FITB 10-Q Quarter ended Sept. 30, 2017

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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 September 30, 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 705,581,268 shares of the Registrant’s common stock, without par value, outstanding as of October 31, 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; (29) the negotiation and (if any) implementation by Vantiv, Inc. and/or Worldpay Group plc of the potential acquisition of Worldpay Group plc by Vantiv, Inc. and such other actions as Vantiv, Inc. and Worldpay Group plc may take in furtherance thereof; and (30) 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.

TABLE 1: Selected Financial Data

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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 September 30, 2017, the Bancorp had $142.3 billion in assets and operated 1,155 full-service banking centers and 2,465 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 8.6% interest in Vantiv Holding, LLC. The carrying value of the Bancorp’s investment in Vantiv Holding, LLC was $219 million at September 30, 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 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 September 30, 2017, net interest income on an FTE basis and noninterest income provided 38% and 62% of total revenue, respectively. For the nine months ended September 30, 2017, 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 both the three and nine months ended September 30, 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, net securities gains and other noninterest income. Noninterest expense includes personnel costs, net occupancy expense, technology and communication costs, card and processing expense, equipment expense and other noninterest expense.

Vantiv, Inc. Share Sale

On August 7, 2017, Fifth Third Bancorp and Fifth Third Bank entered into a transaction agreement with Vantiv, Inc. and Vantiv Holding, LLC under which Fifth Third Bank agreed to exercise its right to exchange 19.79 million of its Class B Units in Vantiv Holding, LLC for 19.79 million shares of Vantiv, Inc.’s Class A Common Stock and Vantiv, Inc. agreed to repurchase the newly issued shares of Class A Common Stock upon issue directly from Fifth Third Bank at a price of $64.04 per share, the closing share price of the Class A Common Stock on the New York Stock Exchange on August 4, 2017.

As a result of these transactions, the Bancorp recognized a gain of approximately $1.0 billion during the third quarter of 2017. Following the share repurchase, the Bancorp beneficially owns approximately 8.6% of Vantiv Holding, LLC’s equity through its ownership of approximately 15.25 million Class B Units of Vantiv Holding, LLC. The Bancorp continues to account for this investment under the equity method given the nature of Vantiv Holding, LLC’s structure as a limited liability company and contractual arrangements between Vantiv Holding, LLC and the Bancorp. For more information, refer to Note 19 of the Notes to Condensed Consolidated Financial Statements.

Accelerated Share Repurchase Transactions

During the nine months ended September 30, 2017, 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.

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

For more information on the accelerated share repurchase program, refer to Note 16 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 nine months ended September 30, 2017, refer to Table 2.

TABLE 2: Summary of Accelerated Share Repurchase Transactions

Senior Notes Offering

On June 15, 2017, the Bancorp issued and sold $700 million of 2.60% senior fixed-rate notes, with a maturity of five years, due on June 15, 2022. 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 plus accrued and unpaid interest thereon to, but excluding, the redemption date.

Automobile Loan Securitization

In a securitization transaction that occurred in September of 2017, the Bancorp transferred $1.1 billion in aggregate automobile loans to a bankruptcy remote trust which subsequently issued approximately $1.0 billion of asset-backed notes, of which approximately $261 million of the asset-backed notes were retained by the Bancorp, resulting in approximately $750 million of outstanding notes included in long-term debt in the Condensed Consolidated Balance Sheets. Additionally, as discussed in Note 11, the bankruptcy remote trust was deemed to be a VIE and the Bancorp, as the primary beneficiary, consolidated the VIE. The third-party holders of the asset-backed notes do not have recourse to the general assets of the Bancorp. For additional information on this automobile loan securitization, refer to Note 11 and Note 15 of the Notes to Condensed Consolidated Financial Statements.

Earnings Summary

The Bancorp’s net income available to common shareholders for the third quarter of 2017 was $999 million, or $1.35 per diluted share, which was net of $15 million in preferred stock dividends. The Bancorp’s net income available to common shareholders for the third quarter of 2016 was $501 million, or $0.65 per diluted share, which was net of $15 million in preferred stock dividends. The Bancorp’s net income available to common shareholders for the nine months ended September 30, 2017 was $1.6 billion, or $2.16 per diluted share, which was net of $52 million in preferred stock dividends. For the nine months ended September 30, 2016, the Bancorp’s net income available to common shareholders was $1.1 billion, or $1.44 per diluted share, which was net of $52 million in preferred stock dividends.

Net interest income on an FTE basis (non-GAAP) was $977 million and $2.9 billion for the three and nine months ended September 30, 2017, respectively, an increase of $64 million and $131 million compared to the same periods in the prior year. For both the three and nine months ended September 30, 2017, net interest income was positively impacted by increases in yields on average loans and leases, increases in average taxable securities and decreases in average long-term debt. Additionally, net interest income was positively impacted by the decisions of the Federal Open Market Committee in December 2016, March 2017 and June 2017 to raise the target range of federal funds rate 25 bps and a favorable consumer loan mix shift. These positive impacts were partially offset by decreases in average loans and leases and increases in the rates paid on average other short-term borrowings, average long-term debt and average interest-bearing core deposits during both the three and nine months ended September 30, 2017. Net interest margin on an FTE basis (non-GAAP) was 3.07% and 3.03% for the three and nine months ended September 30, 2017, respectively compared to 2.88% for both periods in the prior year.

Noninterest income increased $721 million for the three months ended September 30, 2017 compared to the same period in the prior year primarily due to an increase in other noninterest income, partially offset by a decrease in corporate banking revenue. Other noninterest income increased $740 million during the three months ended September 30, 2017 compared to the three months ended September 30, 2016 primarily due to the gain on sale of Vantiv, Inc. shares, a decrease in the net losses on disposition and impairment of bank premises and equipment and an increase in private equity investment income. These benefits were partially offset by the impact of income from the TRA transactions associated with Vantiv, Inc. during the third quarter of 2016, as well as an increase in the loss on the swap associated with the sale of Visa, Inc. Class B shares and a decrease in equity method income from the Bancorp’s interest in Vantiv Holding, LLC during the three months ended September 30, 2017. Corporate banking revenue decreased $10 million for the three months ended September 30, 2017 compared to the same period in the prior year primarily due to a decrease in lease remarketing fees.

Noninterest income increased $573 million for the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016 primarily due to an increase in other noninterest income, partially offset by decreases in corporate banking revenue and mortgage banking net revenue. Other noninterest income increased $685 million during the nine months ended September 30, 2017 compared to the same period in the prior year primarily due to the gain on sale of Vantiv, Inc. shares, an increase in private equity investment income and a decrease in the net losses on disposition and impairment of bank premises and equipment. These benefits were partially offset by the impact of certain transactions that occurred during the nine months ended September 30, 2016 which included the impact of income from the TRA transactions associated with Vantiv, Inc., positive valuation adjustments on the warrant associated with Vantiv Holding, LLC and the gains on the sale of certain retail branch operations. The nine months ended September 30, 2017 also included a reduction in equity method income from the Bancorp’s interest in Vantiv Holding, LLC and an increase in the loss on the swap associated with the sale of Visa, Inc. Class B Shares. Corporate banking revenue decreased $54 million during the nine months ended September 30, 2017 compared to the same period in the prior year primarily due to decreases in lease remarketing fees, foreign exchange fees and letter of credit fees. Mortgage banking net revenue decreased $49 million during the nine months ended September 30, 2017 compared to the same period in the prior year primarily driven by a decrease in origination fees and gains on loan sales.

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

Noninterest expense increased $2 million for the three months ended September 30, 2017 compared to the same period in the prior year primarily due to increases in personnel costs partially offset by a decrease in other noninterest expense. Personnel costs increased $6 million for the three months ended September 30, 2017 compared to the same period in the prior year driven by an increase in base compensation primarily due to personnel additions in information technology. Other noninterest expense decreased $8 million for the three months ended September 30, 2017 compared to the same period in the prior year primarily due to the benefit from the reserve for unfunded commitments and a decrease in donations expense and loan and lease expense, partially offset by increases in losses and adjustments and marketing expense.

Noninterest expense decreased $24 million for the nine months ended September 30, 2017 compared to the same period in the prior year primarily due to decreases in other noninterest expense, card and processing expense and net occupancy expense, partially offset by an increase in personnel costs. Other noninterest expense decreased $28 million for the nine months ended September 30, 2017 compared to the same period in the prior year primarily due to the benefit from the reserve for unfunded commitments and decreases in impairment on affordable housing investments, loan and lease expense, donations expense, and losses and adjustments, partially offset by increases in professional service fees and marketing expense. Card and processing expense decreased $6 million for the nine months ended September 30, 2017 compared to the same period in the prior year primarily due to the impact of renegotiated service contracts. Net occupancy expense decreased $5 million for the nine months ended September 30, 2017 compared to the same period in the prior year due to lower rent expense driven by a reduction in the number of full-service banking centers and ATM locations. These items were partially offset by an increase in personnel costs of $17 million for the nine months ended September 30, 2017 compared to the same period in the prior year driven by increases in long-term incentive compensation, base compensation and medical and FICA expenses, partially offset by a decrease in severance costs related to the Bancorp’s voluntary early retirement program in 2016.

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 $67 million and $193 million for the three and nine months ended September 30, 2017, respectively, compared to $80 million and $289 million for the comparable periods in 2016. Net losses charged-off as a percent of average portfolio loans and leases decreased to 0.29% during the three months ended September 30, 2017 compared to 0.45% during the same period in the prior year and decreased to 0.32% for the nine months ended September 30, 2017 compared to 0.41% for the same period in the prior year. At September 30, 2017, nonperforming portfolio assets as a percent of portfolio loans and leases and OREO decreased to 0.60% 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 September 30, 2017, as calculated under the Basel III transition provisions, the CET1 capital ratio was 10.59%, the Tier I risk-based capital ratio was 11.72%, the Total risk-based capital ratio was 15.16% and the Tier I leverage ratio was 9.97%.

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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:

TABLE 3: Non-GAAP Financial Measures - Net Interest Income, Net Interest Margin and Efficiency Ratio 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.

The following table reconciles the non-GAAP financial measure of return on average tangible common equity to U.S. GAAP:

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.

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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 nine months ended September 30, 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. The Bancorp may also purchase servicing rights from time to time. Effective January 1, 2017, the Bancorp elected to prospectively adopt the fair value method for all existing classes of its residential mortgage servicing rights portfolio. Upon this election, all servicing rights in these classes are measured at fair value at each reporting date and changes in the fair value of servicing rights are reported in earnings in the period in which the changes occur. Servicing rights are valued using internal OAS models. Significant management 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 12 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)

Net Interest Income

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

Tables 7 and 8 present the components of net interest income, net interest margin and net interest rate spread for the three and nine months ended September 30, 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 and leases held for sale have been included in the average loan and lease balances. Average outstanding securities balances are based on amortized cost with any unrealized gains or losses on available-for-sale and other securities included in other assets.

Net interest income on an FTE basis (non-GAAP) was $977 million and $2.9 billion for the three and nine months ended September 30, 2017, respectively, an increase of $64 million and $131 million compared to the same periods in the prior year. Net interest income was positively impacted by an increase in yields on average loans and leases of 42 bps and 31 bps for the three and nine months ended September 30, 2017, respectively. Net interest income also benefited from increases in average taxable securities of $2.5 billion and $2.3 billion for the three and nine months ended September 30, 2017, respectively, and decreases in average long-term debt of $2.6 billion and $1.9 billion for the three and nine months ended September 30, 2017, respectively, compared to the same periods in the prior year. Additionally, net interest income was positively impacted by the decisions of the Federal Open Market Committee in December 2016, March 2017 and June 2017 to raise the target range of the federal funds rate 25 bps and a favorable consumer loan mix shift. These positive impacts were partially offset by decreases in average loans and leases and increases in the rates paid on average other short-term borrowings, average long-term debt and average interest-bearing core deposits for both the three and nine months ended September 30, 2017 compared to the same periods in the prior year. Average loans and leases decreased $1.8 billion and $1.7 billion for the three and nine months ended September 30, 2017, respectively, compared to the same periods in the prior year. The rates paid on average other short-term borrowings increased 79 bps and 56 bps, respectively, for the three and nine months ended September 30, 2017 compared to the same periods in the prior year. The rates paid on average long-term debt increased 42 bps for both the three and nine months ended September 30, 2017 compared to the same periods in the prior year. The rates paid on average interest-bearing core deposits increased 13 bps and 9 bps, respectively, for the three and nine months ended September 30, 2017 compared to the same periods in the prior year.

Net interest rate spread was 2.79% and 2.77% during the three and nine months ended September 30, 2017, respectively, compared to 2.66% and 2.68% in the same periods in the prior year. Yields on average interest-earning assets increased 28 bps and 21 bps for the three and nine months ended September 30, 2017, respectively, partially offset by a 15 bps and 12 bps increase in rates paid on average interest-bearing liabilities for the three and nine months ended September 30, 2017, respectively, compared to the same periods in the prior year.

Net interest margin on an FTE basis (non-GAAP) was 3.07% and 3.03% for the three and nine months ended September 30, 2017, respectively, compared to 2.88% for both the three and nine months ended September 30, 2016. The increase for both periods was driven primarily by the previously mentioned increases in the net interest rate spread partially offset by a decrease in average free funding balances. The decrease in average free funding balances for both periods was driven by a decrease in average demand deposits of $1.1 billion and $729 million for the three and nine months ended September 30, 2017, respectively, compared to the same periods in the prior year.

Interest income on an FTE basis from loans and leases (non-GAAP) increased $83 million and $166 million for the three and nine months ended September 30, 2017, respectively, compared to the same periods in the prior year. The increase for both periods was driven by the previously mentioned increases in yields on average loans and leases, partially offset by decreases in average loans and leases. Average loans and leases decreased for both periods primarily due to decreases in average commercial and industrial loans and average automobile loans partially offset by an increase in average 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 and other short-term investments increased $13 million and $37 million for the three and nine months ended September 30, 2017, respectively, compared to the same periods in the prior year primarily as a result of the aforementioned increases in average taxable securities.

Interest expense on core deposits increased $20 million and $45 million for the three and nine months ended September 30, 2017, respectively, compared to the same periods in the prior year. These increases were primarily due to increases in the cost of average interest-bearing core deposits to 39 bps and 35 bps for the three and nine months ended September 30, 2017, respectively, from 26 bps for both the three and nine months ended September 30, 2016. The increase in the cost of average interest-bearing core deposits for both periods was primarily due to increases 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 $12 million and $27 million for the three and nine months ended September 30, 2017, respectively, compared to the same periods in the prior year primarily due to the previously mentioned increases in the rates paid on average other short-term borrowings and average long-term debt partially offset by the aforementioned decreases 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 and nine months ended September 30, 2017, average wholesale funding represented 25% and 24% of average interest-bearing liabilities, respectively, compared to 26% during both the three and nine months ended September 30, 2016.

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

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)

TABLE 8: Condensed Average Balance Sheets and Analysis of Net Interest Income on an FTE Basis