Form 10-K
Table of Contents

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2017 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

     35  

Recent Accounting Standards

     37  

Critical Accounting Policies

     37  

Statements of Income Analysis

     40  

Business Segment Review

     48  

Fourth Quarter Review

     56  

Balance Sheet Analysis

     58  

Risk Management - Overview

     64  

Credit Risk Management

     65  

Market Risk Management

     79  

Liquidity Risk Management

     83  

Operational Risk Management

     85  

Compliance Risk Management

     85  

Capital Management

     86  

Off-Balance Sheet Arrangements

     87  

Contractual Obligations and Other Commitments

     88  

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

     89  

Reports of Independent Registered Public Accounting Firm

     90  

Financial Statements

  

Consolidated Balance Sheets

     92  

Consolidated Statements of Income

     93  

Consolidated Statements of Comprehensive Income

     94  

Consolidated Statements of Changes in Equity

     95  

Consolidated Statements of Cash Flows

     96  

 

Notes to Consolidated Financial Statements

        

Summary of Significant Accounting and Reporting Policies

     97      Commitments, Contingent Liabilities and Guarantees      138  

Supplemental Cash Flow Information

     107      Legal and Regulatory Proceedings      142  

Restrictions on Cash, Dividends and Other Capital Actions

     107      Related Party Transactions      144  

Investment Securities

     109      Income Taxes      147  

Loans and Leases

     111      Retirement and Benefit Plans      149  

Credit Quality and the Allowance for Loan and Lease Losses

     113      Accumulated Other Comprehensive Income      153  

Bank Premises and Equipment

     121      Common, Preferred and Treasury Stock      155  

Operating Lease Equipment

     121      Stock-Based Compensation      156  

Goodwill

     122      Other Noninterest Income and Other Noninterest Expense      160  

Intangible Assets

     122      Earnings Per Share      161  

Variable Interest Entities

     123      Fair Value Measurements      162  

Sales of Receivables and Servicing Rights

     126      Regulatory Capital Requirements and Capital Ratios      173  

Derivative Financial Instruments

     128      Parent Company Financial Statements      174  

Other Assets

     133      Business Segments      176  

Short-Term Borrowings

     134      Subsequent Events      178  

Long-Term Debt

     135        

Annual Report on Form 10-K

     179        

Consolidated Ten Year Comparison

     206        

Directors and Officers

     207        

Corporate Information

        

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) deteriorating credit quality; (2) loan concentration by location or industry of borrowers or collateral; (3) problems encountered by other financial institutions; (4) inadequate sources of funding or liquidity; (5) unfavorable actions of rating agencies; (6) inability to maintain or grow deposits; (7) limitations on the ability to receive dividends from subsidiaries; (8) cyber-security risks; (9) Fifth Third’s ability to secure confidential information and deliver products and services through the use of computer systems and telecommunications networks; (10) failures by third-party service providers; (11) inability to manage strategic initiatives and/or organizational changes; (12) inability to implement technology system enhancements; (13) failure of internal controls and other risk management systems; (14) losses related to fraud, theft or violence; (15) inability to attract and retain skilled personnel; (16) adverse impacts of government regulation; (17) governmental or regulatory changes or other actions; (18) failures to meet applicable capital requirements; (19) regulatory objections to Fifth Third’s capital plan; (20) regulation of Fifth Third’s derivatives activities; (21) regulatory objections to Fifth Third’s resolution plan; (22) deposit insurance premiums; (23) assessments for the orderly liquidation fund; (24) changes in LIBOR; (25) weakness in the national or local economies; (26) global political and economic uncertainty or negative actions; (27) changes in interest rates; (28) changes and trends in capital markets; (29) fluctuation of Fifth Third’s stock price; (30) volatility in mortgage banking revenue; (31) litigation, investigations, and enforcement proceedings by governmental authorities; (32) breaches of contractual covenants, representations and warranties; (33) competition and changes in the financial services industry; (34) changing retail distribution strategies, customer preferences and behavior; (35) difficulties in identifying, acquiring or integrating suitable strategic partnerships, investments or acquisitions; (36) potential dilution from future acquisitions; (37) loss of income and/or difficulties encountered in the sale and separation of businesses, investments or other assets; (38) results of Vantiv Holding, LLC or other investments or acquired entities; (39) difficulties from or changes in Fifth Third’s investment in, relationship with, and nature of the operations of Vantiv Holding, LLC; (40) changes in accounting standards or interpretation or declines in the value of Fifth Third’s goodwill or other intangible assets; (41) inaccuracies or other failures from the use of models; (42) effects of critical accounting policies and judgments or the use of inaccurate estimates; (43) weather related events or other natural disasters; and (44) the impact of reputational risk created by these or other developments on such matters as business generation and retention, funding and liquidity.


Table of Contents

GLOSSARY OF ABBREVIATIONS AND ACRONYMS

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

APR: Annual Percentage Rate

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

CFPB: United States Consumer Financial Protection Bureau

C&I: Commercial and Industrial

CRA: Community Reinvestment Act

DCF: Discounted Cash Flow

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

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

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

FICA: Federal Insurance Contributions Act

FICO: Fair Isaac Corporation (credit rating)

FINRA: Financial Industry Regulatory Authority

FNMA: Federal National Mortgage Association

FRB: Federal Reserve Bank

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

 

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

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

PSA: Performance Share Award

RCC: Risk Compliance Committee

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

TCJA: Tax Cuts and Jobs Act

TDR: Troubled Debt Restructuring

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


Table of Contents

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)        2017                  2016                2015                2014                  2013               

Income Statement Data

                 

Net interest income (U.S. GAAP)

   $ 3,798         3,615        3,533        3,579        3,561    

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

     3,824         3,640        3,554        3,600        3,581    

Noninterest income

     3,224         2,696        3,003        2,473        3,227    

Total revenue(a)

     7,048         6,336        6,557        6,073        6,808    

Provision for loan and lease losses

     261         343        396        315        229    

Noninterest expense

     3,990         3,903        3,775        3,709        3,961    

Net income attributable to Bancorp

     2,194         1,564        1,712        1,481        1,836    

Net income available to common shareholders

     2,119               1,489        1,637        1,414        1,799          

Common Share Data

                 

Earnings per share - basic

   $ 2.88         1.95        2.03        1.68        2.05    

Earnings per share - diluted

     2.83         1.93        2.01        1.66        2.02    

Cash dividends declared per common share

     0.60         0.53        0.52        0.51        0.47    

Book value per share

     21.67         19.82        18.48        17.35        15.85    

Market value per share

     30.34               26.97        20.10        20.38        21.03          

Financial Ratios

                 

Return on average assets

     1.56       1.10        1.22        1.12        1.48    

Return on average common equity

     13.9         9.8        11.3        10.0        13.1    

Return on average tangible common equity(b)

     16.5         11.6        13.5        12.2        16.0    

Dividend payout ratio

     20.8         27.2        25.6        30.3        22.9    

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

     11.80         11.67        11.33        11.59        11.56    

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

     8.94         8.87        8.59        8.43        8.63    

Net interest margin(a)(b)

     3.03         2.88        2.88        3.10        3.32    

Net interest rate spread(a)(b)

     2.76         2.66        2.69        2.94        3.15    

Efficiency(a)(b)

     56.6               61.6        57.6        61.1        58.2          

Credit Quality

                 

Net losses charged-off

   $ 298         362        446        575        501    

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

     0.32       0.39        0.48        0.64        0.58    

ALLL as a percent of portfolio loans and leases

     1.30         1.36        1.37        1.47        1.79    

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

     1.48         1.54        1.52        1.62        1.97    

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

     0.53               0.80        0.70        0.82        1.10          

Average Balances

                 

Loans and leases, including held for sale

   $       92,731         94,320        93,339        91,127        89,093    

Total securities and other short-term investments

     33,562         31,965        30,245        24,866        18,861    

Total assets

     140,636         142,266        140,078        131,909        123,704    

Transaction deposits(d)

     96,052         95,371        95,244        89,715        82,915    

Core deposits(e)

     99,823         99,381        99,295        93,477        86,675    

Wholesale funding(f)

     20,360         21,813        20,210        19,154        17,769    

Bancorp shareholders’ equity

     16,590               16,597        15,865        15,290        14,302          
Regulatory Capital and Liquidity Ratios    Basel III Transitional(g)      Basel I(h)  

CET1 capital

     10.61       10.39        9.82        -        -    

Tier I risk-based capital

     11.74         11.50        10.93        10.83        10.43    

Total risk-based capital

     15.16         15.02        14.13        14.33        14.17    

Tier I leverage

     10.01         9.90        9.54        9.66        9.73    

Modified LCR

     129               128        -        -        -          
(a)

Amounts presented on an FTE basis. The FTE adjustment for the years ended December 31, 2017, 2016, 2015, 2014 and 2013 was $26, $25, $21, $21 and $20, 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 weighted values are added together resulting in the total risk-weighted assets. Under the banking agencies’ Final Rule published in November 2017 pertaining to certain regulatory capital items for banks subject to the standardized approach, the Bancorp is no longer subject to certain transition provisions and phase-outs beyond 2017.

(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.

 

31  Fifth Third Bancorp


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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, net interest rate spread 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, 2017, net interest income on an FTE basis and noninterest income provided 54% and 46% of total revenue, respectively. The Bancorp derives the majority of its revenues within the U.S. from customers domiciled in the U.S. Revenue from foreign countries and external customers domiciled in foreign countries was immaterial to the 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, other short-term borrowings and long-term debt. Net interest income is affected by the general level of interest rates, the relative level of short-term and long-term interest rates, changes in interest rates and changes in the amount and composition of interest-earning assets and interest-bearing liabilities. Generally, the rates of interest the Bancorp earns on its assets and pays on its liabilities are established for a period of time. The change in market interest rates over time exposes the Bancorp to interest rate risk through potential adverse changes to net interest income and financial position. The Bancorp manages this risk by continually analyzing and adjusting the composition of its assets and liabilities based on their payment streams and interest rates, the timing of their maturities and their sensitivity to changes in market interest rates. Additionally, in the ordinary course of business, the Bancorp enters into certain derivative transactions as part of its overall strategy to manage its interest rate and prepayment risks. The Bancorp is also exposed to the risk of loss on its loan and lease portfolio as a result of changing expected cash flows caused by borrower credit events, such as loan defaults and inadequate collateral.

Noninterest income is derived from service charges on deposits, wealth and asset management revenue, corporate banking revenue, card and processing revenue, mortgage banking net revenue, net securities gains 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.

The Tax Cuts and Jobs Act

On December 22, 2017, the U.S. government enacted comprehensive tax legislation known as the TCJA. The TCJA makes broad and complex changes to the U.S. tax code including, but not limited to, reducing the top federal statutory corporate tax rate from 35 percent to 21 percent effective for tax years beginning after December 31, 2017. U.S. GAAP requires the Bancorp to recognize the tax effects of changes in tax laws and rates on its deferred taxes in the period in which the law is enacted. As a result, for the year ended December 31, 2017, the Bancorp remeasured its deferred tax assets and liabilities and recognized an income tax benefit of approximately $220 million. Additionally, as a result of the TCJA, the Bancorp recognized a $27 million decrease to interest income related to the tax treatment of leveraged leases and recognized $68 million of impairment on certain affordable housing investments in other noninterest expense. As a result of the TCJA, during the fourth quarter of 2017 the Bancorp decided to make a $15 million contribution to the Fifth Third Foundation recognized within other noninterest expense and also paid $15 million in one-time employee bonuses.

Vantiv, Inc. and Vantiv Holding, LLC Transactions

During the third quarter of 2017, the Bancorp and Fifth Third Bank entered into a transaction agreement with Vantiv, Inc. and Vantiv Holding, LLC under which Fifth Third Bank agreed to exercise its right to exchange 19.79 million of its Class B Units in Vantiv Holding, LLC for 19.79 million shares of Vantiv, Inc.’s Class A Common Stock and Vantiv, Inc. agreed to repurchase the newly issued shares of Class A Common Stock upon issue directly from Fifth Third Bank at a price of $64.04 per share, the closing share price of the Class A Common Stock on the New York Stock Exchange on August 4, 2017. As a result of these transactions, the Bancorp recognized a gain of approximately $1.0 billion during the third quarter of 2017.

As of December 31, 2017, the Bancorp continued to hold approximately 15 million Class B Units of Vantiv Holding, LLC which may be exchanged for Class A Common Stock of Vantiv, Inc. (now Worldpay, Inc.), on a one-for-one basis or at Worldpay, Inc.’s option for cash which represented approximately 8.6% ownership of Vantiv Holding, LLC as of December 31, 2017. In addition, the Bancorp holds approximately 15 million Class B Common Shares of Worldpay, Inc., which give the Bancorp voting rights, but no economic interest in Worldpay, Inc. These securities are subject to certain terms and restrictions.

On January 16, 2018, Vantiv, Inc. completed its previously announced acquisition of Worldpay Group plc. with the resulting combined company named Worldpay, Inc. As a result of this transaction, the Bancorp expects to recognize a gain of approximately $415 million in other noninterest income in the Bancorp’s first quarter of 2018 Quarterly Report on Form 10-Q for the dilution in its ownership interest in Vantiv Holding, LLC from approximately 8.6% to approximately 4.9%. The Bancorp’s remaining interest in Vantiv Holding, LLC continues to be accounted for as an equity method investment given the nature of Vantiv Holding, LLC’s structure as a limited liability company and contractual arrangements between Vantiv Holding, LLC and the Bancorp. For more information on Worldpay, Inc., formerly Vantiv, Inc., and Vantiv Holding, LLC transactions, refer to Note 19 and Note 31 of the Notes to Consolidated Financial Statements.

 

 

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

 

NorthStar Strategy

In the third quarter of 2016, the Bancorp launched the NorthStar Strategy, a three-year plan designed to help deliver strong, consistent returns through longer term economic cycles. Underpinning the strategy is the Bancorp’s goal of striving to be the One Bank people most value and trust.

The Bancorp is focused on:

 

Building a differentiated brand and corporate reputation by improving the customer experience and increasing brand equity.

 

Growing profitable and long-term relationships with customers.

 

Leveraging analytics and technology to help drive further efficiency improvements, revenue growth and improved profitability.

 

Generating an annualized return on average tangible common equity (non-GAAP) at the upper end of a range of 14% to 16%, a return on average assets at the mid to upper end of a range of 1.35% to 1.45% 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 fintech companies, 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, 2017 and 2016, the Bancorp entered into or settled a number of accelerated share repurchase transactions. As part of these transactions, the Bancorp entered into forward contracts in which the final number of shares delivered at settlement was based generally on a discount to the average daily volume weighted-average price of the Bancorp’s common stock during the term of the repurchase agreements. For more information on the accelerated share repurchase program, refer to Note 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, 2017 and 2016, refer to Table 2. For further information on a subsequent event related to an accelerated share repurchase transaction, refer to Note 31 of the Notes to Consolidated Financial Statements.

 

 

TABLE 2: SUMMARY OF ACCELERATED SHARE REPURCHASE TRANSACTIONS    

 

 

Repurchase Date   Amount ($ in millions)    

 

Shares Repurchased on 
Repurchase Date 

    Shares Received from
Forward Contract Settlement
    Total Shares  
Repurchased  
    Settlement Date      

 

 

December 14, 2015

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

March 4, 2016

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

August 5, 2016

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

December 20, 2016

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

May 1, 2017

    342       11,641,971       2,248,250       13,890,221       July 31, 2017  

August 17, 2017

    990       31,540,480       4,291,170       35,831,650       December 18, 2017  

December 19, 2017

    273       7,727,273       (a )      (a )      (a ) 

 

 
(a)

The settlement of the transaction is expected to occur on or before March 19, 2018.

 

Senior Notes Offerings

On June 15, 2017, the Bancorp issued and sold $700 million of senior notes to third-party investors. The senior notes bear a fixed-rate of interest of 2.60% per annum. The notes are unsecured, senior obligations of the Bancorp. Payment of the full principal amounts of the notes is due upon maturity on June 15, 2022. These fixed-rate senior notes will be redeemable by the Bancorp, 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 October 30, 2017, the Bank issued and sold, under its bank notes program, $1.1 billion in aggregate principal amount of unsecured senior bank notes due on October 30, 2020. The bank notes consisted of $750 million of 2.20% senior fixed-rate notes and $300 million of senior floating-rate notes at three-month LIBOR plus 25 bps. The Bancorp entered into an interest rate swap to convert the fixed-rate notes to a floating-rate, which resulted in an effective interest rate of three-month LIBOR plus 24 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. For additional information on these senior notes offerings, refer to Note 16 of the Notes to Consolidated Financial Statements.

Automobile Loan Securitization

In a securitization transaction that occurred in September of 2017, the Bancorp transferred an aggregate amount of $1.1 billion in consumer automobile loans to a bankruptcy remote trust which was deemed to be a VIE. This trust then subsequently issued approximately $1.0 billion of asset-backed notes, of which approximately $261 million were retained by the Bancorp, resulting in approximately $747 million of outstanding notes included in long-term debt in the Consolidated Balance Sheets as of December 31, 2017. Third-party holders of this debt do not have recourse to the general assets of the Bancorp. For additional information on this automobile loan securitization, refer to Note 11 and Note 16 of the Notes to Consolidated Financial Statements.

Legislative and Regulatory Developments

The FRB conducted a regularly scheduled examination covering 2014 through 2016 to determine the Bank’s compliance with the CRA. This CRA examination resulted in a change in rating from “Needs to Improve” to “Outstanding”. For further information, refer to the Regulation and Supervision subsection of Part I, Item 1 of the Annual Report on Form 10-K.

 

 

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TABLE 3: CONDENSED CONSOLIDATED STATEMENTS OF INCOME    

              

 

 
For the years ended December 31 ($ in millions, except per share data)      2017        2016          2015          2014           2013          

 

 

Interest income (FTE)(a)

   $ 4,515        4,218       4,049       4,051        3,993    

Interest expense

     691        578       495       451        412    

 

 

Net Interest Income (FTE)(a)

     3,824        3,640       3,554       3,600        3,581    

Provision for loan and lease losses

     261        343       396       315        229    

 

 

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

     3,563        3,297       3,158       3,285        3,352    

Noninterest income

     3,224        2,696       3,003       2,473        3,227    

Noninterest expense

     3,990        3,903       3,775       3,709        3,961    

 

 

Income Before Income Taxes (FTE)(a)

     2,797        2,090       2,386       2,049        2,618    

Fully taxable equivalent adjustment

     26        25       21       21        20    

Applicable income tax expense

     577        505       659       545        772    

 

 

Net Income

     2,194        1,560       1,706       1,483        1,826    

Less: Net income attributable to noncontrolling interests

     -        (4     (6     2        (10  

 

 

Net Income Attributable to Bancorp

     2,194        1,564       1,712       1,481        1,836    

Dividends on preferred stock

     75        75       75       67        37    

 

 

Net Income Available to Common Shareholders

   $         2,119        1,489       1,637       1,414        1,799    

 

 

Earnings per share - basic

   $ 2.88        1.95       2.03       1.68        2.05    

Earnings per share - diluted

   $ 2.83        1.93       2.01       1.66        2.02    

 

 

Cash dividends declared per common share

   $ 0.60        0.53       0.52       0.51        0.47    

 

 
(a)

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

 

Earnings Summary

The Bancorp’s net income available to common shareholders for the year ended December 31, 2017 was $2.1 billion, or $2.83 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, 2016 was $1.5 billion, or $1.93 per diluted share, which was net of $75 million in preferred stock dividends.

Net interest income on an FTE basis (non-GAAP) was $3.8 billion and $3.6 billion for the years ended December 31, 2017 and 2016, respectively. Net interest income was positively impacted by an increase in yields on average loans and leases, an increase in average taxable securities and a decrease in average long-term debt for the year ended December 31, 2017 compared to the year ended December 31, 2016. Additionally, net interest income was positively impacted by the decisions of the Federal Open Market Committee to raise the target range of the federal funds rate 25 bps in December 2016, March 2017, June 2017 and December 2017. These positive impacts were partially offset by a decrease in average loans and leases and increases in the rates paid on average other short-term borrowings, average long-term debt and average interest-bearing core deposits during the year ended December 31, 2017. Net interest margin on an FTE basis (non-GAAP) was 3.03% and 2.88% for the years ended December 31, 2017 and 2016, respectively.

Noninterest income increased $528 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to an increase in other noninterest income, partially offset by decreases in corporate banking revenue and mortgage banking net revenue. Other noninterest income increased $669 million from the year ended December 31, 2016 primarily due to the gain on sale of Vantiv, Inc. shares, an increase in private equity investment income and the impact of the net losses on disposition and impairment of bank premises and equipment during the year ended December 31, 2016. These benefits were partially offset by the impact of certain transactions that occurred during the year ended December 31, 2016 which included the impact of income from the TRA transactions associated with Vantiv, Inc., positive valuation adjustments and the gain on sale of the warrant associated with Vantiv Holding, LLC and gains on the sales of certain retail branch operations. The year ended December 31, 2017 also included an increase in the loss on the swap associated with the sale

of Visa, Inc. Class B Shares and a reduction in equity method income from the Bancorp’s interest in Vantiv Holding, LLC. Corporate banking revenue decreased $79 million from the year ended December 31, 2016 primarily due to decreases in lease remarketing fees, foreign exchange fees and letter of credit fees. Mortgage banking net revenue decreased $61 million from the year ended December 31 2016 primarily due to a decrease in origination fees and gains on loan sales.

Noninterest expense increased $87 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to increases in other noninterest expense and personnel costs. Other noninterest expense increased $46 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to increases in the impairment on affordable housing investments, professional service fees and marketing expense, partially offset by decreases in the provision for the reserve for unfunded commitments, losses and adjustments and loan and lease expense. Personnel costs increased $38 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 driven by increases in base compensation, medical and FICA expenses and long-term incentive compensation, partially offset by a decrease in severance costs related to the Bancorp’s voluntary early retirement program in 2016. The increase in personnel costs also included the impact of one-time employee bonuses that the Bancorp paid as a result of benefits received from the TCJA.

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 $261 million and $343 million for the years ended December 31, 2017 and 2016, respectively. Net losses charged-off as a percent of average portfolio loans and leases decreased to 0.32% during the year ended December 31, 2017 compared to 0.39% during the year ended December 31, 2016. At December 31, 2017, nonperforming portfolio assets as a percent of portfolio loans and leases and OREO decreased to 0.53% compared to 0.80% at December 31, 2016. For further discussion on credit quality, refer to the Credit Risk Management subsection of the Risk Management section of MD&A.

 

 

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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, 2017, as calculated under the Basel III standardized approach, the CET1 capital ratio was 10.61%, the Tier I

risk-based capital ratio was 11.74%, the Total risk-based capital ratio was 15.16% and the Tier I leverage ratio was 10.01%.

 

 

NON-GAAP FINANCIAL MEASURES

 

The following are non-GAAP measures which provide useful insight to the reader of the Consolidated Financial Statements but should be supplemental to primary U.S. GAAP measures and should not be read in isolation or relied upon as a substitute for the 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, interest income on an FTE basis, net interest margin, net interest rate spread and the efficiency ratio to U.S. GAAP:

 

TABLE 4: NON-GAAP FINANCIAL MEASURES - FINANCIAL MEASURES AND RATIOS ON AN FTE BASIS         

 

 
For the years ended December 31 ($ in millions)        2017        2016            2015          

 

 

Net interest income (U.S. GAAP)

   $ 3,798            3,615          3,533     

Add: FTE adjustment

     26            25          21     

 

 

Net interest income on an FTE basis (1)

   $ 3,824            3,640          3,554     

Interest income (U.S. GAAP)

   $ 4,489            4,193          4,028     

Add: FTE adjustment

     26            25          21     

 

 

Interest income on an FTE basis (2)

   $ 4,515            4,218          4,049     

Interest expense (3)

   $ 691            578          495     

Noninterest income (4)

     3,224            2,696          3,003     

Noninterest expense (5)

     3,990            3,903          3,775     

Average interest-earning assets (6)

             126,293            126,285          123,584     

Average interest-bearing liabilities (7)

     85,090            85,332          84,342     

Ratios:

               

Net interest margin on an FTE basis (1) / (6)

     3.03          2.88          2.88     

Net interest rate spread on an FTE basis (2) / (6) - (3) / (7)

     2.76            2.66          2.69     

Efficiency ratio on an FTE basis (5) / (1) + (4)

     56.6            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)          2017        2016           2015          

 

 

Income before income taxes (U.S. GAAP)

   $ 2,771            2,065          2,365     

Add: FTE adjustment

     26            25          21     

 

 

Income before income taxes on an FTE basis

   $               2,797            2,090          2,386     

 

 

 

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

 

 
For the years ended December 31 ($ in millions)    2017     2016              

 

 

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

   $ 2,119       1,489    

Add: Intangible amortization, net of tax

     1       1    

 

 

Tangible net income available to common shareholders (1)

   $ 2,120       1,490    

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

   $ 16,590       16,597    

Less:  Average preferred stock

     (1,331     (1,331  

  Average goodwill

     (2,425     (2,416  

  Average intangible assets and other servicing rights

     (18     (10  

 

 

Average tangible common equity (2)

   $           12,816       12,840    

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

     16.5   %      11.6    

 

 

 

The Bancorp considers various measures when evaluating capital utilization and adequacy, including the tangible equity ratio and tangible common equity ratio, 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. The Bancorp encourages readers to consider its Consolidated Financial Statements in their entirety and not to rely on any single financial measure.

 

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

 

TABLE 7:  NON-GAAP FINANCIAL MEASURES - CAPITAL RATIOS

      

 

As of December 31 ($ in millions)    2017     2016             

 

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

   $ 16,365       16,205    

Less:  Preferred stock

     (1,331     (1,331  

  Goodwill

     (2,445     (2,416  

  Intangible assets and other servicing rights

     (27     (10  

  AOCI

     (73     (59  

 

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

     12,489       12,389    

Add:  Preferred stock

     1,331       1,331    

 

Tangible equity (2)

   $ 13,820       13,720    

 

Total Assets (U.S. GAAP)

   $ 142,193       142,177    

Less:  Goodwill

     (2,445     (2,416  

   Intangible assets and other servicing rights

     (27     (10  

  AOCI, before tax

     (92     (91  

 

Tangible assets, excluding unrealized gains / losses (3)

   $             139,629       139,660    

 

Ratios:

      

Tangible equity as a percentage of tangible assets (2) / (3)

     9.90  %      9.82    

Tangible common equity as a percentage of tangible assets (1) / (3)

     8.94       8.87    

 

 

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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 applicable

to the Bancorp during 2017 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. Effective January 1, 2017, the Bancorp elected to adopt the fair value method of measuring all existing classes of its residential mortgage servicing rights as described below. Previously, the Bancorp had measured its servicing rights subsequent to initial recognition using the amortization method. There have been no other material changes to the valuation techniques or models described below during the year ended December 31, 2017.

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.

 

 

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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. 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. The Bancorp may also purchase servicing rights. Effective January 1, 2017, the Bancorp elected to prospectively adopt the fair value method for all existing classes of its residential mortgage servicing rights portfolio. Upon this election, all servicing rights in these classes are measured at fair value at each reporting date and changes in the fair value of servicing rights are reported in earnings in the period in which the changes occur. Servicing rights are valued using internal OAS models. Significant management judgement is necessary to identify key economic assumptions used in estimating the fair value 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. In order to assist in the assessment of the fair value of servicing rights, the Bancorp obtains external valuations of the servicing rights 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. Prior to the election of the fair value method, servicing rights were initially recorded at fair value and subsequently amortized in proportion to, and over the period of, estimated net servicing revenue. Servicing rights were 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. 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. The Bancorp employs various valuation approaches to measure fair value including the market, income and cost approaches. 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.

 

 

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TABLE 8: FAIR VALUE SUMMARY

           

 

 
As of ($ in millions)          December 31, 2017             December 31, 2016              

 

   

 

 

 
       Balance               Level 3               Balance                Level 3               

 

 

Assets carried at fair value

  $        34,287        1,003        32,872        156       

As a percent of total assets

       24            23        -       

Liabilities carried at fair value

  $        633        142        687        96       

As a percent of total liabilities

                 1        -       

 

 

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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Table of Contents

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 9 and 10 present the components of net interest income, net interest margin and net interest rate spread for the years ended December 31, 2017, 2016 and 2015, as well as the relative impact of changes in the balance sheet and changes in interest rates on net interest income. Nonaccrual loans and leases and loans and leases held for sale have been included in the average loan and lease balances. Average outstanding securities balances are based on amortized cost with any unrealized gains or losses on available-for-sale and other securities included in other assets.

Net interest income on an FTE basis (non-GAAP) was $3.8 billion and $3.6 billion for the years ended December 31, 2017 and 2016, respectively. Net interest income was positively impacted by an increase in yields on average loans and leases of 33 bps for the year ended December 31, 2017. Net interest income also benefited from an increase in average taxable securities of $2.1 billion and a decrease in average long-term debt of $1.6 billion for the year ended December 31, 2017 compared to the year ended December 31, 2016. Additionally, net interest income was positively impacted by the decisions of the Federal Open Market Committee to raise the target range of the federal funds rate 25 bps in December 2016, March 2017, June 2017 and December 2017. These positive impacts were partially offset by a decrease in average loans and leases and increases in the rates paid on average other short-term borrowings, average long-term debt and average interest-bearing core deposits for the year ended December 31, 2017 compared to the year ended December 31, 2016. Average loans and leases decreased $1.6 billion for the year ended December 31, 2017 compared to the year ended December 31, 2016. The rates paid on average other short-term borrowings, average long-term debt and average interest-bearing core deposits increased 60 bps, 39 bps and 11 bps, respectively, for the year ended December 31, 2017 compared to the year ended December 31, 2016.

Net interest rate spread was 2.76% during the year ended December 31, 2017 compared to 2.66% during the year ended December 31, 2016. Yields on average interest-earning assets increased 23 bps, partially offset by a 13 bps increase in rates paid on average interest-bearing liabilities for the year ended December 31, 2017 compared to the year ended December 31, 2016.

Net interest margin on an FTE basis (non-GAAP) was 3.03% for the year ended December 31, 2017 compared to 2.88% for the

year ended December 31, 2016. The increase for the year ended December 31, 2017 was driven primarily by the previously mentioned increase in the net interest rate spread, partially offset by a decrease in average free funding balances. The decrease in average free funding balances was driven by a decrease in average demand deposits of $769 million for the year ended December 31, 2017 compared to the year ended December 31, 2016.

Interest income on an FTE basis from loans and leases (non-GAAP) increased $246 million compared to the year ended December 31, 2016 driven by the previously mentioned increase in yields on average loans and leases, partially offset by a decrease in average loans and leases. Average loans and leases decreased primarily due to a decrease in average commercial and industrial loans and average automobile loans, partially offset by an increase in average residential mortgage loans. Interest income from credit cards included the impact of a $12 million benefit related to a revised estimate of refunds offered to certain bankcard customers in the first quarter of 2017 compared to a $16 million reduction in interest income for the expected refunds in the fourth quarter of 2016. In addition, the Bancorp’s interest income on commercial leases was reduced by $27 million during the fourth quarter of 2017 due to the remeasurement related to the tax treatment of leveraged leases resulting from the impact of the TCJA. 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 $51 million compared to the year ended December 31, 2016 primarily as a result of the aforementioned increases in average taxable securities.

Interest expense on core deposits increased $70 million for the year ended December 31, 2017 compared to the year ended December 31, 2016. The increase was primarily due to an increase in the cost of average interest-bearing core deposits to 37 bps for the year ended December 31, 2017 from 26 bps for the year ended December 31, 2016. The increase in the cost of average interest-bearing core deposits was primarily due to an increase in the cost of average interest checking deposits and average money market deposits. Refer to the Deposits subsection of the Balance Sheet Analysis section of MD&A for additional information on the Bancorp’s deposits.

Interest expense on average wholesale funding increased $43 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to the previously mentioned increase in the rates paid on average other short-term borrowings and average long-term debt, partially offset by the aforementioned decrease 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 24% and 26% of average interest-bearing liabilities during the years ended December 31, 2017 and 2016, 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.

 

 

40  Fifth Third Bancorp


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

 

TABLE 9: CONSOLIDATED AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME ON AN FTE BASIS

 

 

 
For the years ended December 31    2017     2016     2015  

 

   

 

 

   

 

 

 
($ in millions)    Average
Balance
     Revenue/
Cost
    

    Average    
    Yield/    

    Rate    

    Average
Balance
     Revenue/
Cost
    

    Average    
    Yield/    

    Rate    

    Average
Balance
     Revenue/
Cost
         Average    
    Yield/    
    Rate    
 

 

 

Assets:

                        

Interest-earning assets:

                        

Loans and leases:(a)

                        

Commercial and industrial loans

   $ 41,577        1,514        3.64   $ 43,184        1,413        3.27   $ 42,594        1,334        3.13%  

Commercial mortgage loans

     6,844        256        3.74       6,899        229        3.32       7,121        227        3.19      

Commercial construction loans

     4,374        179        4.09       3,648        125        3.42       2,717        86        3.17      

Commercial leases

     4,011        82        2.04       3,916        105        2.69       3,796        106        2.78      

 

 

Total commercial loans and leases

     56,806        2,031        3.58       57,647        1,872        3.25       56,228        1,753        3.12      

 

 

Residential mortgage loans

     16,053        566        3.53       15,101        535        3.54       13,798        509        3.69      

Home equity

     7,308        310        4.24       7,998        302        3.78       8,592        312        3.63      

Automobile loans

     9,407        275        2.92       10,708        290        2.71       11,847        315        2.66      

Credit card

     2,141        253        11.84       2,205        214        9.69       2,303        237        10.27      

Other consumer loans and leases

     1,016        68        6.68       661        44        6.56       571        45        8.00      

 

 

Total consumer loans and leases

     35,925        1,472        4.10       36,673        1,385        3.78       37,111        1,418        3.82      

 

 

Total loans and leases

   $ 92,731        3,503        3.78   $ 94,320        3,257        3.45   $ 93,339        3,171        3.40%  

Securities:

                        

Taxable

     32,106        993        3.09       30,019        950        3.16       26,932        867        3.22      

Exempt from income taxes(a)

     66        4        5.45       80        3        4.51       55        3        5.23      

Other short-term investments

     1,390        15        1.04       1,866        8        0.44       3,258        8        0.25      

 

 

Total interest-earning assets

   $ 126,293        4,515        3.57   $ 126,285        4,218        3.34   $ 123,584        4,049        3.28%  

Cash and due from banks

     2,224             2,303             2,608        

Other assets

     13,345             14,963             15,179        

Allowance for loan and lease losses

     (1,226)             (1,285)             (1,293)        

 

 

Total assets

   $  140,636           $ 142,266           $ 140,078        

 

 

Liabilities and Equity:

                        

Interest-bearing liabilities:

                        

Interest checking deposits

   $ 26,382        109        0.41   $ 25,143        58        0.23   $ 26,160        50        0.19%  

Savings deposits

     13,958        8        0.06       14,346        7        0.05       14,951        9        0.06      

Money market deposits

     20,231        74        0.37       19,523        53        0.27       18,152        44        0.24      

Foreign office deposits

     388        1        0.20       497        1        0.16       817        1        0.16      

Other time deposits

     3,771        46        1.23       4,010        49        1.24       4,051        49        1.20      

 

 

Total interest-bearing core deposits

     64,730        238        0.37       63,519        168        0.26       64,131        153        0.24      

Certificates $100,000 and over

     2,564        36        1.38       2,735        36        1.30       2,869        33        1.16      

Other deposits

     277        3        1.05       333        1        0.41       57        -        0.16      

Federal funds purchased

     557        6        1.01       506        2        0.39       920        1        0.13      

Other short-term borrowings

     3,158        30        0.96       2,845        10        0.36       1,721        2        0.12      

Long-term debt

     13,804        378        2.74       15,394        361        2.35       14,644        306        2.09      

 

 

Total interest-bearing liabilities

   $ 85,090        691        0.81   $ 85,332        578        0.68   $ 84,342        495        0.59%  

Demand deposits

     35,093             35,862             35,164        

Other liabilities

     3,839             4,445             4,672        

 

 

Total liabilities

   $ 124,022           $ 125,639           $ 124,178        

Total equity

   $ 16,614           $ 16,627           $ 15,900        

 

 

Total liabilities and equity

   $ 140,636           $   142,266           $   140,078        

 

 

Net interest income (FTE)(b)

      $   3,824           $   3,640           $ 3,554     

Net interest margin (FTE)(b)

           3.03           2.88           2.88%  

Net interest rate spread (FTE)(b)

           2.76             2.66             2.69      

Interest-bearing liabilities to interest-earning assets

 

        67.37             67.57             68.25      

 

 
(a)

The FTE adjustments included in the above table were $26, $25 and $21 for the years ended December 31, 2017, 2016 and 2015, respectively.

(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.

 

41  Fifth Third Bancorp


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

 

TABLE 10: CHANGES IN NET INTEREST INCOME ATTRIBUTABLE TO VOLUME AND YIELD/RATE(a)

 

 

 
For the years ended December 31    2017 Compared to 2016            2016 Compared to 2015  

 

    

 

 

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

 

 

Assets:

               

Interest-earning assets:

               

Loans and leases:

               

Commercial and industrial loans

   $ (54     155       101          19       60       79     

Commercial mortgage loans

     (2     29       27          (7     9       2     

Commercial construction loans

     27       27       54          32       7       39     

Commercial leases

     3       (26     (23        3       (4     (1)    

 

 

Total commercial loans and leases

     (26     185       159          47       72       119     

 

 

Residential mortgage loans

     34       (3     31          47       (21     26     

Home equity

     (27     35       8          (22     12       (10)    

Automobile loans

     (37     22       (15        (31     6       (25)    

Credit card

     (7     46       39          (10     (13     (23)    

Other consumer loans and leases

     23       1       24          8       (9     (1)    

 

 

Total consumer loans and leases

     (14     101       87          (8     (25     (33)    

 

 

Total loans and leases

   $ (40     286       246          39       47       86     

Securities:

               

Taxable

     64       (21     43          98       (15     83     

Exempt from income taxes

     -       1       1          (4     4       -     

Other short-term investments

     (2     9       7          -       -       -     

 

 

Total change in interest income

   $ 22       275       297          133       36       169     

 

 

Liabilities:

               

Interest-bearing liabilities:

               

Interest checking deposits

   $ 4       47       51          (3     11       8     

Savings deposits

     (1     2       1          -       (2     (2)    

Money market deposits

     1       20       21          4       5       9     

Foreign office deposits

     -       -       -          -       -       -     

Other time deposits

     (3     -       (3        (1     1       -     

 

 

Total interest-bearing core deposits

     1       69       70          -       15       15     

Certificates $100,000 and over

     (2     2       -          (1     4       3     

Other deposits

     -       2       2          1       -       1     

Federal funds purchased

     1       3       4          -       1       1     

Other short-term borrowings

     1       19       20          2       6       8     

Long-term debt

     (39     56       17          15       40       55     

 

 

Total change in interest expense

   $ (38     151       113          17       66       83     

 

 

Total change in net interest income

   $                 60       124       184          116       (30     86     

 

 
(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 $261 million for the year ended December 31, 2017 compared to $343 million for the same period in the prior year. The decrease in provision expense for the year ended December 31, 2017 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 a decrease in outstanding loan balances. The ALLL declined $57 million from December 31, 2016 to $1.2 billion at December 31, 2017. At December 31, 2017, the ALLL as a percent of portfolio loans and leases decreased to 1.30%, compared to 1.36% at December 31, 2016.

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 and lease portfolio composition, nonperforming assets, net charge-offs and other factors considered by the Bancorp in assessing the credit quality of the loan and lease portfolio and the ALLL.

 

 

42  Fifth Third Bancorp


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

 

Noninterest Income

Noninterest income increased $528 million for the year ended December 31, 2017 compared to the year ended December 31, 2016. The following table presents the components of noninterest income:

 

TABLE 11: COMPONENTS OF NONINTEREST INCOME

              

 

 
For the years ended December 31 ($ in millions)    2017           2016           2015           2014           2013         

 

 

Service charges on deposits

   $ 554        558        563        560        549        

Wealth and asset management revenue

     419        404        418        407        393        

Corporate banking revenue

     353        432        384        430        400        

Card and processing revenue

     313        319        302        295        272        

Mortgage banking net revenue

     224        285        348        310        700        

Other noninterest income

     1,357        688        979        450        879        

Securities gains, net

     2        10        9        21        21        

Securities gains, net - non-qualifying hedges on MSRs

     2        -        -        -        13        

 

 

Total noninterest income

   $       3,224        2,696        3,003        2,473        3,227        

 

 

 

Service charges on deposits

Service charges on deposits decreased $4 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to a decrease of $4 million in commercial deposit fees.

Wealth and asset management revenue

Wealth and asset management revenue increased $15 million for the year ended December 31, 2017 compared to the year ended December 31, 2016. The increase from the prior year was primarily due to an increase of $13 million in private client service fees driven by an increase in assets under management as a result of strong market performance and the impact of an acquisition in the second quarter of 2017. The Bancorp’s trust and registered investment advisory businesses had approximately $362 billion and $315 billion in total assets under care as of December 31, 2017 and 2016, respectively, and managed $37 billion and $31 billion in assets for individuals, corporations and not-for-profit organizations as of December 31, 2017 and 2016, respectively.

Corporate banking revenue

Corporate banking revenue decreased $79 million for the year ended December 31, 2017 compared to the year ended December 31, 2016. The decrease from the prior year was primarily driven by a decrease in lease remarketing fees of $62 million which included $52

million of impairment charges related to certain operating lease assets for the year ended December 31, 2017 compared to $20 million during the year ended December 31, 2016. The decrease also included $4 million in impairment charges on certain leveraged leases during the year ended December 31, 2017 and the impact of $16 million in gains on certain leveraged lease terminations during the year ended December 31, 2016. Additionally, the decrease in corporate banking revenue for the year ended December 31, 2017 compared to the year ended December 31, 2016 included a $15 million decrease in foreign exchange fees and a $6 million decrease in letter of credit fees.

Card and processing revenue

Card and processing revenue decreased $6 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily driven by higher reward costs.

Mortgage banking net revenue

Mortgage banking net revenue decreased $61 million for the year ended December 31, 2017 compared to the year ended December 31, 2016.

 

 

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

 

 

TABLE 12: COMPONENTS OF MORTGAGE BANKING NET REVENUE

        

 

 
For the years ended December 31 ($ in millions)    2017        2016       2015         

 

 

Origination fees and gains on loan sales

   $ 138        186        171        

Net mortgage servicing revenue:

        

Gross mortgage servicing fees

     206        199        222        

MSR amortization

     -        (131      (139)       

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

           (120      31        94        

 

 

Net mortgage servicing revenue

     86        99        177        

 

 

Mortgage banking net revenue

   $ 224        285        348        

 

 

 

Origination fees and gains on loan sales decreased $48 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 driven by a decrease in originations and lower margins due to the interest rate environment. Residential mortgage loan originations decreased to $8.2 billion for the year ended December 31, 2017 from $10.0 billion for the year ended December 31, 2016. Additionally, during the year ended December 31, 2017, the Bancorp purchased $109 million of MSRs.

Effective January 1, 2017, the Bancorp elected to prospectively adopt the fair value method for all existing classes of its residential mortgage servicing rights portfolio. Upon this election, all servicing rights are measured at fair value at each reporting date and changes

in the fair value of servicing rights are reported in mortgage banking net revenue in the Consolidated Statements of Income in the period in which the changes occur.

Prior to the election of the fair value method, servicing rights were initially recorded at fair value and subsequently amortized in proportion to, and over the period of, estimated net servicing revenue. Servicing rights were assessed for impairment monthly, based on fair value, with temporary impairment recognized through a valuation allowance.

 

 

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Net mortgage servicing revenue decreased $13 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to a decrease in net valuation adjustments (including MSR amortization) of $20 million, partially offset by an increase in gross mortgage servicing fees of $7 million. Refer to Table 13 for the components of net valuation adjustments

on the MSR portfolio and the impact of the non-qualifying hedging strategy:

 

 

TABLE 13: COMPONENTS OF NET VALUATION ADJUSTMENTS ON MSRs

       

 

 
For the years ended December 31 ($ in millions)    2017         2016         2015         

 

 

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

   $ 2       24        90        

Changes in fair value:

       

Due to changes in inputs or assumptions

     (1     -        -        

Other changes in fair value

     (121     -        -        

Recovery of MSR impairment

     -       7        4        

 

 

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

   $           (120     31        94        

 

 

 

Mortgage rates decreased during the year ended December 31, 2017 which caused modeled prepayment speeds to increase, leading to fair value adjustments on servicing rights. The fair value of the MSR portfolio decreased $1 million due to changes to inputs to the valuation model including prepayment speeds and OAS spread assumptions and decreased $121 million due to the passage of time, including the impact of regularly scheduled repayments, paydowns and payoffs for the year ended December 31, 2017.

Mortgage rates increased during the year ended December 31, 2016 which caused the modeled prepayment speeds to decrease, leading to a recovery of temporary impairment of $7 million on the servicing rights during the year. Prior to the election of the fair value method, servicing rights were deemed temporarily impaired when a borrower’s loan rate was distinctly higher than prevailing rates. Temporary impairment on servicing rights was reversed when the prevailing rates returned 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 of 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 recognized net gains of $2 million during the year ended December 31, 2017, recorded in securities gains, net, non-qualifying hedges on MSRs in the Bancorp’s Consolidated Statements of Income. The Bancorp did not hold or sell any securities related to the non-qualifying hedging strategy during the year ended December 31, 2016.

The Bancorp’s total residential mortgage loans serviced at December 31, 2017 and 2016 were $76.1 billion and $69.3 billion, respectively, with $60.0 billion and $53.6 billion, respectively, of residential mortgage loans serviced for others.

 

 

Other noninterest income

The following table presents the components of other noninterest income:

 

TABLE 14: COMPONENTS OF OTHER NONINTEREST INCOME

         

 

 
For the years ended December 31 ($ in millions)      2017      2016       2015           

 

 

Gain on sale of Vantiv, Inc. shares

     $ 1,037             -       331        

Operating lease income

       96             102       89        

Cardholder fees

       54             46       43        

BOLI income

       52             53       48        

Equity method income from interest in Vantiv Holding, LLC

       47             66       63        

Income from the TRA associated with Vantiv, Inc.

       44             313       80        

Private equity investment income

       36             11       28        

Consumer loan and lease fees

       23             23       23        

Banking center income

       20             20       21        

Insurance income

       8             11       14        

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

       (80)            (56     (37)       

Net (losses) gains on loan sales

       (2)            10       38        

Gain on sale of certain retail branch operations

       -             19       -        

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

       -             9       89        

Valuation adjustments on the warrant associated with Vantiv Holding, LLC

       -             64       236        

Net losses on disposition and impairment of bank premises and equipment

       -             (13     (101)       

Other, net

       22             10       14        

 

 

Total other noninterest income

     $       1,357             688       979        

 

 

 

Other noninterest income increased $669 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to the gain on sale of Vantiv, Inc. shares, an increase in private equity investment income and the impact of the net losses on disposition and impairment of bank premises and equipment during the year ended December 31, 2016. These benefits were

partially offset by the impact of certain transactions that occurred during the year ended December 31, 2016 which included the impact of income from the TRA transactions associated with Vantiv, Inc., positive valuation adjustments and the gain on sale of the warrant associated with Vantiv Holding, LLC and gains on the sales of certain retail branch operations.

 

 

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The year ended December 31, 2017 also included an increase in the loss on the swap associated with the sale of Visa, Inc. Class B Shares and a reduction in equity method income from the Bancorp’s interest in Vantiv Holding, LLC.

The Bancorp recognized a $1.0 billion gain on the sale of Vantiv, Inc. shares during the year ended December 31, 2017. For additional information, refer to Note 19 of the Notes to Consolidated Financial Statements.

Private equity investment income increased $25 million compared to the year ended December 31, 2016 driven by gains on the sales of certain private equity funds during the year ended December 31, 2017 and the impact of 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.

Net losses on disposition and impairment of bank premises and equipment decreased $13 million during the year ended December 31, 2017 compared to the same period in the prior year. This decrease was driven by the impact of impairment charges of $7 million during the year ended December 31, 2017, compared to $32 million during the year ended December 31, 2016. 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. Refer to Note 7 of the Notes to Consolidated Financial Statements for further information.

Income from the TRA associated with Vantiv, Inc. was $44 million during the year ended December 31, 2017 compared to $313 million for the year ended December 31, 2016. The decrease 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 the existing Vantiv, Inc. TRA and the expected

obligation to terminate and settle the remaining Vantiv, Inc. TRA cash flows upon the exercise of put or call options. This termination did not impact the TRA payments of $44 million and $33 million recognized in 2017 and 2016, respectively.

The Bancorp recognized positive valuation adjustments on the stock warrant associated with Vantiv, Holding LLC of $64 million during the year ended December 31, 2016. The stock warrant was not outstanding during 2017 as the Bancorp exercised the remaining warrant in Vantiv Holding, LLC during the fourth quarter of 2016 and recognized a gain of $9 million.

During the year ended December 31, 2016, the Bancorp recognized $19 million of gains on the sales of its retail branch operations in the St. Louis MSA to Great Southern Bank and Pittsburgh MSA to First National Bank of Pennsylvania.

The Bancorp recognized negative valuation adjustments of $80 million and $56 million related to the Visa total return swap during the years ended December 31, 2017 and 2016, respectively. The increase from the prior year was attributable to litigation developments during the year ended December 31, 2017 and an increase in Visa, Inc.’s share price. 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.

Equity method earnings from the Bancorp’s interest in Vantiv Holding, LLC decreased $19 million compared to the year ended December 31, 2016 primarily due to a decrease in the Bancorp’s ownership percentage of Vantiv Holding, LLC from approximately 17.9% at December 31, 2016 to approximately 8.6% at December 31, 2017.

 

 

Noninterest Expense

Noninterest expense increased $87 million for the year ended December 31, 2017 compared to the year ended December 31, 2016, primarily due to increases in other noninterest expense, personnel costs (salaries, wages and incentives plus employee benefits) and technology and communications expense. The following table presents the components of noninterest expense:

 

TABLE 15: COMPONENTS OF NONINTEREST EXPENSE

                    

 

 
For the years ended December 31 ($ in millions)    2017          2016           2015           2014           2013           

 

 

Salaries, wages and incentives

   $ 1,633        1,612          1,525          1,449          1,581          

Employee benefits

     356        339          323          334          357          

Net occupancy expense

     295        299          321          313          307          

Technology and communications

     245        234          224          212          204          

Card and processing expense

     129        132          153          141          134          

Equipment expense

     117        118          124          121          114          

Other noninterest expense

     1,215        1,169          1,105          1,139          1,264          

 

 

Total noninterest expense

   $         3,990        3,903          3,775          3,709          3,961          

 

 

Efficiency ratio on an FTE basis(a)

     56.6       61.6          57.6          61.1          58.2          

 

 
(a)

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

 

Personnel costs increased $38 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 driven by increases in base compensation, medical and FICA expenses and long-term incentive compensation, partially offset by a decrease in severance costs related to the Bancorp’s voluntary early retirement program in 2016. The increase in personnel costs also included the impact of one-time employee bonuses of $15 million that the Bancorp paid as a result of benefits received from the TCJA. Full-

time equivalent employees totaled 18,125 at December 31, 2017 compared to 17,844 at December 31, 2016.

Technology and communications expense increased $11 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 driven primarily by increased investment in regulatory, compliance and growth initiatives.

 

 

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The following table presents the components of other noninterest expense:

 

TABLE 16: COMPONENTS OF OTHER NONINTEREST EXPENSE

              

 

 
For the years ended December 31 ($ in millions)      2017            2016            2015           

 

 

Impairment on affordable housing investments

     $ 222          168          145        

FDIC insurance and other taxes

       127          126          99        

Marketing

       114          104          110        

Loan and lease

       102          110          118        

Operating lease

       87          86          74        

Professional service fees

       83          61          70        

Losses and adjustments

       59          73          55        

Data processing

       58          51          45        

Travel

       46          45          54        

Postal and courier

       42          46          45        

Recruitment and education

       35          37          33        

Donations

       28          23          29        

Supplies

       14          14          16        

Insurance

       12          15          17        

Provision for the reserve for unfunded commitments

       -          23          4        

Other, net

       186          187          191        

 

 

Total other noninterest expense

     $           1,215          1,169          1,105        

 

 

 

Other noninterest expense increased $46 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to increases in the impairment on affordable housing investments, professional service fees and marketing expense, partially offset by decreases in the provision for the reserve for unfunded commitments, losses and adjustments and loan and lease expense.

Impairment on affordable housing investments increased $54 million for the year ended December 31, 2017 compared to the year ended December 31, 2016. The increase was driven by $68 million of impairment on certain affordable housing investments recognized during the fourth quarter of 2017 primarily due to the change in the federal statutory corporate tax rate pursuant to the TCJA. Professional service fees increased $22 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to investments in the NorthStar strategy and other strategic initiatives. Marketing expense increased $10 million

for the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to the new brand campaign. The provision for the reserve for unfunded commitments decreased $23 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to an increase in estimated loss rates related to unfunded commitments during 2016 and a decrease in the unfunded commitments outstanding during 2017. Losses and adjustments decreased $14 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to the impact of favorable legal settlements during the year ended December 31, 2017 partially offset by increases in operational losses. Loan and lease expense decreased $8 million for the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to lower loan closing and appraisal costs driven by a decline in residential mortgage loan originations.

 

 

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Applicable Income Taxes

The U.S. government enacted comprehensive tax legislation, the TCJA, on December 22, 2017. The TCJA makes broad and complex changes to the U.S. tax code including, but not limited to, reducing the top federal statutory corporate tax rate from 35 percent to 21 percent effective for tax years beginning after December 31, 2017. U.S. GAAP requires the Bancorp to recognize the tax effects of changes in tax laws and rates on its deferred taxes in the period in which the law is enacted. For the year ended December 31, 2017 the Bancorp is subject to a top federal statutory corporate tax rate of 35 percent. For years beginning after December 31, 2017, the Bancorp will be subject to a federal statutory corporate tax rate of 21 percent. As such, the Bancorp expects its effective tax rate to significantly decrease from historical levels beginning in 2018.

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 rate for the year ended December 31, 2017 was 20.8% which was a decrease of 3.6% from 2016 primarily driven by a $220 million benefit from the remeasurement of deferred taxes as a result of the aforementioned reduction in the federal statutory corporate tax rate resulting from the TCJA, partially offset by the impact of an increase in income before taxes. The effective tax rates for the years ended December 31, 2017 and 2016 included the impact of $178 million and $182 million, respectively, in tax credits and $34 million and $56 million of tax benefits from tax exempt income, respectively.

For stock-based awards, U.S. GAAP 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. The Bancorp cannot predict its stock price or whether and when its employees will exercise stock-based awards in the future. Based on its stock price at December 31, 2017, the Bancorp estimates that it may be necessary to recognize $12 million of additional income tax benefit over the next twelve months related to the settlement of stock-based awards, primarily in the first half of 2018. 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 17: APPLICABLE INCOME TAXES

             

 

 
For the years ended December 31 ($ in millions)    2017     2016      2015      2014      2013          

 

 

Income before income taxes

   $         2,771                   2,065                    2,365                    2,028                    2,598          

Applicable income tax expense

     577       505        659        545        772          

Effective tax rate

     20.8  %      24.4        27.8        26.9        29.7          

 

 

 

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BUSINESS SEGMENT REVIEW

 

The Bancorp reports on four business segments: Commercial Banking, Branch Banking, Consumer Lending and Wealth and Asset Management. 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.

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 rates 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 rates and credit rates as dictated by changes in interest rates for various interest-earning assets and interest-bearing liabilities and by the review of behavioral 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, 2017 to reflect the current market rates and updated market assumptions. These rates were generally higher than those in place during 2016, thus net interest income for deposit-providing business segments was positively impacted during 2017. 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 2017.

The Bancorp’s methodology for allocating provision for loan and lease losses expense to the business segments includes 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. Provision for loan and lease losses expense attributable to loan and lease growth and changes in ALLL factors is 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 following table summarizes net income (loss) by business segment:

 

TABLE 18: NET INCOME (LOSS) BY BUSINESS SEGMENT

      

 

 

For the years ended December 31 ($ in millions)

     2017               2016               2015        

 

 

Income Statement Data

      

Commercial Banking

   $ 806       995       718        

Branch Banking

     494       431       297        

Consumer Lending

     (19     20       111        

Wealth and Asset Management

     74       93       58        

General Corporate and Other

     839       21       522        

 

 

Net income

     2,194       1,560       1,706        

Less: Net income attributable to noncontrolling interests

     -       (4     (6)       

 

 

Net income attributable to Bancorp

     2,194       1,564       1,712        

Dividends on preferred stock

     75       75       75        

 

 

Net income available to common shareholders

   $         2,119       1,489       1,637        

 

 

 

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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 19: COMMERCIAL BANKING

        

 

 
For the years ended December 31 ($ in millions)    2017       2016       2015          

 

 

Income Statement Data

        

Net interest income (FTE)(a)

   $ 1,678        1,839        1,646        

Provision for loan and lease losses

     38        76        298        

Noninterest income:

        

Corporate banking revenue

     348        430        378        

Service charges on deposits

     287        292        284        

Other noninterest income

     203        185        191        

Noninterest expense:

        

Personnel costs

     294        296        303        

Other noninterest expense

     1,202        1,130        1,066        

 

 

Income before income taxes (FTE)

     982        1,244        832        

Applicable income tax expense(a)(b)

     176        249        114        

 

 

Net income

   $ 806        995        718        

 

 

Average Balance Sheet Data

        

Commercial loans and leases, including held for sale

   $       53,743            54,597            53,010        

Demand deposits

     19,519        20,735        20,677        

Interest checking deposits

     9,080        8,582        9,069        

Savings and money market deposits

     5,337        6,686        6,652        

Other time deposits and certificates $100,000 and over

     899        1,046        1,230        

Foreign office deposits

     372        496        813        

 

 
(a)

Includes FTE adjustments of $26, $25 and $21 for the years ended December 31, 2017, 2016 and 2015, respectively. This is a non-GAAP measure.

(b)

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

 

Comparison of the year ended 2017 with 2016

Net income was $806 million for the year ended December 31, 2017 compared to net income of $995 million for the year ended December 31, 2016. The decrease in net income was driven by decreases in net interest income and noninterest income and an increase in noninterest expense partially offset by a decrease in the provision for loan and lease losses.

Net interest income on an FTE basis decreased $161 million from the year ended December 31, 2016 primarily driven by increases in FTP charge rates on loans and leases and increases in the rates paid of core deposits. The decrease in net interest income was partially offset by increases in yields on average commercial loans and leases of 37 bps from the year ended December 31, 2016.

Provision for loan and lease losses decreased $38 million from the year ended December 31, 2016 primarily driven by a decrease in net charge-offs on commercial and industrial loans partially offset by a reduction in the benefit from criticized assets. Net charge-offs as a percent of average portfolio loans and leases decreased to 19 bps for the year ended December 31, 2017 compared to 33 bps for the year ended December 31, 2016.

Noninterest income decreased $69 million from the year ended December 31, 2016 primarily driven by a decrease in corporate banking revenue partially offset by an increase in other noninterest income. Corporate banking revenue decreased $82 million from the year ended December 31, 2016 driven by a decrease in lease remarketing fees of $62 million which included $52 million of impairment charges related to certain operating lease assets for the year ended December 31, 2017 compared to $20 million during the year ended December 31, 2016. Additionally, corporate banking revenue included a $15 million decrease in foreign exchange fees

and a $6 million decrease in letter of credit fees for the year ended December 31, 2017 compared to the year ended December 31, 2016. Other noninterest income increased $18 million from the year ended December 31, 2016 driven by an increase in private equity investment income primarily due to gains on the sale of certain private equity investments.

Noninterest expense increased $70 million from the year ended December 31, 2016 primarily as a result of an increase in other noninterest expense. The increase in other noninterest expense was driven by $68 million of impairment on certain affordable housing investments recognized during the fourth quarter of 2017 primarily due to the change in the federal statutory corporate tax rate pursuant to the TCJA.

Average commercial loans decreased $854 million from the year ended December 31, 2016 primarily due to a decrease in average commercial and industrial loans partially offset by an increase in average commercial construction loans. Average commercial and industrial loans decreased $1.7 billion from the year ended December 31, 2016 primarily as a result of deliberate exits from certain loans that did not meet the Bancorp’s risk-adjusted profitability targets and softer loan demand. Average commercial construction loans increased $725 million from the year ended December 31, 2016 primarily due to increases in demand and draw levels on existing commitments.

Average core deposits decreased $2.2 billion from the year ended December 31, 2016. The decrease was primarily driven by decreases in average savings and money market deposits and average demand deposits which decreased $1.3 billion and $1.2 billion, respectively, from the year ended December 31, 2016 primarily due to lower average balances per account.

 

 

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These decreases were partially offset by an increase in average interest checking deposits of $498 million from the year ended December 31, 2016 primarily due to the acquisition of new customers.

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.

 

 

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Branch Banking

Branch Banking provides a full range of deposit and loan products to individuals and small businesses through 1,154 full-service banking centers. Branch Banking offers depository and loan products, such as checking and savings accounts, home equity loans

and lines of credit, credit cards and loans for automobiles and other personal financing needs, as well as products designed to meet the specific needs of small businesses, including cash management services.

 

 

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

 

TABLE 20: BRANCH BANKING

        

 

 
For the years ended December 31 ($ in millions)    2017       2016       2015            

 

 

Income Statement Data

        

Net interest income

   $ 1,782        1,669        1,555        

Provision for loan and lease losses

     153        138        151        

Noninterest income:

        

Service charges on deposits

     265        265        277        

Card and processing revenue

     251        253        236        

Wealth and asset management revenue

     141        140        157        

Other noninterest income

     99        97        (18)       

Noninterest expense:

        

Personnel costs

     526        520        524        

Net occupancy and equipment expense

     228        234        248        

Card and processing expense

     127        128        145        

Other noninterest expense

     740        739        681        

 

 

Income before income taxes

     764        665        458        

Applicable income tax expense

     270        234        161        

 

 

Net income

   $ 494        431        297        

 

 

Average Balance Sheet Data

        

Consumer loans, including held for sale

   $       13,008            13,572            14,374        

Commercial loans, including held for sale

     1,918        1,870        2,021        

Demand deposits

     13,895        13,332        12,715        

Interest checking deposits

     10,226        9,659        9,128        

Savings and money market deposits

     27,603        25,974        25,342        

Other time deposits and certificates $100,000 and over

     4,965        5,205        5,161        

 

 

 

Comparison of the year ended 2017 with 2016

Net income was $494 million for the year ended December 31, 2017 compared to net income of $431 million for the year ended December 31, 2016. The increase was driven by an increase in net interest income partially offset by an increase in the provision for loan and lease losses.

Net interest income increased $113 million from the year ended December 31, 2016 primarily due to an increase in FTP credits driven by an increase in average core deposits, an increase in FTP credit rates on core deposits and increases in yields on average consumer and commercial loans. These benefits to net interest income were partially offset by increases in FTP charge rates on loans and leases and increases in the rates paid on core deposits. Additionally, interest income from credit cards included the impact of a $12 million benefit related to a revised estimate of refunds offered to certain bankcard customers in the first quarter of 2017 compared to a $16 million reduction in interest income for the expected refunds in the fourth quarter of 2016.

Provision for loan and lease losses increased $15 million from the year ended December 31, 2016 as net charge-offs as a percent of average portfolio loans and leases increased to 102 bps for the year ended December 31, 2017 compared to 91 bps for the year ended December 31, 2016.

Noninterest income increased $1 million from the year ended December 31, 2016 primarily driven by an increase in other noninterest income partially offset by a decrease in card and processing revenue. Other noninterest income increased $2 million from the year ended December 31, 2016 primarily due to impairment charges on bank premises and equipment of $7 million recognized during the year ended December 31, 2017 compared to $32 million recognized during the year ended December 31, 2016 as

well as an increase of $8 million in ATM transaction fees from the year ended December 31, 2016. These positive impacts for the year ended December 31, 2017 were partially offset by the recognition of $19 million of gains on the sales of retail branch operations in the St. Louis and Pittsburgh MSAs during the year ended December 31, 2016, as well as a gain of $11 million on the sale of the agent bankcard loan portfolio during the second quarter of 2016. Card and processing revenue decreased $2 million from the year ended December 31, 2016 primarily driven by higher rewards costs.

Noninterest expense was flat from the year ended December 31, 2016 as a decrease in net occupancy and equipment expense was offset by an increase in personnel costs. Net occupancy and equipment expense decreased $6 million from the year ended December 31, 2016 primarily due to a decrease in rent expense driven by a reduction in the number of full-service banking centers and ATM locations. Personnel costs increased $6 million from the year ended December 31, 2016 primarily due to an increase in incentive compensation partially offset by a decrease in base compensation.

Average consumer loans decreased $564 million from the year ended December 31, 2016 primarily driven by a decrease in average home equity loans and average residential mortgage loans of $547 million and $236 million, respectively, as payoffs exceeded new loan production. These declines were partially offset by an increase in average other consumer loans of $285 million from the year ended December 31, 2016 primarily due to growth in point-of-sale loan originations.

Average core deposits increased $2.5 billion from the year ended December 31, 2016 primarily driven by growth in average savings and money market deposits of $1.6 billion, growth in average interest checking deposits of $567 million and growth in average demand deposits of $563 million.

 

 

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The growth in average savings and money market deposits, average interest checking deposits and average demand deposits was driven by an increase in average balances per customer account and acquisition of new customers.

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.

 

 

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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 21: CONSUMER LENDING        

 

 
For the years ended December 31 ($ in millions)    2017     2016      2015        

 

 

Income Statement Data

       

Net interest income

   $ 240       248        249        

Provision for loan and lease losses

     40       44        44        

Noninterest income:

       

Mortgage banking net revenue

     217       277        341        

Other noninterest income

     20       26        66        

Noninterest expense:

       

Personnel costs

     189       195        185        

Other noninterest expense

     278       280        255        

 

 

Income (loss) before income taxes

     (30     32        172        

Applicable income tax (benefit) expense

     (11     12        61        

 

 

Net income (loss)

   $ (19     20        111        

 

 

Average Balance Sheet Data

       

Residential mortgage loans, including held for sale

   $       11,494       10,530        9,251        

Home equity

     293       356        424        

Automobile loans

     8,939           10,172            11,341        

Other consumer loans, including held for sale

     -       -        11        

 

 

 

Comparison of the year ended 2017 with 2016

Consumer Lending incurred a net loss of $19 million for the year ended December 31, 2017 compared to net income of $20 million for the year ended December 31, 2016. The decrease was driven by a decrease in noninterest income.

Net interest income decreased $8 million from the year ended December 31, 2016 primarily driven by an increase in FTP charges on loans and leases partially offset by an increase in yields on average automobile loans.

Provision for loan and lease losses decreased $4 million from the year ended December 31, 2016. Net charge-offs as a percent of average portfolio loans and leases decreased to 20 bps for the year ended December 31, 2017 compared to 22 bps for the year ended December 31, 2016.

Noninterest income decreased $66 million from the year ended December 31, 2016 driven primarily by a decrease in mortgage banking net revenue. Mortgage banking net revenue decreased $60 million from the year ended December 31, 2016 primarily driven by decreases of $48 million and $12 million in mortgage origination fees and gains on loan sales and net mortgage servicing revenue, respectively. 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.

Noninterest expense decreased $8 million from the year ended December 31, 2016 driven by a decrease in personnel costs. Personnel costs decreased $6 million from the year ended December 31, 2016 primarily driven by decreases in incentive and base compensation.

Average consumer loans decreased $332 million from the year ended December 31, 2016 as a decrease in average automobile loans was partially offset by an increase in average residential mortgage loans. Average automobile loans decreased $1.2 billion from the year ended December 31, 2016 as payoffs exceeded new loan production due to a strategic shift focusing on improving risk-adjusted returns. Average residential mortgage loans, including held for sale, increased $964 million from the year ended December 31,

2016 primarily due to the continued retention of certain agency conforming ARMs and certain other fixed-rate loans originated during the year ended December 31, 2017.

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.

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. 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.

 

 

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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.

 

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 five main businesses: FTS, an indirect wholly-owned subsidiary of the Bancorp; ClearArc Capital, Inc., an indirect wholly-owned subsidiary of the Bancorp; Fifth Third Insurance Agency, 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 Insurance Agency, Inc. assists clients with their financial and risk management needs. Fifth Third Private Bank offers holistic strategies to affluent clients in wealth planning, investing, insurance and wealth protection. Fifth Third Institutional Services provides advisory services for institutional clients including states and municipalities.

 

 

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

 

TABLE 22: WEALTH AND ASSET MANAGEMENT    

            

 

 
For the years ended December 31 ($ in millions)    2017          2016         2015         

 

 

Income Statement Data

            

Net interest income

   $ 154          168          128        

Provision for loan and lease losses

     6          1          3        

Noninterest income:

            

Wealth and asset management revenue

     407          391          406        

Other noninterest income

     12          8          12        

Noninterest expense:

            

Personnel costs

     181          168          170        

Other noninterest expense

     273          254          285        

 

 

Income before income taxes

     113          144          88        

Applicable income tax expense

     39          51          30        

 

 

Net income

   $ 74          93          58        

 

 

Average Balance Sheet Data

            

Loans and leases, including held for sale

   $       3,277          3,135          2,805        

Core deposits

     8,782          8,554          9,357        

 

 

 

Comparison of the year ended 2017 with 2016

Net income was $74 million for the year ended December 31, 2017 compared to net income of $93 million for the year ended December 31, 2016. The decrease in net income was driven by an increase in noninterest expense and a decrease in net interest income partially offset by an increase in noninterest income.

Net interest income decreased $14 million from the year ended December 31, 2016 primarily due to to increases in FTP charge rates on loans and leases as well as increases in the rates paid on interest checking deposits. These negative impacts were partially offset by increases in interest income on loans and leases as a result of increases in yields and average balances. The decrease was also partially offset by an increase in FTP credits on interest checking deposits and savings and money market deposits.

Provision for loan and leases losses increased $5 million from the year ended December 31, 2016 primarily driven by an increase in net charge-offs on commercial and industrial loans.

Noninterest income increased $20 million from the year ended December 31, 2016 due to increases in wealth and asset management revenue and other noninterest income. Wealth and asset management revenue increased $16 million from the year ended December 31, 2016 primarily due to an increase in private client service fees driven by an increase in assets under management as a result of strong market performance and the impact of an acquisition in the second quarter of 2017. Other noninterest income increased $4 million from the year ended December 31, 2016 driven by an increase in insurance income as a result of acquisitions in the first and fourth quarters of 2017.

Noninterest expense increased $32 million from the year ended December 31, 2016 due to increases in other noninterest expense and personnel costs. Other noninterest expense increased $19 million from the year ended December 31, 2016 driven by an increase in corporate overhead allocations. Personnel costs increased $13 million from the year ended December 31, 2016 due to higher base compensation primarily driven by the aforementioned acquisitions completed during 2017 as well as higher incentive compensation.

Average loans and leases increased $142 million from the year ended December 31, 2016 driven by an increase in average residential mortgage loans due to increases in new loan origination activity. This increase was partially offset by a decline in average home equity balances.

Average core deposits increased $228 million from the year ended December 31, 2016 primarily due to increases in average interest checking deposits and average savings and money market deposits.

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.

 

 

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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.

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 2017 with 2016

Net interest income increased $254 million from the year ended December 31, 2016 primarily driven by an increase in the benefit related to the FTP charges on loans and leases as well as an increase in interest income on taxable securities. These positive impacts were partially offset by increases in FTP credit rates on deposits allocated to the business segments, a decrease in interest income on loans and leases as well as an increase in interest expense on long-term debt.

Provision for loan and leases losses decreased $60 million from the year ended December 31, 2016 primarily due to a reduction in the benefit for criticized assets allocated to the business segments coupled with an increase in the benefit from the reduction in the ALLL.

Noninterest income increased $643 million from the year ended December 31, 2016 primarily driven by the recognition of a $1.0 billion gain on the sale of Vantiv, Inc. shares during the third quarter of 2017. The increase was partially offset by the impact of a $280 million gain recognized during the third quarter of 2016 from the termination and settlement of gross cash flows from the existing Vantiv, Inc. TRA and the expected obligation to terminate and settle the remaining Vantiv, Inc. TRA cash flows upon the exercise of put or call options. This termination did not impact the TRA payments of $44 million and $33 million recognized in 2017 and 2016, respectively. The year ended December 31, 2016 also included positive valuation adjustments on the stock warrant associated with Vantiv Holding, LLC of $64 million. The stock warrant was not outstanding during 2017 as the Bancorp exercised the remaining warrant in Vantiv Holding, LLC during the fourth quarter of 2016

and recognized a gain of $9 million. The increase in noninterest income from December 31, 2016 was partially offset by negative valuation adjustments related to the Visa total return swap of $80 million for the year ended December 31, 2017 compared with $56 million for the prior year. Additionally, equity method earnings from the Bancorp’s interest in Vantiv Holding, LLC decreased $19 million from the year ended December 31, 2016. 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.

Noninterest expense decreased $6 million from the year ended December 31, 2016. The decrease was primarily due to increases in corporate overhead allocations from General Corporate and Other to the other business segments and decreases in the provision for the reserve for unfunded commitments partially offset by increases in personnel costs and technical and communications expense.

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.

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.

 

 

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

 

FOURTH QUARTER REVIEW

 

The Bancorp’s 2017 fourth quarter net income available to common shareholders was $486 million, or $0.67 per diluted share, compared to net income available to common shareholders of $999 million, or $1.35 per diluted share, for the third quarter of 2017 and net income available to common shareholders of $372 million, or $0.49 per diluted share, for the fourth quarter of 2016.

Net interest income on an FTE basis was $963 million during the fourth quarter of 2017 and decreased $14 million from the third quarter of 2017 and increased $54 million from the fourth quarter of 2016. The decrease from the third quarter of 2017 was primarily driven by a $27 million reduction due to the remeasurement related to the tax treatment of leveraged leases resulting from the TCJA, partially offset by an increase in yields on interest-earnings assets. The increase in net interest income in comparison to the fourth quarter of 2016 was primarily driven by an increase in short-term market rates and the impact of a $16 million reduction in interest income related to estimated refunds to be offered to certain bankcard customers during the fourth quarter of 2016, partially offset by the aforementioned leveraged lease remeasurement.

Fourth quarter 2017 noninterest income of $577 million decreased $984 million compared to the third quarter of 2017 and decreased $43 million compared to the fourth quarter of 2016. The decrease from the third quarter of 2017 was primarily due to decreases in other noninterest income, corporate banking revenue and mortgage banking net revenue. The year-over-year decrease was primarily the result of decreases in corporate banking revenue, other noninterest income and mortgage banking net revenue.

Service charges on deposits of $138 million were flat compared to the previous quarter and decreased $3 million compared to the fourth quarter of 2016. The decrease from the fourth quarter of 2016 was driven by a decrease in commercial deposit fees.

Corporate banking revenue of $77 million decreased $24 million compared to both the third quarter of 2017 and the fourth quarter of 2016. The decrease compared to both the third quarter of 2017 and the fourth quarter of 2016 was primarily driven by the impact of $25 million of impairment charges related to certain operating lease assets in the fourth quarter of 2017.

Mortgage banking net revenue was $54 million in the fourth quarter of 2017 compared to $63 million in the third quarter of 2017 and $65 million in the fourth quarter of 2016. The decrease in mortgage banking net revenue compared to the third quarter of 2017 was driven by lower origination fees and gains on loan sales. The decrease from the prior year was driven by negative valuation adjustments (including MSR amortization). Fourth quarter 2017 originations were $1.9 billion, compared with $2.1 billion in the previous quarter and $2.7 billion in the fourth quarter of 2016. Fourth quarter 2017 originations resulted in gains of $32 million on mortgages sold, compared with gains of $40 million during the previous quarter and $30 million during the fourth quarter of 2016. Gross mortgage servicing fees were $54 million in the fourth quarter of 2017, $56 million in the third quarter of 2017 and $48 million in the fourth quarter of 2016. Mortgage banking net revenue is also affected by net valuation adjustments, which include MSR amortization and MSR valuation adjustments, including adjustments due to changes to prepayment speeds, OAS spread assumptions and the passage of time and mark-to-market adjustments on free-standing derivatives used to economically hedge the MSR portfolio. Net negative valuation adjustments were $32 million and

$33 million in the fourth and third quarters of 2017, respectively, and $13 million in the fourth quarter of 2016.

Wealth and asset management revenue of $106 million increased $4 million from the previous quarter and increased $6 million from the fourth quarter of 2016. The increases from the third quarter of 2017 and the fourth quarter of 2016 were primarily driven by an increase in private client service fees.

Card and processing revenue of $80 million increased $1 million from both the third quarter of 2017 and the fourth quarter of 2016. The increase from the third quarter of 2017 and the fourth quarter of 2016 reflected increased credit card spend volume, partially offset by higher rewards.

Other noninterest income of $123 million decreased $953 million compared to the third quarter of 2017 and decreased $14 million from the fourth quarter of 2016. The decrease from the third quarter of 2017 included the impact of a $1.0 billion gain on the sale of Vantiv, Inc. shares recognized during the third quarter of 2017, partially offset by a gain of $44 million pursuant to Fifth Third’s TRA with Vantiv, Inc. recognized in the fourth quarter of 2017. Quarterly results also included valuation adjustments on the Visa total return swap which were charges of $11 million and $47 million in the fourth and third quarter of 2017, respectively, and a benefit of $6 million in the fourth quarter of 2016. Fourth quarter of 2016 also included a gain of $33 million pursuant to Fifth Third’s TRA with Vantiv, Inc. and a gain of $9 million on the exercise of the remaining warrant in Vantiv Holding, LLC.

The net gains on investment securities were $1 million during the fourth quarter of 2017 compared to an immaterial amount in the third quarter of 2017 and net losses of $3 million during the fourth quarter of 2016. Net losses on securities held as non-qualifying hedges for MSRs were $2 million during the fourth quarter of 2017 compared to net gains of $2 million during the third quarter of 2017 and zero during the fourth quarter of 2016.

Noninterest expense of $1.1 billion increased $98 million from the previous quarter and increased $113 million from the fourth quarter of 2016. The increases in noninterest expense compared to both the third quarter of 2017 and the fourth quarter of 2016 were primarily driven by increases in other noninterest expense and personnel costs. The increases in other noninterest expense from the third quarter of 2017 and the fourth quarter of 2016 were driven by increases of $62 million and $63 million, respectively, in impairment on affordable housing investments and a $15 million contribution made to the Fifth Third Foundation during the fourth quarter of 2017. The increase in noninterest expense from both the third quarter of 2017 and fourth quarter of 2016 also included an increase in personnel costs related to the impact of one-time employee bonuses of $15 million that the Bancorp paid as a result of benefits received from the TCJA.

The ALLL as a percentage of portfolio loans and leases was 1.30% as of December 31, 2017, compared to 1.31% as of September 30, 2017 and 1.36% as of December 31, 2016. The provision for loan and lease losses was $67 million in both the fourth and third quarters of 2017 compared to $54 million in the fourth quarter of 2016. Net losses charged-off were $76 million in the fourth quarter of 2017, or 33 bps of average portfolio loans and leases on an annualized basis, compared with net losses charged-off of $68 million in the third quarter of 2017 and $73 million in the fourth quarter of 2016.

 

 

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TABLE 23: QUARTERLY INFORMATION (unaudited)                                                           
        2017        2016

For the three months ended ($ in millions, except per share data)

                    12/31          9/30          6/30          3/31            12/31          9/30(b)            6/30(b)            3/31(b)  

Net interest income(a)(b)

    $       963           977           945           939           909           913           908           909 

Provision for loan and lease losses

          67           67           52           74           54           80           91           119 

Noninterest income

          577           1,561           564           523           620           840           599           637 

Noninterest expense

          1,073           975           957           986           960           973           983           986 

Net income attributable to Bancorp

          509           1,014           367           305           395           516           328           326 

Net income available to common shareholders

          486           999           344           290           372           501           305           311 

Earnings per share, basic

          0.68           1.37           0.46           0.38           0.49           0.66           0.40           0.40 

Earnings per share, diluted

                0.67           1.35           0.45           0.38             0.49           0.65           0.39           0.40 
(a)

Amounts presented on an FTE basis. The FTE adjustment was $7 for both the three months ended December 31, 2017 and September 30, 2017 and $6 for both the three months ended June 30, 2017, March 31, 2017 and each period presented during the year ended December 31, 2016.

(b)

Net tax deficiencies of $1 million, $5 million and $0 were reclassified from capital surplus to applicable income tax expense at March 31, 2016, June 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 2016 WITH 2015

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.

The provision for loan and lease losses decreased to $343 million during the year ended December 31, 2016 compared to $396 million during the year ended December 31, 2015 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. 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.

Net interest income on an FTE basis (non-GAAP) was $3.6 billion for both the years ended December 31, 2016 and 2015. For the year ended December 31, 2016, net interest income was positively impacted by increases in average taxable securities of $3.1 billion and average loans and leases of $981 million 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 increases 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 both the 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 the 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 the same period in 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.

Noninterest expense increased $128 million during 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.

 

 

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BALANCE SHEET ANALYSIS

 

Loans and Leases

The Bancorp classifies its commercial loans and leases based upon primary purpose and consumer loans and leases based upon product or collateral. Table 24 summarizes end of period loans and leases,

including loans and leases held for sale and Table 25 summarizes average total loans and leases, including loans and leases held for sale.

 

 

TABLE 24: COMPONENTS OF TOTAL LOANS AND LEASES (INCLUDING LOANS AND LEASES HELD FOR SALE)

 

As of December 31 ($ in millions)    2017      2016      2015      2014      2013      

 

 

Commercial loans and leases:

              

Commercial and industrial loans

   $ 41,170            41,736            42,151            40,801            39,347      

Commercial mortgage loans

     6,610        6,904        6,991        7,410        8,069      

Commercial construction loans

     4,553        3,903        3,214        2,071        1,041      

Commercial leases

     4,068        3,974        3,854        3,721        3,626      

 

 

Total commercial loans and leases

     56,401        56,517        56,210        54,003        52,083      

 

 

Consumer loans and leases:

              

Residential mortgage loans

     16,077        15,737        14,424        13,582        13,570      

Home equity

     7,014        7,695        8,336        8,886        9,246      

Automobile loans

     9,112        9,983        11,497        12,037        11,984      

Credit card

     2,299        2,237        2,360        2,401        2,294      

Other consumer loans and leases

     1,559        680        658        436        381      

 

 

Total consumer loans and leases

     36,061        36,332        37,275        37,342        37,475      

 

 

Total loans and leases

   $         92,462        92,849        93,485        91,345        89,558      

 

 

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

   $ 91,970        92,098        92,582        90,084        88,614      

 

 

 

Loans and leases, including loans and leases held for sale, decreased $387 million from December 31, 2016. The decrease from December 31, 2016 was the result of a $271 million, or 1%, decrease in consumer loans and leases and a $116 million decrease in commercial loans and leases.

Consumer loans and leases decreased from December 31, 2016 primarily due to decreases in automobile loans and home equity, partially offset by increases in other consumer loans and leases, residential mortgage loans and credit card. Automobile loans decreased $871 million, or 9%, from December 31, 2016 as payoffs exceeded new loan production due to a strategic shift focusing on improving risk-adjusted returns. Home equity decreased $681 million, or 9%, from December 31, 2016 as payoffs exceeded new loan production. Other consumer loans and leases increased $879 million from December 31, 2016 primarily due to growth in point-of-sale loan originations. Residential mortgage loans increased $340 million, or 2%, from December 31, 2016 primarily due to the continued retention of certain agency conforming ARMs and certain other fixed-rate loans originated during the year ended December 31, 2017. Credit card increased $62 million, or 3%, from

December 31, 2016 due to increases in customer accounts and the average balance per active customer as a result of a new product that launched in the fourth quarter of 2016.

Commercial loans and leases decreased from December 31, 2016 primarily due to decreases in commercial and industrial loans and commercial mortgage loans, partially offset by increases in commercial constructions loans and commercial leases. Commercial and industrial loans decreased $566 million, or 1%, from December 31, 2016 primarily as a result of deliberate exits from certain loans that did not meet the Bancorp’s risk-adjusted profitability targets and softer loan demand. Commercial mortgage loans decreased $294 million, or 4% from December 31, 2016 primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns. Commercial construction loans increased $650 million, or 17%, from December 31, 2016 primarily due to increases in demand and draw levels on existing commitments. Commercial leases increased $94 million, or 2%, from December 31, 2016 primarily as a result of an increase in syndication and participation origination activity.

 

 

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

 

 

 
For the years ended December 31 ($ in millions)    2017      2016      2015      2014      2013      

 

 

Commercial loans and leases:

              

 Commercial and industrial loans

   $ 41,577            43,184            42,594            41,178            37,770      

 Commercial mortgage loans

     6,844        6,899        7,121        7,745        8,481      

 Commercial construction loans

     4,374        3,648        2,717        1,492        793      

 Commercial leases

     4,011        3,916        3,796        3,585        3,565      

 

 

Total average commercial loans and leases

     56,806        57,647        56,228        54,000        50,609      

 

 

Consumer loans and leases:

              

 Residential mortgage loans

     16,053        15,101        13,798        13,344        14,428      

 Home equity

     7,308        7,998        8,592        9,059        9,554      

 Automobile loans

     9,407        10,708        11,847        12,068        12,021      

 Credit card

     2,141        2,205        2,303        2,271        2,121      

 Other consumer loans and leases

     1,016        661        571        385        360      

 

 

Total average consumer loans and leases

     35,925        36,673        37,111        37,127        38,484      

 

 

Total average loans and leases

   $ 92,731        94,320        93,339        91,127        89,093      

 

 

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

   $           92,068        93,426        92,423        90,485        86,950      

 

 

 

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Average loans and leases, including loans and leases held for sale, decreased $1.6 billion, or 2%, from December 31, 2016 as a result of an $841 million, or 1%, decrease in average commercial loans and leases and a $748 million, or 2%, decrease in average consumer loans and leases.

Average commercial loans and leases decreased from December 31, 2016 primarily due to a decrease in average commercial and industrial loans, partially offset by an increase in average commercial construction loans. Average commercial and industrial loans decreased $1.6 billion, or 4%, from December 31, 2016 primarily as a result of deliberate exits from certain loans that did not meet the Bancorp’s risk-adjusted profitability targets and softer loan demand. Average commercial construction loans increased $726 million, or 20%, from December 31, 2016 primarily due to increases in demand and draw levels on existing commitments.

Investment Securities

The Bancorp uses investment securities as a means of managing interest rate risk, providing both collateral for pledging purposes and liquidity for satisfying regulatory requirements. Total investment securities were $32.7 billion and $31.6 billion at December 31, 2017 and December 31, 2016, respectively. The available-for-sale investment securities portfolio had an effective duration of 4.7 years at December 31, 2017 compared to 5.0 years at December 31, 2016.

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.

Average consumer loans and leases decreased from December 31, 2016 primarily due to decreases in average automobile loans, average home equity and average credit card, partially offset by increases in average residential mortgage loans and average other consumer loans and leases. Average automobile loans decreased $1.3 billion, or 12%, from December 31, 2016 as payoffs exceeded new loan production due to a strategic shift focusing on improving risk-adjusted returns. Average home equity decreased $690 million, or 9%, from December 31, 2016 as payoffs exceeded new loan production. Average credit card decreased $64 million, or 3%, from December 31, 2016 primarily due to elevated paydowns of mature accounts during the first half of 2017. Average residential mortgage loans increased $952 million, or 6%, from December 31, 2016 primarily driven by the continued retention of certain agency conforming ARMs and certain other fixed-rate loans. Average other consumer loans and leases increased $355 million, or 54%, primarily due to growth in point-of-sale loan originations.

Securities are classified as trading when bought and held principally for the purpose of selling them in the near term. At December 31, 2017, 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, 2017 and 2016. 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 evaluating 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 26: COMPONENTS OF OTTI BY SECURITY TYPE

 

 

 
($ in millions)    2017        2016       2015          

 

 

Available-for-sale and other debt securities

   $           (54      (15      (5)       

Available-for-sale equity securities

     -        (1      -        

 

 

Total OTTI(a)

   $           (54      (16      (5)       

 

 
(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 27: COMPONENTS OF INVESTMENT SECURITIES

 

 

 
As of December 31 ($ in millions)    2017          2016          2015          2014          2013          

 

 

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

              

  U.S. Treasury and federal agencies securities

   $ 98        547        1,155        1,545        1,549      

  Obligations of states and political subdivisions securities

     43        44        50        185        187      

  Mortgage-backed securities:

              

    Agency residential mortgage-backed securities(a)

     15,281        15,525        14,811        11,968        12,294      

    Agency commercial mortgage-backed securities

     10,113        9,029        7,795        4,465        -      

    Non-agency commercial mortgage-backed securities

     3,247        3,076        2,801        1,489        1,368      

  Asset-backed securities and other debt securities

     2,183        2,106        1,363        1,324        2,146      

  Equity securities(b)

     679        697        703        701        865      

 

 

Total available-for-sale and other securities

   $       31,644            31,024            28,678            21,677            18,409      

 

 

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

              

  Obligations of states and political subdivisions securities

   $ 22        24        68        186        207      

  Asset-backed securities and other debt securities

     2        2        2        1        1      

 

 

Total held-to-maturity securities

   $ 24        26        70        187        208      

 

 

Trading securities (fair value):

              

  U.S. Treasury and federal agencies securities

   $ 12        23        19        14        5      

  Obligations of states and political subdivisions securities

     22        39        9        8        13      

  Residential mortgage-backed securities

     395        8        6        9        3      

  Asset-backed securities and other debt securities

     63        15        19        13        7      

  Equity securities

     370        325        333        316        315      

 

 

Total trading securities

   $ 862        410        386        360        343      

 

 
(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 $620 million, or 2%, from December 31, 2016 primarily due to increases in agency commercial mortgage-backed securities and non-agency commercial mortgage-backed securities, partially offset by decreases in U.S. Treasury and federal agencies securities and agency residential mortgage-backed securities.

On an amortized cost basis, available-for-sale and other securities were 25% and 24% of total interest-earning assets at December 31, 2017 and December 31, 2016, respectively. The estimated weighted-average life of the debt securities in the available-for-sale and other securities portfolio was 6.5 years at December 31, 2017 compared to 6.7 years at December 31, 2016. In addition, at December 31, 2017 and 2016 the available-for-sale and other securities portfolio had a weighted-average yield of 3.18% and 3.19%, respectively.

Trading securities increased $452 million from December 31, 2016 primarily due to an increase in agency residential mortgage-backed securities purchased as part of the Bancorp’s non-qualifying

hedging strategy to economically hedge a portion of the risk associated with the MSR portfolio. Refer to Note 12 of the Notes to Consolidated Financial Statements for further information.

Information presented in Table 28 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 $176 million at December 31, 2017 compared to $159 million at 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 28: CHARACTERISTICS OF AVAILABLE-FOR-SALE AND OTHER SECURITIES

 

As of December 31, 2017 ($ 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

   $ -                -          0.6                  2.31%          

Average life 1 – 5 years

     -                -          3.7                  3.16             

Average life 5 – 10 years

     98                98          5.1                  2.12             

Total

   $             98                98          5.1                  2.12%          

Obligations of states and political subdivisions securities:(a)

           

Average life of 1 year or less

     9                9          0.3                  0.02             

Average life 1 – 5 years

     18                19          4.4                  4.17             

Average life 5 – 10 years

     16                16          6.3                  3.67             

Total

   $ 43                44          4.2                  3.13%          

Agency residential mortgage-backed securities:

           

Average life of 1 year or less

     87                88          0.7                  3.81             

Average life 1 – 5 years

     6,476                6,488          3.6                  3.43             

Average life 5 – 10 years

     7,844                7,875          6.8                  3.12             

Average life greater than 10 years

     874                868          11.1                  3.07             

Total

   $ 15,281                15,319          5.7                  3.25%          

Agency commercial mortgage-backed securities:

           

Average life of 1 year or less

     8                8          0.4                  2.88             

Average life 1 – 5 years

     2,799                2,794          3.5                  2.90             

Average life 5 – 10 years

     6,273                6,335          7.3                  3.04             

Average life greater than 10 years

     1,033                1,030          12.1                  3.00             

Total

   $ 10,113                10,167          6.7                  3.00%          

Non-agency commercial mortgage-backed securities:

           

Average life of 1 year or less

     24                24          0.5                  3.86             

Average life 1 – 5 years

     137                138          3.1                  3.15             

Average life 5 – 10 years

     3,086                3,131          7.0                  3.26             

Total

   $ 3,247                3,293          6.7                  3.26%          

Asset-backed securities and other debt securities:

           

Average life of 1 year or less

     17                17          0.6                  3.24             

Average life 1 – 5 years

     528                533          2.9                  3.49             

Average life 5 – 10 years

     259                264          7.5                  2.99             

Average life greater than 10 years

     1,379                1,404          15.4                  3.41             

Total

   $ 2,183                2,218          11.3                  3.38%          

Equity securities

     679                681                      

Total available-for-sale and other securities

   $ 31,644                31,820          6.5                  3.18%          
(a)

Taxable-equivalent yield adjustments included in the above table are 0.00%, 2.25%, 2.00% and 1.69% 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. Average core deposits represented 71% and 70% of the Bancorp’s average asset funding base for the years ended December 31, 2017 and 2016, respectively.

 

 

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

 

TABLE 29: COMPONENTS OF DEPOSITS     

 

 

 
As of December 31 ($ in millions)         2017            2016            2015            2014            2013        

 

 

Demand

   $      35,276          35,782          36,267          34,809          32,634    

Interest checking

        27,703          26,679          26,768          26,800          25,875    

Savings

        13,425          13,941          14,601          15,051          17,045    

Money market

        20,097          20,749          18,494          17,083          11,644    

Foreign office

        484          426          464          1,114          1,976    

 

 

Transaction deposits

        96,985          97,577          96,594          94,857          89,174    

Other time

        3,775          3,866          4,019          3,960          3,530    

 

 

Core deposits

        100,760          101,443          100,613          98,817          92,704    

Certificates $100,000 and over(a)

        2,402          2,378          2,592          2,895          6,571    

Other

        -          -          -          -          -    

 

 

Total deposits

   $          103,162                  103,821                  103,205                  101,712                  99,275    

 

 
(a)

Includes $1.3 billion, $1.3 billion, $1.5 billion, $1.8 billion and $2.3 billion of institutional, retail and wholesale certificates $250,000 and over at December 31, 2017, 2016, 2015, 2014 and 2013, respectively.

 

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Core deposits decreased $683 million, or 1%, from December 31, 2016, driven by a decrease of $592 million in transaction deposits. Transaction deposits decreased from December 31, 2016 primarily due to decreases in money market deposits, savings deposits and demand deposits partially offset by an increase in interest checking deposits. Money market deposits decreased $652 million, or 3%, from December 31, 2016 primarily due to lower balances per account for commercial customers partially offset by competitive pricing related to a promotional product offering during the second half of 2017 which drove customer acquisition for consumer

accounts. The money market promotional product offering also drove balance migration from savings deposits, which decreased $516 million, or 4%, compared to December 31, 2016. Demand deposits decreased $506 million, or 1%, from December 31, 2016 primarily due to lower balances per account for commercial customers. Interest checking deposits increased $1.0 billion, or 4%, from December 31, 2016 primarily due to the acquisition of new commercial customers.

 

 

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

 

TABLE 30: COMPONENTS OF AVERAGE DEPOSITS

                      
($ in millions)         2017        2016         2015          2014          2013            

Demand

   $ 35,093          35,862          35,164          31,755          29,925      

Interest checking

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

Savings

     13,958          14,346          14,951          16,080          18,440      

Money market

     20,231          19,523          18,152          14,670          9,467      

Foreign office

     388          497          817          1,828          1,501      

Transaction deposits

     96,052          95,371          95,244          89,715          82,915      

Other time

     3,771          4,010          4,051          3,762          3,760      

Core deposits

     99,823          99,381          99,295          93,477          86,675      

Certificates $100,000 and over(a)

     2,564          2,735          2,869          3,929          6,339      

Other

     277          333          57          -          17      

Total average deposits

   $         102,664              102,449              102,221              97,406              93,031      
(a)

Includes $1.4 billion, $1.5 billion, $1.6 billion, $1.8 billion and $2.1 billion of average institutional, retail and wholesale certificates $250,000 and over during the years ended December 31, 2017, 2016, 2015, 2014 and 2013, respectively.

 

On an average basis, core deposits increased $442 million from December 31, 2016 primarily due to an increase of $681 million in average transaction deposits partially offset by a decrease of $239 million in average other time deposits. The increase in average transaction deposits was driven by increases in average interest checking deposits and average money market deposits partially offset by decreases in average demand deposits and average savings deposits. Average interest checking deposits increased $1.2 billion, or 5%, from December 31, 2016 primarily due to the acquisition of new commercial customers. Average money market deposits increased $708 million, or 4%, primarily due to competitive pricing related to a promotional product offering during the second half of 2017 which drove customer acquisition for consumer accounts. The money market promotional product offering also drove balance migration from savings deposits, which decreased $388 million, or 3%, compared to December 31, 2016.

The increase in average money market deposits was partially offset by lower average balances per account for commercial customers. Average demand deposits decreased $769 million, or 2%, from December 31, 2016 primarily due to lower average balances per account for commercial customers. Average other time deposits decreased $239 million, or 6%, from December 31, 2016 primarily due to a decrease in average certificates less than $100,000 as a result of the low rate environment. The change in average core deposits from December 31, 2016 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 the first half of 2016.

Average certificates $100,000 and over decreased $171 million, or 6%, from December 31, 2016 due primarily to the maturity and run-off of institutional certificates of deposit since December 31, 2016.

 

 

Contractual Maturities

The contractual maturities of certificates $100,000 and over as of December 31, 2017 are summarized in the following table:    

 

TABLE 31: CONTRACTUAL MATURITIES OF CERTIFICATES $100,000 AND OVER   
($ in millions)        

Next 3 months

   $ 805      

3-6 months

     184      

6-12 months

     383      

After 12 months

     1,030      

Total certificates $100,000 and over

   $         2,402      

 

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The contractual maturities of other time deposits and certificates $100,000 and over as of December 31, 2017 are summarized in the following table:

 

TABLE 32: CONTRACTUAL MATURITIES OF OTHER TIME DEPOSITS AND CERTIFICATES $100,000 AND OVER   
($ in millions)        

Next 12 months

   $ 3,266      

13-24 months

     1,365      

25-36 months

     1,136      

37-48 months

     339      

49-60 months

     62      

After 60 months

     9      

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

   $         6,177      

 

Borrowings

The Bancorp accesses a variety of 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 33

summarizes the end of period components of total borrowings. Average total borrowings as a percent of average interest-bearing liabilities were 21% at December 31, 2017 compared to 22% at December 31, 2016.

 

 

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

 

TABLE 33: COMPONENTS OF BORROWINGS    

              

 

 
As of December 31 ($ in millions)    2017      2016      2015      2014      2013  

 

 

Federal funds purchased

   $ 174        132        151        144        284      

Other short-term borrowings

     4,012        3,535        1,507        1,556        1,380      

Long-term debt

     14,904        14,388        15,810        14,932        9,605      

 

 

Total borrowings

   $         19,090            18,055            17,468            16,632            11,269      

 

 

 

Total borrowings increased $1.0 billion, or 6%, from December 31, 2016 primarily due to increases in long-term debt and other short-term borrowings. Long-term debt increased $516 million from December 31, 2016 primarily driven by the issuances of $1.5 billion of unsecured senior fixed-rate bank notes, $300 million of unsecured senior floating-rate bank notes and asset-backed securities of $750 million related to an automobile loan securitization during the year ended December 31, 2017. These increases were partially offset by $787 million of pay downs on long-term debt associated with automobile loan securitizations and the maturity of $650 million of unsecured senior bank notes and $500 million of unsecured subordinated debt during the year ended December 31, 2017. 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. Other short-term borrowings increased $477 million, from December 31, 2016 driven by an increase of $625 million in FHLB short-term borrowings partially offset by a $115 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.

 

 

The following table summarizes the components of average borrowings:

 

TABLE 34: COMPONENTS OF AVERAGE BORROWINGS    

              

 

 
For the years ended December 31 ($ in millions)    2017      2016      2015      2014      2013  

 

 

Federal funds purchased

   $ 557        506        920        458        503      

Other short-term borrowings

     3,158        2,845        1,721        1,873        3,024      

Long-term debt

     13,804        15,394        14,644        12,894        7,886      

 

 

Total average borrowings

   $         17,519                18,745              17,285              15,225              11,413      

 

 

 

Total average borrowings decreased $1.2 billion, or 7%, compared to December 31, 2016, primarily due to a decrease in average long-term debt partially offset by an increase in average other short-term borrowings. Average long-term debt decreased $1.6 billion compared to December 31, 2016. The decrease was driven primarily by the maturities of unsecured senior notes and subordinated debt, as discussed above, during the first half of 2017, and paydowns on long-term debt associated with automobile loan securitizations. These were partially offset by the issuances of long-term debt, as discussed above, primarily during the second half of 2017. Average

other short-term borrowings increased $313 million compared to December 31, 2016, driven primarily by the aforementioned increase in FHLB short-term borrowings partially offset by the decrease in securities sold under repurchase agreements. Information on the average rates paid on borrowings is discussed in the Net Interest Income subsection of the Statements of Income Analysis section of MD&A. In addition, refer to the Liquidity Risk Management subsection of the Risk Management section of MD&A for a discussion on the role of borrowings in the Bancorp’s liquidity management.

 

 

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RISK MANAGEMENT - OVERVIEW

 

Risk management is critical for effectively serving customers’ financial needs while protecting the Bancorp and achieving strategic goals. It is also essential to reducing the volatility of earnings and safeguarding our brand and reputation. Further, risk management is integral to the Bancorp’s strategic and capital planning processes. It is essential that the Bancorp’s business strategies consistently align to its overall risk appetite and capital considerations. Maintaining risks within the Bancorp’s risk appetite requires that risks are understood by all employees across the enterprise, and appropriate risk mitigants and controls are in place to limit risk to within the risk appetite. To achieve this, the Bancorp implements a framework for managing risk that encompasses business as usual activities and the utilization of a risk process for identifying, assessing, managing, monitoring and reporting risks.

Fifth Third uses a structure consisting of three lines of defense in order to clarify the roles and responsibilities for effective risk management.

The risk taking functions within the lines of business comprise the first line of defense. The first line of defense originates risk through normal business as usual activities; therefore, it is essential that they monitor, assess and manage the risks being taken, implement controls necessary to mitigate those risks and take responsibility for managing their business within the Bancorp’s risk appetite.

Control functions, such as the Risk Management organization, are the second line of defense and are responsible for providing challenge, oversight and governance of activities performed by the first line.

The Audit division is the third line of defense and provides an independent assessment of the Bancorp’s internal control structure and related systems and processes. The Credit Risk Review division provides an independent assessment of credit risk, which includes 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.

Fifth Third’s core values and culture provide a foundation for supporting sound risk management practices by setting expectations for appropriate conduct and accountability across the organization.

All employees are expected to conduct themselves in alignment with Fifth Third’s core values and Code of Business Conduct & Ethics, which may be found on www.53.com, while carrying out their responsibilities. Fifth Third’s Corporate Responsibility and Reputation Committee provides oversight of business conduct policies, programs and strategies, and monitors reporting of potential misconduct, trends or themes across the enterprise. Prudent risk management is a responsibility that is expected from all employees across the first, second and third lines of defense and is a foundational element of Fifth Third’s culture.

Below are the Bancorp’s core principles of risk management that are used to ensure the Bancorp is operating in a safe and sound manner:

   

Understand the risks taken as a necessary part of business; however, the Bancorp ensures risks taken are in alignment with its strategy and risk appetite.

   

Provide transparency and escalate risks and issues as necessary.

   

Ensure Fifth Third’s products and services are designed, delivered and maintained to provide value and benefit to its customers and to Fifth Third, and that potential opportunities remain aligned to the core customer base.

   

Avoid risks that cannot be understood, managed and monitored.

   

Act with integrity in all activities.

   

Focus on providing operational excellence by providing reliable, accurate and efficient services to meet customer’s needs.

   

Maintain a strong financial position to ensure that the Bancorp meets its strategic objectives through all economic cycles and is able to access the capital markets at all times, even under stressed conditions.

   

Protect the Bancorp’s reputation by thoroughly understanding the consequences of business strategies, products and processes.

   

Conduct business in compliance with all applicable laws, rules and regulations and in alignment with internal policies and procedures.

Fifth Third’s success is dependent on effective risk management and understanding and controlling the risks taken in order to deliver sustainable returns for employees and shareholders. The Bancorp’s goal is to ensure that aggregate risks do not exceed its risk capacity, and that risks taken are supportive of the Bancorp’s portfolio diversification and profitability objectives.

Fifth Third’s Risk Management Framework, states its risk appetite and the linkage to strategic and capital planning, defines and sets the tolerance for each of the eight risk types, explains the process used to manage risk across the enterprise and sets forth its risk governance structure.

   

The Board of Directors (the “Board”) and executive management define the risk appetite, which is considered in the development of business strategies, and forms the basis for enterprise risk management. The Bancorp’s risk appetite is set annually in alignment with the strategic, capital and financial plans, and is reviewed by the Board on an annual basis.

   

The Risk Management Process provides a consistent and integrated approach for managing risks and ensuring appropriate risk mitigants and controls are in place, and risks and issues are appropriately escalated. Five components are utilized for effective risk management; identifying, assessing, managing, monitoring and reporting risks.

   

The Board and executive management have identified eight risk types for monitoring the overall risk of the Bancorp; Credit Risk, Market Risk, Liquidity Risk, Operational Risk, Regulatory Compliance Risk, Legal Risk, Reputation Risk and Strategic Risk, and have also qualitatively established a risk tolerance, which is defined as the maximum amount of risk the Bancorp is willing to take for each of the eight risk types. These risk types are assessed on an ongoing basis and reported to the board each quarter, or more frequently, if necessary. In addition, each business and operational function (first line of defense) is accountable for proactively identifying and managing risk using its risk management process. Risk tolerances and risk limits are also established, where appropriate, in order to ensure that businesses and operational functions across the enterprise are able to monitor and manage risks at a more granular level, while ensuring that aggregate risks across the enterprise do not exceed the overall risk appetite.

   

The Bancorp’s risk governance structure includes management committees operating under delegation from, and providing information directly or indirectly to, the Board. The Bancorp Board delegates certain responsibilities to Board sub-committees, including the RCC as outlined in each respective Committee Charter, which may be found on www.53.com.

 

 

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The ERMC, which reports to the RCC, comprises senior management from across the Bancorp and reviews and approves risk management frameworks and policies, oversees the management of all risk types to ensure that aggregated risks remain within the Bancorp’s risk

   

appetite, and fosters a risk culture to ensure appropriate escalation and transparency of risks.

 

 

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 which are described below. These practices include the use of intentional risk-based limits for single name exposures and counterparty selection criteria designed to reduce or eliminate exposure to borrowers who have higher than average default risk and defined weaknesses in financial performance. The Bancorp carefully designed and monitors 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 allowance for credit losses 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 and consumer portfolios using the CCAR model and for certain portfolios, such as real estate and leveraged lending, the stress testing is performed by Credit department personnel at the individual loan level during credit underwriting.

 

 

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

 

TABLE 35: POTENTIAL PROBLEM PORTFOLIO LOANS AND LEASES

 

 

 
As of December 31, 2017 ($ in millions)    Carrying
Value
     Unpaid
Principal
Balance
     Exposure   

 

 

Commercial and industrial loans

   $ 911        912        1,370   

Commercial mortgage loans

     138        138        138   

Commercial leases

     70        70        70   

 

 

Total potential problem portfolio loans and leases

   $             1,119                    1,120                    1,578   

 

 

 

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   

 

 

 

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. A “through the cycle” rating philosophy uses a grading scale that assigns ratings based on average default rates through an entire business cycle for borrowers with similar financial performance. 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. 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 2016-13Measurement of Credit Losses on Financial Instruments,” which will be effective for the Bancorp on January 1, 2020. Scoring systems, various analytical tools and portfolio performance monitoring are used to assess the credit risk in the Bancorp’s homogenous consumer and small business loan portfolios.

 

 

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Overview

Economic growth continues to improve as data has been broadly positive in the fourth quarter of 2017. Growth is expected to continue in 2018 with the implementation of new corporate and consumer tax reduction programs. There have been steady gains in the job market and real GDP is expected to expand at a faster pace in 2018. Household spending continues to be the strongest driver of the U.S. economy. Inflation continues to run below the FRB’s stated objective, however the rate of inflation is expected to increase in 2018. 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. The Bancorp is monitoring potential increased risks in the Retail sector as a result of profitability declines among many large retailers and the year-end 2017 results are expected to show a continued shift to online purchasing.

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 37: COMMERCIAL MORTGAGE LOANS OUTSTANDING BY LTV, LOANS GREATER THAN $1 MILLION

 

 

 
As of December 31, 2017 ($ in millions)    LTV > 100%      LTV 80-100%      LTV < 80%       

 

 

Commercial mortgage owner-occupied loans

   $ 79           110            2,222          

Commercial mortgage nonowner-occupied loans

     14           169            2,208          

 

 

Total

   $                 93                       279                        4,430          

 

 

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          

 

 

 

66  Fifth Third Bancorp


Table of Contents

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

 

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 39: COMMERCIAL LOAN AND LEASE PORTFOLIO (EXCLUDING LOANS AND LEASES HELD FOR SALE)

 

 

 
     2017        2016  
  

 

 

      

 

 

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

 

 

By Industry:

                           

Manufacturing

   $ 10,044               18,948          74            10,070              19,646          50        

Real estate

     7,713               12,493          25            7,206              11,919          26        

Financial services and insurance

     5,792               11,933          1            5,648              11,522          2        

Healthcare

     4,712               6,486          35            4,649              6,450          23        

Business services

     4,147               6,512          42            4,599              6,996          65        

Retail trade

     3,617               7,950          3            4,048              7,598          6        

Communication and information

     3,322               5,308          -            2,901              4,726          -        

Accommodation and food

     3,268               5,321          4            3,051              4,817          5        

Wholesale trade

     3,017               5,363          6            3,482              6,249          24        

Transportation and warehousing