for the year ended December 31, 2016 compared to net income of $297 million for the year ended December 31, 2015. 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 $114 million from the year ended December 31, 2015 primarily driven by an increase in the benefits from FTP credits 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 was negatively impacted by an increase in FTP charge rates on loans and leases.

Provision for loan and lease losses decreased $13 million from the year ended December 31, 2015 primarily due to improved credit trends. Net charge-offs as a percent of average portfolio loans and leases decreased to 91 bps for the year ended December 31, 2016 compared to 96 bps for the year ended December 31, 2015.

Noninterest income increased $103 million from the year ended December 31, 2015. The increase for the year ended December 31, 2016 was driven by an increase in other noninterest income of $115 million primarily due to impairment charges on bank premises and equipment of $32 million recognized during the year ended December 31, 2016 compared to $109 million recognized during the year ended December 31, 2015. Additionally, the increase in other noninterest income for the year ended December 31, 2016 included a gain of $19 million on the sale of certain retail branch operations in the St. Louis and Pittsburgh MSAs in the first and second quarters of 2016, respectively, 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 increased $23 million from the year ended December 31, 2015 primarily driven by an increase in other noninterest expense partially offset by decreases in card and processing expense and net occupancy and equipment expense.

Other noninterest expense increased $58 million from the year ended December 31, 2015 primarily driven by an increase in corporate overhead allocations. Card and processing expense decreased $17 million from the year ended December 31, 2015 primarily due to the impact of renegotiated service contracts. Net occupancy and equipment expense decreased $14 million from the year ended December 31, 2015 primarily due to a decrease in rent expense driven by a reduction in the number of full-service banking centers and ATM locations.

Average consumer loans decreased $802 million from the year ended December 31, 2015 primarily driven by a decrease in average home equity loans and average residential mortgage loans of $488 million and $262 million, respectively, as payoffs exceeded new loan production. Average commercial loans decreased $151 million from the year ended December 31, 2015 primarily due to a decrease in average commercial mortgage loans and average commercial and industrial loans of $100 million and $46 million, respectively, as payoffs exceeded new loan production.

Average core deposits increased $1.7 billion from the year ended December 31, 2015 primarily driven by growth in average savings and money market deposits of $632 million, growth in average demand deposits of $617 million and growth in average interest checking deposits of $531 million. The growth in average savings and money market deposits, average demand deposits and average interest checking deposits was driven by an increase in average balances per customer account and acquisition of new customers.

Comparison of the year ended 2015 with 2014

Net income was $297 million for the year ended December 31, 2015 compared to net income of $350 million for the year ended December 31, 2014. The decrease was driven by decreases in noninterest income and net interest income as well as an increase in noninterest expense partially offset by a decrease in the provision for loan and lease losses.

 

 

53  Fifth Third Bancorp


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Net interest income decreased $18 million from the year ended December 31, 2014 primarily driven by changes made to the Bancorp’s deposit advance product beginning January 1, 2015 and a decline in interest income on home equity loans and residential mortgage loans driven by decreases in average balances partially offset by a decrease in FTP charges due to the decrease in these average balances. The decline in net interest income was partially offset by a decrease in interest expense on core deposits due to a decline in the rates paid and by increases in the benefits from FTP credits for demand deposits, other time deposits and interest checking deposits.

Provision for loan and lease losses decreased $20 million from the year ended December 31, 2014 primarily due to improved credit trends. Net charge-offs as a percent of average portfolio loans and leases decreased to 96 bps for the year ended December 31, 2015 compared to 106 bps for the year ended December 31, 2014.

Noninterest income decreased $74 million from the year ended December 31, 2014. The decrease was primarily driven by decreases in other noninterest income partially offset by increases in card and processing revenue and wealth and asset management revenue. Other noninterest income decreased $87 million from the year ended December 31, 2014 primarily driven by impairment charges on bank premises and equipment of $109 million for the year ended December 31, 2015 compared to $20 million for the year ended December 31, 2014. Card and processing revenue increased $9 million from the year ended December 31, 2014 primarily due to an increase in the number of actively used cards and an increase in customer spend volume. Wealth and asset management revenue increased $5 million from the year ended December 31, 2014 primarily due to an increase of $3 million in recurring securities brokerage fees driven by higher sales volume and an increase of $2 million in private client service fees due to an increase in personal asset management fees.

Noninterest expense increased $11 million from the year ended December 31, 2014 primarily driven by increases in other noninterest expense and card and processing expense partially offset by a decrease in personnel costs. Other noninterest expense increased $12 million from the year ended December 31, 2014 due

to higher operational losses and an increase in corporate overhead allocations. Card and processing expense increased $12 million from the year ended December 31, 2014 driven by increased fraud prevention related expenses. Personnel costs decreased $15 million from the year ended December 31, 2014 driven by a decrease in employee benefits expense due to changes in the Bancorp’s employee benefit plan implemented in 2015 as well as a decrease in base compensation due to a decline in the number of full-time equivalent employees.

Average consumer loans decreased $604 million from the year ended December 31, 2014 primarily due to a decrease in average home equity loans and average residential mortgage loans of $336 million and $261 million, respectively, as payoffs exceeded new loan production. Average commercial loans decreased $154 million from the year ended December 31, 2014 primarily due to a decrease in average commercial mortgage loans and average commercial and industrial loans of $97 million and $63 million, respectively, as payoffs exceeded new loan production.

Average core deposits increased $2.6 billion from the year ended December 31, 2014 primarily driven by growth in average savings and money market deposits of $1.3 billion and growth in average demand deposits of $934 million. The growth in average savings and money market deposits was driven by a promotional product offering and the growth in average demand deposits was driven by an increase in average account balances.

Consumer Lending

Consumer Lending includes the Bancorp’s residential mortgage, home equity, automobile and other indirect lending activities. Direct 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 22: CONSUMER LENDING                     

 

 
For the years ended December 31 ($ in millions)    2016       2015       2014        

 

 

Income Statement Data

        

Net interest income

   $             248        249        258       

Provision for loan and lease losses

     44        44        156       

Noninterest income:

        

Mortgage banking net revenue

     277        341        305       

Other noninterest income

     26        66        45       

Noninterest expense:

        

Personnel costs

     195        185        181       

Other noninterest expense

     280        255        377       

 

 

Income (loss) before income taxes

     32        172        (106)      

Applicable income tax expense (benefit)

     12        61        (37)      

 

 

Net income (loss)

   $ 20        111        (69)      

 

 

Average Balance Sheet Data

        

Residential mortgage loans, including held for sale

   $ 10,530        9,251        8,866      

Home equity

     356        424        496      

Automobile loans

     10,172        11,341        11,517      

Other consumer loans and leases, including held for sale

     -        11        19      

 

 

 

Comparison of the year ended 2016 with 2015

Net income was $20 million for the year ended December 31, 2016 compared to net income of $111 million for the year ended December 31, 2015. The decrease was driven by a decrease in noninterest income and an increase in noninterest expense.

        Net interest income decreased $1 million from the year ended December 31, 2015 primarily driven by an increase in FTP charges on loans and leases partially offset by an increase in FTP credit rates on demand deposits. Net interest income was also impacted by an increase in average residential mortgage loan balances partially offset by a decline in average automobile loan balances.

 

 

54  Fifth Third Bancorp


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The provision for loan and lease losses was flat from the year ended December 31, 2015. Net charge-offs as a percent of average portfolio loans and leases was 22 bps for both the years ended December 31, 2016 and 2015.

Noninterest income decreased $104 million from the year ended December 31, 2015 driven by decreases in mortgage banking net revenue and other noninterest income. Mortgage banking net revenue decreased $64 million from the year ended December 31, 2015 primarily driven by a $79 million decrease in net mortgage servicing revenue partially offset by a $15 million increase in mortgage origination fees and gains on loan sales. Refer to the Noninterest Income subsection of the Statements of Income Analysis section of MD&A for additional information on the fluctuations in mortgage banking net revenue. Other noninterest income decreased $40 million from the year ended December 31, 2015 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 $35 million from the year ended December 31, 2015 driven by increases in other noninterest expense and personnel costs. Other noninterest expense increased $25 million from the year ended December 31, 2015 primarily driven by increases in operational losses and corporate overhead allocations. Personnel costs increased $10 million from the year ended December 31, 2015 primarily driven by increases in base compensation and variable compensation.

Average consumer loans and leases increased $31 million from the year ended December 31, 2015. Average residential mortgage loans, including held for sale, increased $1.3 billion from the year ended December 31, 2015 primarily driven by the continued retention of certain agency conforming ARMs and certain other fixed-rate loans. Average automobile loans decreased $1.2 billion from the year ended December 31, 2015 as payoffs exceeded new loan production.

Comparison of the year ended 2015 with 2014

Net income was $111 million for the year ended December 31, 2015 compared to a net loss of $69 million for the year ended December 31, 2014. The increase was driven by decreases in noninterest expense and the provision for loan and lease losses as well as an increase in noninterest income partially offset by a decrease in net interest income.

Net interest income decreased $9 million from the year ended December 31, 2014 primarily driven by lower yields on average residential mortgage loans and average automobile loans and a decline in average home equity loans partially offset by decreases in FTP charge rates on loans and leases.

The provision for loan and lease losses decreased $112 million from the year ended December 31, 2014 as the prior year included an $87 million charge-off related to the transfer of

certain residential mortgage loans from the portfolio to held for sale in the fourth quarter of 2014. The decrease was also due to improved delinquency metrics on residential mortgage loans and home equity loans. Net charge-offs as a percent of average portfolio loans and leases decreased to 22 bps for the year ended December 31, 2015 compared to 77 bps for the year ended December 31, 2014.

Noninterest income increased $57 million from the year ended December 31, 2014 as a result of increases in mortgage banking net revenue and other noninterest income. Mortgage banking net revenue increased $36 million from the year ended December 31, 2014 driven by a $16 million increase in mortgage origination fees and gains on loan sales and a $20 million increase in net mortgage servicing revenue. Other noninterest income increased $21 million from the year ended December 31, 2014 primarily driven by a $37 million gain on the sale of residential mortgage loans held for sale classified as TDRs in the first quarter of 2015. This increase was partially offset by a decrease in retail service fees.

Noninterest expense decreased $118 million from the year ended December 31, 2014 driven by a decrease in other noninterest expense of $122 million. The decrease in other noninterest expense was primarily due to decreased legal expenses and operational losses partially offset by an increase in corporate overhead allocations.

Average consumer loans and leases increased $129 million from the year ended December 31, 2014. Average residential mortgage loans increased $385 million from the year ended December 31, 2014 primarily due to the continued retention of certain agency conforming ARMs and certain other fixed-rate loans. Average automobile loans and average home equity loans decreased $176 million and $72 million, respectively, from the year ended December 31, 2014 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.

 

 

55  Fifth Third Bancorp


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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

 

TABLE 23: WEALTH AND ASSET MANAGEMENT                     

 

 
For the years ended December 31 ($ in millions)    2016       2015       2014        

 

 

Income Statement Data

        

Net interest income

   $ 168        128        121        

Provision for loan and lease losses

     1        3        1        

Noninterest income:

        

Wealth and asset management revenue

     391        406        397        

Other noninterest income

     8        12        13        

Noninterest expense:

        

Personnel costs

     168        170        162        

Other noninterest expense

     254        285        281        

 

 

Income before income taxes

     144        88        87        

Applicable income tax expense

     51        30        29        

 

 

Net income

   $ 93        58        58        

 

 

Average Balance Sheet Data

        

Loans and leases, including held for sale

   $         3,135                2,805                2,270        

Core deposits

     8,554        9,357        9,535        

 

 

 

Comparison of the year ended 2016 with 2015

Net income was $93 million for the year ended December 31, 2016 compared to net income of $58 million for the year ended December 31, 2015. The increase in net income was primarily driven by an increase in net interest income as well as a decrease in noninterest expense partially offset by a decrease in noninterest income.

Net interest income increased $40 million from the year ended December 31, 2015 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 on average residential mortgage loans and average other consumer loans and leases as well as higher yields on average commercial and industrial loans and average other consumer loans and leases. This increase was partially offset by an increase in FTP charges on loans and leases driven by an increase in average balances.

Provision for loan and leases losses decreased $2 million from the year ended December 31, 2015.

Noninterest income decreased $19 million from the year ended December 31, 2015 primarily due to a $15 million decrease in wealth and asset management revenue driven by a $15 million decrease in securities and brokerage fees as a result of lower transactional fees partially offset by an increase in managed account fee-based business.

Noninterest expense decreased $33 million from the year ended December 31, 2015 primarily driven by a $31 million decrease in other noninterest expense primarily due to a decrease in corporate overhead allocations partially offset by an increase in operational losses.

Average loans and leases increased $330 million from the year ended December 31, 2015 primarily due to increases in average residential mortgage loans and average other consumer loans driven by increases in new loan origination activity.

Average core deposits decreased $803 million from the year ended December 31, 2015 primarily due to a decline in average interest checking balances partially offset by an increase in average savings and money market deposits.

Comparison of the year ended 2015 with 2014

Net income was $58 million for both the years ended December 31, 2015 and 2014.

Net interest income increased $7 million from the year ended December 31, 2014 primarily due to increases in interest income on loans and leases and FTP credits on demand deposits both due to increases in average balances as well as an increase in FTP credits on

interest checking deposits due to an increase in FTP credit rates. These increases were partially offset by increases in FTP charges on loans and leases driven by increases in average balances.

Provision for loan and leases losses increased $2 million from the year ended December 31, 2015.

Noninterest income increased $8 million from the year ended December 31, 2014 primarily due to a $9 million increase in wealth and asset management revenue driven by increases in recurring securities brokerage fees and private client service fees.

Noninterest expense increased $12 million from the year ended December 31, 2014 primarily due to an increase in personnel costs due to higher incentive compensation and base compensation.

Average loans and leases increased $535 million from the year ended December 31, 2014 primarily driven by increases in average residential mortgage loans and average other consumer loans as a result of increases in new loan origination activity partially offset by a decrease in average home equity loans as payoffs exceeded new loan production.

Average core deposits decreased $178 million from the year ended December 31, 2014 primarily due to a decrease in average interest checking balances partially offset by increases in average savings and money market deposits and average demand 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.

Comparison of the year ended 2016 with 2015

Net interest income decreased $260 million from the year ended December 31, 2015 primarily driven by an increase in FTP credits on deposits allocated to business segments primarily due to an increase in FTP credit rates as well as an increase in interest expense on long-term debt. This decrease in net interest income was 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 leases losses was $84 million for the year ended December 31, 2016 compared to a benefit of $100 million for the year ended December 31, 2015 primarily due to decreases in the allocation of provision expense to the business segments.

 

 

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Noninterest income decreased $359 million from December 31, 2015. The decrease included the impact of a gain of $331 million on the sale of Vantiv, Inc. shares and a gain of $89 million on both the sale and exercise of a portion of the warrant associated with Vantiv Holding, LLC, both of which were recognized in the fourth quarter of 2015. In 2016, the Bancorp recognized a gain of $9 million on the exercise of the remaining warrant with Vantiv Holding, LLC. The decrease was also due to the negative valuation adjustment related to the Visa total return swap of $56 million for the year ended December 31, 2016 compared with $37 million for the prior year. In addition, the positive valuation adjustments on the stock warrant associated with Vantiv Holding, LLC were $64 million for the year ended December 31, 2016 compared to the positive valuation adjustments of $236 million during the year ended December 31, 2015. The decrease in noninterest income was partially offset by 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 compared with a $49 million gain recognized by the Bancorp in 2015 for the payment from Vantiv, Inc. to terminate a portion of the Vantiv, Inc. TRA. Noninterest income for the year ended December 31, 2016 also included a gain of $11 million on the sale-leaseback of an office complex during the third quarter of 2016 and a gain of $33 million associated with the annual TRA payment during the fourth quarter of 2016 compared to a $31 million gain during the prior year. Additionally, equity method earnings from the Bancorp’s interest in Vantiv Holding, LLC increased $3 million from December 31, 2015.

Noninterest expense was $90 million and $62 million for the years ended December 31, 2016 and 2015, respectively. The increase 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.

Comparison of the year ended 2015 with 2014

Net interest income decreased $24 million from the year ended December 31, 2014 primarily due to increases in FTP credits on deposits allocated to business segments driven by increases in average deposits. The remaining decrease in net interest income was due to an increase in interest expense on long-term debt and a

decrease in the benefit related to the FTP charges on loans and leases partially offset by an increase in interest income on taxable securities. The provision for loan and leases losses was a benefit of $100 million for the year ended December 31, 2015 compared to a benefit of $154 million for the year ended December 31, 2014 due to decreases in the allocation of provision expense to the business segments and reductions in the ALLL.

Noninterest income was $822 million for the year ended December 31, 2015 compared to $253 million for the year ended December 31, 2014. The increase in noninterest income included the impact of a gain of $331 million on the sale of Vantiv, Inc. shares in the fourth quarter of 2015 compared to a gain of $125 million in 2014. The positive valuation adjustments on the stock warrant associated with Vantiv Holding, LLC were $236 million and $31 million for the years ended December 31, 2015 and 2014, respectively. During the fourth quarter of 2015, the Bancorp recognized a gain of $89 million on both the sale and exercise of a portion of the warrant associated with Vantiv Holding, LLC. Additionally, the Bancorp recognized a gain of $49 million from the payment from Vantiv, Inc. to terminate a portion of a TRA and also recognized a gain of $31 million associated with the annual TRA payment during the fourth quarter of 2015. The Bancorp recognized a gain of $23 million associated with the TRA during the fourth quarter of 2014. Equity method earnings from the Bancorp’s interest in Vantiv Holding, LLC increased $15 million from the year ended December 31, 2014. Noninterest income also included $37 million in negative valuation adjustments related to the Visa total return swap for the year ended December 31, 2015 compared to $38 million for the year ended December 31, 2014.

Noninterest expense for the year ended December 31, 2015 was an expense of $62 million compared to a benefit of $14 million for the year ended December 31, 2014. The increase was primarily due to an increase in personnel costs and an increase in the provision for the reserve for unfunded commitments as well as increases in FDIC insurance and other taxes, donations expense, technology and communications expense and marketing expense. The increase was partially offset by decreased litigation and regulatory activity and increased corporate overhead allocations from General Corporate and Other to the other business segments.

 

 

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FOURTH QUARTER REVIEW

 

The Bancorp’s 2016 fourth quarter net income available to common shareholders was $372 million, or $0.49 per diluted share, compared to net income available to common shareholders of $501 million, or $0.65 per diluted share, for the third quarter of 2016 and net income available to common shareholders of $634 million, or $0.79 per diluted share, for the fourth quarter of 2015.

Net interest income on an FTE basis was $909 million during the fourth quarter of 2016 and decreased $4 million from the third quarter of 2016 and increased $5 million from the fourth quarter of 2015. The decrease from the third quarter of 2016 was primarily driven by the impact of refunds to be offered to certain bankcard customers during the fourth quarter of 2016, partially offset by increased short-term market rates and higher investment securities balances. The increase in net interest income in comparison to the fourth quarter of 2015 was driven by higher investment securities balances and increased short-term market rates, partially offset by the aforementioned bankcard refunds.

Fourth quarter 2016 noninterest income of $620 million decreased $220 million compared to the third quarter of 2016 and decreased $484 million compared to the fourth quarter of 2015. The decrease from the third quarter of 2016 was primarily due to a decrease in other noninterest income and corporate banking revenue. The year-over-year decrease was primarily the result of decreases in other noninterest income and mortgage banking net revenue.

Service charges on deposits of $141 million decreased $2 million from the previous quarter and decreased $3 million compared to the fourth quarter of 2015. The decrease from the third quarter of 2016 was primarily due to a decreases in commercial service charges and retail service charges. The decrease from the fourth quarter of 2015 was driven by a decrease in retail service charges due to lower consumer checking fees.

Corporate banking revenue of $101 million decreased $10 million compared to the previous quarter and decreased $3 million from the fourth quarter of 2015. The decrease compared to the third quarter was driven by decreases in institutional sales revenue and lease remarketing fees, partially offset by an increase in foreign exchange fees. The year-over-year decrease was driven by lower lease remarketing fees and letter of credit fees, partially offset by higher foreign exchange fees and institutional sales revenue.

        Mortgage banking net revenue was $65 million in the fourth quarter of 2016 compared to $66 million in the third quarter of 2016 and $74 million in the fourth quarter of 2015. The decrease in mortgage banking net revenue compared to the third quarter of 2016 was driven by lower production gains, partially offset by positive valuation adjustments. The decrease from the prior year was due to lower margins during the fourth quarter of 2016. Fourth quarter 2016 originations were $2.7 billion, compared with $2.9 billion in the previous quarter and $1.8 billion in the fourth quarter of 2015. Fourth quarter 2016 originations resulted in gains of $30 million on mortgages sold, compared with gains of $61 million during the previous quarter and $37 million during the fourth quarter of 2015. Gross mortgage servicing fees were $48 million in the fourth quarter of 2016, $49 million in the third quarter of 2016 and $53 million in the fourth quarter of 2015. Mortgage banking net revenue is also affected by net servicing asset valuation adjustments, which include MSR amortization and MSR valuation adjustments, including mark-to-market adjustments on free-standing derivatives used to economically hedge the MSR portfolio. MSR amortization was $35 million during both the fourth and third quarters of 2016, compared to $29 million during the fourth quarter of 2015. Net servicing asset valuation adjustments were positive $23 million and negative $9 million in the fourth and third quarters of 2016, respectively, and positive $13 million in the fourth quarter of 2015.

Wealth and asset management revenue of $100 million decreased $1 million from the previous quarter and decreased $2 million from the fourth quarter of 2015. The decline from the third quarter of 2016 was due to a decrease in private client service fees. The year-over-year decrease was due to a decrease in securities and brokerage fees.

Card and processing revenue of $79 million was flat compared to the third quarter of 2016 and increased $2 million compared to the fourth quarter of 2015. The increase from the prior year was driven by an increase in the number of actively used cards and an increase in customer spend volume.

Other noninterest income of $137 million decreased $199 million compared to the third quarter of 2016 and decreased $465 million from the fourth quarter of 2015. Fourth quarter of 2016 results included a gain of $9 million on the exercise of the remaining warrant in Vantiv Holding, LLC and a $33 million gain pursuant to Fifth Third’s TRA with Vantiv, Inc. Third quarter of 2016 results included a $280 million gain from the termination and settlement of certain gross cash flows from the existing Vantiv, Inc. TRA and the expected obligation to terminate and settle certain remaining Vantiv, Inc. TRA cash flows upon the exercise of put or call options and a gain of $11 million on the sale-leaseback of an office complex, partially offset by $28 million in losses on disposition and impairment of bank premises and equipment and the recognition of $9 million of OTTI on certain private equity investments. Fourth quarter 2015 results included a $331 million gain on the sale of Vantiv, Inc. shares, an $89 million gain on both the sale and exercise of a portion of the warrant associated with Vantiv, Holding, LLC, a $49 million gain from a payment received from Vantiv, Inc. to terminate a portion of the TRA and a $31 million gain pursuant to Fifth Third’s TRA with Vantiv, Inc. Fourth quarter of 2015 also included a positive warrant valuation adjustment of $21 million compared to a negative warrant valuation adjustment of $2 million during the third quarter of 2016. Quarterly results also included valuation adjustments on the Visa total return swap which was a benefit of $6 million in the fourth quarter of 2016 and a charge of $12 million and $10 million in the third quarter of 2016 and the fourth quarter of 2015, respectively.

The net losses on investment securities were $3 million in the fourth quarter of 2016 compared to net gains of $4 million in the third quarter of 2016 and $1 million in the fourth quarter of 2015.

Noninterest expense of $960 million decreased $13 million from the previous quarter and decreased $3 million from the fourth quarter of 2015. The decrease in noninterest expense compared to the third quarter of 2016 was driven by lower technology and communications expense and seasonally lower marketing expense. The decrease in noninterest expense from the fourth quarter of 2015 was primarily due to lower card and processing expense due to the impact of renegotiated service contracts and lower net occupancy expense due to a decrease in rent expense driven by a reduction in the number of full-service banking centers and ATM locations, partially offset by higher personnel costs.

        The ALLL as a percentage of portfolio loans and leases was 1.36% as of December 31, 2016, compared to 1.37% as of both September 30, 2016 and December 31, 2015. The provision for loan and lease losses was $54 million in the fourth quarter of 2016 compared to $80 million in the third quarter of 2016 and $91 million in the fourth quarter of 2015. Net charge-offs were $73 million in the fourth quarter of 2016, or 31 bps of average portfolio loans and leases on an annualized basis, compared with net charge-offs of $107 million in the third quarter of 2016 and $80 million in the fourth quarter of 2015.

 

 

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TABLE 24: QUARTERLY INFORMATION (unaudited)  

 

 
     2016      2015  
  

 

 

    

 

 

 
For the three months ended ($ in millions, except per share data)              12/31      9/30(b)      6/30(b)      3/31(b)                12/31      9/30      6/30      3/31  

 

 

Net interest income(a)(b)

     $        909         913         908         909         904         906         892         852   

Provision for loan and lease losses

     54         80         91         119         91         156         79         69   

Noninterest income

     620         840         599         637         1,104         713         556         630   

Noninterest expense

     960         973         983         986         963         943         947         923   

Net income attributable to Bancorp

     395         516         328         326         657         381         315         361   

Net income available to common shareholders

     372         501         305         311         634         366         292         346   

Earnings per share, basic

     0.49         0.66         0.40         0.40         0.80         0.46         0.36         0.42   

Earnings per share, diluted

     0.49         0.65         0.39         0.40         0.79         0.45         0.36         0.42   

 

 
(a)

Amounts presented on an FTE basis. The FTE adjustment was $6 and $5 for each period presented during the years ended December 31, 2016 and 2015, respectively.

(b)

Net tax deficiencies of $1 million, $5 million and $0 were reclassified from capital surplus to applicable income tax expense at March 31, 2016June 30, 2016 and September 30, 2016, respectively, related to the early adoption of ASU 2016-09 during the fourth quarter of 2016, with an effective date of January 1, 2016.

 

COMPARISON OF THE YEAR ENDED 2015 WITH 2014

The Bancorp’s net income available to common shareholders for the year ended December 31, 2015 was $1.6 billion, or $2.01 per diluted share, which was net of $75 million in preferred stock dividends. The Bancorp’s net income available to common shareholders for the year ended December 31, 2014 was $1.4 billion, or $1.66 per diluted share, which was net of $67 million in preferred stock dividends. The provision for loan and lease losses increased to $396 million during the year ended December 31, 2015 compared to $315 million during the year ended December 31, 2014 as the result of the restructuring of a student loan backed commercial credit originated in 2007, a broadening global economic slowdown, stress on capital markets and the prolonged softness in commodity prices. Net charge-offs as a percent of average portfolio loans and leases decreased to 0.48% during 2014 compared to 0.64% during the year ended December 31, 2014.

Net interest income on an FTE basis (non-GAAP) was $3.6 billion for both of the years ended December 31, 2015 and 2014. For the year ended December 31, 2015, net interest income was negatively impacted by a decrease in the net interest rate spread, changes made to the Bancorp’s deposit advance product beginning January 1, 2015 and an increase in average long-term debt of $1.8 billion compared to the year ended December 31, 2014. These negative impacts were partially offset by increases in average taxable securities and average loans and leases of $5.2 billion and $2.2 billion, respectively for the year ended December 31, 2015 compared to the year ended December 31, 2014.

Noninterest income increased $530 million during the year ended December 31, 2015 compared to the year ended December 31, 2014 primarily due to increases in other noninterest income and mortgage banking net revenue, partially offset by a decrease in corporate banking revenue. Other noninterest income increased $529 million compared to the year ended December 31, 2014. The increase included the impact of a gain of $331 million on the sale of Vantiv, Inc. shares in the fourth quarter of 2015, compared to a gain of $125 million during the second quarter of 2014. Other noninterest income also increased for the year ended December 31, 2015 compared to 2014 due to positive valuation adjustments on the stock warrant associated with Vantiv Holding, LLC of $236 million during 2015 compared to positive valuation adjustments of $31 million during 2014. During the fourth quarter

of 2015, the Bancorp recognized a gain of $89 million on both the sale and exercise of a portion of the warrant associated with Vantiv Holding, LLC. Additionally, the Bancorp recognized a gain of $49 million from the payment from Vantiv, Inc. to terminate a portion of the TRA and also recognized a gain of $31 million associated with the annual TRA payment during the fourth quarter of 2015. The Bancorp recognized a gain of $23 million associated with the TRA during the fourth quarter of 2014. Mortgage banking net revenue increased $38 million for the year ended December 31, 2015 compared to 2014 primarily due to increases in net mortgage servicing revenue and origination fees and gains on loan sales. Corporate banking revenue decreased $46 million compared to the year ended December 31, 2014 primarily driven by decreases in syndication fees and lease remarketing fees.

Noninterest expense increased $66 million during the year ended December 31, 2015 compared to 2014 primarily due to increases in total personnel costs, technology and communications expense and card and processing expense partially offset by a decrease in other noninterest expense. Personnel costs increased $65 million for the year ended December 31, 2015 compared to the year ended December 31, 2014 driven by higher executive retirement and severance costs as well as an increase in base compensation and an increase in incentive compensation, primarily in the mortgage business. Technology and communications expense increased $12 million for the year ended December 31, 2015 compared to the year ended December 31, 2014 driven primarily by increased investment in information technology associated with regulatory and compliance initiatives, system maintenance, and other growth initiatives. Card and processing expense increased $12 million for the year ended December 31, 2015 compared to the year ended December 31, 2014 driven primarily by increased fraud prevention related expenses. Other noninterest expense decreased $34 million for the year ended December 31, 2015 compared to the year ended December 31, 2014 primarily due to a decrease in losses and adjustments partially offset by increases in the provision for the reserve for unfunded commitments, marketing expense, donations expense, impairment on affordable housing investments, FDIC insurance and other taxes and operating lease expense.

 

 

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BALANCE SHEET ANALYSIS

 

Loans and Leases

The Bancorp classifies its commercial loans and leases based upon their primary purpose and consumer loans and leases based upon

product or collateral. Table 25 summarizes end of period loans and leases, including loans held for sale and Table 26 summarizes average total loans and leases, including loans held for sale.

 

 

TABLE 25: COMPONENTS OF TOTAL LOANS AND LEASES (INCLUDING LOANS HELD FOR SALE)  

 

 
As of December 31 ($ in millions)    2016          2015          2014          2013          2012          

 

 

Commercial loans and leases:

              

Commercial and industrial loans

   $         41,736        42,151        40,801        39,347        36,077      

Commercial mortgage loans

     6,904        6,991        7,410        8,069        9,116      

Commercial construction loans

     3,903        3,214        2,071        1,041        707      

Commercial leases

     3,974        3,854        3,721        3,626        3,549      

 

 

Total commercial loans and leases

     56,517        56,210        54,003        52,083        49,449      

 

 

Consumer loans and leases:

              

Residential mortgage loans

     15,737        14,424        13,582        13,570        14,873      

Home equity

     7,695        8,336        8,886        9,246        10,018      

Automobile loans

     9,983        11,497        12,037        11,984        11,972      

Credit card

     2,237        2,360        2,401        2,294        2,097      

Other consumer loans and leases

     680        658        436        381        312      

 

 

Total consumer loans and leases

     36,332        37,275        37,342        37,475        39,272      

 

 

Total loans and leases

   $ 92,849        93,485        91,345        89,558        88,721      

 

 

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

   $ 92,098        92,582        90,084        88,614        85,782      

 

 

 

Loans and leases, including loans held for sale, decreased $636 million, or 1%, from December 31, 2015. The decrease from December 31, 2015 was the result of a $943 million, or 3%, decrease in consumer loans and leases, partially offset by a $307 million, or 1%, increase in commercial loans and leases.

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 $1.5 billion, or 13%, from December 31, 2015 and home equity decreased $641 million, or 8%, from December 31, 2015 as payoffs exceeded new loan production. Credit card decreased $123 million, or 5%, from December 31, 2015 primarily due to the sale of the agent bankcard loan portfolio during the second quarter of 2016 and a decrease in the average balance per active customer. Residential mortgage loans increased $1.3 billion, or 9%, from December 31, 2015 primarily due to the continued retention of certain agency conforming ARMs and certain other fixed-rate loans originated during the year ended December 31, 2016.

Commercial loans and leases increased from December 31, 2015 primarily due to increases in commercial construction loans and commercial leases, partially offset by decreases in commercial and industrial loans and commercial mortgage loans. Commercial construction loans increased $689 million, or 21%, from December 31, 2015 primarily as a result of increased demand and draw levels continuing to outpace attrition. Commercial leases increased $120 million, or 3%, from December 31, 2015 primarily as a result of an increase in syndication and participation origination activity. Commercial and industrial loans decreased $415 million, or 1%, from December 31, 2015 primarily as a result of a decline in new origination activity due to increased competition and an increase in attrition from deliberate credit exits in the second half of the year. Commercial mortgage loans decreased $87 million, or 1%, from December 31, 2015 primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns.

 

 

TABLE 26: COMPONENTS OF TOTAL AVERAGE LOANS AND LEASES (INCLUDING LOANS HELD FOR SALE)  

 

 
For the years ended December 31 ($ in millions)    2016          2015        2014        2013        2012        

 

 

Commercial loans and leases:

              

Commercial and industrial loans

   $         43,184        42,594        41,178        37,770        32,911      

Commercial mortgage loans

     6,899        7,121        7,745        8,481        9,686      

Commercial construction loans

     3,648        2,717        1,492        793        835      

Commercial leases

     3,916        3,796        3,585        3,565        3,502      

 

 

Total average commercial loans and leases

     57,647        56,228        54,000        50,609        46,934      

 

 

Consumer loans and leases:

              

Residential mortgage loans

     15,101        13,798        13,344        14,428        13,370      

Home equity

     7,998        8,592        9,059        9,554        10,369      

Automobile loans

     10,708        11,847        12,068        12,021        11,849      

Credit card

     2,205        2,303        2,271        2,121        1,960      

Other consumer loans and leases

     661        571        385        360        340      

 

 

Total average consumer loans and leases

     36,673        37,111        37,127        38,484        37,888      

 

 

Total average loans and leases

   $ 94,320        93,339        91,127        89,093        84,822      

 

 

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

   $ 93,426        92,423        90,485        86,950        82,733      

 

 

 

Average loans and leases, including loans held for sale, increased $981 million, or 1%, from December 31, 2015 as a result of a $1.4

billion, or 3%, increase in average commercial loans and leases, partially offset by a $438 million, or 1%, decrease in average consumer loans and leases.

 

 

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Average commercial loans and leases increased from December 31, 2015 primarily due to increases in average commercial construction loans, average commercial and industrial loans and average commercial leases, partially offset by a decrease in average commercial mortgage loans. Average commercial construction loans increased $931 million, or 34%, from December 31, 2015 primarily as a result of increased demand and draw levels continuing to outpace attrition. Average commercial and industrial loans increased $590 million, or 1%, from December 31, 2015 primarily as a result of an increase in new origination activity resulting from an increase in demand and line utilization in the first half of the year. Average commercial leases increased $120 million, or 3%, from December 31, 2015 primarily as a result of an increase in syndication and participation origination activity. Average commercial mortgage loans decreased $222 million, or 3%, from December 31, 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 December 31, 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 $1.1 billion, or 10%, from December 31, 2015 and average home equity decreased $594 million, or 7%, from December 31, 2015 as payoffs exceeded new loan production. Average credit card decreased $98 million, or 4%, primarily due to the sale of the agent bankcard loan portfolio during the second quarter of 2016 and a decrease in average balance per active customer. Average residential mortgage loans increased $1.3 billion, or 9%, from December 31, 2015 primarily driven by the continued retention of certain agency 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 $31.6 billion and $29.5 billion at December 31, 2016 and December 31, 2015, respectively. The taxable investment securities portfolio had an effective duration of 4.9 years at December 31, 2016 compared to 5.1 years at December 31, 2015.

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. Securities are classified as trading when bought and held principally for the purpose of selling them in the near term. At December 31, 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 December 31, 2016 and 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. Refer to Note 1 of the Notes to Consolidated Financial Statements for the Bancorp’s methodology for both classifying investment securities and management’s evaluation of securities in an unrealized loss position for OTTI.

 

 

The following table provides a summary of OTTI by security type for the years ended December 31:

 

TABLE 27: COMPONENTS OF OTTI BY SECURITY TYPE  

 

 
($ in millions)    2016        2015        2014        

 

 

Available-for-sale and other debt securities

   $             (15)                    (5)                    (24)      

Available-for-sale equity securities

     (1)        -        -      

 

 

Total OTTI(a)

   $ (16)        (5)        (24)      

 

 
(a)

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

 

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

 

TABLE 28: COMPONENTS OF INVESTMENT SECURITIES                                   

 

 
As of December 31 ($ in millions)    2016      2015      2014      2013      2012    

 

 

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

              

U.S. Treasury and federal agencies securities

   $ 547        1,155        1,545        1,549        1,771    

Obligations of states and political subdivisions securities

     44        50        185        187        203    

Mortgage-backed securities:

              

Agency residential mortgage-backed securities(a)

     15,525        14,811        11,968        12,294        8,403    

Agency commercial mortgage-backed securities

     9,029        7,795        4,465        -        -    

Non-agency commercial mortgage-backed securities

     3,076        2,801        1,489        1,368        1,089    

Asset-backed securities and other debt securities

     2,106        1,363        1,324        2,146        2,072    

Equity securities(b)

     697        703        701        865        1,033    

 

 

Total available-for-sale and other securities

   $        31,024        28,678        21,677        18,409        14,571    

 

 

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

              

Obligations of states and political subdivisions securities

   $ 24        68        186        207        282    

Asset-backed securities and other debt securities

     2        2        1        1        2    

 

 

Total held-to-maturity securities

   $ 26        70        187        208        284    

 

 

Trading securities (fair value):

              

U.S. Treasury and federal agencies securities

   $ 23        19        14        5        7    

Obligations of states and political subdivisions securities

     39        9        8        13        17    

Agency residential mortgage-backed securities

     8        6        9        3        7    

Asset-backed securities and other debt securities

     15        19        13        7        15    

Equity securities

     325        333        316        315        161    

 

 

Total trading securities

   $ 410        386        360        343        207    

 

 
(a)

Includes interest-only mortgage-backed securities recorded at fair value with fair value changes recorded in securities gains, net in the Consolidated Statements of Income.

(b)

Equity securities consist of FHLB, FRB and DTCC restricted stock holdings that are carried at cost, FHLMC and FNMA preferred stock holdings and certain mutual fund holdings and equity security holdings.

 

On an amortized cost basis, available-for-sale and other securities increased $2.3 billion, or 8%, from December 31, 2015 primarily due to increases in agency residential and agency commercial mortgage-backed securities and asset-backed securities and other debt 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 24% and 23% of total interest-earning assets at December 31, 2016 and December 31, 2015, respectively. The estimated weighted-average life of the debt securities in the available-for-sale and other securities portfolio was 6.7 years at December 31, 2016 compared to 6.4 years at December 31, 2015. In addition, at both December 31, 2016 and 2015 the available-for-sale and other securities portfolio had a weighted-average yield of 3.19%.

Information presented in Table 29 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 $159 million at December 31, 2016 compared to $366 million at December 31, 2015. The decrease from December 31, 2015 was primarily due to an increase in interest rates during the year ended December 31, 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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TABLE 29: CHARACTERISTICS OF AVAILABLE-FOR-SALE AND OTHER SECURITIES  

 

 
As of December 31, 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

   $ 75                  76              0.2                    4.39 %          

Average life 1 – 5 years

     177                  177              4.6                    1.82              

Average life 5 – 10 years

     295                  296              5.3                    2.11              

 

 

Total

   $ 547                  549              4.4                    2.33 %          

Obligations of states and political subdivisions securities:(a)

           

Average life of 1 year or less

     -                  -              0.4                    5.76              

Average life 1 – 5 years

     9                  9              1.4                    0.10              

Average life 5 – 10 years

     35                  36              6.3                    3.93              

 

 

Total

   $ 44                  45              5.2                    3.15 %          

Agency residential mortgage-backed securities:

           

Average life of 1 year or less

     45                  46              0.8                    3.93              

Average life 1 – 5 years

     4,485                  4,549              4.1                    3.10              

Average life 5 – 10 years

             10,282                  10,301              6.8                    3.36              

Average life greater than 10 years

     713                  712              11.5                    3.19              

 

 

Total

   $ 15,525                  15,608              6.2                    3.28 %          

Agency commercial mortgage-backed securities:

           

Average life of 1 year or less

     17                  17              0.7                    3.08              

Average life 1 – 5 years

     2,104                  2,089              3.5                    2.89              

Average life 5 – 10 years

     6,432                  6,482              7.5                    3.21              

Average life greater than 10 years

     476                  467              11.0                    2.97              

 

 

Total

   $ 9,029                  9,055              6.8                    3.12 %          

Non-agency commercial mortgage-backed securities:

           

Average life of 1 year or less

     121                  122              0.6                    2.27              

Average life 1 – 5 years

     239                  245              3.3                    3.35              

Average life 5 – 10 years

     2,716                  2,745              7.6                    3.26              

 

 

Total

   $ 3,076                  3,112              7.0                    3.23 %          

Asset-backed securities and other debt securities:

           

Average life of 1 year or less

     88                  89              0.5                    3.51              

Average life 1 – 5 years

     525                  529              2.8                    3.34              

Average life 5 – 10 years

     309                  311              8.1                    2.57              

Average life greater than 10 years

     1,184                  1,187              15.4                    2.70              

 

 

Total

   $ 2,106                  2,116              10.6                    2.87 %          

Equity securities

     697                  698              

 

 

Total available-for-sale and other securities

   $ 31,024                  31,183              6.7                    3.19 %          

 

 
(a)

Taxable-equivalent yield adjustments included in the above table are 0.00%, 0.01%, 2.14% and 1.68% for securities with an average life of 1 year or less, 1-5 years, 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 71% of the Bancorp’s average asset funding base for both of the years ended December 31, 2016 and 2015.

 

 

The following table presents the end of period components of deposits:

 

TABLE 30: COMPONENTS OF DEPOSITS  

 

 
As of December 31 ($ in millions)    2016          2015          2014          2013          2012      

 

 

Demand

   $           35,782        36,267        34,809        32,634        30,023  

Interest checking

     26,679        26,768        26,800        25,875        24,477  

Savings

     13,941        14,601        15,051        17,045        19,879  

Money market

     20,749        18,494        17,083        11,644        6,875  

Foreign office

     426        464        1,114        1,976        885  

 

 

Transaction deposits

     97,577        96,594        94,857        89,174        82,139  

Other time

     3,866        4,019        3,960        3,530        4,015  

 

 

Core deposits

     101,443        100,613        98,817        92,704        86,154  

Certificates $100,000 and over(a)

     2,378        2,592        2,895        6,571        3,284  

Other

     -        -        -        -        79  

 

 

Total deposits

   $ 103,821        103,205        101,712        99,275        89,517  

 

 
(a)

Includes $1,280, $1,449, $1,483, $1,479 and $1,402 of certificates $250,000 and over at December 31, 2016, 2015, 2014, 2013 and 2012, respectively.

 

Core deposits increased $830 million, or 1%, from December 31, 2015, driven by an increase of $983 million in transaction deposits.

Transaction deposits increased from December 31, 2015 primarily due to an increase in money market deposits, partially offset by decreases in savings deposits and demand deposits.

 

 

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Money market deposits increased $2.3 billion, or 12%, from December 31, 2015 primarily due to competitive pricing related to a promotional product offering during 2016 which drove customer acquisition and balance migration from savings deposits from December 31, 2015. Savings deposits decreased $660 million, or 5%, from December 31, 2015. Demand deposits decreased $485 million, or 1%, from December 31, 2015 primarily due to lower balances per customer account. Interest checking deposits included a decrease due to lower balances per account for commercial customers, partially offset by the benefit from a shift from the excess cash in trust accounts managed by Fifth Third to interest checking deposit accounts as a result of the recent enactment of

new money market reform. The increase in core deposits from December 31, 2015 included the impact of the sale of $511 million of deposits as part of the branches sold in the St. Louis MSA and Pittsburgh MSA during 2016.

Certificates $100,000 and over decreased $214 million, or 8%, from December 31, 2015 primarily due to the maturity and run-off of retail and institutional certificates of deposit since December 31, 2015.

 

 

The following table presents the components of average deposits for the years ended December 31:

 

TABLE 31: COMPONENTS OF AVERAGE DEPOSITS                                   

 

 
($ in millions)    2016          2015          2014          2013            2012          

 

 

Demand

   $ 35,862        35,164        31,755        29,925            27,196      

Interest checking

     25,143        26,160        25,382        23,582            23,096      

Savings

     14,346        14,951        16,080        18,440            21,393      

Money market

     19,523        18,152        14,670        9,467            4,903      

Foreign office

     497        817        1,828        1,501            1,528      

 

 

Transaction deposits

     95,371        95,244        89,715        82,915            78,116      

Other time

     4,010        4,051        3,762        3,760            4,306      

 

 

Core deposits

     99,381        99,295        93,477        86,675            82,422      

Certificates $100,000 and over(a)

     2,735        2,869        3,929        6,339            3,102      

Other

     333        57        -        17            27      

 

 

Total average deposits

   $         102,449        102,221        97,406        93,031            85,551      

 

 
(a)

Includes $1,310, $1,410, $1,424, $1,283 and $1,678 of average certificates $250,000 and over during the years ended December 31, 2016, 2015, 2014, 2013 and 2012, respectively.

 

On an average basis, core deposits increased $86 million from December 31, 2015 primarily due to an increase of $127 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 increased $1.4 billion, or 8%, primarily due to competitive pricing related to a promotional product offering during 2016 which drove customer acquisition and balance migration from average savings deposits. Average savings deposits decreased $605 million, or 4%, compared to December 31, 2015. Average demand deposits increased $698 million, or 2%, from December 31, 2015 due to higher average customer balances per commercial customer account. Average

interest checking deposits and average foreign office deposits decreased $1.0 billion, or 4%, and $320 million, or 39%, respectively, from December 31, 2015 primarily due to a decrease in average commercial customer balances per account. The increase in average core deposits from December 31, 2015 included the sale of deposits as part of the St. Louis MSA and Pittsburgh MSA during 2016, which impacted average core deposits by approximately $200 million. Average other deposits increased $276 million from December 31, 2015 primarily due to an increase in Eurodollar trade deposits. Average certificates $100,000 and over decreased $134 million, or 5%, from December 31, 2015 due primarily to the maturity and run-off of retail and institutional certificates of deposit since December 31, 2015.

 

 

Contractual Maturities

The contractual maturities of certificates $100,000 and over as of December 31, 2016 are summarized in the following table:

 

TABLE 32: CONTRACTUAL MATURITIES OF CERTIFICATES $100,000 AND OVER       

 

 
($ in millions)       

 

 

Next 3 months

   $ 191      

3-6 months

     125      

6-12 months

     483      

After 12 months

     1,579      

 

 

Total certificates $100,000 and over

   $            2,378      

 

 

 

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The contractual maturities of other time deposits and certificates $100,000 and over as of December 31, 2016 are summarized in the following table:

 

TABLE 33: CONTRACTUAL MATURITIES OF OTHER TIME DEPOSITS AND CERTIFICATES $100,000 AND OVER              

 

 
($ in millions)              

 

 

Next 12 months

   $            2,173     

13-24 months

     1,601     

25-36 months

     1,181     

37-48 months

     999     

49-60 months

     275     

After 60 months

     15     

 

 

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

   $ 6,244     

 

 

 

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 34 summarizes

the end of period components of total borrowings. Total borrowings as a percentage of average interest-bearing liabilities were 21% at both December 31, 2016 and 2015.

 

 

The following table summarizes the end of period components of borrowings:

 

TABLE 34: COMPONENTS OF BORROWINGS                                      

 

 
As of December 31 ($ in millions)            2016          2015         2014         2013         2012        

 

 

Federal funds purchased

   $           132        151       144       284       901    

Other short-term borrowings

     3,535        1,507       1,556       1,380       6,280    

Long-term debt

     14,388        15,810  (a)      14,932  (a)      9,605  (a)      7,060  (a)   

 

 

Total borrowings

   $           18,055        17,468       16,632       11,269       14,241    

 

 
(a)

Upon adoption of ASU 2015-03 on January 1, 2016, the Consolidated Balance Sheets for the years ended December 31, 2015, 2014, 2013 and 2012 were adjusted to reflect the reclassification of $34, $36, $28 and $25, respectively, of debt issuance costs from other assets to long-term debt. For further information, refer to Note 1 of the Notes to Consolidated Financial Statements.

 

Total borrowings increased $587 million, or 3%, from December 31, 2015 primarily due to an increase in other short-term borrowings partially offset by a decrease in long-term debt. Other short-term borrowings increased $2.0 billion, from December 31, 2015 driven by an increase of $2.5 billion in FHLB short-term borrowings partially offset by a $264 million decrease in securities sold under repurchase agreements. 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 15 of the Notes to Consolidated Financial Statements. Long-term debt decreased

$1.4 billion, or 9%, from December 31, 2015 primarily driven by the maturity of $3.5 billion of unsecured senior bank notes, the maturity of $250 million of unsecured subordinated bank notes and $1.4 billion of pay downs on long-term debt associated with automobile loan securitizations. The decrease was partially offset by debt issuances during the year ended December 31, 2016 of $2.8 billion of unsecured senior fixed-rate bank notes, $750 million of unsecured subordinated fixed-rate bank notes, and $250 million of unsecured senior floating-rate bank notes. For additional information regarding automobile securitizations and long-term debt, refer to Note 11 and Note 16, respectively, of the Notes to Consolidated Financial Statements.

 

 

The following table summarizes the components of average borrowings:

 

TABLE 35: COMPONENTS OF AVERAGE BORROWINGS        

 

 
For the years ended December 31 ($ in millions)            2016          2015         2014         2013         2012        

 

 

Federal funds purchased

   $           506        920       458       503       560    

Other short-term borrowings

     2,845        1,721       1,873       3,024       4,246    

Long-term debt

     15,394                14,644  (a)              12,894  (a)              7,886  (a)              8,991  (a)   

 

 

Total average borrowings

   $           18,745        17,285       15,225       11,413       13,797    

 

 
(a)

Upon adoption of ASU 2015-03 on January 1, 2016, the Consolidated Balance Sheets for the years ended 2015, 2014, 2013 and 2012 were adjusted to reflect the reclassification of $33, $34, $28 and $52, respectively, of average debt issuance costs from average other assets to average long-term debt. For further information, refer to Note 1 of the Notes to Consolidated Financial Statements.

 

Total average borrowings increased $1.5 billion, or 8%, compared to December 31, 2015, due to increases in average long-term debt and average other short-term borrowings partially offset by a decrease in average federal funds purchased. The increase in average long-term debt of $750 million, or 5%, was driven primarily by the issuances of certain long-term debt as discussed above in the second and third quarter of 2016, partially offset by certain maturities, as previously mentioned, in the fourth quarter of 2016. The level of average federal funds purchased and average other short-term borrowings can fluctuate significantly from period to period depending on funding needs and which sources

are used to satisfy those needs. The increase in average other short-term borrowings, compared to December 31, 2015, of $1.1 billion was primarily due to an increase in FHLB short-term advances. Information on the average rates paid on borrowings is presented 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

 

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 expectations 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 limits and key risk indicator thresholds. Those limits and thresholds 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. Treasury is responsible for the economic capital program. Credit Risk Management is responsible for the quantitative analytics to support the consumer and commercial portfolio and risk rating models, ALLL methodology and analytics needed to assess credit risk and develop mitigation strategies related to that risk. Credit Risk Management 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 six 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 ALLL 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 Consolidated Financial Statements for further information on the Bancorp’s credit grade categories, which are derived from standard regulatory rating definitions. In addition, stress testing is performed on various commercial portfolios using the CCAR model and for certain portfolios, such as Real Estate and Leveraged Lending, the stress testing is performed at the individual loan level during credit underwriting.

 

 

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

 

TABLE 36: POTENTIAL PROBLEM PORTFOLIO LOANS AND LEASES         

 

 
As of December 31, 2016 ($ in millions)   

  Carrying

  Value

       Unpaid  
Principal  
Balance  
       Exposure           

 

 

Commercial and industrial loans

   $                1,108          1,110          1,807     

Commercial mortgage loans

     102          102          104     

Commercial leases

     22          22          22     

 

 

Total potential problem portfolio loans and leases

   $ 1,232          1,234          1,933     

 

 

 

TABLE 37: 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 allowance for credit loss 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 eleven 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.

 

 

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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.

Overview

Economic growth continues to improve as data has been broadly positive. There have been steady gains in the job market and real GDP is expected to expand at a moderate pace in 2017. Household spending continues to be the strongest driver of the U.S. economy. Inflation continues to run below the FRB’s stated objective, but has increased over the past several months and could rise further if unemployment continues to fall. Improving global conditions are supporting U.S. manufacturing activity and housing prices continue to increase across the country. 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 38: COMMERCIAL MORTGAGE LOANS OUTSTANDING BY LTV, LOANS GREATER THAN $1 MILLION         

 

 
As of December 31, 2016 ($ in millions)            LTV > 100%        LTV 80-100%        LTV < 80%         

 

 

Commercial mortgage owner-occupied loans

   $               106            178            1,953         

Commercial mortgage nonowner-occupied loans

     22            100            2,598         

 

 

Total

   $ 128            278            4,551         

 

 
TABLE 39: 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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The following table provides detail on commercial loan 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:

 

TABLE 40: COMMERCIAL LOAN AND LEASE PORTFOLIO (EXCLUDING LOANS HELD FOR SALE)

        

 

 
     2016      2015  
As of December 31 ($ in millions)        Outstanding      Exposure      Nonaccrual              Outstanding      Exposure      Nonaccrual         

 

 

By Industry:

                    

Manufacturing

     $      10,070             19,646        50          10,572           20,422        70       

Real estate

     7,206             11,919        26          6,494           10,293        40       

Financial services and insurance

     5,648             11,522        2          5,896           13,021        3       

Healthcare

     4,649             6,450        23          4,676           6,879        22       

Business services

     4,599             6,996        65          4,471           6,765        96       

Retail trade

     4,048             7,598        6          3,764           7,391        8       

Wholesale trade

     3,482             6,249        24          4,082           7,254        23       

Transportation and warehousing

     3,059             4,473        38          3,111           4,619        1       

Accommodation and food

     3,051             4,817        5          2,507           4,104        6       

Communication and information

     2,901             4,726        -          2,913           5,052        2       

Construction

     2,025             3,786        3          1,871           3,403        8       

Entertainment and recreation

     1,736             2,979        3          1,210           2,066        4       

Mining

     1,312             2,621        246          1,499           2,695        36       

Utilities

     1,168             2,799        -          1,217           2,854        -       

Other services

     729             945        24          864           1,188        10       

Public administration

     417             463        -          495           562        -       

Agribusiness

     284             426        2          368           527        4       

Individuals

     66             83        1          139           187        2       

Other