FIFTH THIRD BANCORP - Quarter Report: 2018 March (Form 10-Q)

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, 2018

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 685,495,676 shares of the Registrant’s common stock, without par value, outstanding as of April 30, 2018.

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 the Risk Factors section in Item 1A 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) deteriorating credit quality; (2) loan concentration by location or industry of borrowers or collateral; (3) problems encountered by other financial institutions; (4) inadequate sources of funding or liquidity; (5) unfavorable actions of rating agencies; (6) inability to maintain or grow deposits; (7) limitations on the ability to receive dividends from subsidiaries; (8) cyber-security risks; (9) Fifth Third’s ability to secure confidential information and deliver products and services through the use of computer systems and telecommunications networks; (10) failures by third-party service providers; (11) inability to manage strategic initiatives and/or organizational changes; (12) inability to implement technology system enhancements; (13) failure of internal controls and other risk management systems; (14) losses related to fraud, theft or violence; (15) inability to attract and retain skilled personnel; (16) adverse impacts of government regulation; (17) governmental or regulatory changes or other actions; (18) failures to meet applicable capital requirements; (19) regulatory objections to Fifth Third’s capital plan; (20) regulation of Fifth Third’s derivatives activities; (21) regulatory objections to Fifth Third’s resolution plan; (22) deposit insurance premiums; (23) assessments for the orderly liquidation fund; (24) changes in LIBOR; (25) weakness in the national or local economies; (26) global political and economic uncertainty or negative actions; (27) changes in interest rates; (28) changes and trends in capital markets; (29) fluctuation of Fifth Third’s stock price; (30) volatility in mortgage banking revenue; (31) litigation, investigations, and enforcement proceedings by governmental authorities; (32) breaches of contractual covenants, representations and warranties; (33) competition and changes in the financial services industry; (34) changing retail distribution strategies, customer preferences and behavior; (35) difficulties in identifying, acquiring or integrating suitable strategic partnerships, investments or acquisitions; (36) potential dilution from future acquisitions; (37) loss of income and/or difficulties encountered in the sale and separation of businesses, investments or other assets; (38) results of Vantiv Holding, LLC, a subsidiary of Worldpay, Inc. or other investments or acquired entities; (39) difficulties from or changes in Fifth Third’s investment in, relationship with, and nature of the operations of Vantiv Holding, LLC, a subsidiary of Worldpay, Inc.; (40) changes in accounting standards or interpretation or declines in the value of Fifth Third’s goodwill or other intangible assets; (41) inaccuracies or other failures from the use of models; (42) effects of critical accounting policies and judgments or the use of inaccurate estimates; (43) weather related events or other natural disasters; and (44) the impact of reputational risk created by these or other developments on such matters as business generation and retention, funding and liquidity.

1

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.

2

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.

TABLE 1: Selected Financial Data

3

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, 2018, the Bancorp had $141.5 billion in assets and operated 1,153 full-service banking centers and 2,459 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 4.9% interest in Vantiv Holding, LLC. The carrying value of the Bancorp’s investment in Vantiv Holding, LLC was $632 million at March 31, 2018.

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, 2017. 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 March 31, 2018, net interest income on an FTE basis and noninterest income provided 52% and 48% 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, 2018. Changes in interest rates, credit quality, economic trends and the capital markets are primary factors that drive the performance of the Bancorp. As discussed later in the Risk Management section of MD&A, risk identification, measurement, monitoring, control and reporting are important to the management of risk and to the financial performance and capital strength of the Bancorp.

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

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

Vantiv, Inc. and Vantiv Holding, LLC Transactions

On January 16, 2018, Vantiv, Inc. completed its previously announced acquisition of Worldpay Group plc. with the resulting combined company named Worldpay, Inc. As a result of this transaction, the Bancorp recognized a gain of $414 million in other noninterest income during the first quarter of 2018 associated with the dilution in its ownership interest in Vantiv Holding, LLC from approximately 8.6% to approximately 4.9%. The Bancorp’s remaining interest in Vantiv Holding, LLC of $632 million continues to be accounted for as an equity method investment given the nature of Vantiv Holding, LLC’s structure as a limited liability company and contractual arrangements between Vantiv Holding, LLC and the Bancorp.

Accelerated Share Repurchase Transactions

During the three months ended March 31, 2018, the Bancorp entered into or settled accelerated share repurchase transactions. As part of these transactions, the Bancorp entered into forward contracts in which the final number of shares delivered at settlement was based generally on a discount to the average daily volume weighted-average price of the Bancorp’s common stock during the term of the repurchase agreements. For more information on the accelerated share repurchase program, refer to Note 14 of the Notes to Condensed Consolidated Financial Statements. For a summary of the Bancorp’s accelerated share repurchase transactions that were entered into or settled during the three months ended March 31, 2018, refer to Table 2.

4

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

TABLE 2: Summary of Accelerated Share Repurchase Transactions    

Senior Notes Offering

On March 14, 2018, the Bancorp issued and sold $650 million of 3.95% senior fixed-rate notes, with a maturity of ten years, due on March 14, 2028. These notes will be redeemable by the Bancorp, in whole or in part, on or after the date that is 30 days prior to the maturity date at a redemption price equal to 100% of the principal amount of the notes to be redeemed plus accrued and unpaid interest thereon to, but excluding, the redemption date.

Earnings Summary

The Bancorp’s net income available to common shareholders for the first quarter of 2018 was $689 million, or $0.97 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 2017 was $290 million, or $0.38 per diluted share, which was net of $15 million in preferred stock dividends.

Net interest income on an FTE basis (non-GAAP) was $999 million and $939 million for the three months ended March 31, 2018 and 2017, respectively. Net interest income was positively impacted by an increase in yields on average loans and leases of 42 bps and an increase in average taxable securities of $1.3 billion for the three months ended March 31, 2018 compared to the three months ended March 31, 2017. Additionally, net interest income was positively impacted by the decisions of the FOMC to raise the target range of the federal funds rate 25 bps in June 2017, December 2017 and March 2018. These positive impacts were partially offset by increases in the rates paid on average interest-bearing core deposits, average long-term debt and average other short-term borrowings for the three months ended March 31, 2018 compared to the three months ended March 31, 2017. Net interest margin on an FTE basis (non-GAAP) was 3.18% and 3.02% for the three months ended March 31, 2018 and 2017, respectively.

Noninterest income increased $386 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to an increase in other noninterest income. Other noninterest income increased $383 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to the gain related to Vantiv, Inc’s acquisition of Worldpay Group plc. and an increase in private equity investment income, partially offset by an increase in the loss on the swap associated with the sale of Visa, Inc. Class B Shares, a reduction in equity method income from the Bancorp’s interest in Vantiv Holding, LLC and an increase in the losses on disposition and impairment of bank premises and equipment.

Noninterest expense increased $60 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to increases in personnel costs, technology and communications expense and other noninterest expense. Personnel costs increased $35 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily driven by increases in base compensation, variable compensation and severance costs, partially offset by a decrease in medical expenses. Technology and communications expense increased $10 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 driven primarily by increased investment in regulatory, compliance and growth initiatives. Other noninterest expense increased $16 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to increases in marketing expense and impairment on affordable housing investments, partially offset by a decrease in professional service fees and an increase in the benefit from the reserve for unfunded commitments.

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 $23 million and $74 million for the three months ended March 31, 2018 and 2017, respectively. Net losses charged-off as a percent of average portfolio loans and leases were 0.36% during the first quarter of 2018 compared to 0.40% during the first quarter of 2017. At March 31, 2018, nonperforming portfolio assets as a percent of portfolio loans and leases and OREO increased to 0.55% compared to 0.53% at December 31, 2017. 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, 2018, as calculated under the Basel III standardized approach, the CET1 capital ratio was 10.82%, the Tier I risk-based capital ratio was 11.95%, the Total risk-based capital ratio was 15.25% and the Tier I leverage ratio was 10.11%.

5

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

NON-GAAP FINANCIAL MEASURES

The following are non-GAAP measures which provide useful insight to the reader of the Condensed Consolidated Financial Statements but should be supplemental to primary U.S. GAAP measures and should not be read in isolation or relied upon as a substitute for the primary U.S. GAAP measures.

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

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

TABLE 3: Non-GAAP Financial Measures - Financial Measures and Ratios on an FTE basis

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

TABLE 4: Non-GAAP Financial Measure - Income Before Income Taxes on an FTE Basis    

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.

6

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 to U.S. GAAP for the three months ended:

TABLE 5: Non-GAAP Financial Measures - Return on Average Tangible Common Equity    

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

7

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, 2017. There have been no material changes to the valuation techniques or models during the three months ended March 31, 2018.

8

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, 2018 and 2017, as well as the relative impact of changes in the balance sheet and changes in interest rates on net interest income. Nonaccrual loans and leases and loans and leases held for sale have been included in the average loan and lease balances. Average outstanding securities balances are based on amortized cost with any unrealized gains or losses included in other assets.

Net interest income on an FTE basis (non-GAAP) was $999 million and $939 million for the three months ended March 31, 2018 and March 31, 2017, respectively. Net interest income was positively impacted by an increase in yields on average loans and leases of 42 bps and an increase in average taxable securities of $1.3 billion for the three months ended March 31, 2018 compared to the three months ended March 31, 2017. Additionally, net interest income was positively impacted by the decisions of the FOMC to raise the target range of the federal funds rate 25 bps in June 2017, December 2017 and March 2018. These positive impacts were partially offset by increases in the rates paid on average interest-bearing core deposits, average long-term debt and average other short-term borrowings for the three months ended March 31, 2018 compared to the three months ended March 31, 2017. The rates paid on both average interest-bearing core deposits and average long-term debt increased 21 bps and the rates paid on average other short-term borrowings increased 79 bps for the three months ended March 31, 2018 compared to the same period in the prior year.

Net interest rate spread on an FTE basis (non-GAAP) was 2.88% during the three months ended March 31, 2018 compared to 2.78% in the same period in 2017. Yields on average interest-earning assets increased 34 bps, partially offset by a 24 bps increase in the rates paid on average interest-bearing liabilities for the three months ended March 31, 2018 compared to the three months ended March 31, 2017.

Net interest margin on an FTE basis (non-GAAP) was 3.18% for the three months ended March 31, 2018 compared to 3.02% for the three months ended March 31, 2017. The increase from March 31, 2017 was driven primarily by the previously mentioned increase in the net interest rate spread, partially offset by a decrease in average free funding balances. The decrease in average free funding balances was driven by a decrease in average demand deposits of $1.3 billion for the three months ended March 31, 2018 compared to the three months ended March 31, 2017.

Interest income on an FTE basis from loans and leases (non-GAAP) increased $96 million during the three months ended March 31, 2018 compared to the three months ended March 31, 2017. The increase was primarily due to an increase in yields on average commercial and industrial loans, average construction loans, average commercial mortgage loans and average home equity 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 and other short-term investments increased $21 million during the three months ended March 31, 2018 compared to the three months ended March 31, 2017 driven by the aforementioned increases in average taxable securities and yields on average taxable securities.

Interest expense on core deposits increased $36 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to an increase in the cost of average interest-bearing core deposits to 52 bps for the three months ended March 31, 2018 from 31 bps for the three months ended March 31, 2017. The increase in the cost of average interest-bearing core deposits was primarily due to an increase in the cost of average interest checking deposits and average money market deposits. Refer to the Deposits subsection of the Balance Sheet Analysis section of MD&A for additional information on the Bancorp’s deposits.

Interest expense on average wholesale funding increased $21 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to the aforementioned increase in the rates paid on average other short-term borrowings and average long-term debt coupled with an increase in average long-term debt. Refer to the Borrowings subsection of the Balance Sheet Analysis section of MD&A for additional information on the Bancorp’s borrowings. During both the three months ended March 31, 2018 and 2017, average wholesale funding represented 23% 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.

9

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

TABLE 7: Condensed Average Balance Sheets and Analysis of Net Interest Income on an FTE Basis

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, 2017. 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 $23 million and $74 million for the three months ended March 31, 2018 and 2017, respectively. The decrease in provision expense for the three months ended March 31, 2018 compared to the same period in the prior year was primarily due to a decrease in the level of commercial criticized assets combined with overall improved credit quality. The ALLL decreased $58 million from December 31, 2017 to $1.1 billion at March 31, 2018. At March 31, 2018, the ALLL as a percent of portfolio loans and leases decreased to 1.24%, compared to 1.30% at December 31, 2017.

10

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 increased $386 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017.

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 $5 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017. The increase from the prior year was primarily due to an increase of $5 million in private client service fees driven by an increase in assets under management as a result of strong market performance and the impact of an acquisition in the second quarter of 2017. The Bancorp’s trust and registered investment advisory business had approximately $363 billion and $323 billion in total assets under care as of March 31, 2018 and 2017, respectively, and managed $37 billion and $33 billion in assets for individuals, corporations and not-for-profit organizations as of March 31, 2018 and 2017, respectively.

Corporate banking revenue

Corporate banking revenue increased $14 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017. The increase from the prior year was primarily driven by an increase in lease remarketing fees of $28 million 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. The increase was partially offset by a decrease in business lending fees, syndication fees and letter of credit fees of $6 million, $5 million and $2 million, respectively.

Card and processing revenue

Card and processing revenue increased $5 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily driven by an increase in the number of actively used cards and customer spend volume.

Mortgage banking net revenue

Mortgage banking net revenue increased $4 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017.

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 $5 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 due to a decrease in originations and lower margins due to the interest rate environment. Residential mortgage loan originations decreased to $1.6 billion for the three months ended March 31, 2018 from $1.9 billion for the three months ended March 31, 2017.

11

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

Net mortgage servicing revenue increased $9 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to an increase in gross mortgage servicing fees of $6 million and a decrease in net negative valuation adjustments of $3 million. 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, 2018 which caused modeled prepayment speeds to slow. The fair value of the MSR increased $57 million due to changes to inputs to the valuation model including prepayment speeds and OAS spread assumptions and decreased $29 million due to the passage of time, including the impact of regularly scheduled repayments, paydowns and payoffs during the three months ended March 31, 2018. Mortgage rates also 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.

Further detail on the valuation of MSRs can be found in Note 10 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 11 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 may acquire various securities as a component of its non-qualifying hedging strategy. The Bancorp recognized net losses of $13 million during the three months ended March 31, 2018, recorded in securities losses, net, non-qualifying hedges on MSRs in the Bancorp’s Condensed Consolidated Statements of Income. The Bancorp did not sell any securities related to the non-qualifying hedging strategy during the three months ended March 31, 2017.

The Bancorp’s total residential mortgage loans serviced as of March 31, 2018 and 2017 were $77.2 billion and $71.4 billion, respectively, with $61.0 billion and $55.4 billion, respectively, of residential mortgage loans serviced for others.

Other noninterest income

The following table presents the components of other noninterest income:

TABLE 11: Components of Other Noninterest Income

Other noninterest income increased $383 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to the gain related to Vantiv, Inc.’s acquisition of Worldpay Group plc. and an increase in private equity investment income, partially offset by an increase in the loss on the swap associated with the sale of Visa, Inc. Class B Shares, a reduction in equity method income from the Bancorp’s interest in Vantiv Holding, LLC and an increase in the losses on disposition and impairment of bank premises and equipment.

12

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

The Bancorp recognized a $414 million gain related to Vantiv, Inc.’s acquisition of Worldpay Group plc. during the three months ended March 31, 2018. For additional information, refer to Note 17 of the Notes to Condensed Consolidated Financial Statements. Private equity investment income increased $5 million for the three months ended March 31, 2018 compared to the same period in the prior year primarily due to the recognition of positive net valuation adjustments on certain private equity investments in the first quarter of 2018. For additional information on the valuation of private equity investments, refer to Note 21 of the Notes to Condensed Consolidated Financial Statements.

The Bancorp recognized negative valuation adjustments of $39 million and $13 million related to the Visa total return swap for the three months ended March 31, 2018 and 2017, respectively. The increase from the prior year was primarily attributable to litigation developments during the quarter and an increase in Visa, Inc’s share price. For additional information on the valuation of the swap associated with the sale of Visa, Inc. Class B Shares, refer to Note 21 of the Notes to Condensed Consolidated Financial Statements. Equity method income from the Bancorp’s interest in Vantiv Holding, LLC decreased $12 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 due to a decrease in the Bancorp’s ownership interest in Vantiv Holding, LLC from approximately 17.8% as of March 31, 2017 to approximately 4.9% as of March 31, 2018 and the impact of Worldpay, Inc.’s acquisition and integration costs. Net losses on disposition and impairment of bank premises and equipment increased $7 million compared to the same period in the prior year. The increase was driven by the impact of impairment charges of $8 million during the three months ended March 31, 2018 compared to $3 million during the three months ended March 31, 2017.

Noninterest Expense

Noninterest expense increased $60 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to increases in personnel costs (salaries, wages and incentives plus employee benefits), technology and communications expense and other noninterest expense. The following table presents the components of noninterest expense:

TABLE 12: Components of Noninterest Expense

Personnel costs increased $35 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily driven by increases in base compensation, variable compensation and severance costs, partially offset by a decrease in medical expenses. The increase in base compensation was primarily due to personnel additions in information technology as well as an increase in the Bancorp’s minimum wage as a result of benefits received from the TCJA. Full-time equivalent employees totalled 18,344 at March 31, 2018 compared to 17,763 at March 31, 2017.

Technology and communications expense increased $10 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 driven primarily by increased investment in regulatory, compliance and growth initiatives.

13

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

Other noninterest expense increased $16 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to increases in marketing expense and impairment on affordable housing investments, partially offset by a decrease in professional service fees and an increase in the benefit from the reserve for unfunded commitments.

Marketing expense increased $13 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to an increase in advertising volume related to the brand campaign and promotional offers. Impairment on affordable housing investments increased $9 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily driven by the change in the federal statutory corporate tax rate pursuant to the TCJA. Professional service fees decreased $9 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 primarily due to a decrease in legal fees and consulting fees. The benefit from the reserve for unfunded commitments was $10 million for the three months ended March 31, 2018 compared to $2 million for the same period in the prior year as a result of a decrease in total unfunded commitments outstanding as of March 31, 2018 combined with overall improved credit quality.

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 and tax credits, partially offset by the effect of certain nondeductible expenses. The tax credits are associated with the Low-Income Housing Tax Credit program established under Section 42 of the IRC, the New Markets Tax Credit program established under Section 45D of the IRC, the Rehabilitation Investment Tax Credit program established under Section 47 of the IRC and the Qualified Zone Academy Bond program established under Section 1397E of the IRC.

The decrease in the effective tax rate for the three months ended March 31, 2018 compared to the same period in the prior year was primarily related to the reduction in the federal statutory corporate tax rate partially offset by changes to previously deductible items associated with the enactment of the TCJA.

For stock-based awards, U.S. GAAP requires that the tax consequences for the difference between the expense recognized for financial reporting and the Bancorp’s actual tax deduction for the stock-based awards be recognized through income tax expense in the interim periods in which they occur. The Bancorp cannot predict its stock price or whether and when its employees will exercise stock-based awards in the future. Based on its stock price at March 31, 2018, the Bancorp estimates that it may be necessary to recognize $12 million of additional income tax benefit over the next twelve months related to the settlement of stock-based awards, primarily in the second quarter of 2018. However, the amount of income tax expense or benefit recognized upon settlement may vary significantly from expectations based on the Bancorp’s stock price and the number of SARs exercised by employees.

14

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 based upon product or collateral. Table 15 summarizes end of period loans and leases, including loans and leases held for sale and Table 16 summarizes average total loans and leases, including loans and leases held for sale.

TABLE 15: Components of Total Loans and Leases (including loans and leases held for sale)

Loans and leases, including loans and leases held for sale, increased $225 million from December 31, 2017. The increase from December 31, 2017 was the result of a $477 million, or 1%, increase in commercial loans and leases, partially offset by a $252 million, or 1%, decrease in consumer loans.

Commercial loans and leases increased from December 31, 2017 primarily due to increases in commercial and industrial loans and commercial construction loans, partially offset by decreases in commercial leases and commercial mortgage loans. Commercial and industrial loans increased $508 million, or 1%, from December 31, 2017 primarily as a result of increased draw levels on existing commitments and a decrease in payoffs. Commercial construction loans increased $213 million, or 5%, from December 31, 2017 primarily due to increases in demand and draw levels on existing commitments. Commercial leases decreased $149 million, or 4%, from December 31, 2017 primarily as a result of a decrease in syndication and participation origination activity. Commercial mortgage loans decreased $95 million, or 1%, from December 31, 2017 primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns.

Consumer loans decreased from December 31, 2017 primarily due to decreases in home equity, credit card and automobile loans, partially offset by increases in residential mortgage loans and other consumer loans. Home equity decreased $257 million, or 4%, from December 31, 2017 as payoffs exceeded new loan production. Credit card decreased $111 million, or 5%, from December 31, 2017 primarily due to seasonal trends from the paydown of year-end balances which were higher due to holiday spending. Automobile loans decreased $94 million, or 1%, from December 31, 2017 as payoffs exceeded new loan production due to a strategic shift focusing on improving risk-adjusted returns. Residential mortgage loans increased $154 million, or 1%, from December 31, 2017 primarily due to the continued retention of certain agency conforming ARMs and certain other fixed-rate loans originated during the three months ended March 31, 2018. Other consumer loans increased $56 million, or 4%, from December 31, 2017 primarily due to growth in point-of-sale loan originations.

TABLE 16: Components of Average Loans and Leases (including loans and leases held for sale)

15

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

Average loans and leases, including loans and leases held for sale, increased $78 million from March 31, 2017. The increase from March 31, 2017 was the result of a $289 million, or 1%, increase in average commercial loans and leases, partially offset by a $211 million, or 1%, decrease in average consumer loans.

Average commercial loans and leases increased from March 31, 2017 primarily due to an increase in average commercial construction loans, partially offset by a decrease in average commercial mortgage loans. Average commercial construction loans increased $684 million, or 17%, from March 31, 2017 primarily due to increases in demand and draw levels on existing commitments. Average commercial mortgage loans decreased $358 million, or 5%, primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns.

Average consumer loans decreased from March 31, 2017 primarily due to decreases in average automobile loans and average home equity, partially offset by increases in average other consumer loans and average residential mortgage loans. Average automobile loans decreased $722 million, or 7%, from March 31, 2017 as payoffs exceeded new loan production due to a strategic shift focusing on improving risk-adjusted returns. Average home equity decreased $692 million, or 9%, from March 31, 2017 as payoffs exceeded new loan production. Average other consumer loans increased $834 million primarily due to growth in point-of-sale loan originations. Average residential mortgage loans increased $286 million, or 2%, from March 31, 2017 primarily driven by the continued retention of certain agency conforming ARMs and certain other fixed-rate loans.

Investment Securities

The Bancorp uses investment securities as a means of managing interest rate risk, providing both collateral for pledging purposes and liquidity for satisfying regulatory requirements. Total investment securities were $32.8 billion and $32.7 billion at March 31, 2018 and December 31, 2017, respectively. The taxable investment securities portfolio had an effective duration of 5.2 years at March 31, 2018 compared to 4.7 years at December 31, 2017.

Debt 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. Debt securities are classified as trading when bought and held principally for the purpose of selling them in the near term. At March 31, 2018, the Bancorp’s investment portfolio consisted primarily of AAA-rated available-for-sale debt securities. The Bancorp did not hold any securities classified as below investment grade at March 31, 2018 and an immaterial amount as of December 31, 2017. The Bancorp did not recognize OTTI on its available-for-sale debt and other securities, included in securities gains, net, in the Condensed Consolidated Statements of Income, during the three months ended March 31, 2018 and recognized $10 million during the three months ended March 31, 2017.

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

TABLE 17: Components of Investment Securities

On an amortized cost basis, available-for-sale debt and other securities increased $653 million from December 31, 2017 primarily due to increases in agency commercial mortgage-backed securities and agency residential mortgage-backed securities.

16

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

On an amortized cost basis, available-for-sale debt and other securities were 25% of total interest-earning assets at both March 31, 2018 and December 31, 2017. The estimated weighted-average life of the debt securities in the available-for-sale debt and other securities portfolio was 6.8 years at March 31, 2018 compared to 6.5 years at December 31, 2017. In addition, at March 31, 2018, the debt securities in the available-for-sale debt and other securities portfolio had a weighted-average yield of 3.15%, compared to 3.18% at December 31, 2017.

Trading debt securities increased $79 million from December 31, 2017 primarily due to an increase in asset-backed securities and other debt securities.

Information presented in Table 18 is on a weighted-average life basis, anticipating future prepayments. Yield information is presented on an FTE basis and is computed using amortized cost balances. Maturity and yield calculations for the total available-for-sale debt and other securities portfolio exclude other securities that have no stated yield or maturity. Total net unrealized losses on the available-for-sale debt and other securities portfolio were $411 million at March 31, 2018 compared to net unrealized gains of $174 million at December 31, 2017. The fair value of investment securities is impacted by interest rates, credit spreads, market volatility and liquidity conditions. The fair value of investment securities generally decreases when interest rates increase or when credit spreads expand.

TABLE 18: Characteristics of Available-for-Sale Debt and Other Securities