FIFTH THIRD BANCORP - Quarter Report: 2017 March (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2017

Commission File Number 001-33653

(Exact name of Registrant as specified in its charter)

Fifth Third Center

Cincinnati, Ohio 45263

(Address of principal executive offices)

Registrant’s telephone number, including area code: (800) 972-3030

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ☐    No  ☒

There were 750,269,402 shares of the Registrant’s common stock, without par value, outstanding as of April 30, 2017.

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FINANCIAL CONTENTS

FORWARD-LOOKING STATEMENTS

This report contains statements that we believe are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended, and Rule 3b-6 promulgated thereunder. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. They usually can be identified by the use of forward-looking language such as “will likely result,” “may,” “are expected to,” “is anticipated,” “potential,” “estimate,” “forecast,” “projected,” “intends to,” or may include other similar words or phrases such as “believes,” “plans,” “trend,” “objective,” “continue,” “remain,” or similar expressions, or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” or similar verbs. You should not place undue reliance on these statements, as they are subject to risks and uncertainties, including but not limited to the risk factors set forth in our most recent Annual Report on Form 10-K. When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements we may make. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to us. There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements. Factors that might cause such a difference include, but are not limited to: (1) general economic or real estate market conditions, either nationally or in the states in which Fifth Third, one or more acquired entities and/or the combined company do business, weaken or are less favorable than expected; (2) deteriorating credit quality; (3) political developments, wars or other hostilities may disrupt or increase volatility in securities markets or other economic conditions; (4) changes in the interest rate environment reduce interest margins; (5) prepayment speeds, loan origination and sale volumes, charge-offs and loan loss provisions; (6) Fifth Third’s ability to maintain required capital levels and adequate sources of funding and liquidity; (7) maintaining capital requirements and adequate sources of funding and liquidity may limit Fifth Third’s operations and potential growth; (8) changes and trends in capital markets; (9) problems encountered by larger or similar financial institutions may adversely affect the banking industry and/or Fifth Third; (10) competitive pressures among depository institutions increase significantly; (11) changes in customer preferences or information technology systems; (12) effects of critical accounting policies and judgments; (13) changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board (FASB) or other regulatory agencies; (14) legislative or regulatory changes or actions, or significant litigation, adversely affect Fifth Third, one or more acquired entities and/or the combined company or the businesses in which Fifth Third, one or more acquired entities and/or the combined company are engaged, including the Dodd-Frank Wall Street Reform and Consumer Protection Act; (15) ability to maintain favorable ratings from rating agencies; (16) failure of models or risk management systems or controls; (17) fluctuation of Fifth Third’s stock price; (18) ability to attract and retain key personnel; (19) ability to receive dividends from its subsidiaries; (20) potentially dilutive effect of future acquisitions on current shareholders’ ownership of Fifth Third; (21) declines in the value of Fifth Third’s goodwill or other intangible assets; (22) effects of accounting or financial results of one or more acquired entities; (23) difficulties from Fifth Third’s investment in, relationship with, and nature of the operations of Vantiv Holding, LLC; (24) loss of income from any sale or potential sale of businesses (25) difficulties in separating the operations of any branches or other assets divested; (26) losses or adverse impacts on the carrying values of branches and long-lived assets in connection with their sales or anticipated sales; (27) inability to achieve expected benefits from branch consolidations and planned sales within desired timeframes, if at all; (28) ability to secure confidential information and deliver products and services through the use of computer systems and telecommunications networks; and (29) the impact of reputational risk created by these developments on such matters as business generation and retention, funding and liquidity.

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Glossary of Abbreviations and Acronyms

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

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

The following is Management’s Discussion and Analysis of Financial Condition and Results of Operations of certain significant factors that have affected Fifth Third Bancorp’s (the “Bancorp” or “Fifth Third”) financial condition and results of operations during the periods included in the Condensed Consolidated Financial Statements, which are a part of this filing. Reference to the Bancorp incorporates the parent holding company and all consolidated subsidiaries. The Bancorp’s banking subsidiary is referred to as the Bank.

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

OVERVIEW

Fifth Third Bancorp is a diversified financial services company headquartered in Cincinnati, Ohio. At March 31, 2017, the Bancorp had $140.2 billion in assets and operated 1,155 full-service banking centers, including 91 Bank Mart® locations open seven days a week, inside select grocery stores, and 2,471 ATMs in ten states throughout the Midwestern and Southeastern regions of the U.S. The Bancorp reports on four business segments: Commercial Banking, Branch Banking, Consumer Lending and Wealth and Asset Management. The Bancorp also has an approximate 18% interest in Vantiv Holding, LLC. The carrying value of the Bancorp’s investment in Vantiv Holding, LLC was $430 million at March 31, 2017.

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, 2016. Each of these items could have an impact on the Bancorp’s financial condition, results of operations and cash flows. In addition, refer to the Glossary of Abbreviations and Acronyms in this report for a list of terms included as a tool for the reader of this quarterly report on Form 10-Q. The abbreviations and acronyms identified therein are used throughout this MD&A, as well as the Condensed Consolidated Financial Statements and Notes to the Condensed Consolidated Financial Statements.

Net interest income, net interest margin and the efficiency ratio are presented in MD&A on an FTE basis. The FTE basis adjusts for the tax-favored status of income from certain loans and securities held by the Bancorp that are not taxable for federal income tax purposes. The Bancorp believes this presentation to be the preferred industry measurement of net interest income as it provides a relevant comparison between taxable and non-taxable amounts. The FTE basis for presenting net interest income is a non-GAAP measure. For further information, refer to the Non-GAAP Financial Measures section of MD&A.

The Bancorp’s revenues are dependent on both net interest income and noninterest income. For the three months ended March 31, 2017, 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 months ended March 31, 2017. Changes in interest rates, credit quality, economic trends and the capital markets are primary factors that drive the performance of the Bancorp. As discussed later in the Risk Management section of MD&A, risk identification, measurement, monitoring, control and reporting are important to the management of risk and to the financial performance and capital strength of the Bancorp.

Net interest income is the difference between interest income earned on assets such as loans, leases and securities, and interest expense incurred on liabilities such as deposits, other short-term borrowings and long-term debt. Net interest income is affected by the general level of interest rates, the relative level of short-term and long-term interest rates, changes in interest rates and changes in the amount and composition of interest-earning assets and interest-bearing liabilities. Generally, the rates of interest the Bancorp earns on its assets and pays on its liabilities are established for a period of time. The change in market interest rates over time exposes the Bancorp to interest rate risk through potential adverse changes to net interest income and financial position. The Bancorp manages this risk by continually analyzing and adjusting the composition of its assets and liabilities based on their payment streams and interest rates, the timing of their maturities and their sensitivity to changes in market interest rates. Additionally, in the ordinary course of business, the Bancorp enters into certain derivative transactions as part of its overall strategy to manage its interest rate and prepayment risks. The Bancorp is also exposed to the risk of loss on its loan and lease portfolio, as a result of changing expected cash flows caused by borrower credit events, such as, loan defaults and inadequate collateral.

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

Accelerated Share Repurchase Transactions

During the three months ended March 31, 2017, the Bancorp settled the accelerated share repurchase transaction entered into on December 20, 2016. For a summary of the transaction, refer to Table 2.

Earnings Summary

The Bancorp’s net income available to common shareholders for the first quarter of 2017 was $290 million, or $0.38 per diluted share, which was net of $15 million in preferred stock dividends. The Bancorp’s net income available to common shareholders for the first quarter of 2016 was $311 million, or $0.40 per diluted share, which was net of $15 million in preferred stock dividends.

Net interest income on an FTE basis (non-GAAP) was $939 million and $909 million for the three months ended March 31, 2017 and 2016, respectively. Net interest income was positively impacted by an increase in average taxable securities of $2.2 billion and a decrease in average long-term debt of $1.1 billion. Net interest income also benefited from an increase in yields on average loans and leases of 23 bps which included the impact of a $12 million benefit in interest income related to a revised estimate of refunds to be offered to certain bankcard customers and by the decision of the Federal Open Market Committee in December 2016 and March 2017 to raise the target range of the federal funds rate 25 bps.

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

These positive impacts were partially offset by a decrease in average loans and leases of $1.3 billion as well as an increase in rates paid on average long-term debt and average interest-bearing core deposits of 43 bps and 6 bps, respectively. Net interest margin on an FTE basis was 3.02% and 2.91% for the three months ended March 31, 2017 and 2016, respectively.

Noninterest income decreased $114 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily due to decreases in other noninterest income, corporate banking revenue and mortgage banking net revenue. Other noninterest income decreased $59 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily due to the first quarter of 2016 impact of a $47 million positive valuation adjustment on the stock warrant associated with Vantiv Holding, LLC, an $8 million gain on the sale of its retail branch operations in the St. Louis MSA and a $1 million positive valuation adjustment on the swap associated with Visa, Inc. Class B Shares compared with a negative valuation adjustment of $13 million during the first quarter of 2017. The decrease was partially offset by an $11 million increase in private equity investment income. Corporate banking revenue decreased $28 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily driven by a decrease in lease remarketing fees which included the impact of a $31 million impairment charge related to certain operating lease assets that was recognized during the first quarter of 2017. Mortgage banking net revenue decreased $26 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily due to a $13 million decrease in origination fees and gains on loan sales and a $13 million decrease in net mortgage servicing revenue.

Noninterest expense was flat for the three months ended March 31, 2017 compared to the three months ended March 31, 2016. Personnel costs increased $19 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily driven by increases in long-term incentive compensation and variable compensation, partially offset by a $14 million decrease in severance costs related to the Bancorp’s voluntary early retirement program in 2016. Other noninterest expense decreased $15 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily due to decreases in losses and adjustments, the provision for the reserve for unfunded commitments and marketing expense, partially offset by an increase in professional service fees. Card and processing expense decreased $5 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily due to the impact of renegotiated service contracts.

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

Credit Summary

The provision for loan and lease losses was $74 million and $119 million for the three months ended March 31, 2017 and 2016, respectively. Net losses charged-off as a percent of average portfolio loans and leases were 0.40% during the first quarter of 2017 compared to 0.42% during the first quarter of 2016. At March 31, 2017, nonperforming portfolio assets as a percent of portfolio loans and leases and OREO decreased to 0.79% compared to 0.80% at December 31, 2016. For further discussion on credit quality, refer to the Credit Risk Management subsection of the Risk Management section of MD&A.

Capital Summary

The Bancorp’s capital ratios exceed the “well-capitalized” guidelines as defined by the PCA requirements of the U.S. banking agencies. As of March 31, 2017, as calculated under the Basel III transition provisions, the CET1 capital ratio was 10.76%, the Tier I risk-based capital ratio was 11.90%, the Total risk-based capital ratio was 15.45% and the Tier I leverage ratio was 10.15%.

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

NON-GAAP FINANCIAL MEASURES

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

The FTE basis adjusts for the tax-favored status of income from certain loans and securities held by the Bancorp that are not taxable for federal income tax purposes. The Bancorp believes this presentation to be the preferred industry measurement of net interest income as it provides a relevant comparison between taxable and non-taxable amounts.

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

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

(a)    A net tax deficiency of $1 million was reclassified from capital surplus to applicable income tax expense at March 31, 2016, related to the early adoption of ASU 2016-09 during the fourth quarter of 2016, with an effective date of January 1, 2016.

The Bancorp considers various measures when evaluating capital utilization and adequacy, including the tangible equity ratio, tangible common equity ratio and tangible book value per share, in addition to capital ratios defined by the U.S. banking agencies. These calculations are intended to complement the capital ratios defined by the U.S. banking agencies for both absolute and comparative purposes. Because U.S. GAAP does not include capital ratio measures, the Bancorp believes there are no comparable U.S. GAAP financial measures to these ratios. These ratios are not formally defined by U.S. GAAP or codified in the federal banking regulations and, therefore, are considered to be non-GAAP financial measures.

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

Additionally, the Bancorp became subject to the Basel III Final Rule on January 1, 2015 which defined various regulatory capital ratios including the CET1 ratio. The CET1 capital ratio has transition provisions that will be phased out over time. The Bancorp is presenting the CET1 capital ratio on a fully phased-in basis for comparative purposes with other organizations. The Bancorp considers the fully phased-in CET1 ratio a non-GAAP measure since it is not the CET1 ratio in effect for the periods presented. Since analysts and the U.S. banking agencies may assess the Bancorp’s capital adequacy using these ratios, the Bancorp believes they are useful to provide investors the ability to assess its capital adequacy on the same basis. The Bancorp encourages readers to consider its Condensed Consolidated Financial Statements in their entirety and not to rely on any single financial measure.

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

TABLE 6: Non-GAAP Financial Measures - Capital Ratios

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

RECENT ACCOUNTING STANDARDS

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

CRITICAL ACCOUNTING POLICIES

The Bancorp’s Condensed Consolidated Financial Statements are prepared in accordance with U.S. GAAP. Certain accounting policies require management to exercise judgment in determining methodologies, economic assumptions and estimates that may materially affect the Bancorp’s financial position, results of operations and cash flows. The Bancorp’s critical accounting policies include the accounting for the ALLL, reserve for unfunded commitments, income taxes, valuation of servicing rights, fair value measurements, goodwill and legal contingencies. These accounting policies are discussed in detail in the Critical Accounting Policies section of the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2016. Effective January 1, 2017, the Bancorp elected to adopt the fair value method of measuring all existing classes of its residential mortgage servicing rights as described below. Previously, the Bancorp had measured its servicing rights subsequent to initial recognition using the amortization method. There have been no other material changes to the valuation techniques or models during the three months ended March 31, 2017.

Valuation of Servicing Rights

When the Bancorp sells loans through either securitizations or individual loan sales in accordance with its investment policies, it often obtains servicing rights. Effective January 1, 2017, the Bancorp elected to prospectively adopt the fair value method for all existing classes of its residential mortgage servicing rights portfolio. Upon this election, all servicing rights are measured at fair value at each reporting date and changes in the fair value of servicing rights are reported in earnings in the period in which the changes occur. Servicing rights are valued using internal OAS models. Significant management judgment is necessary to identify key economic assumptions used in estimating the fair value of the servicing rights including the prepayment speeds of the underlying loans, the weighted-average life, the OAS spread and the weighted-average coupon rate, as applicable. The primary risk of material changes to the value of the servicing rights resides in the potential volatility in the economic assumptions used, particularly the prepayment speeds. In order to assist in the assessment of the fair value of servicing rights, the Bancorp obtains external valuations of the servicing rights portfolio from third parties and participates in peer surveys that provide additional confirmation of the reasonableness of key assumptions utilized in the internal OAS model.

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

For additional information on servicing rights, refer to Note 11 of the Notes to Condensed Consolidated Financial Statements.

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

STATEMENTS OF INCOME ANALYSIS

Net Interest Income

Net interest income is the interest earned on loans and leases (including yield-related fees), securities and other short-term investments less the interest paid for core deposits (includes transaction deposits and other time deposits) and wholesale funding (includes certificates $100,000 and over, other deposits, federal funds purchased, other short-term borrowings and long-term debt). The net interest margin is calculated by dividing net interest income by average interest-earning assets. Net interest rate spread is the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities. Net interest margin is typically greater than net interest rate spread due to the interest income earned on those assets that are funded by noninterest-bearing liabilities, or free funding, such as demand deposits or shareholders’ equity.

Table 7 presents the components of net interest income, net interest margin and net interest rate spread for the three months ended March 31, 2017 and 2016, as well as the relative impact of changes in the balance sheet and changes in interest rates on net interest income. Nonaccrual loans and leases and loans held for sale have been included in the average loan and lease balances. Average outstanding securities balances are based on amortized cost with any unrealized gains or losses on available-for-sale securities included in other assets.

Net interest income on an FTE basis (non-GAAP) was $939 million and $909 million for the three months ended March 31, 2017 and 2016, respectively. Net interest income was positively impacted by an increase in average taxable securities of $2.2 billion and a decrease in average long-term debt of $1.1 billion. Net interest income also benefited from an increase in yields on average loans and leases of 23 bps which included the impact of a $12 million benefit in interest income related to a revised estimate of refunds to be offered to certain bankcard customers. Additionally, net interest income was positively impacted by the decision of the Federal Open Market Committee in December 2016 and March 2017 to raise the target range of the federal funds rate 25 bps coupled with an increase in the net interest rate spread to 2.78% in the first quarter of 2017 from 2.70% in the same period in 2016. Yields on average interest-earning assets increased 17 bps and were partially offset by a 9 bps increase in the rates paid on average interest-bearing liabilities for the three months ended March 31, 2017 compared to the three months ended March 31, 2016. These positive impacts were partially offset by a decrease in average loans and leases of $1.3 billion as well as an increase in rates paid on average long-term debt and average interest-bearing core deposits of 43 bps and 6 bps, respectively.

Net interest margin on an FTE basis was 3.02% for the three months ended March 31, 2017 compared to 2.91% for the three months ended March 31, 2016. The increase from March 31, 2016 was driven primarily by the previously mentioned increase in the net interest rate spread partially offset by a $317 million increase in average interest-earning assets and a decrease in average free funding. The decrease in average free funding balances was driven by a decrease in average demand deposits of $117 million partially offset by an increase in average shareholders’ equity of $49 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016.

Interest income on an FTE basis from loans and leases increased $35 million compared to the first quarter of 2016 primarily due to an increase in yields on average loans and leases of 23 bps for the three months ended March 31, 2017 compared to the three months ended March 31, 2016. The increase was primarily due to increases in yields on average commercial and industrial loans and credit cards. The increase in credit card yields was primarily the result of the aforementioned $12 million benefit in interest income related to a revised estimate of refunds to be offered to certain bankcard customers. These positive impacts were partially offset by a decrease in average loans and leases of $1.3 billion for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily due to decreases in commercial and industrial loans and automobile loans, partially offset by an increase in residential mortgage loans. For more information on the Bancorp’s loan and lease portfolio, refer to the Loans and Leases subsection of the Balance Sheet Analysis section of MD&A. Interest income from investment securities increased $13 million compared to the three months ended March 31, 2016 primarily as a result of the aforementioned increase in average taxable securities.

Interest expense on core deposits increased $10 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily due to an increase in the cost of average interest-bearing core deposits to 31 bps for the three months ended March 31, 2017 from 25 bps for the three months ended March 31, 2016. The increase was primarily due to an increase in the cost of average money market deposits and average interest checking deposits. Refer to the Deposits subsection of the Balance Sheet Analysis section of MD&A for additional information on the Bancorp’s deposits.

Interest expense on average wholesale funding increased $8 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily due to the aforementioned increase in the rates paid on average long-term debt partially offset by the decrease in average long-term debt. Refer to the Borrowings subsection of the Balance Sheet Analysis section of MD&A for additional information on the Bancorp’s borrowings. During the three months ended March 31, 2017 and 2016, respectively, average wholesale funding represented 23% and 26% of average interest-bearing liabilities. For more information on the Bancorp’s interest rate risk management, including estimated earnings sensitivity to changes in market interest rates, see the Market Risk Management subsection of the Risk Management section of MD&A.

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

Provision for Loan and Lease Losses

The Bancorp provides as an expense an amount for probable loan and lease losses within the loan and lease portfolio that is based on factors previously discussed in the Critical Accounting Policies section of the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2016. The provision is recorded to bring the ALLL to a level deemed appropriate by the Bancorp to cover losses inherent in the portfolio. Actual credit losses on loans and leases are charged against the ALLL. The amount of loans and leases actually removed from the Condensed Consolidated Balance Sheets are referred to as charge-offs. Net charge-offs include current period charge-offs less recoveries on previously charged-off loans and leases.

The provision for loan and lease losses was $74 million and $119 million for the three months ended March 31, 2017 and 2016, respectively. The decrease in provision expense for the three months ended March 31, 2017 compared to the same period in the prior year was primarily due to a decrease in the level of commercial criticized assets, which reflected improvement in the national economy and stabilization of commodity prices, and a decrease in outstanding loan balances. The ALLL decreased $15 million from December 31, 2016 to $1.2 billion at March 31, 2017. At March 31, 2017, the ALLL as a percent of portfolio loans and leases decreased to 1.35%, compared to 1.36% at December 31, 2016.

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

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

Noninterest Income

Noninterest income decreased $114 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016.

The following table presents the components of noninterest income:

TABLE 8: Components of Noninterest Income

Wealth and asset management revenue

Wealth and asset management revenue increased $6 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily due to a $4 million increase in private client service fees and a $2 million increase in securities and brokerage fees. These increases were driven by an increase in assets under management as a result of strong market performance and increased asset production. The Bancorp’s Trust, Brokerage and Insurance businesses had approximately $323 billion and $303 billion in total assets under care as of March 31, 2017 and 2016, respectively, and managed $33 billion and $29 billion in assets, respectively, for individuals, corporations and not-for-profit organizations as of March 31, 2017 and 2016.

Corporate banking revenue

Corporate banking revenue decreased $28 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016. The decrease from the prior year was primarily driven by a decrease in lease remarketing fees which included the impact of a $31 million impairment charge related to certain operating lease assets that was recognized during the first quarter of 2017.

Card and processing revenue

Card and processing revenue decreased $5 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily due to higher reward costs and the sale of the agent bankcard portfolio during the second quarter of 2016.

Mortgage banking net revenue

Mortgage banking net revenue decreased $26 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016.

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

TABLE 9: Components of Mortgage Banking Net Revenue

Origination fees and gains on loan sales decreased $13 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily due to a decrease in originations driven by a decrease in demand due to an increase in interest rates.

Effective January 1, 2017, the Bancorp elected to prospectively adopt the fair value method for all existing classes of its residential mortgage servicing rights portfolio. Upon this election, all servicing rights are measured at fair value at each reporting date and changes in the fair value of servicing rights are reported in mortgage banking net revenue in the Condensed Consolidated Statements of Income in the period in which the changes occur.

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

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

Net mortgage servicing revenue decreased $13 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily due to decreases in net valuation adjustments and gross mortgage servicing fees of $8 million and $5 million, respectively. Refer to Table 10 for the components of net valuation adjustments on the MSR portfolio and the impact of the non-qualifying hedging strategy:

TABLE 10: Components of Net Valuation Adjustments on MSRs

Mortgage rates increased during the three months ended March 31, 2017 which caused modeled prepayment speeds to slow. The fair value of the MSR increased $4 million due to changes to inputs to the valuation model including prepayment speeds and OAS spread assumptions and decreased $27 million due to the passage of time, including the impact of regularly scheduled repayments, paydowns and payoffs during the three months ended March 31, 2017.

Mortgage rates decreased during the three months ended March 31, 2016 which caused modeled prepayment speeds to increase which led to temporary impairment on servicing rights during the three months ended March 31, 2016. Previously, servicing rights were deemed impaired when a borrower’s loan rate was distinctly higher than prevailing rates. Temporary impairment on servicing rights was reversed when the prevailing rates returned to a level commensurate with the borrower’s loan rate.

Further detail on the valuation of MSRs can be found in Note 11 of the Notes to Condensed Consolidated Financial Statements. The Bancorp maintains a non-qualifying hedging strategy to manage a portion of the risk associated with changes in the valuation on the MSR portfolio. Refer to Note 12 of the Notes to Condensed Consolidated Financial Statements for more information on the free-standing derivatives used to economically hedge the MSR portfolio.

The Bancorp’s total residential mortgage loans serviced as of March 31, 2017 and 2016 were $71.4 billion and $72.3 billion, respectively, with $55.4 billion and $57.8 billion, respectively, of residential mortgage loans serviced for others.

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

Other noninterest income

The following table presents the components of other noninterest income:

TABLE 11: Components of Other Noninterest Income

Other noninterest income decreased $59 million in the first quarter of 2017 compared to the first quarter of 2016 primarily due to a valuation adjustment on the stock warrant associated with Vantiv Holding, LLC, gains on the sale of certain retail branch operations and a valuation adjustment on the swap associated with Visa, Inc. Class B Shares. The decrease was partially offset by an increase in private equity investment income.

During the first quarter of 2016, the Bancorp recognized a $47 million positive valuation adjustment on the stock warrant associated with Vantiv Holding, LLC. The stock warrant was not outstanding during 2017 as the Bancorp exercised the remaining warrant in Vantiv Holding, LLC during the fourth quarter of 2016. The fair value of the stock warrant was calculated using the Black-Scholes option-pricing model, which utilized several key inputs (Vantiv, Inc. stock price, strike price of the warrant and several unobservable inputs). The positive valuation adjustment for the three months ended March 31, 2016 was primarily due to an increase of 14% in Vantiv, Inc.’s share price from December 31, 2015 to March 31, 2016.

The Bancorp recognized a $13 million negative valuation adjustment related to the Visa total return swap for the three months ended March 31, 2017 compared to a positive valuation adjustment of $1 million for the three months ended March 31, 2016. For additional information on the valuation of the warrant associated with the sale of Vantiv Holding, LLC and the valuation of the swap associated with the sale of Visa, Inc. Class B Shares, refer to Note 19 of the Notes to Condensed Consolidated Financial Statements. During the first quarter of 2016, the Bancorp recognized an $8 million gain on the sale of its retail branch operations in the St. Louis MSA to Great Southern Bank as part of the previously announced Branch Consolidation and Sales Plan. Private equity investment income increased $11 million for the three months ended March 31, 2017 compared to the same period in the prior year primarily due to gains on the sale of certain private equity funds.

Noninterest Expense

Noninterest expense was flat for the three months ended March 31, 2017 compared to the three months ended March 31, 2016. The following table presents the components of noninterest expense:

TABLE 12: Components of Noninterest Expense

Personnel costs increased $19 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily driven by increases in long-term incentive compensation and variable compensation, partially offset by a $14 million decrease in severance costs related to the Bancorp’s voluntary early retirement program in 2016. The increase in the long-term incentive compensation was due to the Bancorp issuing non-executive grants in the first quarter of 2017 where they have historically been issued in the second quarter. Full-time equivalent employees totaled 17,763 at March 31, 2017 compared to 18,200 at March 31, 2016.

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

Card and processing expense decreased $5 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily due to the impact of renegotiated service contracts.

The following table presents the components of other noninterest expense:

TABLE 13: Components of Other Noninterest Expense

Other noninterest expense decreased $15 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily due to decreases in losses and adjustments, the provision for the reserve for unfunded commitments and marketing expense, partially offset by an increase in professional service fees.

Losses and adjustments decreased $8 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 primarily due to the impact of legal reserves established in the first quarter of 2016. The benefit from the reserve for unfunded commitments was $2 million for the three months ended March 31, 2017 compared to a provision for unfunded commitments of $6 million for the same period in the prior year as a result of the decrease in total unfunded commitments outstanding from December 31, 2016. Marketing expense decreased $7 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 due to disciplined expense control. Professional service fees increased $7 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 due to an increase in legal fees.

Applicable Income Taxes

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

TABLE 14: Applicable Income Taxes

Applicable income tax expense for all periods includes the benefit from tax-exempt income, tax-advantaged investments, certain gains on sales of leveraged leases that are exempt from federal taxation and tax credits, partially offset by the effect of certain nondeductible expenses. The tax credits are associated with the Low-Income Housing Tax Credit program established under Section 42 of the IRC, the New Markets Tax Credit program established under Section 45D of the IRC, the Rehabilitation Investment Tax Credit program established under Section 47 of the IRC and the Qualified Zone Academy Bond program established under Section 1397E of the IRC.

For stock-based awards, U.S. GAAP requires that the tax consequences for the difference between the expense recognized for financial reporting and the Bancorp’s actual tax deduction for the stock-based awards be recognized through income tax expense in the interim periods in which they occur. The decrease in the effective tax rate for the three months ended March 31, 2017 compared to the same period in the prior year was primarily related to a reduction in income tax expense for the recognition of excess tax benefits related to stock-based awards recorded in the first quarter of 2017.

In 2017, the Bancorp transitioned to granting its annual non-executive stock based compensation awards in the first quarter of the calendar year rather than the second quarter as it had done in previous years. In light of this change to the timing of these annual grants, the Bancorp expects to recognize the excess tax benefits or deficiencies associated with its restricted stock awards primarily in the first and second quarters of 2017, 2018, 2019 and 2020 as these annual awards vest.

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

The Bancorp cannot predict its stock price or whether and when its employees will exercise stock-based awards in the future. Based on its stock price at March 31, 2017, the Bancorp estimates that it may be necessary to recognize $1 million of additional income tax benefit over the next twelve months related to the settlement of stock-based awards. However, the amount of income tax expense or benefit recognized upon settlement may vary significantly from expectations based on the Bancorp’s stock price and the number of SARs exercised by employees.

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

BALANCE SHEET ANALYSIS

Loans and Leases

The Bancorp classifies its commercial loans and leases based upon primary purpose and consumer loans and leases based upon product or collateral. Table 15 summarizes end of period loans and leases, including loans held for sale and Table 16 summarizes average total loans and leases, including loans held for sale.

Loans and leases, including loans held for sale, decreased $605 million, or 1%, from December 31, 2016. The decrease from December 31, 2016 was the result of a $471 million, or 1%, decrease in consumer loans and leases and a $134 million decrease in commercial loans and leases.

Consumer loans and leases decreased from December 31, 2016 primarily due to decreases in automobile loans, home equity and credit card, partially offset by an increase in residential mortgage loans. Automobile loans decreased $411 million, or 4%, from December 31, 2016 and home equity decreased $226 million, or 3%, from December 31, 2016 as payoffs exceeded new loan production. Credit card decreased $167 million, or 7%, from December 31, 2016 primarily due to seasonal trends from the paydown of year-end balances which were higher due to holiday spending. Residential mortgage loans increased $205 million, or 1%, from December 31, 2016 primarily due to the continued retention of certain conforming ARMs and certain other fixed-rate loans originated during the three months ended March 31, 2017.

Commercial loans and leases decreased from December 31, 2016 primarily due to a decrease in commercial and industrial loans, partially offset by an increase in commercial construction loans and commercial leases. Commercial and industrial loans decreased $660 million, or 2%, from December 31, 2016 primarily as a result of deliberate exits from certain loans that did not meet the Bancorp’s risk-adjusted profitability targets and softer loan demand. Commercial construction loans increased $380 million, or 10%, from December 31, 2016 primarily as a result of draw levels outpacing attrition. Commercial leases increased $119 million, or 3%, from December 31, 2016 primarily as a result of an increase in origination activity.

Average loans and leases, including loans held for sale, decreased $1.3 billion, or 1%, from March 31, 2016. The decrease from March 31, 2016 was the result of a $809 million, or 2%, decrease in average consumer loans and leases and a $478 million, or 1%, decrease in average commercial loans and leases.

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

Average consumer loans and leases decreased from March 31, 2016 primarily due to decreases in average automobile loans, average home equity and average credit card, partially offset by an increase in average residential mortgage loans. Average automobile loans decreased $1.5 billion, or 13%, from March 31, 2016 and average home equity decreased $660 million, or 8%, from March 31, 2016 as payoffs exceeded new loan production. Average credit card decreased $136 million, or 6%, primarily due to the sale of the agent bankcard loan portfolio during the second quarter of 2016 and elevated paydowns of mature accounts. Average residential mortgage loans increased $1.4 billion, or 10%, from March 31, 2016 primarily driven by the continued retention of certain conforming ARMs and certain other fixed-rate loans.

Average commercial loans and leases decreased from March 31, 2016 primarily due to a decrease in average commercial and industrial loans, partially offset by an increase in average commercial construction loans. Average commercial and industrial loans decreased $1.2 billion, or 3%, from March 31, 2016 primarily as a result of deliberate exits from certain loans that did not meet the Bancorp’s risk-adjusted profitability targets and softer loan demand. Average commercial construction loans increased $690 million, or 21%, from March 31, 2016 primarily as a result of an increase in new loan origination activity resulting from an increase in demand.

Investment Securities

The Bancorp uses investment securities as a means of managing interest rate risk, providing both liquidity support and collateral for pledging purposes. Total investment securities were $32.2 billion and $31.6 billion at March 31, 2017 and December 31, 2016, respectively. The taxable investment securities portfolio had an effective duration of 5.0 years at March 31, 2017 compared to 4.9 years at December 31, 2016.

Securities are classified as available-for-sale when, in management’s judgment, they may be sold in response to, or in anticipation of, changes in market conditions. Securities that management has the intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. Securities are classified as trading when bought and held principally for the purpose of selling them in the near term. At March 31, 2017, the Bancorp’s investment portfolio consisted primarily of AAA-rated available-for-sale securities. Securities classified as below investment grade were immaterial at both March 31, 2017 and December 31, 2016. The Bancorp’s management has evaluated the securities in an unrealized loss position in the available-for-sale and held-to-maturity portfolios for OTTI.

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