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 nine months ended September 30, % September 30, % ($ in millions, except for per share data) 2020 2019 Change 2020 2019 Change Income Statement Data Net interest income (U.S. GAAP)$ 1,170 1,242 (6)$ 3,600 3,569 1 Net interest income (FTE)(a)(b) 1,173 1,246 (6) 3,610 3,582 1 Noninterest income 722 740 (2) 2,043 2,501 (18) Total revenue (FTE)(a) 1,895 1,986 (5) 5,653 6,083 (7) Provision for (benefit from) credit losses(c) (15) 134 NM 1,110 310 258 Noninterest expense 1,161 1,159 - 3,482 3,499 - Net income 581 549 6 823 1,778 (54) Net income available to common shareholders 562 530 6 754 1,718 (56) Common Share Data Earnings per share - basic$ 0.78 0.72 8$ 1.05 2.40 (56) Earnings per share - diluted 0.78 0.71 10 1.04 2.37 (56) Cash dividends declared per common share 0.27 0.24 13 0.81 0.70 16 Book value per share 29.25 27.32 7 29.25 27.32 7 Market value per share 21.32 27.38 (22) 21.32 27.38 (22) Financial Ratios Return on average assets 1.14 % 1.28 (11) 0.58 % 1.47 (61) Return on average common equity 10.7 10.7 - 4.9 12.7 (61) Return on average tangible common equity(b) 13.8 14.2 (3) 6.5 16.5 (61) Dividend payout 34.6 33.3 4 77.1 29.2 164
Average total Bancorp shareholders' equity
as a percent of average assets 11.33 12.43 (9) 11.71 11.99 (2)
Tangible common equity as a percent of tangible
assets (excluding AOCI)(b) 6.99 8.21 (15) 6.99 8.21 (15) Net interest margin(a)(b) 2.58 3.32 (22) 2.85 3.32 (14) Net interest rate spread (a)(b) 2.42 2.93 (17) 2.62 2.92 (10) Efficiency(a)(b) 61.3 58.4 5 61.6 57.5 7 Credit Quality Net losses charged off$ 101 99 2$ 353 256 38 Net losses charged off as a percent of average portfolio loans and leases 0.35 % 0.36 (3) 0.41 % 0.32 28 ALLL as a percent of portfolio loans and leases 2.32 1.04 123 2.32 1.04 123 ACL as a percent of portfolio loans and leases(d) 2.49 1.19 109 2.49 1.19 109 Nonperforming portfolio assets as a percent of portfolio loans and leases and OREO 0.84 0.47 79 0.84 0.47 79 Average Balances Loans and leases, including held for sale$ 114,613 110,666 4$ 115,401 106,719 8
Securities and other short-term investments 66,091 38,188
73 54,021 37,369 45
Total assets 202,533 169,585 19 190,973 162,119 18
Transaction deposits(e) 148,567 114,541 30 136,293 109,396 25
Core deposits(f) 152,278 120,364 27 140,695 114,853 23
Wholesale funding(g) 21,762 22,492 (3) 22,441 22,772 (1)
Bancorp shareholders' equity 22,952 21,087 9 22,364 19,430 15
Regulatory Capital (h)
CET1 capital 10.14 % 9.56 6 10.14 % 9.56 6
Tier I risk-based capital 11.64 10.81 8 11.64 10.81 8
Total risk-based capital 14.93 13.68 9 14.93 13.68 9
Tier I leverage 8.37 9.36 (11) 8.37 9.36 (11)
(a)Amounts presented on an FTE basis. The FTE adjustments were $3 and $4 for the
three months ended September 30, 2020 and 2019, respectively, and $10 and $13
for the nine months ended September 30, 2020 and 2019, 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 of September 30, 2020 are calculated pursuant to
the five-year transition provision option to phase in the effects of CECL on
regulatory capital.
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Management's Discussion and Analysis of Financial Condition and Results of Operations
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OVERVIEW
Fifth Third Bancorp is a diversified financial services company headquartered in
Cincinnati, Ohio . At September 30, 2020 , the Bancorp had $202 billion in assets
and operated 1,122 full-service banking centers and 2,414 Fifth Third branded
ATMs in eleven states throughout the Midwestern and Southeastern regions of the
U.S. The Bancorp reports on four business segments: Commercial Banking, Branch
Banking, Consumer Lending and Wealth and Asset Management.
This overview of MD&A highlights selected information in the financial results
of the Bancorp and may not contain all of the information that is important to
you. For a more complete understanding of trends, events, commitments,
uncertainties, liquidity, capital resources and critical accounting policies and
estimates, you should carefully read this entire document as well as the
Bancorp's Annual Report on Form 10-K for the year ended December 31, 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 the three months ended September 30, 2020 , net interest income on an
FTE basis and noninterest income provided 62% and 38% of total revenue,
respectively. For the nine months ended September 30, 2020 , net interest income
on an FTE basis and noninterest income provided 64% and 36% of total revenue,
respectively. The Bancorp derives the majority of its revenues within the U.S.
from customers domiciled in the U.S. Revenue from foreign countries and external
customers domiciled in foreign countries was immaterial to the Condensed
Consolidated Financial Statements for the three and nine months ended
September 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, wealth and asset
management revenue, commercial banking 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
The COVID-19 pandemic has introduced significant economic uncertainty during the
three and nine months ended September 30, 2020 . To address concerns that
COVID-19 may overwhelm the health care system, states across the U.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
fluctuations in the number of COVID-19 cases mean that it remains unknown when
there will be a return to normal economic activity. During the third 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 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 forced liquidations and restore liquidity in the financial markets. The FRB cut rates to the zero lower bound, announced unlimited purchases
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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.
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 expanded the SBA's business loan guarantee program. Paycheck Protection Program loans were available to a broader range of entities than ordinary SBA loans, deferred principal and interest repayment and may be forgiven if the borrower demonstrates that the loan proceeds were used for qualified payroll costs and certain other expenses. 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. TheFederal Housing Administration , Fannie Mae and Freddie Mac have independently extended their moratorium on foreclosures and evictions for single-family federally backed mortgages until at leastDecember 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, forbearances 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 . As ofSeptember 30, 2020 , the Bancorp held approximately 40,000 loans with a carrying amount of$5.2 billion under the program. 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.
Preferred Stock Offering OnJuly 30, 2020 , the Bancorp issued in a registered public offering 350,000 depositary shares, representing 14,000 shares of 4.50% fixed-rate reset non-cumulative perpetual preferred stock, Series L, for net proceeds of approximately$346 million . Each preferred share has a$25,000 liquidation preference. For more information on the preferred stock offering, including disclosure on the redemption options, refer to Note 18 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 by the end of 2021. Although the full impact of such reforms and actions remains unclear, the Bancorp continues to prepare to transition from LIBOR to these alternative reference rates. Inthe United States , it is likely that LIBOR-priced transactions and products will transfer to the Secured Overnight Financing Rate ("SOFR"). There are risks inherent with the transition to any alternative rate such as SOFR as the rates may behave differently than LIBOR in reaction to monetary, market and economic events.
The Bancorp's LIBOR transition plan is organized around 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 and technological readiness, and risk management, among other things, to facilitate the transition to alternative reference rates.
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 assist 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 evaluate 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
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•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
•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 third quarter
of 2020 was $562 million , or $0.78 per diluted share, which was net of $19
million in preferred stock dividends. The Bancorp's net income available to
common shareholders for the third quarter of 2019 was $530 million , or $0.71 per
diluted share, which was net of $19 million in preferred stock dividends. The
Bancorp's net income available to common shareholders for the nine months ended
September 30, 2020 was $754 million , or $1.04 per diluted share, which was net
of $69 million in preferred stock dividends. The Bancorp's net income available
to common shareholders for the nine months ended September 30, 2019 was $1.7
billion , or $2.37 per diluted share, which was net of $60 million in preferred
stock dividends.
Net interest income on an FTE basis (non-GAAP) was $1.2 billion for the three
months ended September 30, 2020 , a decrease of $73 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 141 bps. The decreases
in yields on average interest-earning assets were primarily driven by decreases
in yields on total average loans and leases primarily as a result of decreases
in yields on average commercial and industrial loans, average commercial
mortgage loans, average commercial construction loans and average home equity
rates of 131 bps, 174 bps, 221 bps and 161 bps, respectively, for the three
months ended September 30, 2020 compared to the same period in the prior year.
The net interest income impact of lower yields on average interest-earning
assets was partially offset by decreases in rates paid on average
interest-bearing liabilities of 90 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 and average
long-term debt rates of 102 bps, 99 bps and 64 bps, respectively, for the three
months ended September 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 $2.7 billion and
$1.9 billion , respectively, for the three months ended September 30, 2020
compared to the same period in the prior year.
Net interest income on an FTE basis (non-GAAP) was $3.6 billion for the nine
months ended September 30, 2020 , an increase of $28 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 71 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 and average long-term debt of 82 bps, 73
bps and 49 bps, respectively, for the nine months ended September 30, 2020
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 $5.1
billion , $2.1 billion and $1.5 billion , respectively, for the nine months ended
September 30, 2020 compared to the same period in the prior year. These positive
impacts were partially offset by decreases in yields on average interest-earning
assets of 101 bps. The decreases in yields on average interest-earning assets
were primarily driven by decreases in yields on total average loans and leases
primarily driven by decreases in yields on average commercial and industrial
loans, average commercial mortgage loans, average commercial construction loans
and average home equity rates of 104 bps, 128 bps, 173 bps and 130 bps,
respectively, for the nine months ended September 30, 2020 compared to the same
period in the prior year. Net interest income was also negatively impacted by
increases in average interest checking deposits and average money market
deposits of $10.6 billion and $4.1 billion , respectively, for the nine months
ended September 30, 2020 compared to the same period in the prior year. Net
interest margin on an FTE basis (non-GAAP) was 2.58% and 2.85% for the three and
nine months ended September 30, 2020 , respectively, compared to 3.32% for both
the comparable 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 benefit from credit losses was $15 million
and the provision for credit losses was $1.1 billion for the three and nine
months ended September 30, 2020 , respectively, compared to the provision for
credit losses of $134 million and $310 million during the same periods in the
prior year. The decrease in provision expense for the three months ended
September 30, 2020 compared to the same period in the prior year was primarily
driven by factors which caused a decrease in the ACL from the second quarter of
2020 including improved economic forecasts, improved consumer credit quality and
lower period-end loan and lease balances, partially offset by continued
increases in commercial criticized assets and nonperforming loans. The increase
in provision expense for the nine months ended September 30, 2020 compared to
the same period in the prior year was 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 change in the provision
for credit losses for both periods 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
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leases were 0.35% and 0.36% for the three months ended September 30, 2020 and
2019, respectively, and 0.41% and 0.32% for the nine months ended September 30,
2020 and 2019, respectively. At September 30, 2020 , nonperforming portfolio
assets as a percent of portfolio loans and leases and OREO increased to 0.84%
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 $18 million for the three months ended
September 30, 2020 compared to the same period in the prior year, primarily due
to decreases in other noninterest income, mortgage banking net revenue and
leasing business revenue, partially offset by an increase in wealth and asset
management revenue. Other noninterest income decreased $38 million for the three
months ended September 30, 2020 compared to the three months ended September 30,
2019 primarily due to a decrease in private equity investment income as well as
increases in the loss on the swap associated with the sale of Visa, Inc. Class B
Shares and the net losses on disposition and impairment of bank premises and
equipment. Mortgage banking net revenue decreased $19 million for the three
months ended September 30, 2020 compared to the same period in the prior year,
primarily due to a decrease in net mortgage servicing revenue. Leasing business
revenue decreased $15 million for the three months ended September 30, 2020
compared to the same period in the prior year primarily driven by decreases in
lease remarketing fees and operating lease income. Wealth and asset management
revenue increased $8 million for the three months ended September 30, 2020
compared to the same period in the prior year, primarily driven by increases in
private client service fees and broker income.
Noninterest income decreased $458 million for the nine months ended
September 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 wealth and asset
management revenue. Other noninterest income decreased $637 million for the nine
months ended September 30, 2020 compared to the nine months ended September 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 and an increase in the loss on the swap associated with the
sale of Visa, Inc. Class B Shares . Mortgage banking net revenue increased $81
million for the nine months ended September 30, 2020 , compared to the same
period in the prior year, primarily due to increases in origination fees and
gains on loan sales partially offset by a decrease in net mortgage servicing
revenue. Commercial banking revenue increased $54 million for the nine months
ended September 30, 2020 compared to the same period in the prior year,
primarily driven by increases in institutional sales and bridge fees partially
offset by a decrease in loan syndication fees. Wealth and asset management
revenue increased $29 million for the nine months ended September 30, 2020
compared to the same period in the prior year primarily driven by increases in
private client service fees, broker income and institutional fees.
Noninterest expense increased $2 million for the three months ended
September 30, 2020 compared to the same period in the prior year primarily due
to an increase in compensation and benefits expense, partially offset by
decreases in other noninterest expense, marketing expense and technology and
communications expense. The Bancorp recognized an immaterial amount of
merger-related expenses related to the MB Financial, Inc. acquisition for the
three months ended September 30, 2020 compared to $28 million in the same period
in the prior year. Compensation and benefits expense increased $53 million for
the three months ended September 30, 2020 compared to the same period in the
prior year primarily due to the impact of strategic hiring, the impact of
raising the Bancorp's minimum wage in the fourth quarter of 2019 and an increase
in severance expense. Other noninterest expense decreased $20 million for the
three months ended September 30, 2020 compared to the same period in the prior
year primarily due to decreases in travel expense and professional service fees,
partially offset by an increase in FDIC insurance and other taxes. Marketing
expense decreased $17 million for the three months ended September 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 and other account acquisition programs. Technology and communications
expense decreased $11 million for the three months ended September 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.
Noninterest expense decreased $17 million for the nine months ended
September 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 an increase in compensation and benefits expense. The
Bancorp recognized $16 million of merger-related expenses related to the MB
Financial, Inc. acquisition for the nine months ended September 30, 2020
compared to $213 million in the same period in the prior year. Technology and
communications expense decreased $47 million for the nine months ended
September 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 $43 million for the nine
months ended September 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 and other account acquisition programs.
Compensation and benefits expenses increased $68 million for the nine months
ended September 30, 2020 compared to the same period in the prior year primarily
due to the impact of strategic hiring and the impact of raising the Bancorp's
minimum wage in the fourth quarter of 2019. Compensation and benefits expense
for the nine months ended September 30, 2020 included $10 million of special
payments to employees providing essential banking services through the COVID-19
pandemic.
9
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Table of Contents
Management's Discussion and Analysis of Financial Condition and Results of Operations
(continued)
For more information on net interest income, noninterest income and noninterest expense refer to the Statements of Income Analysis section of MD&A.
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 ofSeptember 30, 2020 . As ofSeptember 30, 2020 , the Bancorp's capital ratios, as defined by theU.S. banking agencies, were: •CET1 capital ratio: 10.14%; •Tier I risk-based capital ratio: 11.64%; •Total risk-based capital ratio: 14.93%; •Tier I leverage ratio: 8.37% 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 primaryU.S. GAAP measures and should not be read in isolation or relied upon as a substitute for the primaryU.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 toU.S. GAAP: TABLE 2: Non-GAAP Financial Measures - Financial Measures and Ratios on an FTE basis For the three months ended For the nine months ended September 30, September 30, ($ in millions) 2020 2019 2020 2019 Net interest income (U.S. GAAP)$ 1,170 1,242 3,600 3,569 Add: FTE adjustment 3 4 10 13 Net interest income on an FTE basis (1)$ 1,173 1,246 3,610 3,582 Net interest income on an FTE basis (annualized) (2) 4,667 4,943 4,823 4,789 Interest income (U.S. GAAP)$ 1,329 1,625 4,257 4,694 Add: FTE adjustment 3 4 10 13 Interest income on an FTE basis$ 1,332 1,629 4,267 4,707 Interest income on an FTE basis (annualized) (3) 5,299 6,463 5,701 6,293 Interest expense (annualized) (4)$ 633 1,520 878 1,504 Noninterest income (5) 722 740 2,043 2,501 Noninterest expense (6) 1,161 1,159 3,482 3,499 Average interest-earning assets (7) 180,704 148,854 169,422 144,088 Average interest-bearing liabilities (8) 123,626 107,633 119,132 103,742
Ratios:
Net interest margin on an FTE basis (2) / (7) 2.58 % 3.32 2.85 3.32 Net interest rate spread on an FTE basis ((3) / (7)) - ((4) / (8)) 2.42 2.93 2.62 2.92 Efficiency ratio on an FTE basis (6) / ((1) + (5)) 61.3 58.4 61.6 57.5 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 three months ended For the nine months ended September 30, September 30, ($ in millions) 2020 2019 2020 2019 Net income available to common shareholders (U.S. GAAP)$ 562 530 754 1,718 Add: Intangible amortization, net of tax 9 11 29 24 Tangible net income available to common shareholders$ 571 541 783 1,742 Tangible net income available to common shareholders (annualized) (1) 2,272 2,146 1,046 2,329Average Bancorp's shareholders' equity (U.S. GAAP)$ 22,952 21,087 22,364 19,430 Less: Average preferred stock (2,007) (1,445) (1,849) (1,369) Average goodwill (4,261) (4,286) (4,257) (3,762) Average intangible assets (164) (208) (178) (161) Average tangible common equity (2)$ 16,520 15,148 16,080 14,138 Return on average tangible common equity (1) / (2) 13.8 % 14.2 6.5 16.5 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
September 30, December 31,
As of ($ in millions) 2020 2019
Total Bancorp Shareholders' Equity (U.S. GAAP) $ 22,951 21,203
Less: Preferred stock (2,116) (1,770)
Goodwill (4,261) (4,252)
Intangible assets (157) (201)
AOCI (2,831) (1,192)
Tangible common equity, excluding AOCI (1) 13,586 13,788
Add: Preferred stock 2,116 1,770
Tangible equity (2) $ 15,702 15,558
Total Assets (U.S. GAAP) $ 201,996 169,369
Less: Goodwill (4,261) (4,252)
Intangible assets (157) (201)
AOCI, before tax (3,584) (1,509)
Tangible assets, excluding AOCI (3) $ 193,994 163,407
Ratios:
Tangible equity as a percentage of tangible assets (2) / (3) 8.09 % 9.52
Tangible common equity as a percentage of tangible assets (1) / (3) 6.99 8.44
11-------------------------------------------------------------------------------- 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 withU.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 endedDecember 31, 2019 . OnJanuary 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 endedDecember 31, 2019 for discussion on the critical accounting policies for the ALLL, reserve for unfunded commitments and goodwill for periods prior toJanuary 1, 2020 . There have been no other material changes to the valuation techniques or models during the nine months endedSeptember 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. The Bancorp completed its annual goodwill impairment test as ofSeptember 30, 2020 and concluded that the fair values of each of its reporting units exceeded their respective carrying amounts. While the Bancorp concluded that its goodwill was not impaired as ofSeptember 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 nine months endedSeptember 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 endedSeptember 30, 2020 , a decrease of$73 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 141 bps. The decreases in yields on average interest-earning assets were primarily driven by decreases in yields on total average loans and leases primarily as a result of decreases in yields on average commercial and industrial loans, average commercial mortgage loans, average commercial construction loans and average home equity rates of 131 bps, 174 bps, 221 bps and 161 bps, respectively, for the three months endedSeptember 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 endedSeptember 30, 2020 was primarily due to a decrease in market rates, impacting the Bancorp's portfolios of floating interest rate loans, which are primarily LIBOR- and Prime-based. The Bancorp's portfolios of fixed interest rate loans also decreased in yield as a result of increased refinance activity and lower reinvestment yields due to lower overall market rates. The net interest income impact of lower yields on average interest-earning assets was partially offset by decreases in rates paid on average interest-bearing liabilities of 90 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 and average long-term debt rates of 102 bps, 99 bps and 64 bps, respectively, for the three months endedSeptember 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$2.7 billion and$1.9 billion , respectively, for the three months endedSeptember 30, 2020 compared to the same period in the prior year. Net interest income on an FTE basis (non-GAAP) was$3.6 billion for the nine months endedSeptember 30, 2020 , an increase of$28 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 71 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 and average long-term debt of 82 bps, 73 bps and 49 bps, respectively, for the nine months endedSeptember 30, 2020 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$5.1 billion ,$2.1 billion and$1.5 billion , respectively, for the nine months endedSeptember 30, 2020 compared to the same period in the prior year. These positive impacts were partially offset by decreases in yields on average interest-earning assets of 101 bps. The decreases in yields on average interest-earning assets were primarily driven by decreases in yields on total average loans and leases primarily driven by decreases in yields on average commercial and industrial loans, average commercial mortgage loans, average commercial construction loans and average home equity rates of 104 bps, 128 bps, 173 bps and 130 bps, respectively, for the nine months endedSeptember 30, 2020 compared to the same period in the prior year. Net interest income was also negatively impacted by increases in average interest checking deposits and average money market deposits of$10.6 billion and$4.1 billion , respectively, for the nine months endedSeptember 30, 2020 compared to the same period in the prior year. Net interest income for both the three and nine months endedSeptember 30, 2020 compared to the same periods in the prior year 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 nine months endedSeptember 30, 2020 , net interest income included$13 million and$44 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$28 million and$47 million for the three and nine months endedSeptember 30, 2019 , respectively. Net interest rate spread on an FTE basis (non-GAAP) was 2.42% and 2.62% during the three and nine months endedSeptember 30, 2020 , respectively, compared to 2.93% and 2.92% in the same periods in the prior year. Yields on average interest-earning assets decreased 141 bps and 101 bps, respectively, for the three and nine months endedSeptember 30, 2020 , partially offset by decreases in the rates paid on average interest-bearing liabilities of 90 bps and 71 bps, respectively, for the three and nine months endedSeptember 30, 2020 compared to the three and nine months endedSeptember 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 2.58% and 2.85% for the three and nine months endedSeptember 30, 2020 , respectively, compared to 3.32% for both the comparable periods in the prior year. Net interest margin was negatively impacted by increases in average interest-earning assets of$31.9 billion and$25.3 billion for the three and nine months endedSeptember 30, 2020 , respectively, which was primarily attributable to growth in low yielding cash balances reported in other short-term investments. These negative impacts were partially offset by increases in average free funding balances primarily driven by increases in average demand deposits of$15.2 billion and$10.1 billion , respectively, and average shareholders' equity of$1.7 billion and$2.8 billion , respectively, for the three and nine months endedSeptember 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$274 million and$406 million during the three and nine months endedSeptember 30, 2020 , respectively, compared to the three and nine months endedSeptember 30, 2019 driven by the previously mentioned decreases in yields on average loans and leases, partially offset by increases in average commercial and industrial loans, average indirect secured consumer loans and average commercial mortgage loans for the three and nine months endedSeptember 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$23 million and$34 million during the three and nine months endedSeptember 30, 2020 , respectively, compared to the three and nine months endedSeptember 30, 2019 primarily due to decreases in yields on average other short-term investments and average taxable securities, partially offset by increases in average balances. Interest expense on core deposits decreased$181 million and$361 million for the three and nine months endedSeptember 30, 2020 , respectively, compared to the three and nine months endedSeptember 30, 2019 primarily due to decreases in the cost of average interest-bearing core deposits to 13 bps and 35 bps for the three and nine months endedSeptember 30, 2020 , respectively, from 101 bps for both the three and nine months endedSeptember 30, 2019 . 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. 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$43 million and$107 million for the three and nine months endedSeptember 30, 2020 , respectively, compared to the three and nine months endedSeptember 30, 2019 primarily due to the previously mentioned decreases in rates paid on average long-term debt as well as decreases in rates paid on average other short-term borrowings and average certificates$100,000 and over. Refer to the Borrowings subsection of the Balance Sheet Analysis section of MD&A for additional information on the Bancorp's borrowings. During the three and nine months endedSeptember 30, 2020 , average wholesale funding represented 18% and 19%, respectively, of average interest-bearing liabilities, compared to 21% and 22% for the three and nine months endedSeptember 30, 2019 , respectively. For more information on the Bancorp's interest rate risk management, including estimated earnings sensitivity to changes in market interest rates, see the Interest Rate and Price Risk Management subsection of the Risk Management section of MD&A. 16 -------------------------------------------------------------------------------- Table of Contents Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) TABLE 5: Condensed Average Balance Sheets and Analysis of Net Interest Income on an FTE Basis Attribution of Change in For the three months ended September 30, 2020 September 30, 2019 Net Interest Income(a) Revenue/ Average Yield/ Revenue/ Average Yield/ ($ 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 $ 54,056 455 3.35 % $ 51,364 604 4.66 % $ 28 (177) (149)
Commercial mortgage loans 11,071 87 3.12 10,695 131 4.86 4 (48) (44)
Commercial construction loans 5,534 44 3.18 5,267 71 5.39 4 (31) (27)
Commercial leases 2,966 26 3.44 3,563 30 3.34 (5) 1 (4)
Total commercial loans and leases 73,627 612 3.30 70,889 836 4.68 31 (255) (224)
Residential mortgage loans 17,814 156 3.48 17,733 164 3.67 1 (9) (8)
Home equity 5,581 50 3.59 6,267 82 5.20 (9) (23) (32)
Indirect secured consumer loans 12,599 125 3.93 10,707 114 4.22 19 (8) 11
Credit card 2,134 61 11.37 2,448 77 12.57 (9) (7) (16)
Other consumer loans 2,858 46 6.46 2,622 51 7.69 4 (9) (5)
Total consumer loans 40,986 438 4.25 39,777 488 4.87 6 (56) (50)
Total loans and leases $ 114,613 1,050 3.64 % $ 110,666 1,324 4.75 % $ 37 (311) (274)
Securities:
Taxable 36,147 273 3.01 35,653 291 3.24 3 (21) (18)
Exempt from income taxes(b) 153 1 2.99 38 - 3.18 1 - 1
Other short-term investments 29,791 8 0.10 2,497 14 2.18 18 (24) (6)
Total interest-earning assets $ 180,704 1,332 2.93 % $ 148,854 1,629 4.34 % $ 59 (356) (297)
Cash and due from banks 2,944 2,769
Other assets 21,583 19,077
Allowance for loan and lease losses (2,698) (1,115)
Total assets $ 202,533 $ 169,585
Liabilities and Equity:
Interest-bearing liabilities:
Interest checking deposits $ 49,800 13 0.10 % $ 37,729 106 1.12 % $ 26 (119) (93)
Savings deposits 17,013 2 0.04 14,405 7 0.18 1 (6) (5)
Money market deposits 31,151 11 0.14 26,962 77 1.13 10 (76) (66)
Foreign office deposits 189 - 0.06 222 - 0.37 - - -
Other time deposits 3,711 9 0.95 5,823 26 1.79 (7) (10) (17)
Total interest-bearing core deposits 101,864 35 0.13 85,141 216 1.01 30 (211) (181)
Certificates $100,000 and over 3,633 11 1.26 4,795 27 2.20 (6) (10) (16)
Other deposits - - - 47 - 1.97 - - -
Federal funds purchased 273 - 0.20 739 4 2.06 (2) (2) (4)
Other short-term borrowings 1,626 5 1.28 1,278 8 2.55 2 (5) (3)
Long-term debt 16,230 108 2.62 15,633 128 3.26 6 (26) (20)
Total interest-bearing liabilities $ 123,626 159 0.51 % $ 107,633 383 1.41 % $ 30 (254) (224)
Demand deposits 50,414 35,223
Other liabilities 5,541 5,522
Total liabilities $ 179,581 $ 148,378
Total equity $ 22,952 $ 21,207
Total liabilities and equity $ 202,533 $ 169,585
Net interest income (FTE)(c) $ 1,173 $ 1,246 $ 29 (102) (73)
Net interest margin (FTE)(c) 2.58 % 3.32 %
Net interest rate spread (FTE)(c) 2.42 2.93
Interest-bearing liabilities to
interest-earning assets 68.41 72.31
(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 $4 for the three
months ended September 30, 2020 and 2019, respectively.
(c)Net interest income (FTE), net interest margin (FTE) and net interest rate
spread (FTE) are non-GAAP measures. For further information, refer to the
Non-GAAP Financial Measures section of MD&A.
17
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Management's Discussion and Analysis of Financial Condition and Results of Operations
(continued)
TABLE 6: Condensed Average Balance Sheets and Analysis of Net Interest Income on an FTE Basis
Attribution of Change in
For the nine months ended September 30, 2020 September 30, 2019 Net Interest Income(a)
Revenue/ Average Yield/ Revenue/ Average Yield/
($ 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 $ 54,948 1,511 3.67 % $ 49,895 1,757 4.71 % $ 168 (414) (246)
Commercial mortgage loans 11,105 305 3.66 9,593 354 4.94 51 (100) (49)
Commercial construction loans 5,405 154 3.82 5,119 213 5.55 11 (70) (59)
Commercial leases 3,074 79 3.46 3,643 90 3.31 (15) 4 (11)
Total commercial loans and leases 74,532 2,049 3.67 68,250 2,414 4.73 215 (580) (365)
Residential mortgage loans 17,748 471 3.55 17,163 474 3.69 16 (19) (3)
Home equity 5,802 173 3.98 6,333 250 5.28 (19) (58) (77)
Indirect secured consumer loans 12,179 367 4.02 10,030 304 4.05 65 (2) 63
Credit card 2,293 199 11.61 2,418 227 12.52 (12) (16) (28)
Other consumer loans 2,847 147 6.88 2,525 143 7.59 18 (14) 4
Total consumer loans 40,869 1,357 4.43 38,469 1,398 4.86 68 (109) (41)
Total loans and leases $ 115,401 3,406 3.94 % $ 106,719 3,812 4.78 % $ 283 (689) (406)
Securities:
Taxable 36,312 837 3.08 35,151 861 3.28 29 (53) (24)
Exempt from income taxes(b) 157 4 3.00 35 1 3.72 3 - 3
Other short-term investments 17,552 20 0.15 2,183 33 1.99 42 (55) (13)
Total interest-earning assets $ 169,422 4,267 3.36 % $ 144,088 4,707 4.37 % $ 357 (797) (440)
Cash and due from banks 2,981 2,641
Other assets 20,870 16,501
Allowance for loan and lease losses (2,300) (1,111)
Total assets $ 190,973 $ 162,119
Liabilities and Equity:
Interest-bearing liabilities:
Interest checking deposits $ 46,631 117 0.33 % $ 35,995 310 1.15 % $ 74 (267) (193)
Savings deposits 16,031 9 0.07 13,963 17 0.17 3 (11) (8)
Money market deposits 29,434 83 0.38 25,357 210 1.11 29 (156) (127)
Foreign office deposits 193 - 0.25 198 1 0.49 - (1) (1)
Other time deposits 4,402 42 1.27 5,457 74 1.81 (13) (19) (32)
Total interest-bearing core deposits 96,691 251 0.35 80,970 612 1.01 93 (454) (361)
Certificates $100,000 and over 3,685 43 1.56 4,650 75 2.14 (14) (18) (32)
Other deposits 95 1 0.76 269 5 2.43 (2) (2) (4)
Federal funds purchased 412 2 0.68 1,298 23 2.42 (10) (11) (21)
Other short-term borrowings 1,916 13 0.90 1,017 23 2.97 12 (22) (10)
Long-term debt 16,333 347 2.84 15,538 387 3.33 19 (59) (40)
Total interest-bearing liabilities $ 119,132 657 0.74 % $ 103,742 1,125 1.45 % $ 98 (566) (468)
Demand deposits 44,004 33,883
Other liabilities 5,473 4,950
Total liabilities $ 168,609 $ 142,575
Total equity $ 22,364 $ 19,544
Total liabilities and equity $ 190,973 $ 162,119
Net interest income (FTE)(c) $ 3,610 $ 3,582 $ 259 (231) 28
Net interest margin (FTE)(c) 2.85 % 3.32 %
Net interest rate spread (FTE)(c) 2.62 2.92
Interest-bearing liabilities to
interest-earning assets 70.32 72.00
(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 $10 and $13 for the nine
months ended September 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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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 benefit from credit losses was $15 million and the provision for credit
losses was $1.1 billion for the three and nine months ended September 30, 2020 ,
respectively, compared to the provision for credit losses of $134 million and
$310 million during the same periods in the prior year. The decrease in
provision expense for the three months ended September 30, 2020 compared to the
same period in the prior year was primarily driven by factors which caused a
decrease in the ACL from the second quarter of 2020 including improved economic
forecasts, improved consumer credit quality and lower period-end loan and lease
balances, partially offset by continued increases in commercial criticized
assets and nonperforming loans. The increase in provision expense for the nine
months ended September 30, 2020 compared to the same period in the prior year
was 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 change in the provision for credit losses for both
periods 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 $1.4 billion from December 31, 2019 to $2.6 billion at
September 30, 2020 . At September 30, 2020 , the ALLL as a percent of portfolio
loans and leases increased to 2.32%, compared to 1.10% at December 31, 2019 . The
reserve for unfunded commitments increased $38 million from December 31, 2019 to
$182 million at September 30, 2020 . The ACL as a percent of portfolio loans and
leases increased to 2.49% at September 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 (benefit from) 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 (benefit from)
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 $18 million and $458 million for the three and nine
months ended September 30, 2020 , respectively, compared to the three and nine
months ended September 30, 2019 .
The following table presents the components of noninterest income: TABLE 7: Components of Noninterest Income
For the three months ended For the nine months ended
September 30, September 30,
($ in millions) 2020 2019 % Change 2020 2019 % Change
Service charges on deposits $ 144 143 1 $ 414 417 (1)
Wealth and asset management
revenue 132 124 6 387 358 8
Commercial banking revenue 125 123 2 387 333 16
Mortgage banking net revenue 76 95 (20) 295 214 38
Card and processing revenue 92 94 (2) 260 266 (2)
Leasing business revenue 77 92 (16) 207 199 4
Other noninterest income 26 64 (59) 42 679 (94)
Securities gains, net 51 5 920 48 30 60
Securities gains (losses), net -
non-qualifying hedges on mortgage
servicing rights (1) - NM 3 5 (40)
Total noninterest income $ 722 740 (2) $ 2,043 2,501 (18)
Service charges on deposits
Service charges on deposits increased $1 million and decreased $3 million for
the three and nine months ended September 30, 2020 , respectively, compared to
the three and nine months ended September 30, 2019 . The increase for the three
months ended September 30, 2020 compared to the same period in the prior year
was driven by an increase in commercial deposit fees of $9 million partially
offset by a decrease in consumer deposit fees of $8 million . The decrease for
the nine months ended September 30, 2020 compared to the same period in
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Management's Discussion and Analysis of Financial Condition and Results of Operations
(continued)
the prior year was due to a decrease of
Wealth and asset management revenue Wealth and asset management revenue increased$8 million and$29 million for the three and nine months endedSeptember 30, 2020 , respectively, compared to the three and nine months endedSeptember 30, 2019 primarily driven by increases in private client service fees of$5 million and$13 million , respectively, and broker income of$4 million and$12 million , respectively. The increase for the nine months endedSeptember 30, 2020 also included the impact of an increase in institutional fees of$5 million compared to the same period in the prior year. The Bancorp's trust and registered investment advisory businesses had approximately$422 billion and$397 billion in total assets under care as ofSeptember 30, 2020 and 2019, respectively, and managed$53 billion and$46 billion in assets for individuals, corporations and not-for-profit organizations as ofSeptember 30, 2020 and 2019, respectively. Commercial banking revenue Commercial banking revenue increased$2 million and$54 million for the three and nine months endedSeptember 30, 2020 , respectively, compared to the three and nine months endedSeptember 30, 2019 . The increase for the three months endedSeptember 30, 2020 compared to the same period in the prior year was primarily due to an increase in institutional sales of$16 million partially offset by decreases in contract revenue from commercial customer derivatives and loan syndication fees of$7 million and$6 million , respectively. The increase for the nine months endedSeptember 30, 2020 compared to the same period in the prior year was primarily driven by increases in institutional sales and bridge fees of$58 million and$9 million , respectively, partially offset by a decrease in loan syndication fees of$19 million . Mortgage banking net revenue Mortgage banking net revenue decreased$19 million and increased$81 million for the three and nine months endedSeptember 30, 2020 , respectively, compared to the three and nine months endedSeptember 30, 2019 .
The following table presents the components of mortgage banking net revenue: TABLE 8: Components of Mortgage Banking Net Revenue
For the three months ended For the nine months ended
September 30, September 30,
($ in millions) 2020 2019 2020 2019
Origination fees and gains on loan sales $ 93 64 269 126
Net mortgage servicing revenue:
Gross mortgage servicing fees 66 71 197 196
Net valuation adjustments on MSRs and
free-standing derivatives purchased to
economically hedge MSRs (83) (40) (171) (108)
Net mortgage servicing revenue (17) 31 26 88
Total mortgage banking net revenue $ 76 95 295 214
Origination fees and gains on loan sales increased $29 million and $143 million
for the three and nine months ended September 30, 2020 , respectively, compared
to the three and nine months ended September 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 $4.5 billion
and $12.0 billion for the three and nine months ended September 30, 2020 ,
respectively, from $3.4 billion and $7.9 billion for the three and nine months
ended September 30, 2019 , respectively.
Net mortgage servicing revenue decreased $48 million and $62 million for the
three and nine months ended September 30, 2020 , respectively, compared to the
three and nine months ended September 30, 2019 primarily due to increases in net
negative valuation adjustments of $43 million and $63 million , respectively. The
decrease for the three months ended September 30, 2020 compared to the same
period in the prior year also included the impact of a decrease in gross
mortgage servicing fees of $5 million . Refer to Table 9 for the components of
net valuation adjustments on the MSR portfolio and the impact of the
non-qualifying hedging strategy.
20
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Management's Discussion and Analysis of Financial Condition and Results of Operations
(continued)
TABLE 9: Components of Net Valuation Adjustments on MSRs
For the three months ended For the nine months ended
September 30, September 30,
($ in millions) 2020 2019 2020 2019
Changes in fair value and settlement of
free-standing derivatives purchased to
economically hedge the MSR portfolio $ (12) 130 348 308
Changes in fair value:
Due to changes in inputs or assumptions 4 (120) (340) (294)
Other changes in fair value (75) (50) (179) (122)
Net valuation adjustments on MSRs and
free-standing derivatives purchased to
economically hedge MSRs $ (83) (40) (171) (108)
Mortgage rates decreased during both the three and nine months ended
September 30, 2020 and 2019, which caused modeled prepayment speeds to rise.
Additionally, swap rates increased for the three months ended September 30,
2020 , which caused modeled OAS assumptions to increase. The fair value of the
MSR portfolio increased $4 million and decreased $340 million for the three and
nine months ended September 30, 2020 , respectively, compared to decreases of
$120 million and $294 million for the three and nine months ended September 30,
2019 , respectively, due to changes to inputs to the valuation model, including
prepayment speeds and OAS assumptions. The fair value of the MSR portfolio
decreased $75 million and $179 million for the three and nine months ended
September 30, 2020 , respectively, compared to $50 million and $122 million for
the three and nine months ended September 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 losses of $1 million
and net gains of $3 million during the three and nine months ended September 30,
2020 , respectively, compared to net losses of an immaterial amount and net gains
of $5 million during the three and nine months ended September 30, 2019 ,
respectively, recorded in securities gains (losses), net - non-qualifying hedges
on MSRs in the Bancorp's Condensed Consolidated Statements of Income.
The Bancorp's total residential mortgage loans serviced as of September 30, 2020
and 2019 were $91.4 billion and $100.5 billion , respectively, with $73.5 billion
and $82.7 billion , respectively, of residential mortgage loans serviced for
others.
Card and processing revenue
Card and processing revenue decreased $2 million and $6 million for the three
and nine months ended September 30, 2020 , respectively, compared to the three
and nine months ended September 30, 2019 . The decrease for the nine months ended
September 30, 2020 compared to the same period in the prior year was primarily
driven by a decrease in customer spend volume, partially offset by lower reward
costs and increases in other EFT income driven by the MB Financial, Inc.
acquisition at the end of the first quarter of 2019.
Leasing business revenue
Leasing business revenue decreased $15 million for the three months ended
September 30, 2020 compared to the same period in the prior year primarily
driven by decreases in lease remarketing fees and operating lease income of $10
million and $5 million , respectively. Leasing business revenue increased $8
million for the nine months ended September 30, 2020 compared to the same period
in the prior year primarily driven by increases in lease syndication fees and
operating lease income of $9 million and $7 million , respectively, partially
offset by a decrease in lease remarketing fees of $6 million . The increase in
operating lease income for the nine months ended September 30, 2020 was driven
by the acquisition of MB Financial, Inc. at the end of the first quarter of
2019.
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Management's Discussion and Analysis of Financial Condition and Results of Operations
(continued)
Other noninterest income
The following table presents the components of other noninterest income:
TABLE 10: Components of Other Noninterest
Income
For the three months ended For the nine months ended
September 30, September 30,
($ in millions) 2020 2019 2020 2019
BOLI income $ 15 15 47 44
Cardholder fees 12 14 33 44
Consumer loan and lease fees 5 6 15 17
Insurance income 5 4 15 14
Banking center income 5 6 15 17
Loss on swap associated with the sale of Visa ,
Inc. Class B Shares (22) (11) (73) (63)
Net losses on disposition and impairment of
bank premises and equipment (11) (3) (26) (24)
Private equity investment (loss) income 3 21 (5) 43
Gain on sale of Worldpay, Inc. shares - - - 562
Equity method income from interest in Worldpay
Holding, LLC - - - 2
Other, net 14 12 21 23
Total other noninterest income $ 26 64 42 679
Other noninterest income decreased $38 million for the three months ended
September 30, 2020 compared to the three months ended September 30, 2019
primarily due to a decrease in private equity investment income as well as
increases in the loss on the swap associated with the sale of Visa, Inc. Class B
Shares and the net losses on disposition and impairment of bank premises and
equipment.
Private equity investment income decreased $18 million for the three months
ended September 30, 2020 compared to the same period in the prior year primarily
driven by the recognition of gains on certain private equity investments during
the three months ended September 30, 2019 . For additional information on the
valuation of private equity investments, refer to Note 24 of the Notes to
Condensed Consolidated Financial Statements. The Bancorp recognized negative
valuation adjustments of $22 million related to the Visa total return swap
during the three months ended September 30, 2020 compared to negative valuation
adjustments of $11 million during the three months ended September 30, 2019 . For
additional information on the valuation of the swap associated with the sale of
Visa, Inc. Class B Shares , refer to Note 24 of the Notes to Condensed
Consolidated Financial Statements. Net losses on disposition and impairment of
bank premises and equipment increased $8 million for the three months ended
September 30, 2020 compared to the three months ended September 30, 2019
primarily driven by the impact of losses on the disposition of certain
long-lived assets as well as impairment charges. For additional information on
impairment of bank premises and equipment, refer to Note 8 and Note 24 of the
Notes to Condensed Consolidated Financial Statements.
Other noninterest income decreased $637 million for the nine months ended
September 30, 2020 compared to the nine months ended September 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
and an increase in the loss on the swap associated with the sale of Visa, Inc.
Class B Shares .
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 $48 million for the nine months ended September 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 nine months ended September 30, 2020 compared to positive
net valuation adjustments and gains on certain private equity investments during
the nine months ended September 30, 2019 . For additional information on the
valuation of private equity investments, refer to Note 24 of the Notes to
Condensed Consolidated Financial Statements. The Bancorp recognized negative
valuation adjustments of $73 million related to the Visa total return swap
during the nine months ended September 30, 2020 compared to negative valuation
adjustments of $63 million during the nine months ended September 30, 2019 . For
additional information on the valuation of the swap associated with the sale of
Visa, Inc. Class B Shares , refer to Note 24 of the Notes to Condensed
Consolidated Financial Statements.
22
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Management's Discussion and Analysis of Financial Condition and Results of Operations
(continued)
Noninterest Expense
Noninterest expense increased $2 million for the three months ended
September 30, 2020 compared to the same period in the prior year primarily due
to an increase in compensation and benefits expense, partially offset by
decreases in other noninterest expense, marketing expense and technology and
communications expense. Noninterest expense decreased $17 million for the nine
months ended September 30, 2020 compared to the same period in the prior year
primarily due to decreases in technology and communications expense and
marketing expense, partially offset by an increase in compensation and benefits
expense.
The following table presents the components of noninterest expense: TABLE 11: Components of Noninterest Expense
For the three months ended For the nine months ended
September 30, September 30,
($ in millions) 2020 2019 % Change 2020 2019 % Change
Compensation and benefits $ 637 584 9 $ 1,911 1,843 4
Technology and communications 89 100 (11) 272 319 (15)
Net occupancy expense 90 84 7 254 248 2
Leasing business expense 35 40 (13) 103 97 6
Equipment expense 33 33 - 97 96 1
Card and processing expense 29 33 (12) 89 98 (9)
Marketing expense 23 40 (43) 74 117 (37)
Other noninterest expense 225 245 (8) 682 681 -
Total noninterest expense $ 1,161 1,159
- $ 3,482 3,499 -
Efficiency ratio on an FTE basis(a) 61.3 % 58.4 61.6 % 57.5
(a)This is a non-GAAP measure. For further information, refer to the Non-GAAP Financial Measures section of MD&A.
The Bancorp recognized an immaterial amount and$28 million of merger-related expenses for the three months endedSeptember 30, 2020 and 2019, respectively, and$16 million and$213 million for the nine months endedSeptember 30, 2020 and 2019, respectively. The following table provides a summary of merger-related expenses recorded in noninterest expense: TABLE 12: Merger-Related Expenses For the three months ended For the nine months ended September 30, September 30, ($ in millions) 2020 2019 2020 2019 Compensation and benefits $ - 14 4 88 Technology and communications - 8 6 68 Net occupancy expense - 3 4 10 Equipment expense - - - 1 Card and processing expense - - - 1 Marketing expense - - - 7 Other noninterest expense - 3 2 38 Total $ - 28 16 213 Technology and communications expense decreased$11 million and$47 million for the three and nine months endedSeptember 30, 2020 , respectively, compared to the same periods in the prior year primarily driven by decreased integration and conversion costs related to the acquisition ofMB Financial, Inc. Marketing expense decreased$17 million and$43 million for the three and nine months endedSeptember 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 and other account acquisition programs. Compensation and benefits expense increased$53 million and$68 million for the three and nine months endedSeptember 30, 2020 , respectively, compared to the same periods in the prior year primarily due to strategic hiring and the impact of raising the Bancorp's minimum wage in the fourth quarter of 2019. The increase for the three months endedSeptember 30, 2020 also included an increase in severance expense of$18 million . Compensation and benefits expense for the three and nine months endedSeptember 30, 2020 included zero and$10 million , respectively, of special payments to employees providing essential banking services through the COVID-19 pandemic. Full-time equivalent employees totaled 20,283 atSeptember 30, 2020 compared to 19,478 atSeptember 30, 2019 . 23 -------------------------------------------------------------------------------- Table of Contents Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
The following table presents the components of other noninterest expense: TABLE 13: Components of Other Noninterest Expense
For the three months ended For the nine months ended
September 30, September 30,
($ in millions) 2020 2019 2020 2019
Loan and lease $ 41 40 116 101
Losses and adjustments 23 25 94 81
FDIC insurance and other taxes 36 22 86 60
Data processing 20 19 55 53
Intangible amortization 12 14 36 31
Professional service fees 10 17 33 53
Postal and courier 9 9 27 28
Travel 4 18 23 51
Recruitment and education 5 8 16 19
Insurance 4 4 11 10
Supplies 3 4 10 11
Donations 2 3 9 9
Other, net 56 62 166 174
Total other noninterest expense $ 225 245 682 681
Other noninterest expense decreased $20 million for the three months ended
September 30, 2020 compared to the same period in the prior year primarily due
to decreases in travel expense and professional service fees, partially offset
by an increase in FDIC insurance and other taxes. Travel expense decreased $14
million for the three months ended September 30, 2020 compared to the same
period in the prior year primarily due to reduced business travel as a direct
result of the COVID-19 pandemic. Professional service fees decreased $7 million
for the three months ended September 30, 2020 compared to the same period in the
prior year primarily due to decreases in consulting fees and acquisition costs.
FDIC insurance and other taxes increased $14 million for the three months ended
September 30, 2020 compared to the same period in the prior year primarily due
to an increase in the assessment base.
Other noninterest expense increased $1 million for the nine months ended
September 30, 2020 compared to the same period in the prior year primarily due
to increases in FDIC insurance and other taxes, loan and lease expense and
losses and adjustments, partially offset by decreases in travel expenses and
professional service fees. FDIC insurance and other taxes increased $26 million
for the nine months ended September 30, 2020 compared to the same period in the
prior year primarily due to an increase in the assessment base. Loan and lease
expense increased $15 million for the nine months ended September 30, 2020
compared to the same period in the prior year primarily due to an increase in
loan closing expenses. Losses and adjustments increased $13 million for the nine
months ended September 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. Travel
expenses decreased $28 million for the nine months ended September 30, 2020
compared to the same period in the prior year primarily due to business travel
being suspended for the second quarter of 2020 and reduced travel in the third
quarter of 2020 as a direct result of the COVID-19 pandemic. Professional
service fees decreased $20 million for the nine months ended September 30, 2020
compared to the same period in the prior year primarily due to decreases in
consulting fees and acquisition costs. Additionally, other noninterest expense
included $6 million of debt extinguishment costs associated with FHLB advances
extinguished during the nine months ended September 30, 2020 .
Applicable Income Taxes
The Bancorp's income before income taxes, applicable income tax expense and
effective tax rate are as follows:
TABLE 14: Applicable Income Taxes
For the three months ended For the nine months ended
September 30, September 30,
($ in millions) 2020 2019 2020 2019
Income before income taxes $ 746 689 1,051 2,261
Applicable income tax expense 165 140 228 483
Effective tax rate 22.1 % 20.2 21.6 21.4
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
24
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Management's Discussion and Analysis of Financial Condition and Results of Operations
(continued)
Credit program established under Section 47 of the IRC and the Qualified Zone Academy Bond program established under Section 1397E of the IRC.
The increase in the effective tax rate for the three months endedSeptember 30, 2020 compared to the same period in the prior year was primarily related to the amount of income tax benefit recognized related to gains on sales of leases that are exempt from federal taxation for the three months endedSeptember 30, 2019 as well as an increase in estimated state income tax expense and an increase in non-deductible expenses for the three months endedSeptember 30, 2020 . 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 atSeptember 30, 2020 , the Bancorp estimates it may be necessary to recognize$5 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. 25 --------------------------------------------------------------------------------
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