FIFTH THIRD BANCORP The following is Management's Discussion and Analysis of Financial Condition and Results of Operations of certain significant factors that have affectedFifth Third Bancorp's (the "Bancorp" or "Fifth Third") financial condition and results of operations during the periods included in the Condensed Consolidated Financial Statements, which are a part of this filing. Reference to the Bancorp incorporates the parent holding company and all consolidated subsidiaries. The Bancorp's banking subsidiary is referred to as the Bank. 3 -------------------------------------------------------------------------------- Table of Contents TABLE 1: Selected Financial Data For the three months ended For the six months ended June 30, % June 30, % ($ in millions, except for per share data) 2020 2019 Change 2020 2019 Change Income Statement Data Net interest income (U.S. GAAP)$ 1,200 1,245 (4)$ 2,429 2,327 4 Net interest income (FTE)(a)(b) 1,203 1,250 (4) 2,436 2,336 4 Noninterest income 650 660 (2) 1,321 1,761 (25) Total revenue (FTE)(a) 1,853 1,910 (3) 3,757 4,097 (8) Provision for credit losses(c) 485 85 471 1,125 175 543 Noninterest expense 1,121 1,243 (10) 2,321 2,341 (1) Net income 195 453 (57) 243 1,228 (80) Net income available to common shareholders 163 427 (62) 193 1,187 (84) Common Share Data Earnings per share - basic$ 0.23 0.57 (60)$ 0.27 1.68 (84) Earnings per share - diluted 0.23 0.57 (60) 0.27 1.66 (84) Cash dividends declared per common share 0.27 0.24 13 0.54 0.46 17 Book value per share 28.88 26.17 10 28.88 26.17 10 Market value per share 19.28 27.90 (31) 19.28 27.90 (31) Financial Ratios Return on average assets 0.40 % 1.08 (63) 0.26 % 1.56 (83) Return on average common equity 3.2 9.1 (65) 1.9 13.9 (86) Return on average tangible common equity(b) 4.3 12.3 (65) 2.7 17.8 (85) Dividend payout 117.4 42.1 179 200.0 27.4 630
Average total Bancorp shareholders' equity
as a percent of average assets 11.30 12.02 (6) 11.92 11.74 2
Tangible common equity as a percent of tangible
assets (excluding AOCI)(b) 6.77 8.27 (18) 6.76 8.27 (18) Net interest margin(a)(b) 2.75 3.37 (18) 2.99 3.33 (10) Net interest rate spread (a)(b) 2.55 2.95 (14) 2.75 2.91 (5) Efficiency(a)(b) 60.5 65.1 (7) 61.8 57.1 8 Credit Quality Net losses charged-off$ 130 78 67$ 252 156 62 Net losses charged-off as a percent of average portfolio loans and leases 0.44 % 0.29 52 0.44 % 0.30 47 ALLL as a percent of portfolio loans and leases 2.34 1.02 129 2.34 1.02 129 ACL as a percent of portfolio loans and leases(d) 2.50 1.15 117 2.50 1.15 117 Nonperforming portfolio assets as a percent of portfolio loans and leases and OREO 0.65 0.51 27 0.65 0.51 27 Average Balances Loans and leases, including held for sale$ 119,418 110,993 8$ 115,799 104,712 11 Securities and other short-term investments 56,806 37,797 50 47,920 36,953 30 Total assets 198,387 167,578 18 185,129 158,324 17 Transaction deposits(e) 142,079 112,847 26 130,087 106,780 22 Core deposits(f) 146,500 118,525 24 134,838 112,051 20 Wholesale funding(g) 23,739 23,633 - 22,786 22,915 (1) Bancorp shareholders' equity 22,420 20,135 11 22,066 18,588 19Regulatory Capital (h) CET1 capital 9.72 % 9.57 2 9.72 % 9.57 2 Tier I risk-based capital 10.96 10.62 3 10.96 10.62 3 Total risk-based capital 14.24 13.53 5 14.24 13.53 5 Tier I leverage 8.16 9.24 (12) 8.16 9.24 (12) (a)Amounts presented on an FTE basis. The FTE adjustments for the three months endedJune 30, 2020 and 2019 were$3 and$5 , respectively, and for the six months endedJune 30, 2020 and 2019 were$7 and$9 , respectively. (b)These are non-GAAP measures. For further information, refer to the Non-GAAP Financial Measures section of MD&A. (c)The provision for credit losses is the sum of the provision for loan and lease losses and the provision for the reserve for unfunded commitments. (d)The ACL is the sum of the ALLL and the reserve for unfunded commitments. (e)Includes demand deposits, interest checking deposits, savings deposits, money market deposits and foreign office deposits. (f)Includes transaction deposits and other time deposits. (g)Includes certificates$100,000 and over, other deposits, federal funds purchased, other short-term borrowings and long-term debt. (h)Regulatory capital ratios as ofJune 30, 2020 are calculated pursuant to the five-year transition provision option to phase in the effects of CECL on regulatory capital. 4 -------------------------------------------------------------------------------- Table of Contents Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) OVERVIEWFifth Third Bancorp is a diversified financial services company headquartered inCincinnati, Ohio . AtJune 30, 2020 , the Bancorp had$202.9 billion in assets and operated 1,122 full-service banking centers and 2,456 Fifth Third branded ATMs in ten states throughout the Midwestern and Southeastern regions of theU.S. The Bancorp reports on four business segments: Commercial Banking, Branch Banking, Consumer Lending and Wealth and Asset Management. This overview of MD&A highlights selected information in the financial results of the Bancorp and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources and critical accounting policies and estimates, you should carefully read this entire document as well as the Bancorp's Annual Report on Form 10-K for the year endedDecember 31, 2019 . Each of these items could have an impact on the Bancorp's financial condition, results of operations and cash flows. In addition, refer to the Glossary of Abbreviations and Acronyms in this report for a list of terms included as a tool for the reader of this quarterly report on Form 10-Q. The abbreviations and acronyms identified therein are used throughout this MD&A, as well as the Condensed Consolidated Financial Statements and Notes to Condensed 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 both the three and six months endedJune 30, 2020 , net interest income on an FTE basis and noninterest income provided 65% and 35% of total revenue, respectively. The Bancorp derives the majority of its revenues within theU.S. from customers domiciled in theU.S. Revenue from foreign countries and external customers domiciled in foreign countries was immaterial to the Condensed Consolidated Financial Statements for the three and six months endedJune 30, 2020 . 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, commercial banking revenue, wealth and asset management revenue, mortgage banking net revenue, card and processing revenue, leasing business revenue, other noninterest income and net securities gains or losses. Noninterest expense includes compensation and benefits, technology and communications costs, net occupancy expense, leasing business expense, equipment expense, card and processing expense, marketing expense and other noninterest expense.
COVID-19 Global Pandemic TheU.S. economy continued to retract during the second quarter of 2020 as a result of the spread of COVID-19. To address concerns that COVID-19 may overwhelm the health care system, states across theU.S. declared lockdowns that restricted social gatherings and ordered temporary closures of businesses deemed non-essential. Despite the partial lifting of these measures in some of the states in the Bancorp's geographic footprint, the recent increase in cases means that it remains unknown when there will be a return to normal economic activity. During the second quarter of 2020, the Bancorp observed the impact of the pandemic on its business. The decline of asset prices, reduction in interest rates, widening of credit spreads, borrower and counterparty credit deterioration and market volatility had the most immediate negative impacts on current quarter performance. Although the Bancorp is unable to estimate the extent of the impact, the continuing pandemic and related global economic crisis will adversely impact its future operating results. As the cases of COVID-19 continued to rise, the disruption in the financial markets led the FRB to enact unprecedented policies to offset the forced liquidations and restore liquidity in the financial markets. The FRB cut rates to the zero lower bound, announced unlimited purchases of treasuries along with agency mortgage-backed securities and commercial mortgage-backed securities, and announced several facilities designed to support the smooth functioning of credit markets. 5 -------------------------------------------------------------------------------- Table of Contents Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Government Response to theCOVID-19 Pandemic Congress , the FRB and the otherU.S. state and federal financial regulatory agencies have taken actions to mitigate disruptions to economic activity and financial stability resulting from the COVID-19 pandemic. The descriptions below summarize certain significant government actions taken in response to the COVID-19 pandemic. The descriptions are qualified in their entirety by reference to the particular statutory or regulatory provisions or government programs summarized. The CARES Act The Coronavirus Aid, Relief and Economic Security (CARES) Act was signed into law onMarch 27, 2020 and has subsequently been amended several times. Among other provisions, the CARES Act includes funding for the SBA to expand lending, relief from certainU.S. GAAP requirements to allow COVID-19-related loan modifications to not be categorized as TDRs and a range of incentives to encourage deferment, forbearance or modification of consumer credit and mortgage contracts. One of the key CARES Act programs is the Paycheck Protection Program, which temporarily expands the SBA's business loan guarantee program throughAugust 8, 2020 . Paycheck Protection Program loans are available to a broader range of entities than ordinary SBA loans, require six-month deferral of principal and interest repayment, and the loan may be forgiven in an amount equal to payroll costs and certain other expenses during either an eight-week or twenty-four week covered period. The CARES Act contains additional protections for homeowners and renters of properties with federally-backed mortgages, including a 60-day moratorium on the initiation of foreclosure proceedings beginning onMarch 18, 2020 and a 120-day moratorium on initiating eviction proceedings effectiveMarch 27, 2020 . Borrowers of federally-backed mortgages have the right under the CARES Act to request up to 360 days of forbearance on their mortgage payments if they experience financial hardship directly or indirectly due to the COVID-19 public health emergency. Fannie Mae and Freddie Mac have independently extended their moratorium on foreclosures and evictions for single-family federally backed mortgages until at leastAugust 31, 2020 . Also pursuant to the CARES Act, theU.S. Treasury has the authority to provide loans, guarantees and other investments in support of eligible businesses, states and municipalities affected by the economic effects of COVID-19. Some of these funds have been used to support several FRB programs and facilities described below or additional programs or facilities that are established by its authority under Section 13(3) of the Federal Reserve Act and meeting certain criteria. FRB Actions The FRB has taken a range of actions to support the flow of credit to households and businesses. For example, onMarch 15, 2020 , the FRB reduced the target range for the federal funds rate to 0 to 0.25% and announced that it would increase its holdings ofU.S. Treasury securities and agency mortgage-backed securities and begin purchasing agency commercial mortgage-backed securities. The FRB has also encouraged depository institutions to borrow from the discount window and has lowered the primary credit rate for such borrowing by 150 basis points while extending the term of such loans up to 90 days. Reserve requirements have been reduced to zero as ofMarch 26, 2020 . In addition, the FRB has established, or has taken steps to establish, a range of facilities and programs to support theU.S. economy andU.S. marketplace participants in response to economic disruptions associated with COVID-19. Through these facilities and programs, the FRB, relying on its authority under Section 13(3) of the Federal Reserve Act, has taken steps to directly or indirectly purchase assets from, or make loans to,U.S. companies, financial institutions, municipalities and other market participants. FRB facilities and programs established, or in the process of being established, include: •Paycheck Protection Program Liquidity Facility to provide financing related to Paycheck Protection Program loans made by banks; •Main Street New Loan Facility, a Main Street Priority Loan Facility, and a Main Street Expanded Loan Facility to purchase loan participations, under specified conditions, from banks lending to small and mediumU.S. businesses; •Primary Dealer Credit Facility to provide liquidity to primary dealers through a secured lending facility; •Commercial Paper Funding Facility to purchase the commercial paper of certainU.S. issuers; •Primary Market Corporate Credit Facility to purchase corporate bonds directly from, or make loans directly to, eligible participants; •Secondary Market Corporate Credit Facility to purchase corporate bonds trading in secondary markets, including from exchange-traded funds, that were issued by eligible participants; •Term Asset-Backed Securities Loan Facility to make loans secured by asset-backed securities; •Municipal Liquidity Facility to purchase bonds directly fromU.S. state, city and county issuers; and •Money Market Mutual Fund Liquidity Facility to purchase certain assets from, or make loans to, financial institutions providing financing to eligible money market mutual funds. These facilities and programs are in various stages of development, and the Bancorp and the Bank currently, or may in the future participate in some of them, including as an agent or intermediary on behalf of clients or customers or in an advisory capacity. For commercial and consumer customers, Fifth Third has provided a host of relief options, including loan covenant relief, loan maturity extensions, payment deferrals and fee waivers. 6 -------------------------------------------------------------------------------- Table of Contents Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Paycheck Protection Program As previously discussed, the Bancorp is participating in the SBA's Paycheck Protection Program which was created by the CARES Act onMarch 27, 2020 . The Bancorp has originated approximately 37,000 loans in the amount of$5.5 billion under the program as ofJune 30, 2020 . For further discussion on Fifth Third's hardship relief programs as a result of the COVID-19 pandemic, refer to the Credit Risk Management subsection of the Risk Management section of MD&A and Note 4 and Note 7 of the Notes to Condensed Consolidated Financial Statements. Senior Notes Offering OnJanuary 31, 2020 , the Bank issued and sold, under its bank notes program,$1.25 billion in aggregate principal amount of senior fixed-rate notes. The bank notes consisted of$650 million of 1.80% senior fixed-rate notes, with a maturity of three years, due onJanuary 30, 2023 ; and$600 million of 2.25% senior fixed-rate notes, with a maturity of seven years, due onFebruary 1, 2027 . OnMay 5, 2020 , the Bancorp issued and sold$1.25 billion in aggregate principal amount of senior fixed-rate notes. The notes consisted of$500 million of 1.625% senior fixed-rate notes, with a maturity of three years, due onMay 5, 2023 ; and$750 million of 2.55% senior fixed-rate notes, with a maturity of seven years, due onMay 5, 2027 .
For more information on the senior notes offerings, including disclosure on the redemption options, refer to Note 17 of the Notes to Condensed Consolidated Financial Statements.
LIBOR Transition InJuly 2017 , the Chief Executive of theUnited Kingdom Financial Conduct Authority (the "FCA"), which regulates LIBOR, announced thatFCA will stop persuading or compelling banks to submit rates for the calculation of LIBOR to the administrator of LIBOR after 2021. Since then, central banks around the world, including theFederal Reserve , have commissioned working groups of market participants and official sector representatives with the goal of finding suitable replacements for LIBOR. The Bancorp has substantial exposure to LIBOR-based products within its commercial lending, commercial deposits, business banking, consumer lending and capital markets lines of business as well as corporate treasury function. It is expected that a transition away from the widespread use of LIBOR to alternative reference rates will occur over the course of the next few years. Although the full impact of such reforms and actions remains unclear, the Bancorp is preparing to transition from LIBOR to these alternative reference rates. The Bancorp's transition plan includes a number of key work streams, including continued engagement with central bank and industry working groups and regulators, active client engagement, comprehensive review of legacy documentation, internal operational readiness, and risk management, among other things, to facilitate the transition to alternative reference rates. The transition away from LIBOR is expected to be gradual and complicated. There remain a number of unknown factors regarding the transition from LIBOR that could impact the Bancorp's business, including, for example, the pace of the transition to replacement rates, including industry coalescence around an alternative reference rate such as SOFR, our ability to identify exposures to LIBOR across our business lines, the specific terms and parameters for any potential alternative reference rates, the prices of and the liquidity of trading markets for products based on the alternative reference rates, our ability to transition to and develop appropriate systems and analytics for one or more alternative reference rates, our ability to maintain contractual continuity and our ability to identify and remediate any operational issues. For a further discussion of the various risks the Bancorp faces in connection with the expected replacement of LIBOR on its operations, see "Risk Factors-Market Risks-The replacement of LIBOR could adversely affect Fifth Third's revenue or expenses and the value of those assets or obligations." in Item 1A. Risk Factors of the Bancorp's Annual Report on Form 10-K for the year endedDecember 31, 2019 . Key Performance Indicators The Bancorp, as a banking institution, utilizes various key indicators of financial condition and operating results in managing and monitoring the performance of the business. In addition to traditional financial metrics, such as revenue and expense trends, the Bancorp monitors other financial measures that assists in evaluating growth trends, capital strength and operational efficiencies. The Bancorp analyzes these key performance indicators against its past performance, its forecasted performance and with the performance of its peer banking institutions. These indicators may change from time to time as the operating environment and businesses change.
The following are key performance indicators used by management to make operating decisions and capital utilization:
•CET1 Capital Ratio: CET1 capital divided by risk-weighted assets as defined by
the Basel III standardized approach to risk-weighting of assets
•Return on Average Tangible Common Equity (non-GAAP): Tangible net income
available to common shareholders divided by average tangible common equity
•Efficiency Ratio: Noninterest expense divided by the sum of net interest income
on an FTE basis (non-GAAP) and noninterest income
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•Earnings per share, diluted: Net income allocated to common shareholders
divided by average common shares outstanding after the effect of dilutive
stock-based awards
•Nonperforming portfolio assets ratio: Nonperforming portfolio assets divided by
portfolio loans and leases and OREO
•Return on average assets: Net income annualized divided by quarterly average
assets
Earnings Summary
The Bancorp's net income available to common shareholders for the second quarter
of 2020 was $163 million , or $0.23 per diluted share, which was net of $32
million in preferred stock dividends. The Bancorp's net income available to
common shareholders for the second quarter of 2019 was $427 million , or $0.57
per diluted share, which was net of $26 million in preferred stock dividends.
The Bancorp's net income available to common shareholders for the six months
ended June 30, 2020 was $193 million , or $0.27 per diluted share, which was net
of $50 million in preferred stock dividends. The Bancorp's net income available
to common shareholders for the six months ended June 30, 2019 was $1.2 billion ,
or $1.66 per diluted share, which was net of $41 million in preferred stock
dividends.
Net interest income on an FTE basis (non-GAAP) was $1.2 billion for the three
months ended June 30, 2020 , a decrease of $47 million compared to the same
period in the prior year. Net interest income was negatively impacted by
decreases in yields on average interest-earning assets of 121 bps. The decreases
in yields on average interest-earning assets were primarily driven by decreases
in yields on average commercial and industrial loans, average commercial
mortgage loans, average commercial construction loans and average home equity of
132 bps, 167 bps, 218 bps and 170 bps, respectively, for the three months ended
June 30, 2020 compared to the same period in the prior year. Net interest income
was also adversely impacted by an increase in average interest checking deposits
of $13.2 billion for the three months ended June 30, 2020 compared to the same
period in the prior year. These negative impacts were partially offset by
decreases in the rates paid on average interest-bearing liabilities of 81 bps.
The decreases in rates paid on average interest-bearing liabilities were
primarily driven by decreases in average interest checking deposits, average
money market deposits, average long-term debt and average certificates $100,000
and over of 93 bps, 82 bps, 59 bps and 70 bps, respectively, for the three
months ended June 30, 2020 compared to the same period in the prior year. Net
interest income also benefited from increases in average commercial and
industrial loans and average indirect secured consumer loans of $6.9 billion and
$1.9 billion for the three months ended June 30, 2020 , respectively, compared to
the same period in the prior year.
Net interest income on an FTE basis (non-GAAP) was $2.4 billion for the six
months ended June 30, 2020 , an increase of $100 million compared to the same
period in the prior year. Net interest income was positively impacted by
decreases in the rates paid on average interest-bearing liabilities of 61 bps.
The decreases in rates paid on average interest-bearing liabilities were
primarily driven by decreases in rates paid on average interest checking
deposits, average money market deposits, average long-term debt and average
certificates $100,000 and over of 71 bps, 58 bps, 42 bps and 40 bps,
respectively, compared to the same period in the prior year. Net interest income
also benefited from increases in average commercial and industrial loans,
average indirect secured consumer loans and average commercial mortgage loans of
$6.3 billion , $2.3 billion and $2.1 billion for the six months ended June 30,
2020 , respectively, compared to the same period in the prior year. These
positive impacts were partially offset by decreases in yields on total average
loans and leases. The decreases in yields on total average loans and leases were
primarily driven by decreases in yields on average commercial and industrial
loans, average commercial mortgage loans, average commercial construction loans
and average home equity of 90 bps, 104 bps, 148 bps and 116 bps, respectively,
for the six months ended June 30, 2020 compared to the same period in the prior
year. Net interest income was also negatively impacted by an increase in average
interest checking deposits of $9.9 billion for the six months ended June 30,
2020 compared to the same period in the prior year. Net interest margin on an
FTE basis (non-GAAP) was 2.75% and 2.99% for the three and six months ended
June 30, 2020 , respectively, compared to 3.37% and 3.33% for the same periods in
the prior year.
Effective January 1, 2020 , the Bancorp adopted ASU 2016-13 which established a
new approach for estimating credit losses on certain types of financial
instruments. The Bancorp recognized an initial increase to the ACL of
approximately $653 million upon adoption of ASU 2016-13 on January 1, 2020 ,
which included $171 million from the non-PCD loan portfolio resulting from the
MB Financial, Inc. acquisition. The provision for credit losses was $485 million
and $1.1 billion for the three and six months ended June 30, 2020 , respectively,
compared to $85 million and $175 million during the same periods in the prior
year. The increases in provision expense for both the three and six months ended
June 30, 2020 compared to the same periods in the prior year were primarily due
to an increase in the ACL reflecting deterioration in the macroeconomic
environment as a result of the impact of the COVID-19 pandemic, continued
pressure on energy prices and the resulting impact of this environment on
commercial borrowers as reflected in increased levels of commercial criticized
assets. The increase in the provision for credit losses also reflected the
impact of the change in methodology for estimating credit losses from the
incurred loss methodology to the expected credit loss methodology beginning in
the first quarter of 2020. Net losses charged-off as a percent of average
portfolio loans and leases were 0.44% and 0.29% for the three months ended
June 30, 2020 and 2019, respectively, and 0.44% and 0.30% for the six months
ended June 30, 2020 and 2019, respectively. At June 30, 2020 , nonperforming
portfolio assets as a percent of portfolio loans and leases and OREO increased
to 0.65% compared to 0.62% at December 31, 2019 . For further discussion on
credit quality refer to the Credit Risk Management subsection of the Risk
Management section of MD&A as well as Note 7 of the Notes to Condensed
Consolidated Financial Statements.
Noninterest income decreased $10 million for the three months ended June 30,
2020 compared to the same period in the prior year, primarily due to decreases
in other noninterest income, service charges on deposits and leasing business
revenue, partially offset by increases in
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mortgage banking revenue and commercial banking revenue. Other noninterest
income decreased $35 million for the three months ended June 30, 2020 compared
to the three months ended June 30, 2019 primarily due to a decrease in private
equity investment income as well as increases in the net losses on disposition
and impairment of bank premises and equipment and the loss on the swap
associated with the sale of Visa, Inc. Class B Shares . Service charges on
deposits decreased $21 million for the three months ended June 30, 2020 compared
to the same period in the prior year, due to decreases in consumer deposit fees
and commercial deposit fees of $14 million and $7 million , respectively. Leasing
business revenue decreased $19 million for the three months ended June 30, 2020
compared to the same period in the prior year primarily driven by decreases in
leasing business solutions revenue and operating lease income of $13 million and
$6 million , respectively. Mortgage banking net revenue increased $36 million for
the three months ended June 30, 2020 compared to the same period in the prior
year, primarily due to increases in origination fees and gains on loan sales.
Commercial banking revenue increased $30 million for the three months ended
June 30, 2020 compared to the same period in the prior year, primarily driven by
an increase in institutional sales of $34 million , partially offset by a
decrease in loan syndication fees of $7 million .
Noninterest income decreased $440 million for the six months ended June 30, 2020
compared to the same period in the prior year, primarily due to a decrease in
other noninterest income, partially offset by increases in mortgage banking net
revenue, commercial banking revenue and leasing business revenue. Other
noninterest income decreased $598 million for the six months ended June 30, 2020
compared to the six months ended June 30, 2019 primarily due to the gain on sale
of Worldpay, Inc. shares recognized during the first quarter of 2019 as well as
a decrease in private equity investment income. Mortgage banking net revenue
increased $100 million for the six months ended June 30, 2020 , compared to the
same period in the prior year, primarily due to increases in origination fees
and gains on loan sales. Commercial banking revenue increased $52 million for
the six months ended June 30, 2020 compared to the same period in the prior
year, primarily driven by increases in institutional sales, commercial customer
derivatives and bridge fees of $43 million , $8 million and $8 million ,
respectively, partially offset by a decrease in loan syndication fees of $13
million . Leasing business revenue increased $23 million for the six months ended
June 30, 2020 compared to the same period in the prior year primarily driven by
increases in operating lease income and lease syndication fees of $12 million
and $11 million , respectively, partially offset by a decrease in leasing
business solutions revenue of $6 million .
Noninterest expense decreased $122 million for the three months ended June 30,
2020 compared to the same period in the prior year primarily due to decreases in
technology and communications expense, other noninterest expense, marketing
expense and compensation and benefits expense. The Bancorp recognized $9 million
of merger-related expenses related to the MB Financial, Inc. acquisition for the
three months ended June 30, 2020 compared to $109 million in the same period in
the prior year. Technology and communications expense decreased $46 million for
the three months ended June 30, 2020 compared to the same period in the prior
year primarily driven by decreased integration and conversion costs related to
the acquisition of MB Financial, Inc. Other noninterest expense decreased $24
million for the three months ended June 30, 2020 compared to the same period in
the prior year primarily due to decreases in losses and adjustments and travel
expense, partially offset by an increase in loan and lease expense. Marketing
expense decreased $21 million for the three months ended June 30, 2020 compared
to the same period in the prior year primarily due to the impact of the COVID-19
pandemic, which resulted in a pause or slowdown in numerous marketing campaigns,
including running less advertising as well as the suspension of cash bonus
programs. Compensation and benefits expense decreased $14 million for the three
months ended June 30, 2020 compared to the same period in the prior year
primarily due to a decrease in merger-related expenses related to the
acquisition of MB Financial, Inc. , partially offset by higher deferred
compensation expense. Compensation and benefits expense for the three months
ended June 30, 2020 included $7 million of special payments to employees
providing essential banking services through the COVID-19 pandemic.
Noninterest expense decreased $20 million for the six months ended June 30, 2020
compared to the same period in the prior year primarily due to decreases in
technology and communications expense and marketing expense, partially offset by
increases in compensation and benefits expense and other noninterest expense.
The Bancorp recognized $16 million of merger-related expenses related to the MB
Financial, Inc. acquisition for the six months ended June 30, 2020 compared to
$185 million in the same period in the prior year. Technology and communications
expense decreased $36 million for the six months ended June 30, 2020 compared to
the same period in the prior year primarily driven by decreased integration and
conversion costs related to the acquisition of MB Financial, Inc. Marketing
expense decreased $26 million for the six months ended June 30, 2020 compared to
the same period in the prior year primarily due to the impact of the COVID-19
pandemic, which resulted in a pause or slowdown in numerous marketing campaigns,
including running less advertising as well as the suspension of cash bonus
programs. Compensation and benefits expenses increased $23 million for the six
months ended June 30, 2020 compared to the same period in the prior year
primarily due to the addition of personnel costs from the acquisition of MB
Financial, Inc. and the impact of raising the Bancorp's minimum wage in the
fourth quarter of 2019, partially offset by a reduction in merger-related
expenses. Compensation and benefits expense for the six months ended June 30,
2020 included $10 million of special payments to employees providing essential
banking services through the COVID-19 pandemic. Other noninterest expense
increased $11 million for the six months ended June 30, 2020 compared to the
same period in the prior year primarily due to increases in losses and
adjustments and loan and lease expense, partially offset by a decrease in travel
expenses.
For more information on net interest income, noninterest income and noninterest expense refer to the Statements of Income Analysis section of MD&A.
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Capital Summary
The Bancorp calculated its regulatory capital ratios under the Basel III
standardized approach to risk-weighting of assets and pursuant to the five-year
transition provision option to phase in the effects of CECL on regulatory
capital as of June 30, 2020 . As of June 30, 2020 , the Bancorp's capital ratios,
as defined by the U.S. banking agencies, were:
•CET1 capital ratio: 9.72%;
•Tier I risk-based capital ratio: 10.96%;
•Total risk-based capital ratio: 14.24%;
•Tier I leverage ratio: 8.16%
NON-GAAP FINANCIAL MEASURES
The following are non-GAAP measures which provide useful insight to the reader
of the Condensed Consolidated Financial Statements but should be supplemental to
primary U.S. GAAP measures and should not be read in isolation or relied upon as
a substitute for the primary U.S. GAAP measures.
The FTE basis adjusts for the tax-favored status of income from certain loans
and securities held by the Bancorp that are not taxable for federal income tax
purposes. The Bancorp believes this presentation to be the preferred industry
measurement of net interest income as it provides a relevant comparison between
taxable and non-taxable amounts.
The following table reconciles the non-GAAP financial measures of net interest
income on an FTE basis, interest income on an FTE basis, net interest margin,
net interest rate spread and the efficiency ratio to U.S. GAAP:
TABLE 2: Non-GAAP Financial Measures - Financial Measures
and Ratios on an FTE basis
For the six months
For the three months ended ended
June 30, June 30,
($ in millions) 2020 2019 2020 2019
Net interest income (U.S. GAAP) $ 1,200 1,245 2,429 2,327
Add: FTE adjustment 3 5 7 9
Net interest income on an FTE basis (1) $ 1,203 1,250 2,436 2,336
Net interest income on an FTE basis
(annualized) (2) 4,838 5,014 4,899 4,711
Interest income (U.S. GAAP) $ 1,403 1,636 2,928 3,069
Add: FTE adjustment 3 5 7 9
Interest income on an FTE basis $ 1,406 1,641 2,935 3,078
Interest income on an FTE basis (annualized)
(3) 5,655 6,582 5,902 6,207
Interest expense (annualized) (4) $ 816 1,568 1,003 1,496
Noninterest income (5) 650 660 1,321 1,761
Noninterest expense (6) 1,121 1,243 2,321 2,341
Average interest-earning assets (7) 176,224 148,790 163,719 141,665
Average interest-bearing liabilities (8) 124,478 106,340 116,861 101,764
Ratios:
Net interest margin on an FTE basis (2) / (7) 2.75 % 3.37 2.99 3.33 Net interest rate spread on an FTE basis ((3) / (7)) - ((4) / (8)) 2.55 2.95 2.75 2.91 Efficiency ratio on an FTE basis (6) / ((1) + (5)) 60.5 65.1 61.8 57.1 The Bancorp believes return on average tangible common equity is an important measure for comparative purposes with other financial institutions, but is not defined underU.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. 10 -------------------------------------------------------------------------------- Table of Contents Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) The following table reconciles the non-GAAP financial measure of return on average tangible common equity toU.S. GAAP. TABLE 3: Non-GAAP Financial Measures - Return on Average Tangible Common Equity For the six months For the three months ended ended June 30, June 30, ($ in millions) 2020 2019 2020 2019 Net income available to common shareholders (U.S. GAAP)$ 163 427 193 1,187 Add: Intangible amortization, net of tax 9 11 20 13 Tangible net income available to common shareholders$ 172 438 213 1,200 Tangible net income available to common shareholders (annualized) (1) 692 1,757 428 2,420Average Bancorp's shareholders' equity (U.S. GAAP)$ 22,420 20,135 22,066 18,588 Less: Average preferred stock (1,770) (1,331) (1,770) (1,331) Average goodwill (4,261) (4,301) (4,256) (3,496) Average intangible assets (178) (215) (186) (137) Average tangible common equity (2)$ 16,211 14,288 15,854 13,624 Return on average tangible common equity (1) / (2) 4.3 % 12.3 2.7 17.8 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 theU.S. banking agencies. These calculations are intended to complement the capital ratios defined by theU.S. banking agencies for both absolute and comparative purposes. BecauseU.S. GAAP does not include capital ratio measures, the Bancorp believes there are no comparableU.S. GAAP financial measures to these ratios. These ratios are not formally defined byU.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 Condensed Consolidated Financial Statements in their entirety and not to rely on any single financial measure.
The following table reconciles non-GAAP capital ratios to
June 30, December 31,
As of ($ in millions) 2020 2019
Total Bancorp Shareholders' Equity (U.S. GAAP) $ 22,335 21,203
Less: Preferred stock (1,770) (1,770)
Goodwill (4,261) (4,252)
Intangible assets (171) (201)
AOCI (2,951) (1,192)
Tangible common equity, excluding AOCI (1) 13,182 13,788
Add: Preferred stock 1,770 1,770
Tangible equity (2) $ 14,952 15,558
Total Assets (U.S. GAAP) $ 202,906 169,369
Less: Goodwill (4,261) (4,252)
Intangible assets (171) (201)
AOCI, before tax (3,735) (1,509)
Tangible assets, excluding AOCI (3) $ 194,739 163,407
Ratios:
Tangible equity as a percentage of tangible assets (2) / (3) 7.68 % 9.52
Tangible common equity as a percentage of tangible assets (1) / (3) 6.77
8.44
11
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Table of Contents
Management's Discussion and Analysis of Financial Condition and Results of Operations
(continued)
RECENT ACCOUNTING STANDARDS
Note 4 of the Notes to Condensed Consolidated Financial Statements provides a
discussion of the significant new accounting standards applicable to the Bancorp
and the expected impact of significant accounting standards issued, but not yet
required to be adopted.
CRITICAL ACCOUNTING POLICIES
The Bancorp's Condensed Consolidated Financial Statements are prepared in
accordance with U.S. GAAP. Certain accounting policies require management to
exercise judgment in determining methodologies, economic assumptions and
estimates that may materially affect the 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, valuation of
servicing rights, fair value measurements, goodwill and legal contingencies.
These accounting policies are discussed in detail in the Critical Accounting
Policies section of the Bancorp's Annual Report on Form 10-K for the year ended
December 31, 2019 . On January 1, 2020 , the Bancorp adopted ASU 2016-13
("Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses
on Financial Instruments") and its related subsequent amendments, along with ASU
2017-04 ("Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for
Goodwill Impairment"). For additional information about these ASUs and their
impacts on the Bancorp, refer to Note 4 of the Notes to Condensed Consolidated
Financial Statements. In conjunction with the adoption of these ASUs, the
Bancorp has revised its Critical Accounting Policies for the ALLL, reserve for
unfunded commitments and goodwill as described below. Refer to the Critical
Accounting Policies section of the Bancorp's Annual Report on Form 10-K for the
year ended December 31, 2019 for discussion on the critical accounting policies
for the ALLL, reserve for unfunded commitments and goodwill for periods prior to
January 1, 2020 . There have been no other material changes to the valuation
techniques or models during the six months ended June 30, 2020 .
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 7 of the Notes to Condensed Consolidated Financial Statements. The Bancorp maintains the ALLL to absorb the amount of credit losses that are expected to be incurred over the remaining contractual terms of the related loans and leases. Contractual terms are adjusted for expected prepayments but are not adjusted for expected extensions, renewals or modifications except in circumstances where the Bancorp reasonably expects to execute a TDR with the borrower or where certain extension or renewal options are embedded in the original contract and not unconditionally cancellable by the Bancorp. Accrued interest receivables on loans are presented in other assets in the Condensed Consolidated Balance Sheets. When accrued interest is deemed to be uncollectible (typically when a loan is placed on nonaccrual status), interest income is reversed. The Bancorp follows established policies for placing loans on nonaccrual status, so uncollectible accrued interest receivable is reversed in a timely manner. As a result, the Bancorp has elected not to measure an allowance for credit losses for accrued interest receivables. For additional information on the Bancorp's accounting policies related to nonaccrual loans and leases, refer to Note 1 of the Notes to Consolidated Financial Statements included in the Bancorp's Annual Report on Form 10-K for the year endedDecember 31, 2019 . Credit losses are charged and recoveries are credited to the ALLL. 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 of loans and leases, including historical credit loss experience, current and forecasted market and economic conditions and consideration of various qualitative factors that, in management's judgment, deserve consideration in estimating expected credit losses. Provisions for credit losses are recorded for the amounts necessary to adjust the ALLL to the Bancorp's current estimate of expected credit losses on portfolio loans and leases. 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 judgment and includes an estimate of expected credit losses on a collective basis for groups of loans and leases with similar risk characteristics and specific allowances for loans and leases which are individually evaluated.
Larger commercial loans and leases included within aggregate borrower relationship balances exceeding$1 million that exhibit observed credit weaknesses, as well as loans that have been modified in a TDR, are individually evaluated for an ALLL. The Bancorp considers the current value of collateral, credit quality of any guarantees, the guarantor's liquidity and willingness to cooperate, the loan or lease structure and other factors when determining the amount of the ALLL. Other factors may include the borrower's susceptibility to risks presented by the forecasted macroeconomic environment, 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. Significant management judgment is required when evaluating which of these factors are most relevant in individual circumstances, and when estimating the amount of expected credit losses based on those factors. When loans and leases are individually evaluated, allowances are determined based on management's estimate of the borrower's ability to repay the loan or lease given the availability of collateral and other sources of cash flow, as well as an 12 -------------------------------------------------------------------------------- Table of Contents Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) evaluation of legal options available to the Bancorp. Allowances for individually evaluated loans and leases that are collateral-dependent are typically measured based on the fair value of the underlying collateral, less expected costs to sell. Individually evaluated loans and leases that are not collateral-dependent are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate. The Bancorp evaluates the collectability of both principal and interest when assessing the need for a loss accrual. Specific allowances on individually evaluated commercial loans and leases, including TDRs, are reviewed quarterly and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience. Expected credit losses are estimated on a collective basis for loans and leases that are not individually evaluated. These include commercial loans and leases that do not meet the criteria for individual evaluation as well as homogeneous loans in the residential mortgage and consumer portfolio segments. For collectively evaluated loans and leases, the Bancorp uses models to forecast expected credit losses based on the probability of a loan or lease defaulting, the expected balance at the estimated date of default and the expected loss percentage given a default. The estimate of the expected balance at the time of default considers prepayments and, for loans with available credit, expected utilization rates. The Bancorp's expected credit loss models were developed based on historical credit loss experience and observations of migration patterns for various credit risk characteristics (such as internal credit risk grades, external credit ratings or scores, delinquency status, loan-to-value trends, etc.) over time, with those observations evaluated in the context of concurrent macroeconomic conditions. The Bancorp developed its models from historical observations capturing a full economic cycle when possible. The Bancorp's expected credit loss models consider historical credit loss experience, current market and economic conditions, and forecasted changes in market and economic conditions if such forecasts are considered reasonable and supportable. Generally, the Bancorp considers its forecasts to be reasonable and supportable for a period of up to three years from the estimation date. For periods beyond the reasonable and supportable forecast period, expected credit losses are estimated by reverting to historical loss information without adjustment for changes in economic conditions. This reversion is phased in ratably over a two-year period. The Bancorp evaluates the length of its reasonable and supportable forecast period, its reversion period and reversion methodology at least annually, or more often if warranted by economic conditions or other circumstances. The Bancorp also considers qualitative factors in determining the ALLL. These considerations inherently require significant management judgment to determine the appropriate factors to be considered and the extent of their impact on the ALLL estimate. Qualitative factors are used to capture characteristics in the portfolio that impact expected credit losses but that are not fully captured within the Bancorp's expected credit loss models. These include adjustments for changes in policies or procedures in underwriting, monitoring or collections, lending and risk management personnel and results of internal audit and quality control reviews. These may also include adjustments, when deemed necessary, for specific idiosyncratic risks such as geopolitical events, natural disasters and their effects on regional borrowers and changes in product structures. Qualitative factors may also be used to address the impacts of unforeseen events on key inputs and assumptions within the Bancorp's expected credit loss models, such as the reasonable and supportable forecast period, changes to historical loss information or changes to the reversion period or methodology. When evaluating the adequacy of allowances, consideration is also given to regional geographic concentrations and the closely associated effect that changing economic conditions may have on the Bancorp's customers. Overall, the collective evaluation process requires significant management judgment when determining the estimation methodology and inputs into the models, as well as in evaluating the reasonableness of the modeled results and the appropriateness of qualitative adjustments. The Bancorp's forecasts of market and economic conditions and the internal risk grades assigned to loans and leases in the commercial portfolio segment are examples of inputs to the expected credit loss models that require significant management judgment. These inputs have the potential to drive significant variability in the resulting ALLL.
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 expected credit losses related to unfunded credit facilities and is included in other liabilities in the Condensed Consolidated Balance Sheets. The determination of the adequacy of the reserve is based upon expected credit losses over the remaining contractual life of the commitments, taking into consideration the current funded balance and estimated exposure over the reasonable and supportable forecast period. 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 provision for credit losses in the Condensed Consolidated Statements of Income.
Business combinations entered into by the Bancorp typically include the recognition 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 isSeptember 30 , and more frequently if events or circumstances indicate that there may be impairment. 13 -------------------------------------------------------------------------------- Table of Contents Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) 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 quantitative impairment test is required or the decision to bypass the qualitative assessment is elected, the Bancorp performs 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, an impairment loss is recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. A recognized impairment loss cannot be reversed in future periods even if the fair value of the reporting unit subsequently recovers. 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. During the first and second quarters of 2020, the Bancorp performed a qualitative assessment of its goodwill in consideration of the overall economic impact of the COVID-19 pandemic and the uncertainties it has introduced. Based upon this assessment, the Bancorp concluded it was not more likely than not that the fair value of its reporting units were less than their carrying amounts. While there was no indication of impairment as ofJune 30, 2020 , further deterioration in economic conditions could significantly impact the impairment analysis and may result in future goodwill impairment charges that, if incurred, could have a material adverse effect on the Bancorp's results of operations in the period such charges are recognized. Refer to Note 11 of the Notes to Condensed Consolidated Financial Statements for further information regarding the Bancorp's goodwill. 14 -------------------------------------------------------------------------------- Table of Contents Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) STATEMENTS OF INCOME ANALYSIS Net Interest Income Net interest income is the interest earned on loans and leases (including yield-related fees), securities and other short-term investments less the interest incurred on 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 5 and 6 present the components of net interest income, net interest margin and net interest rate spread for the three and six months endedJune 30, 2020 and 2019, as well as the relative impact of changes in the average 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 included in average other assets. Net interest income on an FTE basis (non-GAAP) was$1.2 billion for the three months endedJune 30, 2020 , a decrease of$47 million compared to the same period in the prior year. Net interest income was negatively impacted by decreases in yields on average interest-earning assets of 121 bps. The decreases in yields on average interest-earning assets were primarily driven by decreases in yields on average commercial and industrial loans, average commercial mortgage loans, average commercial construction loans and average home equity of 132 bps, 167 bps, 218 bps and 170 bps, respectively, for the three months endedJune 30, 2020 compared to the same period in the prior year. The decrease in yields on total average loans and leases for the three months endedJune 30, 2020 was primarily due to a decrease in market rates, as LIBOR rates decreased throughout the second quarter of 2020, impacting the Bancorp's portfolios of floating interest rate LIBOR-based loans. The decrease in market rates was partially offset by the positive impact of the LIBOR/Federal Funds spread, as LIBOR remained at wider spreads to the Federal Funds rate for a portion of the quarter. The LIBOR/Federal Funds spread widening typically benefits the Bancorp as it generally results in loan yields decreasing more slowly than deposit costs. This spread gradually normalized during the middle of the second quarter and the full impact of the normalization is expected to negatively impact net interest income for the remainder of 2020. Net interest income was also adversely impacted by an increase in average interest checking deposits of$13.2 billion for the three months endedJune 30, 2020 compared to the same period in the prior year. These negative impacts were partially offset by decreases in the rates paid on average interest-bearing liabilities of 81 bps. The decreases in rates paid on average interest-bearing liabilities were primarily driven by decreases in average interest checking deposits, average money market deposits, average long-term debt and average certificates$100,000 and over of 93 bps, 82 bps, 59 bps and 70 bps, respectively, for the three months endedJune 30, 2020 compared to the same period in the prior year. Net interest income also benefited from increases in average commercial and industrial loans and average indirect secured consumer loans of$6.9 billion and$1.9 billion for the three months endedJune 30, 2020 , respectively, compared to the same period in the prior year. Net interest income on an FTE basis (non-GAAP) was$2.4 billion for the six months endedJune 30, 2020 , an increase of$100 million compared to the same period in the prior year. Net interest income was positively impacted by decreases in the rates paid on average interest-bearing liabilities of 61 bps. The decreases in rates paid on average interest-bearing liabilities were primarily driven by decreases in rates paid on average interest checking deposits, average money market deposits, average long-term debt and average certificates$100,000 and over of 71 bps, 58 bps, 42 bps and 40 bps, respectively, compared to the same period in the prior year. Net interest income also benefited from increases in average commercial and industrial loans, average indirect secured consumer loans and average commercial mortgage loans of$6.3 billion ,$2.3 billion and$2.1 billion for the six months endedJune 30, 2020 , respectively, compared to the same period in the prior year. These positive impacts were partially offset by decreases in yields on total average loans and leases. The decreases in yields on total average loans and leases were primarily driven by decreases in yields on average commercial and industrial loans, average commercial mortgage loans, average commercial construction loans and average home equity of 90 bps, 104 bps, 148 bps and 116 bps, respectively, for the six months endedJune 30, 2020 compared to the same period in the prior year. Net interest income was also negatively impacted by an increase in average interest checking deposits of$9.9 billion for the six months endedJune 30, 2020 compared to the same period in the prior year. Net interest income for both the three and six months endedJune 30, 2020 was adversely impacted by theMarch 2020 ,October 2019 ,September 2019 andAugust 2019 decisions of theFOMC to lower the target range of the federal funds rate. During the three and six months endedJune 30, 2020 , net interest income included$15 million and$31 million , respectively, of amortization and accretion of premiums and discounts on acquired loans and leases and assumed deposits and long-term debt from acquisitions compared to$18 million and$20 million for the three and six months endedJune 30, 2019 , respectively. Net interest rate spread on an FTE basis (non-GAAP) was 2.55% and 2.75% during the three and six months endedJune 30, 2020 , respectively, compared to 2.95% and 2.91% in the same periods in the prior year. Yields on average interest-earning assets decreased 121 bps and 77 bps, respectively, for the three and six months endedJune 30, 2020 , partially offset by decreases in the rates paid on average interest-bearing liabilities of 81 bps and 61 bps, respectively, for the three and six months endedJune 30, 2020 compared to the three and six months endedJune 30, 2019 . 15 -------------------------------------------------------------------------------- Table of Contents Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Net interest margin on an FTE basis (non-GAAP) was 2.75% and 2.99% for the three and six months endedJune 30, 2020 , respectively, compared to 3.37% and 3.33% for the same periods in the prior year. Net interest margin was negatively impacted by increases in average interest-earning assets of$27.4 billion and$22.1 billion for the three and six months endedJune 30, 2020 , respectively, as well as the previously mentioned decreases in the net interest rate spread compared to the same periods in the prior year due to lower market rates. These negative impacts were partially offset by increases in average free funding balances primarily driven by increases in average demand deposits of$9.9 billion and$7.6 billion , respectively, and average shareholders' equity of$2.1 billion and$3.4 billion , respectively, for the three and six months endedJune 30, 2020 compared to the same periods in the prior year. Net interest margin results are expected to remain suppressed as a result of increased liquidity levels in the form of excess cash balances which are expected to remain at elevated levels driven by the amount of fiscal stimulus that has increased the banking industry's balance sheets, including the Bancorp's. Interest income on an FTE basis (non-GAAP) from loans and leases decreased$223 million and$132 million during the three and six months endedJune 30, 2020 , respectively, compared to the three and six months endedJune 30, 2019 driven by the previously mentioned decreases in yields on average loans, partially offset by the previously mentioned increases in average loans for the three and six months endedJune 30, 2020 compared to the same periods in the prior year. 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 on an FTE basis (non-GAAP) from investment securities and other short-term investments decreased$12 million and$11 million during the three and six months endedJune 30, 2020 , respectively, compared to the three and six months endedJune 30, 2019 primarily due to decreases in yields on average taxable securities and average other short-term investments, partially offset by increases in average balances. Interest expense on core deposits decreased$144 million and$181 million for the three and six months endedJune 30, 2020 , respectively, compared to the three and six months endedJune 30, 2019 primarily due to decreases in the cost of average interest-bearing core deposits to 27 bps and 46 bps for the three and six months endedJune 30, 2020 , respectively, from 103 bps and 101 bps for the three and six months endedJune 30, 2019 , respectively. The decreases in the cost of average interest-bearing core deposits were primarily due to the previously mentioned decreases in the rates paid on average interest checking deposits and average money market deposits, partially offset by the previously mentioned increases in average interest checking 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 decreased$44 million and$62 million for the three and six months endedJune 30, 2020 , respectively, compared to the three and six months endedJune 30, 2019 primarily due to the previously mentioned decreases in the rates paid on average long-term debt and average certificates$100,000 and over as well as decreases in the rates paid on average other short-term borrowings. Refer to the Borrowings subsection of the Balance Sheet Analysis section of MD&A for additional information on the Bancorp's borrowings. During both the three and six months endedJune 30, 2020 , average wholesale funding represented 19% of average interest-bearing liabilities, compared to 22% and 23% for the three and six months endedJune 30, 2019 , respectively. For more information on the Bancorp's interest rate risk management, including estimated earnings sensitivity to changes in market interest rates, see the Interest Rate and Price Risk Management subsection of the Risk Management section of MD&A. 16 -------------------------------------------------------------------------------- Table of Contents Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
TABLE 5: Condensed Average Balance Sheets and Analysis of Net Interest Income on an FTE Basis
Attribution of Change in
For the three months ended June 30, 2020 June 30, 2019 Net Interest Income(a)
Revenue/ Average Yield/ Revenue/ Average Yield/
($ in millions) Average Balance Cost Rate Average Balance Cost Rate Volume Yield/ Rate Total
Assets:
Interest-earning assets:
Loans and leases:(b)
Commercial and industrial loans $ 59,106 510 3.47 % $ 52,187 623 4.79 % $ 73 (186) (113)
Commercial mortgage loans 11,224 96 3.44 10,635 136 5.11 6 (46) (40)
Commercial construction loans 5,548 49 3.53 5,248 75 5.71 4 (30) (26)
Commercial leases 3,056 26 3.47 3,811 33 3.51 (7) - (7)
Total commercial loans and leases 78,934 681 3.47 71,881 867 4.84 76 (262) (186)
Residential mortgage loans 17,405 153 3.53 17,589 162 3.70 (2) (7) (9)
Home equity 5,820 52 3.60 6,376 84 5.30 (7) (25) (32)
Indirect secured consumer loans 12,124 122 4.04 10,190 105 4.11 19 (2) 17
Credit card 2,248 63 11.28 2,408 75 12.38 (6) (6) (12)
Other consumer loans 2,887 47 6.50 2,549 48 7.58 6 (7) (1)
Total consumer loans 40,484 437 4.34 39,112 474 4.85 10 (47) (37)
Total loans and leases $ 119,418 1,118 3.76 % $ 110,993 1,341 4.84 % $ 86 (309) (223)
Securities:
Taxable 36,817 282 3.08 35,467 290 3.28 10 (18) (8)
Exempt from income taxes(b) 156 1 2.96 40 - 3.50 1 - 1
Other short-term investments 19,833 5 0.11 2,290 10 1.80 13 (18) (5)
Total interest-earning assets $ 176,224 1,406 3.21 % $ 148,790 1,641 4.42 % $ 110 (345) (235)
Cash and due from banks 3,121 2,931
Other assets 21,394 16,972
Allowance for loan and lease losses (2,352) (1,115)
Total assets $ 198,387 $ 167,578
Liabilities and Equity:
Interest-bearing liabilities:
Interest checking deposits $ 49,760 29 0.24 % $ 36,514 107 1.17 % $ 28 (106) (78)
Savings deposits 16,354 3 0.06 14,418 6 0.17 1 (4) (3)
Money market deposits 30,022 24 0.32 25,934 74 1.14 10 (60) (50)
Foreign office deposits 182 - 0.09 163 - 0.53 - - -
Other time deposits 4,421 13 1.21 5,678 26 1.84 (5) (8) (13)
Total interest-bearing core deposits 100,739 69 0.27 82,707 213 1.03 34 (178) (144)
Certificates $100,000 and over 4,067 14 1.40 5,780 30 2.10 (8) (8) (16)
Other deposits 31 - 0.04 40 - 2.92 - - -
Federal funds purchased 309 - 0.16 1,151 8 2.61 (4) (4) (8)
Other short-term borrowings 2,377 2 0.32 1,119 9 3.08 5 (12) (7)
Long-term debt 16,955 118 2.80 15,543 131 3.39 11 (24) (13)
Total interest-bearing liabilities $ 124,478 203 0.66 % $ 106,340 391 1.47 % $ 38 (226) (188)
Demand deposits 45,761 35,818
Other liabilities 5,727 5,088
Total liabilities $ 175,966 $ 147,246
Total equity $ 22,421 $ 20,332
Total liabilities and equity $ 198,387 $ 167,578
Net interest income (FTE)(c) $ 1,203 $ 1,250 $ 72 (119) (47)
Net interest margin (FTE)(c) 2.75 % 3.37 %
Net interest rate spread (FTE)(c) 2.55 2.95
Interest-bearing liabilities to
interest-earning assets 70.64 71.47
(a)Changes in interest not solely due to volume or yield/rate are allocated in
proportion to the absolute dollar amount of change in volume and yield/rate.
(b)The FTE adjustments included in the above table were $3 and $5 for the three
months ended June 30, 2020 and 2019, respectively.
(c)Net interest income (FTE), net interest margin (FTE) and net interest rate
spread (FTE) are non-GAAP measures. For further information, refer to the
Non-GAAP Financial Measures section of MD&A.
17
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Management's Discussion and Analysis of Financial Condition and Results of Operations
(continued)
TABLE 6: Condensed Average Balance Sheets and Analysis of Net Interest Income on an FTE Basis
Attribution of Change in
For the six months ended June 30, 2020 June 30, 2019 Net Interest Income(a)
Revenue/ Average Revenue/ Average
($ in millions) Average Balance Cost Yield/ Rate Average Balance Cost Yield/ Rate Volume Yield/ Rate Total
Assets:
Interest-earning assets:
Loans and leases:(b)
Commercial and industrial loans $ 55,399 1,056 3.83 % $ 49,145 1,154 4.73 % $ 139 (237) (98)
Commercial mortgage loans 11,122 218 3.94 9,035 223 4.98 47 (52) (5)
Commercial construction loans 5,340 110 4.15 5,044 141 5.63 8 (39) (31)
Commercial leases 3,128 54 3.47 3,684 60 3.30 (9) 3 (6)
Total commercial loans and leases 74,989 1,438 3.86 66,908 1,578 4.76 185 (325) (140)
Residential mortgage loans 17,715 315 3.58 16,873 310 3.71 16 (11) 5
Home equity 5,913 123 4.16 6,366 168 5.32 (10) (35) (45)
Indirect secured consumer loans 11,967 242 4.07 9,686 190 3.96 47 5 52
Credit card 2,373 138 11.72 2,402 149 12.50 (2) (9) (11)
Other consumer loans 2,842 100 7.09 2,477 93 7.54 13 (6) 7
Total consumer loans 40,810 918 4.53 37,804 910 4.85 64 (56) 8
Total loans and leases $ 115,799 2,356 4.09 % $ 104,712 2,488 4.79 % $ 249 (381) (132)
Securities:
Taxable 36,395 564 3.12 34,896 570 3.30 26 (32) (6)
Exempt from income taxes(b) 159 3 3.00 34 1 4.03 2 - 2
Other short-term investments 11,366 12 0.22 2,023 19 1.87 22 (29) (7)
Total interest-earning assets $ 163,719 2,935 3.61 % $ 141,665 3,078 4.38 % $ 299 (442) (143)
Cash and due from banks 3,000 2,576
Other assets 20,509 15,192
Allowance for loan and lease losses (2,099) (1,109)
Total assets $ 185,129 $ 158,324
Liabilities and Equity:
Interest-bearing liabilities:
Interest checking deposits $ 45,029 104 0.46 % $ 35,113 204 1.17 % $ 47 (147) (100)
Savings deposits 15,534 7 0.09 13,739 11 0.16 1 (5) (4)
Money market deposits 28,565 72 0.51 24,541 133 1.09 19 (80) (61)
Foreign office deposits 196 - 0.35 185 1 0.57 (1) - (1)
Other time deposits 4,751 33 1.40 5,271 48 1.82 (5) (10) (15)
Total interest-bearing core deposits 94,075 216 0.46 78,849 397 1.01 61 (242) (181)
Certificates $100,000 and over 3,711 31 1.71 4,576 47 2.11 (8) (8) (16)
Other deposits 144 1 0.76 381 5 2.46 (2) (2) (4)
Federal funds purchased 481 2 0.82 1,582 20 2.50 (9) (9) (18)
Other short-term borrowings 2,063 8 0.74 884 14 3.28 11 (17) (6)
Long-term debt 16,387 241 2.95 15,492 259 3.37 15 (33) (18)
Total interest-bearing liabilities $ 116,861 499 0.86 % $ 101,764 742 1.47 % $ 68 (311) (243)
Demand deposits 40,763 33,202
Other liabilities 5,438 4,659
Total liabilities $ 163,062 $ 139,625
Total equity $ 22,067 $ 18,699
Total liabilities and equity $ 185,129 $ 158,324
Net interest income (FTE)(c) $ 2,436 $ 2,336 $ 231 (131) 100
Net interest margin (FTE)(c) 2.99 % 3.33 %
Net interest rate spread (FTE)(c) 2.75 2.91
Interest-bearing liabilities to
interest-earning assets 71.38 71.83
(a)Changes in interest not solely due to volume or yield/rate are allocated in
proportion to the absolute dollar amount of change in volume and yield/rate.
(b)The FTE adjustments included in the above table were $7 and $9 for the six
months ended June 30, 2020 and 2019, respectively.
(c)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.
18
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Table of Contents
Management's Discussion and Analysis of Financial Condition and Results of Operations
(continued)
Provision for Credit Losses
The Bancorp provides as an expense an amount for expected credit losses within
the loan and lease portfolio and the portfolio of unfunded loan commitments and
letters of credit that is based on factors discussed in the Critical Accounting
Policies section of this Quarterly Report on Form 10-Q. The provision is
recorded to bring the ALLL and reserve for unfunded commitments to a level
deemed appropriate by the Bancorp to cover losses expected in the portfolios.
Actual credit losses on loans and leases are charged against the ALLL. The
amount of loans and leases actually removed from the Condensed Consolidated
Balance Sheets are referred to as charge-offs. Net charge-offs include current
period charge-offs less recoveries on previously charged-off loans and leases.
The provision for credit losses was $485 million and $1.1 billion for the three
and six months ended June 30, 2020 , respectively, compared to $85 million and
$175 million during the same periods in the prior year. The increases in
provision expense for both the three and six months ended June 30, 2020 compared
to the same periods in the prior year were primarily due to an increase in the
ACL reflecting deterioration in the macroeconomic environment as a result of the
impact of the COVID-19 pandemic, continued pressure on energy prices and the
resulting impact of this environment on commercial borrowers as reflected in
increased levels of commercial criticized assets. The increase in the provision
for credit losses also reflected the impact of the change in methodology for
estimating credit losses from the incurred loss methodology to the expected
credit loss methodology beginning in the first quarter of 2020.
The ALLL increased $1.5 billion from December 31, 2019 to $2.7 billion at
June 30, 2020 . At June 30, 2020 , the ALLL as a percent of portfolio loans and
leases increased to 2.34%, compared to 1.10% at December 31, 2019 . The reserve
for unfunded commitments increased $32 million from December 31, 2019 to $176
million at June 30, 2020 . The ACL as a percent of portfolio loans and leases
increased to 2.50% at June 30, 2020 , compared to 1.23% at December 31, 2019 .
These increases reflect the adoption of ASU 2016-13, which resulted in a
combined increase to the ALLL and reserve for unfunded commitments of
approximately $653 million , as well as the previously mentioned items impacting
the provision for credit losses.
Refer to the Credit Risk Management subsection of the Risk Management section of
MD&A as well as Note 7 of the Notes to Condensed Consolidated Financial
Statements for more detailed information on the provision for credit 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, ALLL and reserve for
unfunded commitments.
Noninterest Income
Noninterest income decreased $10 million and $440 million for the three and six
months ended June 30, 2020 , respectively, compared to the three and six months
ended June 30, 2019 .
The following table presents the components of noninterest income: TABLE 7: Components of Noninterest Income
For the three months ended For the six months ended
June 30, June 30,
($ in millions) 2020 2019 % Change 2020 2019 % Change
Service charges on deposits $ 122 143 (15) $ 270 274 (1)
Commercial banking revenue 137 107 28 261 209 25
Wealth and asset management revenue 120 122 (2) 255 234 9
Mortgage banking net revenue 99 63 57 219 119 84
Card and processing revenue 82 92 (11) 167 171 (2)
Leasing business revenue 57 76 (25) 131 108 21
Other noninterest income 12 47 (74) 18 616 (97)
Securities (losses) gains, net 21 8 163 (3) 25 NM
Securities gains, net -
non-qualifying hedges on mortgage
servicing rights - 2 (100) 3 5 (40)
Total noninterest income $ 650 660 (2) $ 1,321 1,761 (25)
Service charges on deposits
Service charges on deposits decreased $21 million and $4 million for the three
and six months ended June 30, 2020 , respectively, compared to the three and six
months ended June 30, 2019 . The decrease for the three months ended June 30,
2020 compared to the same period in the prior year was due to decreases in
consumer deposit fees and commercial deposit fees of $14 million and $7 million ,
respectively. The decrease for the six months ended June 30, 2020 compared to
the same period in the prior year was due to a decrease of $16 million in
consumer deposit fees partially offset by an increase of $12 million in
commercial deposit fees. The Bancorp currently expects service charges on
deposits revenue to increase in the low double digits range in the third quarter
of 2020 compared to the second quarter of 2020.
19
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Table of Contents
Management's Discussion and Analysis of Financial Condition and Results of Operations
(continued)
Commercial banking revenue
Commercial banking revenue increased $30 million and $52 million for the three
and six months ended June 30, 2020 , respectively, compared to the three and six
months ended June 30, 2019 . The increase for the three months ended June 30,
2020 compared to the same period in the prior year was primarily driven by an
increase in institutional sales of $34 million , partially offset by a decrease
in loan syndication fees of $7 million . The increase for the six months ended
June 30, 2020 compared to the same period in the prior year was primarily driven
by increases in institutional sales, contract revenue from commercial customer
derivatives and bridge fees of $43 million , $8 million and $8 million ,
respectively, partially offset by a decrease in loan syndication fees of $13
million .
Wealth and asset management revenue
Wealth and asset management revenue decreased $2 million and increased $21
million for the three and six months ended June 30, 2020 , respectively, compared
to the three and six months ended June 30, 2019 . The increase for the six months
ended June 30, 2020 compared to the same period in the prior year was primarily
driven by increases in private client service fees, broker income and
institutional fees of $8 million , $8 million , and $4 million , respectively. The
Bancorp's trust and registered investment advisory businesses had approximately
$405 billion and $399 billion in total assets under care as of June 30, 2020 and
2019, respectively, and managed $49 billion and $46 billion in assets for
individuals, corporations and not-for-profit organizations as of June 30, 2020
and 2019, respectively.
Mortgage banking net revenue
Mortgage banking net revenue increased $36 million and $100 million for the
three and six months ended June 30, 2020 , respectively, compared to the three
and six months ended June 30, 2019 .
The following table presents the components of mortgage banking net revenue: TABLE 8: Components of Mortgage Banking Net Revenue
For the six months
For the three months ended ended
June 30, June 30,
($ in millions) 2020 2019 2020 2019
Origination fees and gains on loan sales $ 95 37 176 62
Net mortgage servicing revenue:
Gross mortgage servicing fees 63 70 130 125
Net valuation adjustments on MSRs and
free-standing derivatives purchased to
economically hedge MSRs (59) (44) (87) (68)
Net mortgage servicing revenue 4 26 43 57
Total mortgage banking net revenue $ 99 63 219 119
Origination fees and gains on loan sales increased $58 million and $114 million
for the three and six months ended June 30, 2020 , respectively, compared to the
three and six months ended June 30, 2019 primarily driven by an increase in
originations and gain on sale margins due to the lower interest rate
environment. Residential mortgage loan originations increased to $3.4 billion
and $7.4 billion for the three and six months ended June 30, 2020 , respectively
from $2.9 billion and $4.5 billion for the three and six months ended June 30,
2019 , respectively.
Net mortgage servicing revenue decreased $22 million and $14 million for the
three and six months ended June 30, 2020 , respectively, compared to the three
and six months ended June 30, 2019 . The decrease for the three months ended
June 30, 2020 compared to the same period in the prior year was due to an
increase in net negative valuation adjustments of $15 million and a decrease in
gross mortgage servicing fees of $7 million . The decrease for the six months
ended June 30, 2020 compared to the same period in the prior year was due to an
increase in net negative valuation adjustments of $19 million , partially offset
by an increase in gross mortgage servicing fees of $5 million . Refer to Table 9
for the components of net valuation adjustments on the MSR portfolio and the
impact of the non-qualifying hedging strategy.
TABLE 9: Components of Net Valuation Adjustments on MSRs
For the three months ended For the six months ended
June 30, June 30,
($ in millions) 2020 2019 2020 2019
Changes in fair value and settlement of
free-standing derivatives purchased to
economically hedge the MSR portfolio $ 11 117 361 177
Changes in fair value:
Due to changes in inputs or assumptions (12) (116) (343) (173)
Other changes in fair value (58) (45) (105) (72)
Net valuation adjustments on MSRs and
free-standing derivatives purchased to
economically hedge MSRs $ (59) (44) (87) (68)
20-------------------------------------------------------------------------------- Table of Contents Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Mortgage rates decreased during both the three and six months endedJune 30, 2020 and 2019, which caused modeled prepayment speeds to rise. The fair value of the MSR portfolio decreased$12 million and$343 million for the three and six months endedJune 30, 2020 , respectively, compared to$116 million and$173 million for the three and six months endedJune 30, 2019 , respectively, due to changes to inputs to the valuation model, including prepayment speeds andOAS assumptions. The fair value of the MSR portfolio decreased$58 million and$105 million for the three and six months endedJune 30, 2020 , respectively, compared to$45 million and$72 million for the three and six months endedJune 30, 2019 , respectively, due to the impact of contractual principal payments and actual prepayment activity. Further detail on the valuation of MSRs can be found in Note 14 of the Notes to Condensed Consolidated Financial Statements. The Bancorp maintains a non-qualifying hedging strategy to manage a portion of the risk associated with changes in the valuation of the MSR portfolio. Refer to Note 15 of the Notes to Condensed Consolidated Financial Statements for more information on the free-standing derivatives used to economically hedge the MSR portfolio. In addition to the derivative positions used to economically hedge the MSR portfolio, the Bancorp acquires various securities as a component of its non-qualifying hedging strategy. The Bancorp recognized net gains of an immaterial amount and$3 million during the three and six months endedJune 30, 2020 compared to$2 million and$5 million during the three and six months endedJune 30, 2019 recorded in securities gains, net - non-qualifying hedges on MSRs in the Bancorp's Condensed Consolidated Statements of Income. The Bancorp's total residential mortgage loans serviced as ofJune 30, 2020 and 2019 were$95.4 billion and$102.4 billion , respectively, with$78.8 billion and$84.6 billion , respectively, of residential mortgage loans serviced for others. Card and processing revenue Card and processing revenue decreased$10 million and$4 million for the three and six months endedJune 30, 2020 , respectively, compared to the three and six months endedJune 30, 2019 primarily driven by decreases in customer spend volume, partially offset by lower reward costs and increases in other EFT income driven by theMB Financial, Inc. acquisition at the end of the first quarter of 2019. The Bancorp currently expects card and processing revenue to increase in the low-to-mid single digits range in the third quarter of 2020 compared to the second quarter of 2020. Leasing business revenue Leasing business revenue decreased$19 million for the three months endedJune 30, 2020 compared to the same period in the prior year primarily driven by decreases in leasing business solutions revenue and operating lease income of$13 million and$6 million , respectively. Leasing business revenue increased$23 million for the six months endedJune 30, 2020 compared to the same period in the prior year primarily driven by increases in operating lease income and lease syndication fees of$12 million and$11 million , respectively, partially offset by a decrease in leasing business solutions revenue of$6 million . The increase in operating lease income for the six months endedJune 30, 2020 was driven by the acquisition ofMB Financial, Inc. at the end of the first quarter of 2019. Other noninterest income The following table presents the components of other noninterest income: TABLE 10: Components of Other Noninterest Income For the six months For the three months ended ended June 30, June 30, ($ in millions) 2020 2019 2020 2019 BOLI income $ 17 15 32 29 Cardholder fees 10 15 21 29 Consumer loan and lease fees 5 6 10 11 Insurance income 4 5 10 10 Banking center income 4 6 10 11 Loss on swap associated with the sale ofVisa , Inc. Class B Shares (29) (22) (51) (52) Net losses on disposition and impairment of bank premises and equipment (12) (1) (15) (21) Private equity investment (loss) income 6 18 (8) 22 Gain on sale of Worldpay, Inc. shares - - - 562 Equity method income from interest in Worldpay Holding, LLC - - - 2 Other, net 7 5 9 13 Total other noninterest income $ 12 47 18 616 Other noninterest income decreased$35 million for the three months endedJune 30, 2020 compared to the three months endedJune 30, 2019 primarily due to a decrease in private equity investment income as well as increases in the net losses on disposition and impairment of bank premises and equipment and the loss on the swap associated with the sale of Visa, Inc. ClassB Shares . 21 -------------------------------------------------------------------------------- Table of Contents Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Private equity investment income decreased$12 million for the three months endedJune 30, 2020 compared to the same period in the prior year primarily driven by the recognition of positive net valuation adjustments and gains on certain private equity investments during the three months endedJune 30, 2019 . For additional information on the valuation of private equity investments, refer to Note 23 of the Notes to Condensed Consolidated Financial Statements. Net losses on disposition and impairment of bank premises and equipment increased$11 million for the three months endedJune 30, 2020 compared to the three months endedJune 30, 2019 driven by the impact of impairment charges of$12 million during the three months endedJune 30, 2020 compared to$2 million during the three months endedJune 30, 2019 . For additional information, refer to Note 8 of the Notes to Condensed Consolidated Financial Statements. The Bancorp recognized negative valuation adjustments of$29 million related to theVisa total return swap during the three months endedJune 30, 2020 compared to negative valuation adjustments of$22 million during the three months endedJune 30, 2019 . For additional information on the valuation of the swap associated with the sale of Visa, Inc. ClassB Shares , refer to Note 23 of the Notes to Condensed Consolidated Financial Statements. Other noninterest income decreased$598 million for the six months endedJune 30, 2020 compared to the six months endedJune 30, 2019 primarily due to the gain on sale of Worldpay, Inc. shares recognized during the first quarter of 2019 as well as a decrease in private equity investment income. The Bancorp recognized a$562 million gain related to the sale of Worldpay, Inc. shares during the first quarter of 2019. Private equity investment income decreased$30 million for the six months endedJune 30, 2020 compared to the same period in the prior year primarily driven by negative net valuation adjustments and impairment charges recognized on certain private equity investments during the six months endedJune 30, 2020 compared to positive net valuation adjustments and gains on certain private equity investments during the six months endedJune 30, 2019 . For additional information on the valuation of private equity investments, refer to Note 23 of the Notes to Condensed Consolidated Financial Statements. Noninterest Expense Noninterest expense decreased$122 million for the three months endedJune 30, 2020 compared to the same period in the prior year primarily due to decreases in technology and communications expense, other noninterest expense, marketing expense and compensation and benefits expense. Noninterest expense decreased$20 million for the six months endedJune 30, 2020 compared to the same period in the prior year primarily due to decreases in technology and communications expense and marketing expense, partially offset by increases in compensation and benefits expense and other noninterest expense.
The following table presents the components of noninterest expense: TABLE 11: Components of Noninterest Expense
For the three months ended For the six months ended
June 30, June 30,
($ in millions) 2020 2019 % Change 2020 2019 % Change
Compensation and benefits $ 627 641 (2) $ 1,274 1,251 2
Technology and communications 90 136 (34) 183 219 (16)
Net occupancy expense 82 88 (7) 164 164 -
Leasing business expense 33 38 (13) 68 57 19
Equipment expense 32 33 (3) 64 63 2
Card and processing expense 29 34 (15) 60 64 (6)
Marketing expense 20 41 (51) 51 77 (34)
Other noninterest expense 208 232 (10) 457 446 2
Total noninterest expense $ 1,121 1,243 (10) $ 2,321 2,341 (1)
Efficiency ratio on an FTE basis(a) 60.5 % 65.1 61.8 % 57.1
(a)This is a non-GAAP measure. For further information, refer to the Non-GAAP Financial Measures section of MD&A.
22
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Management's Discussion and Analysis of Financial Condition and Results of Operations
(continued)
The Bancorp recognized $9 million and $16 million of merger-related expenses
related to the MB Financial, Inc. acquisition for the three and six months ended
June 30, 2020 , respectively, compared to $109 million and $185 million in the
same periods in the prior year. The following table provides a summary of
merger-related expenses recorded in noninterest expense:
TABLE 12: Merger-Related Expenses
For the three months ended For the six months ended
June 30, June 30,
($ in millions) 2020 2019 2020 2019
Compensation and benefits $ 2 41 4 75
Technology and communications 4 49 6 60
Net occupancy expense 2 6 4 6
Equipment expense - 1 - 1
Card and processing expense - 1 - 1
Marketing expense - 3 - 6
Other noninterest expense 1 8 2 36
Total $ 9 109 16 185
Technology and communications expense decreased $46 million and $36 million for
the three and six months ended June 30, 2020 , respectively, compared to the same
periods in the prior year primarily driven by decreased integration and
conversion costs related to the acquisition of MB Financial, Inc.
Marketing expense decreased $21 million and $26 million for the three and six
months ended June 30, 2020 , respectively, compared to the same periods in the
prior year primarily due to the impact of the COVID-19 pandemic, which resulted
in a pause or slowdown in numerous marketing campaigns, including running less
advertising as well as the suspension of cash bonus programs.
Compensation and benefits expense decreased $14 million for the three months
ended June 30, 2020 compared to the same period in the prior year primarily due
to a decrease in merger-related expenses related to the acquisition of MB
Financial, Inc. , partially offset by higher deferred compensation expense.
Compensation and benefits expense increased $23 million for the six months ended
June 30, 2020 compared to the same period in the prior year primarily due to the
addition of personnel costs from the acquisition of MB Financial, Inc. and the
impact of raising the Bancorp's minimum wage in the fourth quarter of 2019,
partially offset by a reduction in merger-related expenses. Compensation and
benefits expense for the three and six months ended June 30, 2020 included $7
million and $10 million , respectively, of special payments to employees
providing essential banking services through the COVID-19 pandemic. Full-time
equivalent employees totaled 20,340 at June 30, 2020 compared to 19,758 at
June 30, 2019 .
The following table presents the components of other noninterest expense: TABLE 13: Components of Other Noninterest Expense
For the six months
For the three months ended ended
June 30, June 30,
($ in millions) 2020 2019 2020 2019
Loan and lease $ 40 34 75 61
Losses and adjustments 17 34 71 55
FDIC insurance and other taxes 24 19 49 38
Data processing 17 18 35 34
Intangible amortization 12 14 25 17
Professional service fees 13 18 23 36
Travel 4 19 19 33
Postal and courier 8 10 18 19
Recruitment and education 5 8 11 18
Supplies 3 4 7 7
Insurance 3 3 7 7
Donations 4 3 7 6
Other, net 58 48 110 115
Total other noninterest expense $ 208 232 457 446
Other noninterest expense decreased $24 million for the three months ended
June 30, 2020 compared to the same period in the prior year primarily due to
decreases in losses and adjustments and travel expense, partially offset by an
increase in loan and lease expense. Losses and adjustments decreased $17 million
for the three months ended June 30, 2020 compared to the same period in the
prior year primarily due to a decrease in operational losses, driven by a
reduction in legal settlements expense. Travel expense decreased $15 million for
the three months
23
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Management's Discussion and Analysis of Financial Condition and Results of Operations
(continued)
ended June 30, 2020 compared to the same period in the prior year primarily due
to business travel being suspended for the second quarter of 2020 as a direct
result of the COVID-19 pandemic. Loan and lease expense increased $6 million for
the three months ended June 30, 2020 compared to the same period in the prior
year primarily due to an increase in loan closing expenses. Additionally, other
noninterest expense included $6 million associated with FHLB advances
extinguished during the three months ended June 30, 2020 .
Other noninterest expense increased $11 million for the six months ended
June 30, 2020 compared to the same period in the prior year primarily due to
increases in losses and adjustments and loan and lease expense, partially offset
by a decrease in travel expenses. Losses and adjustments increased $16 million
for the six months ended June 30, 2020 compared to the same period in the prior
year primarily due to an increase in credit valuation adjustments incurred
during the first quarter of 2020 on derivatives associated with customer
accommodation contracts, partially offset by a reduction in legal settlements
expense. Loan and lease expense increased $14 million for the six months ended
June 30, 2020 compared to the same period in the prior year primarily due to an
increase in loan closing expenses. Travel expenses decreased $14 million for the
six months ended June 30, 2020 compared to the same period in the prior year
primarily due to business travel being suspended for the second quarter of 2020
as a direct result of the COVID-19 pandemic. Additionally, other noninterest
expense included $6 million associated with FHLB advances extinguished during
the six months ended June 30, 2020 .
Applicable Income Taxes The following table presents the Bancorp's income before income taxes, applicable income tax expense and effective tax rate: TABLE 14: Applicable Income Taxes
For the six months
For the three months ended ended
June 30, June 30,
($ in millions) 2020 2019 2020 2019
Income before income taxes $ 244 577 304 1,572
Applicable income tax expense 49 124 61 344
Effective tax rate 19.9 % 21.5 20.4 21.9
Applicable income tax expense for all periods presented includes the benefit
from tax-exempt income, tax-advantaged investments and tax credits (and other
related tax benefits), partially offset by the effect of proportional
amortization of qualifying LIHTC investments and certain nondeductible expenses.
The tax credits are primarily 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 decreases in the effective tax rates for both the three and six months ended
For stock-based awards,U.S. GAAP requires 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 atJune 30, 2020 , the Bancorp estimates it may be necessary to recognize$8 million of additional income tax expense over the next twelve months related to the settlement of stock-based awards primarily in the first half of 2021. 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. 24 --------------------------------------------------------------------------------
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