Edgar Filing: FIFTH THIRD BANCORP

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 June 30, 2016

Commission File Number 001-33653

LOGO

(Exact name of Registrant as specified in its charter)

Ohio

31-0854434

(State or other jurisdiction

of incorporation or organization)

(I.R.S. Employer

Identification Number)

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 x 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 x No ¨

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


Large accelerated filer x	Accelerated filer	¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)	Smaller reporting company	¨

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

There were 766,374,461 shares of the Registrant’s common stock, without par value, outstanding as of July 31, 2016.

LOGO

FINANCIAL CONTENTS


Part I. Financial Information
Glossary of Abbreviations and Acronyms			2
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 2)
Selected Financial Data			3
Overview			4
Non-GAAP Financial Measures			8
Recent Accounting Standards			11
Critical Accounting Policies			11
Statements of Income Analysis			12
Balance Sheet Analysis			20
Business Segment Review			25
Risk Management—Overview			32
Credit Risk Management			33
Market Risk Management			46
Liquidity Risk Management			50
Operational Risk Management			52
Compliance Risk Management			52
Capital Management			52
Off-Balance Sheet Arrangements			55
Quantitative and Qualitative Disclosures about Market Risk (Item 3)			56
Controls and Procedures (Item 4)			56
Condensed Consolidated Financial Statements and Notes (Item 1)
Balance Sheets (unaudited)			57
Statements of Income (unaudited)			58
Statements of Comprehensive Income (unaudited)			59
Statements of Changes in Equity (unaudited)			60
Statements of Cash Flows (unaudited)			61
Notes to Condensed Consolidated Financial Statements (unaudited)			62
Part II. Other Information
Legal Proceedings (Item 1)			118
Risk Factors (Item 1A)			118
Unregistered Sales of Equity Securities and Use of Proceeds (Item 2)			119
Exhibits (Item 6)			119
Signatures			120
Certifications

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 as updated by our Quarterly Reports on Form 10-Q. 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) effects of critical accounting policies and judgments; (12) changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board (FASB) or other regulatory agencies; (13) 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; (14) ability to maintain favorable ratings from rating agencies; (15) fluctuation of Fifth Third’s stock price; (16) ability to attract and retain key personnel; (17) ability to receive dividends from its subsidiaries; (18) potentially dilutive effect of future acquisitions on current shareholders’ ownership of Fifth Third; (19) effects of accounting or financial results of one or more acquired entities; (20) difficulties from Fifth Third’s investment in, relationship with, and nature of the operations of Vantiv, LLC; (21) loss of income from any sale or potential sale of businesses (22) difficulties in separating the operations of any branches or other assets divested; (23) inability to achieve expected benefits from branch consolidations and planned sales within desired timeframes, if at all; (24) ability to secure confidential information and deliver products and services through the use of computer systems and telecommunications networks; and (25) the impact of reputational risk created by these developments on such matters as business generation and retention, funding and liquidity.

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.

ALCO: Asset Liability Management Committee

ALLL: Allowance for Loan and Lease Losses

AOCI: Accumulated Other Comprehensive Income

ARM: Adjustable Rate Mortgage

ASF: Available Stable Funding

ASU: Accounting Standards Update

ATM: Automated Teller Machine

BCBS: Basel Committee on Banking Supervision

BHC: Bank Holding Company

BOLI: Bank Owned Life Insurance

BPO: Broker Price Opinion

bps: Basis Points

CCAR: Comprehensive Capital Analysis and Review

CDC: Fifth Third Community Development Corporation

CET1: Common Equity Tier 1

CFE: Collateralized Financing Entity

CFPB: Consumer Financial Protection Bureau

C&I: Commercial and Industrial

DCF: Discounted Cash Flow

DFA: Dodd-Frank Wall Street Reform & Consumer Protection Act

DIF: Deposit Insurance Fund

DTCC: Depository Trust & Clearing Corporation

ERISA: Employee Retirement Income Security Act

ERM: Enterprise Risk Management

ERMC: Enterprise Risk Management Committee

EVE: Economic Value of Equity

FASB: Financial Accounting Standards Board

FDIC: Federal Deposit Insurance Corporation

FFIEC: Federal Financial Institutions Examination Council

FHA: Federal Housing Administration

FHLB: Federal Home Loan Bank

FHLMC: Federal Home Loan Mortgage Corporation

FICO: Fair Isaac Corporation (credit rating)

FINRA: Financial Industry Regulatory Authority

FNMA: Federal National Mortgage Association

FRB: Federal Reserve Bank

FTE: Fully Taxable Equivalent

FTP: Funds Transfer Pricing

FTS: Fifth Third Securities

GDP: Gross Domestic Product

GNMA: Government National Mortgage Association

GSE: United States Government Sponsored Enterprise

HAMP: Home Affordable Modification Program

HARP: Home Affordable Refinance Program

HFS: Held for Sale

HQLA: High Quality Liquid Assets

IPO: Initial Public Offering

IRC: Internal Revenue Code

IRLC: Interest Rate Lock Commitment

ISDA: International Swaps and Derivatives Association, Inc.

LCR: Liquidity Coverage Ratio

LIBOR: London Interbank Offered Rate

LLC: Limited Liability Company

LTV: Loan-to-Value

MD&A: Management’s Discussion and Analysis of Financial Condition and Results of Operations

MSA: Metro Statistical Area

MSR: Mortgage Servicing Right

N/A: Not Applicable

NII: Net Interest Income

NM: Not Meaningful

NSFR: Net Stable Funding Ratio

OAS: Option-Adjusted Spread

OCI: Other Comprehensive Income (Loss)

OREO: Other Real Estate Owned

OTTI: Other-Than-Temporary Impairment

PCA: Prompt Corrective Action

PMI: Private Mortgage Insurance

RSF: Required Stable Funding

SARs: Stock Appreciation Rights

SBA: Small Business Administration

SEC: United States Securities and Exchange Commission

TBA: To Be Announced

TDR: Troubled Debt Restructuring

TILA: Truth in Lending Act

TRA: Tax Receivable Agreement

TruPS: Trust Preferred Securities

U.S.: United States of America

U.S. GAAP: United States Generally Accepted Accounting Principles

VA: United States Department of Veteran Affairs

VIE: Variable Interest Entity

VRDN: Variable Rate Demand Note

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.

TABLE 1: Selected Financial Data



		For the three months ended June 30,		%			For the six months ended June 30,		%
($ in millions, except for per share data)		2016	2015	Change			2016	2015	Change

Income Statement Data
Net interest income (U.S. GAAP)	$	902	887		2	$	1,805	1,734		4
Net interest income (FTE)^(a)(b)		908	892		2		1,817	1,744		4
Noninterest income		599	556		8		1,235	1,187		4
Total revenue^(a)		1,507	1,448		4		3,052	2,931		4
Provision for loan and lease losses		91	79		15		210	148		42
Noninterest expense		983	947		4		1,968	1,871		5
Net income attributable to Bancorp		333	315		6		660	676		(2)
Net income available to common shareholders		310	292		6		622	638		(3)

Common Share Data
Earnings per share – basic	$	0.40	0.36		11	$	0.80	0.78		3
Earnings per share – diluted		0.40	0.36		11		0.80	0.77		4
Cash dividends declared per common share		0.13	0.13		-		0.26	0.26		-
Book value per share		20.09	17.62		14		20.09	17.62		14
Market value per share		17.59	20.82		(16)		17.59	20.82		(16)

Financial Ratios
Return on average assets		0.94 %	0.90		4		0.93 %	0.98		(5)
Return on average common equity		8.2	8.1		1		8.3	8.9		(7)
Return on average tangible common equity^(b)		9.7	9.7		-		9.8	10.7		(8)
Dividend payout ratio		32.5	36.1		(10)		32.5	33.3		(2)
Average total Bancorp shareholders’ equity as a percent of average assets		11.60	11.32		2		11.59	11.41		2
Tangible common equity as a percent of tangible assets^(b)(h)		8.64	8.33		4		8.64	8.33		4
Net interest margin^(a)		2.88	2.90		(1)		2.89	2.88		-
Efficiency^(a)		65.3	65.4		-		64.5	63.8		1

Credit Quality
Net losses charged-off	$	87	86		1	$	183	177		3
Net losses charged-off as a percent of average portfolio loans and leases		0.37 %	0.37		-		0.39 %	0.39		-
ALLL as a percent of portfolio loans and leases		1.38	1.39		(1)		1.38	1.39		(1)
Allowance for credit losses as a percent of portfolio loans and leases^(c)		1.54	1.54		-		1.54	1.54		-
Nonperforming portfolio assets as a percent of portfolio loans and leases and OREO		0.86	0.67		28		0.86	0.67		28

Average Balances
Loans and leases, including held for sale	$	94,807	92,739		2	$	94,443	92,202		2
Total securities and other short-term investments		32,040	30,563		5		31,808	29,805		7
Total assets		142,920	139,960		2		142,251	138,795		2
Transaction deposits^(d)		94,929	96,460		(2)		94,806	95,322		(1)
Core deposits^(e)		98,973	100,534		(2)		98,845	99,370		(1)
Wholesale funding^(f)		23,084	18,330		26		22,509	18,599		21
Bancorp shareholders’ equity		16,584	15,841		5		16,479	15,831		4


Regulatory Capital Ratios		Basel III Transitional^(g)
CET1 capital		9.94 %	9.42⁽ⁱ⁾		6		9.94 %	9.42⁽ⁱ⁾		6
Tier I risk-based capital		11.03	10.51⁽ⁱ⁾		5		11.03	10.51⁽ⁱ⁾		5
Total risk-based capital		14.66	13.69⁽ⁱ⁾		7		14.66	13.69⁽ⁱ⁾		7
Tier I leverage		9.64	9.44⁽ⁱ⁾		2		9.64	9.44⁽ⁱ⁾		2

		Basel III Fully Phased-In
CET1 capital^(b)(g)		9.86	9.31⁽ⁱ⁾		6		9.86	9.31⁽ⁱ⁾		6

(a)

Amounts presented on an FTE basis. The FTE adjustment for the three months ended June 30, 2016 and 2015 was $6 and $5, respectively, and for the six months ended June 30, 2016 and 2015 was $12 and $10, respectively.

(b)

These are non-GAAP measures. For further information, refer to the Non-GAAP Financial Measures section of MD&A.

(c)

The allowance for credit losses is the sum of the ALLL and the reserve for unfunded commitments.

(d)

Includes demand deposits, interest checking deposits, savings deposits, money market deposits and foreign office deposits.

(e)

Includes transaction deposits and other time deposits.

(f)

Includes certificates $100,000 and over, other deposits, federal funds purchased, other short-term borrowings and long-term debt.

(g)

Under the U.S. banking agencies’ Basel III Final Rule, assets and credit equivalent amounts of off-balance sheet exposures are calculated according to the standardized approach for risk-weighted assets. The resulting values are added together in the Bancorp’s total risk-weighted assets.

(h)

Excludes unrealized gains and losses.

(i)

Ratios not restated for the adoption of the amended guidance of ASU 2015-03 “Simplifying the Presentation of Debt Issuance Costs.” Refer to Note 3 of the Notes to Condensed Consolidated Financial Statements for further information.

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 June 30, 2016, the Bancorp had $143.6 billion in assets and operated 1,191 full-service banking centers, including 94 Bank Mart^® locations, open seven days a week, inside select grocery stores, and 2,514 ATMs in ten states throughout the Midwestern and Southeastern regions of the U.S. The Bancorp reports on four business segments: Commercial Banking, Branch Banking, Consumer Lending and Wealth and Asset Management. The Bancorp also has an approximate 18% interest in Vantiv Holding, LLC. The carrying value of the Bancorp’s investment in Vantiv Holding, LLC was $390 million at June 30, 2016.

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, 2015. Each of these items could have an impact on the Bancorp’s financial condition, results of operations and cash flows. In addition, refer to the Glossary of Abbreviations and Acronyms in this report for a list of terms included as a tool for the reader of this quarterly report on Form 10-Q. The abbreviations and acronyms identified therein are used throughout this MD&A, as well as the Condensed Consolidated Financial Statements and Notes to the Condensed Consolidated Financial Statements.

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

The Bancorp’s revenues are dependent on both net interest income and noninterest income. For both the three and six months ended June 30, 2016, net interest income on an FTE basis and noninterest income provided 60% and 40% 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 six months ended June 30, 2016. 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 due to a weakened economy within the Bancorp’s footprint.

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

Branch Consolidation and Sales Plan

The Bancorp monitors changing customer preferences associated with the channels it uses for banking transactions to evaluate the efficiency, competitiveness and quality of the customer service experience in its consumer distribution network. As part of this ongoing assessment, the Bancorp may determine that it is no longer fully committed to maintaining full-service branches at certain of its existing banking center locations. Similarly, the Bancorp may also determine that it is no longer fully committed to building banking centers on certain parcels of land which had previously been held for future branch expansion. On June 16, 2015, the Bancorp’s Board of Directors authorized management to pursue a plan to further develop its distribution strategy, including a plan to consolidate and/or sell certain operating branch locations and certain parcels of undeveloped land that had been acquired by the Bancorp for future branch expansion (the “Branch Consolidation and Sales Plan”). The Bancorp expects to receive approximately $60 million in annual savings from operating expenses upon completion of the Branch Consolidation and Sales Plan. For more information on the Branch Consolidation and Sales Plan, refer to Note 7 of the Notes to Condensed Consolidated Financial Statements.

On September 3, 2015, the Bancorp announced the decision to enter into an agreement to sell branch banking locations, retail accounts, certain private banking deposits and related loan relationships in the Pittsburgh MSA to First National Bank of Pennsylvania. On September 30, 2015, the Bancorp announced the decision to enter into an agreement to sell its retail operations, including retail accounts, certain private banking deposits and related loan relationships in the St. Louis MSA to Great Southern Bank. Both transactions were part of the Branch Consolidation and Sales Plan.

On January 29, 2016, the Bancorp closed the previously announced sale in the St. Louis MSA to Great Southern Bank. The sale included loans, premises and equipment and deposits with aggregate carrying amounts of $158 million, $18 million and $228 million, respectively.

The Bancorp recorded a gain on the sale of $8 million which was recorded in other noninterest income in the Condensed Consolidated Statements of Income.

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

On April 22, 2016, the Bancorp closed the previously announced sale in the Pittsburgh MSA to First National Bank of Pennsylvania. The sale included loans, premises and equipment and deposits with aggregate carrying values of approximately $99 million, $16 million and $302 million, respectively. The Bancorp recorded a gain on the sale of $11 million which was recorded in other noninterest income in the Condensed Consolidated Statements of Income.

Pursuant to the Branch Consolidation and Sales Plan, as of June 30, 2016, the Bancorp intended to consolidate and/or sell 27 operating branch locations and to sell an additional 20 parcels of undeveloped land that had been acquired by the Bancorp for future branch expansion. These operating branches and parcels of undeveloped land represent $20 million and $9 million of land and improvements and buildings, respectively, included in bank premises and equipment in the Condensed Consolidated Balance Sheets and were classified as held for sale as of June 30, 2016.

Accelerated Share Repurchase Transactions

During the six months ended June 30, 2016, 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 six months ended June 30, 2016, refer to Table 2.

TABLE 2: Summary of Accelerated Share Repurchase Transactions




Repurchase Date	Amount ($ in millions)		Shares Repurchased on Repurchase Date		Shares Received from Forward Contract Settlement		Total Shares Repurchased		Settlement Date

December 14, 2015	$	215		9,248,482		1,782,477		11,030,959		January 14, 2016
March 4, 2016		240		12,623,762		1,868,379		14,492,141		April 11, 2016

For further information on a subsequent event related to capital actions, refer to Note 22 of the Notes to Condensed Consolidated Financial Statements.

Open Market Share Repurchase Transactions

Between June 17, 2016 and June 20, 2016, the Bancorp repurchased 1,436,100 shares, or approximately $26 million, of its outstanding common stock through open market repurchase transactions.

Senior and Subordinated Notes Offerings

On March 15, 2016, the Bank issued and sold $1.5 billion in aggregate principal amount of unsecured bank notes. The bank notes consisted of $750 million of 2.30% senior fixed-rate notes, with a maturity of three years, due on March 15, 2019; and $750 million of 3.85% subordinated fixed-rate notes, with a maturity of ten years, due on March 15, 2026. These bank notes will be redeemable by the Bank, 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 up to, but excluding, the redemption date.

On June 14, 2016, the Bank issued and sold $1.3 billion of 2.25% unsecured senior fixed-rate notes, with a maturity of five years, due on June 14, 2021. These bank notes will be redeemable by the Bank, 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 up to, but excluding, the redemption date.

Legislative and Regulatory Developments

During the first quarter of 2016, the FDIC issued a final rule implementing a 4.5 bps surcharge on the quarterly FDIC insurance assessments of insured depository institutions with total consolidated assets of $10 billion or more. The surcharge will take effect at the same time the FDIC is required to lower the regular FDIC insurance assessments by approximately 2 bps under a rule adopted by the FDIC in 2011 which is triggered by the DIF reserve ratio reaching 1.15% of insured deposits. The surcharge will take effect on July 1, 2016 if the DIF reserve ratio reaches 1.15% before July 1, 2016; otherwise it will begin the first day of the calendar quarter after the reserve ratio reaches 1.15%. Surcharges will continue through the quarter that the reserve ratio first reaches or exceeds 1.35% of insured deposits, but not later than December 31, 2018. If the reserve ratio does not reach 1.35% by December 31, 2018, the FDIC will impose a shortfall assessment on March 31, 2019, on insured depository institutions with total consolidated assets of $10 billion or more. The FDIC has announced they expect that surcharges will commence in the second half of 2016 and that they should be sufficient to raise the DIF reserve ratio to 1.35% in approximately eight quarters. Fifth Third estimates the announced changes to the FDIC assessments will result in a net increase in its FDIC insurance expense of approximately $23 million on an annual basis.

The FRB launched the 2016 stress testing program and CCAR on January 28, 2016, with submissions of stress test results and capital plans to the FRB due on April 5, 2016, which the Bancorp submitted as required.

On June 29, 2016, the Bancorp announced the results of its capital plan submitted to the FRB as part of the 2016 CCAR. For BHCs that proposed capital distributions in their plans, the FRB either objected to the plan or provided a non-objection whereby the FRB permitted the proposed capital distributions.

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

The FRB indicated to the Bancorp that it did not object to the following capital actions for the period beginning July 1, 2016 and ending June 30, 2017:

•

The potential increase in the quarterly common stock dividend to $0.14 in the fourth quarter of 2016;

•

The potential repurchase of common shares in an amount up to $660 million, which includes $84 million in repurchases related to share issuances under employee benefit plans;

•

The additional ability to repurchase shares in the amount of any realized after-tax gains from the sale of Vantiv, Inc. common stock, if executed;

•

The additional ability to repurchase shares in the amount of any realized after-tax gains from the termination and settlement of any portion of the TRA with Vantiv, Inc., if executed.

For more information on the 2016 CCAR results refer to the Capital Management subsection of the Risk Management section of MD&A.

Fifth Third offers qualified deposit customers a deposit advance product if they choose to avail themselves of this product to meet short-term, small-dollar financial needs. Fifth Third’s deposit advance product is designed to fully comply with the applicable federal and state laws and use of this product is subject to strict eligibility requirements and advance restriction guidelines to limit dependency on this product as a borrowing source. The Bancorp’s deposit advance balances are included in other consumer loans and leases in the Loans and Leases subsection of the Balance Sheet Analysis section of MD&A and in Table 8 in the Statements of Income Analysis section of MD&A. On January 17, 2014, given developments in industry practice, Fifth Third announced that it would no longer enroll new customers in its deposit advance product and expected to phase out the service to existing customers by the end of 2014. To avoid a disruption to its existing customers during the extension period while the banking industry awaits further regulatory guidance on the deposit advance product, on November 3, 2014, Fifth Third announced changes to its current deposit advance product for existing customers beginning January 1, 2015, including a lower transaction fee, an extended repayment period and a reduced maximum advance period. On June 2, 2016, the CFPB issued proposed rules to create additional consumer protections for certain consumer credit products such as payday loans, vehicle title loans and certain high-cost installment loans. Fifth Third is continuing to offer the service to existing deposit advance product customers and will address how best to meet customers’ need for a small dollar, short-term credit product when the rules are finalized.

In December 2013, the U.S. banking agencies issued final rules to implement section 619 of the DFA, known as the Volcker Rule, which places limitations on banking organizations’ ability to (i) engage in short-term proprietary trading and (ii) own, sponsor or have certain relationships with certain private equity funds, hedge funds, and other private funds (collectively “covered funds”). On July 7, 2016, the FRB announced a third extension of the conformance period, providing the industry until July 21, 2017, to conform investments in and relationships with covered funds that were in place prior to December 31, 2013. The extension does not apply to investments in and relationships with a covered fund made after December 31, 2013 or to short-term proprietary trading activities. The Volcker Rule prohibits banking organizations from engaging in short-term proprietary trading of certain securities, derivatives, commodity futures and options on these instruments for their own account. The Volcker Rule also restricts banking organizations from owning, sponsoring or having certain relationships with covered funds, as well as holding certain collateralized loan obligations that are deemed to contain ownership interests. The Volcker Rule provides several exclusions and exemptions for certain activities, such as underwriting, market making, hedging, trading in certain government obligations and organizing and offering a private fund. Fifth Third does not sponsor any private funds that, under the Volcker Rule, it is prohibited from sponsoring. At June 30, 2016, the Bancorp had approximately $164 million in interests and approximately $29 million in binding commitments to invest in private equity funds that are affected by the Volcker Rule. It is expected that over time the Bancorp may need to dispose of these investments, however no formal plan to sell has been approved as of June 30, 2016.

On October 10, 2014, the U.S. Banking Agencies published final rules implementing a quantitative liquidity requirement consistent with the LCR standard established by the BCBS for large internationally active banking organizations, generally those with $250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposure. In addition, a modified LCR requirement was implemented for BHCs with $50 billion or more in total consolidated assets but that are not internationally active, such as Fifth Third. The Modified LCR became effective January 1, 2016 and requires BHCs to calculate its LCR on a monthly basis. Refer to the Liquidity Risk Management subsection of the Risk Management section of MD&A for further discussion on these ratios.

The FRB conducted a regularly scheduled examination covering 2011 through 2013 to determine the Bancorp’s banking subsidiary’s compliance with the CRA. This CRA examination resulted in a rating of “Needs to Improve”. The Bank believes that the “Needs to Improve” rating reflects legacy issues that have been remediated during the intervening three years. While the Bank’s CRA rating is “Needs to Improve” the Bancorp and the Bank face limitations and conditions on certain activities, including the commencement of new activities and merger with or acquisitions of other financial institutions. The Bank’s next CRA examination is expected to commence during the fourth quarter of 2016.

Earnings Summary

The Bancorp’s net income available to common shareholders for the second quarter of 2016 was $310 million, or $0.40 per diluted share, which was net of $23 million in preferred stock dividends. The Bancorp’s net income available to common shareholders for the second quarter of 2015 was $292 million, or $0.36 per diluted share, which was net of $23 million in preferred stock dividends. The Bancorp’s net income available to common shareholders for the six months ended June 30, 2016 was $622 million, or $0.80 per diluted share, which was net of $38 million in preferred stock dividends. For the six months ended June 30, 2015, the Bancorp’s net income available to common shareholders was $638 million, or $0.77 per diluted share, which was net of $38 million in preferred stock dividends. Pre-provision net revenue was $518 million and $1.1 billion for the three and six months ended June 30, 2016, respectively, compared to $496 million and $1.1 billion for the same periods in 2015. Pre-provision net revenue is a non-GAAP measure. For further information, refer to the Non-GAAP Financial Measures section of MD&A.

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

Noninterest income increased $43 million for the three months ended June 30, 2016 compared to the same period in the prior year primarily due to an increase in other noninterest income partially offset by a decrease in mortgage banking net revenue. Noninterest income increased $48 million for the six months ended June 30, 2016 compared to the same period in the prior year primarily due to increases in other noninterest income and corporate banking revenue partially offset by a decrease in mortgage banking net revenue. Other noninterest income increased $79 million and $50 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods included the impact of impairment charges on bank premises and equipment that were recognized during the three and six months ended June 30, 2015. The three and six months ended June 30, 2016 also included the impact of gains on the sale of certain branches as part of the previously announced Branch Consolidation and Sales Plan and the gain on the sale of the agent bankcard loan portfolio partially offset with $50 million of negative valuation adjustments related to the Visa total return swap. Additionally, the increase in other noninterest income for the six months ended June 30, 2016 was partially offset by the impact of a gain on the sale of residential mortgage loans classified as TDRs during the first quarter of 2015.

Mortgage banking net revenue decreased $42 million and $49 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily due to decreases in net mortgage servicing revenue partially offset by increases in origination fees and gains on loan sales. Corporate banking revenue increased $43 million for the six months ended June 30, 2016 compared to the same period in the prior year primarily driven by increases in lease remarketing fees and syndication fees partially offset by decreases in business lending fees and foreign exchange fees.

Noninterest expense increased $36 million and $97 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily due to increases in personnel costs (salaries, wages and incentives plus employee benefits) and other noninterest expense. Personnel costs increased $31 million and $67 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods was driven by increased base compensation, primarily due to personnel additions in risk and compliance and information technology, and increased long term incentive compensation due to retirement eligibility changes. The increase for the six months ended was also driven by higher retirement and severance costs related to the Bancorp’s voluntary early retirement program. Other noninterest expense increased $9 million for the three months ended June 30, 2016 compared to the same period in the prior year primarily due to increases in impairment on affordable housing investments, losses and adjustments and the provision for the reserve for unfunded commitments partially offset by a decrease in loan and lease expense. Other noninterest expense increased $36 million for the six months ended June 30, 2016 compared to the same period in the prior year primarily due to increases in FDIC insurance and other taxes, the provision for the reserve for unfunded commitments, losses and adjustments and impairment on affordable housing investments partially offset by decreases in loan and lease expense and donations expense.

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 $91 million and $210 million for the three and six months ended June 30, 2016, respectively, compared to $79 million and $148 million for the same periods in 2015. Net losses charged-off as a percent of average portfolio loans and leases were 0.37% and 0.39% for both the three and six months ended June 30, 2016 and 2015, respectively. At June 30, 2016, nonperforming portfolio assets as a percent of portfolio loans and leases and OREO increased to 0.86% compared to 0.70% at December 31, 2015. 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 June 30, 2016, as calculated under the Basel III transition provisions, the CET1 capital ratio was 9.94%, the Tier I risk-based capital ratio was 11.03%, the Total risk-based capital ratio was 14.66% and the Tier I leverage ratio was 9.64%.

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 measure of net interest income on an FTE basis and the efficiency ratio to U.S. GAAP:

TABLE 3: Non-GAAP Financial Measures - Net Interest Income on an FTE Basis and Efficiency Ratio



	For the three months ended June 30,					For the six months ended June 30,
($ in millions)	2016			2015		2016		2015

Net interest income (U.S. GAAP)	$	902			887		1,805		1,734
Add: FTE adjustment		6			5		12		10

Net interest income on an FTE basis (1)	$	908			892		1,817		1,744

Noninterest income (2)	$	599			556		1,235		1,187
Noninterest expense (3)		983			947		1,968		1,871

Efficiency ratio (3) / (1) + (2)		65.3	%		65.4		64.5		63.8

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 Measures - Income Before Income Taxes on an FTE Basis



	For the three months ended June 30,				For the six months ended June 30,
($ in millions)	2016		2015		2016		2015

Income before income taxes (U.S. GAAP)	$	427		417		862		902
Add: FTE adjustment		6		5		12		10

Income before income taxes on an FTE basis	$	433		422		874		912

Pre-provision net revenue is net interest income plus noninterest income minus noninterest expense. The Bancorp believes this measure is important because it provides a ready view of the Bancorp’s pre-tax earnings before the impact of provision expense.

The following table reconciles the non-GAAP financial measure of pre-provision net revenue to U.S. GAAP:

TABLE 5: Non-GAAP Financial Measures - Pre-Provision Net Revenue



	For the three months ended June 30,						For the six months ended June 30,
($ in millions)	2016			2015			2016			2015

Net interest income (U.S. GAAP)	$	902			887			1,805			1,734
Add: Noninterest income		599			556			1,235			1,187
Less: Noninterest expense		(983	)		(947	)		(1,968	)		(1,871)

Pre-provision net revenue	$	518			496			1,072			1,050

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

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



	For the three months ended June 30,						For the six months ended June 30,
($ in millions)	2016			2015			2016			2015

Net income available to common shareholders (U.S. GAAP)	$	310			292			622			638
Add: Intangible amortization, net of tax		-			-			1			1

Tangible net income available to common shareholders	$	310			292			623			639
Tangible net income available to common shareholders (annualized) (1)		1,247			1,171			1,246			1,278

Average Bancorp shareholders’ equity (U.S. GAAP)	$	16,584			15,841			16,479			15,831
Less: Average preferred stock		(1,331	)		(1,331	)		(1,331	)		(1,331)
Average goodwill		(2,416	)		(2,416	)		(2,416	)		(2,416)
Average intangible assets and other servicing rights		(11	)		(15	)		(12	)		(15)

Average tangible common equity (2)	$	12,826			12,079			12,720			12,069

Return on average tangible common equity (1) / (2)		9.7	%		9.7			9.8			10.6

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. 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.

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

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

TABLE 7: Non-GAAP Financial Measures - Capital Ratios


As of ($ in millions)	June 30, 2016			December 31, 2015
Total Bancorp Shareholders’ Equity (U.S. GAAP)	$	16,726			15,839
Less: Preferred stock		(1,331	)		(1,331)
Goodwill		(2,416	)		(2,416)
Intangible assets and other servicing rights		(11	)		(13)
Tangible common equity, including unrealized gains / losses		12,968			12,079
Less: AOCI		(889	)		(197)
Tangible common equity, excluding unrealized gains / losses (1)		12,079			11,882
Add: Preferred stock		1,331			1,331
Tangible equity (2)	$	13,410			13,213

Total Assets (U.S. GAAP)	$	143,625			141,048
Less: Goodwill		(2,416	)		(2,416)
Intangible assets and other servicing rights		(11	)		(13)
AOCI, before tax		(1,368	)		(303)
Tangible assets, excluding unrealized gains / losses (3)	$	139,830			138,316

Ratios:
Tangible equity as a percentage of tangible assets (2) / (3)^(d)		9.59	%		9.55
Tangible common equity as a percentage of tangible assets (1) / (3)^(d)		8.64			8.59

Basel III Final Rule - Transition to Fully Phased-In
CET1 capital (transitional)	$	12,112			11,917
Less: Adjustments to CET1 capital from transitional to fully phased-in^(a)		(4	)		(8)
CET1 capital (fully phased-in) (4)		12,108			11,909
Risk-weighted assets (transitional)^(b)		121,824			121,290	^(e)
Add: Adjustments to risk-weighted assets from transitional to fully phased-in^(c)		932			1,178
Risk-weighted assets (fully phased-in) (5)	$	122,756			122,468	^(e)
CET1 capital ratio under Basel III Final Rule (fully phased-in) (4) / (5)		9.86	%		9.72	^(e)

(a)

Primarily relates to disallowed intangible assets (other than goodwill and MSRs, net of associated deferred tax liabilities).

(b)

Under the banking agencies’ risk-based capital guidelines, assets and credit equivalent amounts of derivatives and off-balance sheet exposures are assigned to broad risk categories. The aggregate dollar amount in each risk category is multiplied by the associated risk-weight of the category. The resulting weighted values are added together, along with the measure for market risk, resulting in the Bancorp’s total risk-weighted assets.

(c)

Primarily relates to higher risk weighting for MSRs.

(d)

Excludes unrealized gains and losses.

(e)

Balances not restated for the adoption of the amended guidance of ASU 2015-03 “Simplifying the Presentation of Debt Issuance Costs.” Refer to Note 3 of the Notes to Condensed Consolidated Financial Statements for further information.

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 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, 2015. No material changes were made to the valuation techniques or models during the six months ended June 30, 2016.

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.

Tables 8 and 9 present the components of net interest income, net interest margin and net interest rate spread for the three and six months ended June 30, 2016 and 2015, as well as the relative impact of changes in the balance sheet and changes in interest rates on net interest income. Nonaccrual loans and leases and loans held for sale have been included in the average loan and lease balances. Average outstanding securities balances are based on amortized cost with any unrealized gains or losses on available-for-sale and other securities included in other assets.

Net interest income on an FTE basis was $908 million and $1.8 billion for the three and six months ended June 30, 2016, respectively, an increase of $16 million and $73 million compared to the same periods in the prior year. Net interest income was positively impacted by increases in average taxable securities of $2.7 billion and $4.6 billion for the three and six months ended June 30, 2016, respectively, and increases in average loans and leases of $2.1 billion and $2.2 billion for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. Additionally, net interest income was positively impacted by the decision of the Federal Open Market Committee in December 2015 to raise the target range of the federal funds rate 25 bps. These positive impacts were partially offset by increases in average long-term debt of $1.6 billion and $1.1 billion for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year coupled with decreases in the net interest rate spread to 2.67% and 2.68% during the three and six months ended June 30, 2016, respectively, from 2.72% and 2.70% in the same periods in the prior year. These decreases in the net interest rate spread were due to an 11 bps and 8 bps increase in the rates paid on average interest-bearing liabilities for the three and six months ended June 30, 2016, respectively, partially offset by a 6 bps increase in yields on average interest-earning assets for both the three and six months ended June 30, 2016 compared to the same periods in the prior year.

Net interest margin on an FTE basis was 2.88% and 2.89% for the three and six months ended June 30, 2016, respectively, compared to 2.90% and 2.88% for the three and six months ended June 30, 2015, respectively. The decrease from the three months ended June 30, 2015 was driven primarily by the aforementioned decrease in net interest rate spread coupled with an increase of $3.5 billion in average interest-earning assets partially offset by an increase in average free funding balances for the three months ended June 30, 2016. The increase for the six months ended June 30, 2016 was driven primarily by an increase in average free funding balances compared to the same period in the prior year partially offset by an increase of $4.2 billion in average interest-earning assets as well as the aforementioned decrease in net interest rate spread. The increase in average free funding balances for both periods was driven by an increase in average demand deposits of $528 million and $981 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year as well as an increase in average shareholders’ equity of $735 million and $641 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year.

Interest income on an FTE basis from loans and leases increased $27 million and $55 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The increases were primarily due to increases in average loans and leases of $2.1 billion and $2.2 billion for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year driven primarily by increases in average commercial and industrial loans, average commercial construction loans and average residential mortgage loans partially offset by decreases in average home equity and average automobile loans. Yields on average loans and leases increased 4 bps and 3 bps for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily driven by an increase in yields on average commercial and industrial loans and average commercial construction 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 $17 million and $59 million for the three and six months ended June 30, 2016, 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 $3 million and $1 million for the three and six months ended June 30, 2016, 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 26 bps for both the three and six months ended June 30, 2016 from 24 bps and 25 bps for the three and six months ended June 30, 2015, respectively. 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. 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 $25 million and $40 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The increases for the three and six months ended June 30, 2016 were primarily due to increases of 32 bps and 25 bps, respectively, in the rates paid on average long-term debt coupled with the aforementioned increases 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 six months ended June 30, 2016, average wholesale funding represented 27% and 26%, respectively, of average interest-bearing liabilities compared to 22% during both the three and six months ended June 30, 2015. For more information on the Bancorp’s interest rate risk management, including estimated earnings sensitivity to changes in market interest rates, refer to the Market Risk Management section of MD&A.

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
For the three months ended	June 30, 2016								June 30, 2015								Attribution of Change in Net Interest Income^(a)
($ in millions)	Average Balance			Revenue/ Cost		Average Yield/ Rate			Average Balance			Revenue/ Cost		Average Yield/ Rate			Volume		Yield/Rate		Total
Assets:
Interest-earning assets:
Loans and leases:^(b)
Commercial and industrial loans	$	43,878			354		3.25	%	$	42,554			334		3.14	%	$	9		11		20
Commercial mortgage loans		6,835			55		3.28			7,149			57		3.22			(3)		1		(2	)
Commercial construction loans		3,551			30		3.36			2,549			20		3.17			9		1		10
Commercial leases		3,904			27		2.71			3,776			27		2.83			1		(1)		-
Total commercial loans and leases		58,168			466		3.22			56,028			438		3.13			16		12		28
Residential mortgage loans		14,842			132		3.57			13,375			123		3.69			13		(4)		9
Home equity		8,059			76		3.81			8,655			79		3.66			(6)		3		(3	)
Automobile loans		10,887			73		2.68			11,902			79		2.65			(7)		1		(6	)
Credit card		2,198			57		10.47			2,296			59		10.33			(3)		1		(2	)
Other consumer loans and leases		653			10		6.36			483			9		8.49			4		(3)		1
Total consumer loans and leases		36,639			348		3.82			36,711			349		3.82			1		(2)		(1	)
Total loans and leases	$	94,807			814		3.45	%	$	92,739			787		3.41	%	$	17		10		27
Securities:
Taxable		30,002			235		3.16			27,344			218		3.20			20		(3)		17
Exempt from income taxes^(b)		85			1		4.09			59			1		4.82			-		-		-
Other short-term investments		1,953			2		0.43			3,160			2		0.25			(1)		1		-
Total interest-earning assets	$	126,847			1,052		3.34	%	$	123,302			1,008		3.28	%	$	36		8		44
Cash and due from banks		2,228								2,636
Other assets		15,140								15,322
Allowance for loan and lease losses		(1,295	)							(1,300	)
Total assets	$	142,920							$	139,960
Liabilities and Equity:
Interest-bearing liabilities:
Interest checking deposits	$	24,714			14		0.22	%	$	26,894			12		0.19	%	$	-		2		2
Savings deposits		14,576			2		0.05			15,156			3		0.05			(1)		-		(1	)
Money market deposits		19,243			13		0.26			18,071			10		0.23			2		1		3
Foreign office deposits		484			-		0.15			955			-		0.14			-		-		-
Other time deposits		4,044			12		1.24			4,074			13		1.24			(1)		-		(1	)
Total interest-bearing core deposits		63,061			41		0.26			65,150			38		0.24			-		3		3
Certificates $100,000 and over		2,819			9		1.29			2,558			8		1.24			1		-		1
Other deposits		467			-		0.40			-			-		-			-		-		-
Federal funds purchased		693			1		0.39			326			-		0.12			1		-		1
Other short-term borrowings		3,754			3		0.36			1,705			1		0.12			-		2		2
Long-term debt		15,351			90		2.36			13,741			69		2.04			10		11		21
Total interest-bearing liabilities	$	86,145			144		0.67	%	$	83,480			116		0.56	%	$	12		16		28
Demand deposits		35,912								35,384
Other liabilities		4,247								5,215
Total liabilities	$	126,304							$	124,079
Total equity	$	16,616							$	15,881
Total liabilities and equity	$	142,920							$	139,960
Net interest income (FTE)				$	908							$	892				$	24		(8)		16
Net interest margin (FTE)							2.88	%							2.90	%
Net interest rate spread (FTE)							2.67								2.72
Interest-bearing liabilities to interest-earning assets							67.91								67.70

(a)

Changes in interest not solely due to volume or yield/rate are allocated in proportion to the absolute dollar amount of change in volume and yield/rate.

(b)

The FTE adjustments included in the above table were $6 and $5 for the three months ended June 30, 2016 and 2015, respectively.

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

TABLE 9: Condensed Average Balance Sheets and Analysis of Net Interest Income on an FTE basis


For the six months ended	June 30, 2016								June 30, 2015								Attribution of Change in Net Interest Income^(a)
($ in millions)	Average Balance			Revenue/ Cost		Average Yield/ Rate			Average Balance			Revenue/ Cost		Average Yield/ Rate			Volume		Yield/Rate		Total
Assets:
Interest-earning assets:
Loans and leases:^(b)
Commercial and industrial loans	$	43,503			701		3.24	%	$	42,011			656		3.15	%	$	26		19		45
Commercial mortgage loans		6,871			112		3.28			7,198			116		3.25			(5)		1		(4	)
Commercial construction loans		3,424			57		3.37			2,375			38		3.20			17		2		19
Commercial leases		3,889			53		2.74			3,746			53		2.87			2		(2)		-
Total commercial loans and leases		57,687			923		3.22			55,330			863		3.15			40		20		60
Residential mortgage loans		14,623			262		3.60			13,444			250		3.76			23		(11)		12
Home equity		8,150			154		3.80			8,728			158		3.66			(10)		6		(4	)
Automobile loans		11,086			147		2.66			11,918			158		2.67			(11)		-		(11	)
Credit card		2,238			118		10.56			2,308			118		10.28			(3)		3		-
Other consumer loans and leases		659			21		6.31			474			23		9.61			7		(9)		(2	)
Total consumer loans and leases		36,756			702		3.83			36,872			707		3.86			6		(11)		(5	)
Total loans and leases	$	94,443			1,625		3.46	%	$	92,202			1,570		3.43	%	$	46		9		55
Securities:
Taxable		29,811			467		3.15			25,235			406		3.25			73		(12)		61
Exempt from income taxes^(b)		82			1		4.20			59			1		5.03			-		-		-
Other short-term investments		1,915			4		0.42			4,511			6		0.25			(5)		3		(2	)
Total interest-earning assets	$	126,251			2,097		3.34	%	$	122,007			1,983		3.28	%	$	114		-		114
Cash and due from banks		2,282								2,733
Other assets		15,002								15,366
Allowance for loan and lease losses		(1,284	)							(1,311	)
Total assets	$	142,251							$	138,795
Liabilities and Equity:
Interest-bearing liabilities:
Interest checking deposits	$	25,227			28		0.23	%	$	26,889			26		0.20	%	$	(2)		4		2
Savings deposits		14,589			4		0.05			15,165			5		0.06			-		(1)		(1	)
Money market deposits		18,949			24		0.25			17,784			24		0.28			2		(2)		-
Foreign office deposits		484			-		0.15			908			1		0.17			(1)		-		(1	)
Other time deposits		4,039			25		1.23			4,048			24		1.20			-		1		1
Total interest-bearing core deposits		63,288			81		0.26			64,794			80		0.25			(1)		2		1
Certificates $100,000 and over		2,817			18		1.29			2,620			16		1.20			1		1		2
Other deposits		234			-		0.40			-			-		-			-		-		-
Federal funds purchased		651			1		0.37			249			-		0.11			-		1		1
Other short-term borrowings		3,659			7		0.37			1,654			1		0.11			2		4		6
Long-term debt		15,148			173		2.29			14,076			142		2.04			12		19		31
Total interest-bearing liabilities	$	85,797			280		0.66	%	$	83,393			239		0.58	%	$	14		27		41
Demand deposits		35,557								34,576
Other liabilities		4,386								4,956
Total liabilities	$	125,740							$	122,925
Total equity	$	16,511							$	15,870
Total liabilities and equity	$	142,251							$	138,795
Net interest income (FTE)				$	1,817							$	1,744				$	100		(27)		73
Net interest margin (FTE)							2.89	%							2.88	%
Net interest rate spread (FTE)							2.68								2.70
Interest-bearing liabilities to interest-earning assets							67.96								68.35

(a)

Changes in interest not solely due to volume or yield/rate are allocated in proportion to the absolute dollar amount of change in volume and yield/rate.

(b)

The FTE adjustments included in the above table were $12 and $10 for the six months ended June 30, 2016 and 2015, respectively.

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

Provision for Loan and Lease Losses

The Bancorp provides as an expense an amount for probable loan and lease losses within the loan and lease portfolio that is based on factors previously discussed in the Critical Accounting Policies section of the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2015. 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 $91 million and $210 million for the three and six months ended June 30, 2016, respectively, compared to $79 million and $148 million during the same periods in the prior year. The increase in provision expense for both periods was primarily due to prolonged softness in commodity prices, slow global economic growth and appreciation in the US dollar. The ALLL increased $27 million from December 31, 2015 to $1.3 billion at June 30, 2016. At June 30, 2016, the ALLL as a percent of portfolio loans and leases increased to 1.38% compared to 1.37% at December 31, 2015.

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 and lease portfolio composition, nonperforming assets, net charge-offs and other factors considered by the Bancorp in assessing the credit quality of the loan and lease portfolio and the ALLL.

Noninterest Income

Noninterest income increased $43 million and $48 million for the three and six months ended June 30, 2016 compared to the same periods in the prior year.

The following table presents the components of noninterest income:

TABLE 10: Components of Noninterest Income


		For the three months ended June 30,							For the six months ended June 30,
($ in millions)		2016		2015		% Change			2016		2015		% Change
Service charges on deposits	$		138		139		(1)	$		274		274		-
Corporate banking revenue			117		113		4			219		176		24
Wealth and asset management revenue			101		105		(4)			203		212		(4)
Card and processing revenue			82		77		6			161		148		9
Mortgage banking net revenue			75		117		(36)			154		203		(24)
Other noninterest income			80		1		NM			215		165		30
Securities gains, net			6		4		50			9		9		-
Total noninterest income	$		599		556		8	$		1,235		1,187		4

Service charges on deposits

Service charges on deposits decreased $1 million for the three months ended June 30, 2016 and were flat for the six months ended June 30, 2016 compared to the same periods in the prior year. The decrease for the three months ended June 30, 2016 compared to the same period in the prior year was due to a $3 million decrease in consumer deposit fees driven by a decrease in consumer checking fees partially offset by a $2 million increase in commercial deposit fees driven by new customer acquisition.

Corporate banking revenue

Corporate banking revenue increased $4 million and $43 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The increase for the three months ended June 30, 2016 compared to the same period in the prior year was primarily driven by an increase in syndication fees partially offset by decreases in lease remarketing fees, business lending fees and institutional sales revenue. The increase for the six months ended June 30, 2016 compared to the same period in the prior year was primarily driven by increases in lease remarketing fees and syndication fees partially offset by decreases in business lending fees and foreign exchange fees. The increase in lease remarketing fees for the six months ended June 30, 2016 compared to the same period in the prior year included the impact of $34 million of impairment charges related to operating lease equipment that was recognized during the six months ended June 30, 2015. The increases in syndication fees for both periods were the result of increased activity in the market.

Wealth and asset management revenue

Wealth and asset management revenue (formerly investment advisory revenue) decreased $4 million and $9 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The decrease for both the three and six months ended June 30, 2016 compared to the same periods in the prior year was primarily due to decreases of $5 million and $9 million, respectively, in transactional securities and brokerage fees driven by lower sales and trading volume. The decrease for the three months ended June 30, 2016 compared to the same period in the prior year was partially offset by a $2 million increase in private client service fees and institutional fees compared to the same period in the prior year. The Bancorp had approximately $305 billion and $304 billion in total assets under care at June 30, 2016 and 2015, respectively, and managed $26 billion and $27 billion in assets for individuals, corporations and not-for-profit organizations at June 30, 2016 and 2015, respectively.

Card and processing revenue

Card and processing revenue increased $5 million and $13 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily driven by an increase in the number of actively used cards and customer spend volume.

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

Mortgage banking net revenue

Mortgage banking net revenue decreased $42 million and $49 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year.

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

TABLE 11: Components of Mortgage Banking Net Revenue



		For the three months ended June 30,					For the six months ended June 30,
($ in millions)		2016			2015		2016			2015

Origination fees and gains on loan sales	$		54			43		95			87
Net mortgage servicing revenue:
Gross mortgage servicing fees			50			56		102			115
MSR amortization			(35	)		(39)		(61	)		(73)
Net valuation adjustments on MSRs and free-standing derivatives used to economically hedge MSRs			6			57		18			74

Net mortgage servicing revenue			21			74		59			116

Mortgage banking net revenue	$		75			117		154			203

Origination fees and gains on loan sales increased $11 million and $8 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year driven by an increase in saleable residential mortgage loan originations. Residential mortgage loan originations increased to $2.7 billion and $4.5 billion during the three and six months ended June 30, 2016, respectively, compared to $2.5 billion and $4.3 billion during the same periods in the prior year.

Net mortgage servicing revenue is comprised of gross mortgage servicing fees and related MSR amortization as well as valuation adjustments on MSRs and mark-to-market adjustments on both settled and outstanding free-standing derivative financial instruments used to economically hedge the MSR portfolio. Net mortgage servicing revenue decreased $53 million and $57 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The decreases for the three and six months ended June 30, 2016 compared to the same periods in the prior year were driven by decreases of $51 million and $56 million in net valuation adjustments, respectively, as well as decreases of $6 million and $13 million in gross mortgage servicing fees, respectively. These decreases were partially offset by decreases in MSR amortization of $4 million and $12 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year.

The following table presents the components of net valuation adjustments on the MSR portfolio and the impact of the non-qualifying hedging strategy:

TABLE 12: Components of Net Valuation Adjustments on MSRs



		For the three months ended June 30,					For the six months ended June 30,
($ in millions)		2016			2015		2016			2015

Changes in fair value and settlement of free-standing derivatives purchased to economically hedge the MSR portfolio	$		51			(30)		149			35
(Provision for) recovery of MSR impairment			(45	)		87		(131	)		39

Net valuation adjustments on MSR and free-standing derivatives entered into to economically hedge MSRs	$		6			57		18			74

Mortgage rates decreased during both the three and six months ended June 30, 2016 which caused modeled prepayment speeds to increase and led to temporary impairment on servicing rights during both periods. Mortgage rates increased during both the three and six months ended June 30, 2015 which caused modeled prepayment speeds to slow and led to the recovery of temporary impairment on servicing rights during the period.

Servicing rights are deemed impaired when a borrower’s loan rate is distinctly higher than prevailing rates. Impairment on servicing rights is reversed when the prevailing rates return to a level commensurate with the borrower’s loan rate. 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 on 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.

The Bancorp’s total residential loans serviced at June 30, 2016 and 2015 were $71.3 billion and $75.4 billion, respectively, with $56.2 billion and $61.7 billion, respectively, of residential mortgage loans serviced for others.

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

Other noninterest income

The following table presents the components of other noninterest income:

TABLE 13: Components of Other Noninterest Income


		For the three months ended June 30,					For the six months ended June 30,
($ in millions)		2016			2015		2016			2015
Valuation adjustments on the warrant associated with Vantiv Holding, LLC	$		19			14		66			85
Operating lease income			25			22		49			44
Equity method income from interest in Vantiv Holding, LLC			18			16		31			26
BOLI income			14			12		27			24
Cardholder fees			10			11		21			22
Gain on sale of branches			11			-		19			-
Consumer loan and lease fees			6			6		11			12
Banking center income			5			6		10			11
Private equity investment income			6			5		10			9
Net gains on loan sales			10			-		8			41
Insurance income			3			4		6			8
Net gains (losses) on disposition and impairment of bank premises and equipment			2			(98)		2			(101)
Loss on swap associated with the sale of Visa, Inc. class B shares			(50	)		(2)		(50	)		(19)
Other, net			1			5		5			3
Total other noninterest income	$		80			1		215			165

Other noninterest income increased $79 million and $50 million during the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods included the impact of impairment charges, included in net losses on disposition and impairment of bank premises and equipment, of $98 million and $102 million which were recognized during the three and six months ended June 30, 2015, respectively. Gain on sale of branches of $11 million and $19 million were recognized for the three and six months ended June 30, 2016, respectively. The three and six months ended June 30, 2016 included the impact of an $11 million gain on the sale of the Bancorp’s retail operations, including retail accounts, certain private banking deposits and related loan relationships in the Pittsburgh MSA to First National Bank of Pennsylvania as part of the previously announced Branch Consolidation and Sales Plan. The six months ended June 30, 2016 also included the impact of an $8 million gain on the sale of the Bancorp’s retail operations, including retail accounts, certain private banking deposits and related loan relationships in the St. Louis MSA to Great Southern Bank during the first quarter 2016 as part of the previously announced Branch Consolidation and Sales Plan.

The Bancorp recognized a positive valuation adjustment on the stock warrant associated with Vantiv Holding, LLC of $19 million and $14 million for the three months ended June 30, 2016 and 2015, respectively. The six months ended June 30, 2016 and 2015 included positive valuation adjustments on the stock warrant associated with Vantiv Holding, LLC of $66 million and $85 million, respectively. The fair value of the stock warrant is calculated using the Black-Scholes option-pricing model, which utilizes several key inputs (Vantiv, Inc. stock price, strike price of the warrant and several unobservable inputs). The positive valuation adjustments for the three months ended June 30, 2016 and 2015 were primarily due to increases of 5% and 1%, respectively, in Vantiv, Inc.’s share price from March 31, 2016 to June 30, 2016 and from March 31, 2015 to June 30, 2015. The positive valuation adjustments for the six months ended June 30, 2016 and 2015 were primarily due to increases of 19% and 13%, respectively, in Vantiv, Inc.’s share price from December 31, 2015 to June 30, 2016 and from December 31, 2014 to June 30, 2015. The changes in the valuation adjustments for the three and six months ended June 30, 2016 compared to the same periods in the prior year included the impact of the sale and exercise of a portion of the warrant during the fourth quarter of 2015. For additional information on the valuation of the warrant, refer to Note 20 of the Notes to Condensed Consolidated Financial Statements.

Net gains on loan sales increased $10 million for the three months ended June 30, 2016 compared to the same period in the prior year primarily due to an $11 million gain on the sale of the agent bankcard loan portfolio during the second quarter of 2016. Gain on loan sales decreased $33 million for the six months ended June 30, 2016 compared to the same period in the prior year as the prior period included the impact of a $37 million gain on the sale of residential mortgage loans classified as TDRs during the first quarter of 2015 compared with the aforementioned gain on the sale of agent bankcard loan portfolio.

During the three months ended June 30, 2016, the Bancorp recognized a $50 million negative valuation adjustment related to the Visa total return swap. This adjustment was primarily attributable to the decision of the United States Court of Appeals for the Second Circuit to vacate and reverse the district court’s approval of the settlement of an interchange antitrust class action litigation matter on June 30, 2016. For additional information on the valuation of the swap associated with the sale of Visa, Inc. Class B shares and the related litigation matters, refer to Note 15, Note 16 and Note 20 of the Notes to Condensed Consolidated Financial Statements.

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

Noninterest Expense

The following table presents the components of noninterest expense:

TABLE 14: Components of Noninterest Expense


		For the three months ended June 30,								For the six months ended June 30,
($ in millions)		2016			2015		% Change			2016			2015		% Change
Salaries, wages and incentives	$		407			383		6	$		810			752		8
Employee benefits			85			78		9			185			176		5
Net occupancy expense			75			83		(10)			152			162		(6)
Technology and communications			60			54		11			116			109		6
Card and processing expense			37			38		(3)			72			74		(3)
Equipment expense			30			31		(3)			60			61		(2)
Other noninterest expense			289			280		3			573			537		7
Total noninterest expense	$		983			947		4	$		1,968			1,871		5
Efficiency ratio on an FTE basis			65.3	%		65.4					64.5	%		63.8

Personnel costs increased $31 million and $67 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods was driven by increased base compensation, primarily due to personnel additions in risk and compliance and information technology, and increased long term incentive compensation due to retirement eligibility changes. The increase for the six months ended June 30, 2016 was also driven by higher retirement and severance costs related to the Bancorp’s voluntary early retirement program. Full-time equivalent employees totaled 18,051 at June 30, 2016 compared to 18,527 at June 30, 2015.

The following table presents the components of other noninterest expense:

TABLE 15: Components of Other Noninterest Expense



		For the three months ended June 30,				For the six months ended June 30,
($ in millions)		2016		2015		2016		2015

Impairment on affordable housing investments	$		43		38		85		75
FDIC insurance and other taxes			28		28		62		44
Loan and lease			28		33		51		60
Marketing			26		27		51		54
Operating lease			21		18		41		36
Losses and adjustments			20		15		43		29
Professional service fees			15		15		30		27
Data processing			12		11		24		22
Postal and courier			12		11		23		23
Travel			11		14		23		27
Recruitment and education			9		7		18		14
Provision for (benefit from) the reserve for unfunded commitments			7		2		13		(3)
Insurance			4		4		8		9
Supplies			4		4		7		8
Donations			3		3		6		11
Other, net			46		50		88		101

Total other noninterest expense	$		289		280		573		537

Other noninterest expense increased $9 million for the three months ended June 30, 2016 compared to the same period in the prior year primarily due to increases in impairment on affordable housing investments, losses and adjustments and the provision for the reserve for unfunded commitments partially offset by a decrease in loan and lease expense. Impairment on affordable housing investments increased $5 million for the three months ended June 30, 2016 compared to the same period in the prior year primarily due to incremental losses resulting from previous growth in the portfolio. Losses and adjustments increased $5 million for the three months ended June 30, 2016 compared to the three months ended June 30, 2015 primarily due to the impact of a favorable legal settlement in the second quarter of 2015. The provision for the reserve for unfunded commitments increased $5 million for the three months ended June 30, 2016 compared to the same period in the prior year primarily due to an increase in estimated loss rates related to unfunded commitments. These increases were partially offset by a decrease in loan and lease expense of $5 million for the three months ended June 30, 2016 compared to the same period in the prior year.

Other noninterest expense increased $36 million for the six months ended June 30, 2016 compared to the same period in the prior year primarily due to increases in FDIC insurance and other taxes, the provision for the reserve for unfunded commitments, losses and adjustments and impairment on affordable housing investments partially offset by decreases in loan and lease expense and donations expense. FDIC insurance and other taxes increased $18 million for the six months ended June 30, 2016 compared to the same period in the prior year primarily due to an increase in the FDIC insurance assessment base and a favorable settlement of a tax liability related to prior years during the first quarter of 2015.

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

The provision for the reserve for unfunded commitments was $13 million for the six months ended June 30, 2016 compared to a benefit of $3 million for the same period in the prior year primarily due to an increase in estimated loss rates related to unfunded commitments. Losses and adjustments increased $14 million for the six months ended June 30, 2016 compared to the same period in the prior year primarily due to the impact of favorable legal settlements in the first and second quarters of 2015. Impairment on affordable housing investments increased $10 million for the six months ended June 30, 2016 compared to the same period in the prior year primarily due to incremental losses resulting from previous growth in the portfolio. The decrease in loan and lease expense of $9 million for the six months ended June 30, 2016 compared to the same period in the prior year included lower loan closing and appraisal costs driven by a decline in automobile loan originations. Donations expense decreased $5 million for the six months ended June 30, 2016 compared to the same period in the prior year primarily due to a $4 million contribution to the Fifth Third Foundation in the first quarter of 2015.

The Bancorp continues to focus on efficiency initiatives as part of its core emphasis on operating leverage and expense control. The efficiency ratio (noninterest expense divided by the sum of net interest income (FTE) and noninterest income) was 65.3% and 64.5% for the three and six months ended June 30, 2016, respectively, compared to 65.4% and 63.8% for the three and six months ended June 30, 2015, respectively.

Applicable Income Taxes

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

TABLE 16: Applicable Income Taxes



		For the three months ended June 30,					For the six months ended June 30,
($ in millions)		2016			2015		2016		2015

Income before income taxes	$		427			417		862		902
Applicable income tax expense			98			108		206		232
Effective tax rate			22.8	%		26.1		23.9		25.8

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 rates for the three and six months ended June 30, 2016 compared to the same periods in the prior year was primarily the result of an $8 million tax benefit related to a change in the estimated deductibility of a prior expense. This benefit was partially offset by a non-cash charge for the write-off of a deferred tax asset related to stock-based awards as described below.

As required under U.S. GAAP, the Bancorp established a deferred tax asset for stock-based awards granted to its employees and directors. When the actual tax deduction for these stock-based awards is less than the expense previously recognized for financial reporting and where the Bancorp has not accumulated an excess tax benefit for previously exercised or released stock-based awards, the Bancorp is required to recognize a non-cash charge to income tax expense upon the write-off of the deferred tax asset previously established for these stock-based awards. As the Bancorp exhausted its accumulated excess tax benefits during the second quarter of 2016, the Bancorp recognized a non-cash charge to income tax expense related to stock-based awards of $2 million for both the three and six months ended June 30, 2016.

Based on the Bancorp’s stock price at June 30, 2016, the Bancorp believes it will recognize a $10 million non-cash charge to income tax expense over the next twelve months related to stock-based awards, primarily in the second quarter of 2017. However, the Bancorp cannot predict its stock price or whether its employees will exercise other stock-based awards with lower exercise prices in the future. Therefore, it is possible the Bancorp may recognize a non-cash charge to income tax expense greater than or less than $10 million over the next twelve months.

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

BALANCE SHEET ANALYSIS

Loans and Leases

The Bancorp classifies its commercial loans and leases based upon primary purpose and consumer loans and leases based upon product or collateral. Table 17 summarizes end of period loans and leases, including loans held for sale and Table 18 summarizes average total loans and leases, including loans held for sale.

TABLE 17: Components of Loans and Leases (including held for sale)


		June 30, 2016				December 31, 2015
As of ($ in millions)		Carrying Value		% of Total		Carrying Value		% of Total
Commercial loans and leases:
Commercial and industrial loans	$		43,575		46	$	42,151		46
Commercial mortgage loans			6,883		7		6,991		7
Commercial construction loans			3,706		4		3,214		3
Commercial leases			3,978		4		3,854		4
Total commercial loans and leases			58,142		61		56,210		60
Consumer loans and leases:
Residential mortgage loans			15,159		16		14,424		15
Home equity			7,988		9		8,336		9
Automobile loans			10,671		11		11,497		12
Credit card			2,172		2		2,360		3
Other consumer loans and leases			654		1		658		1
Total consumer loans and leases			36,644		39		37,275		40
Total loans and leases	$		94,786		100	$	93,485		100
Total portfolio loans and leases (excluding loans held for sale)	$		93,909			$	92,582

Loans and leases, including loans held for sale, increased $1.3 billion, or 1%, from December 31, 2015. The increase from December 31, 2015 was the result of a $1.9 billion, or 3%, increase in commercial loans and leases, partially offset by a $631 million, or 2%, decrease in consumer loans and leases.

Commercial loans and leases increased from December 31, 2015 primarily due to increases in commercial and industrial loans and commercial construction loans partially offset by a decrease in commercial mortgage loans. Commercial and industrial loans increased $1.4 billion, or 3%, from December 31, 2015 primarily as a result of increases in new loan origination activity and line utilization. Commercial construction loans increased $492 million, or 15%, from December 31, 2015 primarily as a result of an increase in new loan origination activity resulting from an increase in demand and targeted marketing efforts. Commercial mortgage loans decreased $108 million, or 2%, from December 31, 2015 primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns.

Consumer loans and leases decreased from December 31, 2015 primarily due to decreases in automobile loans, home equity and credit card, partially offset by an increase in residential mortgage loans. Automobile loans decreased $826 million, or 7%, from December 31, 2015 and home equity decreased $348 million, or 4%, from December 31, 2015 as payoffs exceeded new loan production. Credit card decreased $188 million, or 8%, from December 31, 2015 primarily due to the sale of the agent bankcard loan portfolio during the second quarter of 2016 and seasonal trends from the paydown of year-end balances which were higher due to holiday spending. Residential mortgage loans increased $735 million, or 5%, from December 31, 2015 primarily due to the continued retention of certain conforming ARMs and certain other fixed-rate loans originated during the six months ended June 30, 2016.

TABLE 18: Components of Average Loans and Leases (including held for sale)


		June 30, 2016				June 30, 2015
For the three months ended ($ in millions)		Carrying Value		% of Total		Carrying Value		% of Total
Commercial loans and leases:
Commercial and industrial loans	$		43,878		46	$	42,554		46
Commercial mortgage loans			6,835		7		7,149		7
Commercial construction loans			3,551		4		2,549		3
Commercial leases			3,904		4		3,776		4
Total commercial loans and leases			58,168		61		56,028		60
Consumer loans and leases:
Residential mortgage loans			14,842		16		13,375		14
Home equity			8,059		9		8,655		9
Automobile loans			10,887		11		11,902		13
Credit card			2,198		2		2,296		3
Other consumer loans and leases			653		1		483		1
Total consumer loans and leases			36,639		39		36,711		40
Total average loans and leases	$		94,807		100	$	92,739		100
Total average portfolio loans and leases (excluding loans held for sale)	$		93,931			$	92,173

Average loans and leases, including loans held for sale, increased $2.1 billion, or 2%, from June 30, 2015 as the result of a $2.1 billion, or 4%, increase in average commercial loans, partially offset by a $72 million decrease in average consumer loans and leases.

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

Average commercial loans and leases increased from June 30, 2015 primarily due to increases in average commercial and industrial loans and average commercial construction loans partially offset by a decrease in average commercial mortgage loans. Average commercial and industrial loans increased $1.3 billion, or 3%, from June 30, 2015 primarily as a result of increases in new loan origination activity. Average commercial construction loans increased $1.0 billion, or 39%, from June 30, 2015 primarily as a result of an increase in new loan origination activity resulting from an increase in demand and targeted marketing efforts. Average commercial mortgage loans decreased $314 million, or 4%, from June 30, 2015 primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns.

Average consumer loans and leases decreased from June 30, 2015 primarily due to decreases in average automobile and average home equity, partially offset by increases in average residential mortgage loans and average other consumer loans and leases. Average automobile loans decreased $1.0 billion, or 9%, from June 30, 2015 and average home equity decreased $596 million, or 7%, from June 30, 2015 as payoffs exceeded new loan production. Average residential mortgage loans increased $1.5 billion, or 11%, from June 30, 2015 primarily driven by the continued retention of certain conforming ARMs and certain other fixed-rate loans. Average other consumer loans and leases increased $170 million, or 35%, from June 30, 2015 primarily as a result of an increase in new loan origination activity.

Investment Securities

The Bancorp uses investment securities as a means of managing interest rate risk, providing liquidity support and providing collateral for pledging purposes. Total investment securities were $31.9 billion and $29.5 billion at June 30, 2016 and December 31, 2015, respectively. The taxable investment securities portfolio had an effective duration of 4.2 years at June 30, 2016 compared to 5.1 years at December 31, 2015.

Securities are classified as trading when bought and held principally for the purpose of selling them in the near term. 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. At June 30, 2016, the Bancorp’s investment portfolio consisted primarily of AAA-rated available-for-sale securities. Securities classified as below investment grade were immaterial at both June 30, 2016 and December 31, 2015. The Bancorp’s management has evaluated the securities in an unrealized loss position in the available-for-sale and held-to-maturity portfolios for OTTI.

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

TABLE 19: OTTI Summary by Security Type


		For the three months ended June 30,						For the six months ended June 30,
($ in millions)		2016			2015			2016	2015
Available-for-sale and other debt securities	$		(3	)		(4	)	(4)		(5)
Available-for-sale equity securities			-			-		(1)		-
Total OTTI^(a)	$		(3	)		(4	)	(5)		(5)

(a)

Included in securities gains, net, in the Condensed Consolidated Statements of Income.

TABLE 20: Components of Investment Securities


As of ($ in millions)	June 30, 2016		December 31, 2015
Available-for-sale and other securities: (amortized cost basis)
U.S. Treasury and federal agencies securities	$	1,133		1,155
Obligations of states and political subdivisions securities		49		50
Mortgage-backed securities:
Agency residential mortgage-backed securities^(a)		15,082		14,811
Agency commercial mortgage-backed securities		8,389		7,795
Non-agency commercial mortgage-backed securities		2,911		2,801
Asset-backed securities and other debt securities		1,839		1,363
Equity securities^(b)		698		703
Total available-for-sale and other securities	$	30,101		28,678
Held-to-maturity securities: (amortized cost basis)
Obligations of states and political subdivisions securities	$	60		68
Asset-backed securities and other debt securities		2		2
Total held-to-maturity securities	$	62		70
Trading securities: (fair value)
U.S. Treasury and federal agencies securities	$	16		19
Obligations of states and political subdivisions securities		96		9
Agency residential mortgage-backed securities		8		6
Asset-backed securities and other debt securities		17		19
Equity securities		264		333
Total trading securities	$	401		386

(a)

Includes interest-only mortgage-backed securities of $36 and $50 as of June 30, 2016 and December 31, 2015, respectively, recorded at fair value with fair value changes recorded in securities gains, net in the Condensed Consolidated Statements of Income.

(b)

Equity securities consist of FHLB, FRB and DTCC restricted stock holdings that are carried at par, FHLMC and FNMA preferred stock holdings and certain mutual fund and equity security holdings.

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

On an amortized cost basis, available-for-sale and other securities increased $1.4 billion, or 5%, from December 31, 2015 primarily due to increases in agency residential mortgage-backed securities, agency commercial mortgage-backed securities, non-agency commercial mortgage-backed securities and asset-backed securities and other debt securities.

On an amortized cost basis, available-for-sale and other securities were 24% and 23% of total interest-earning assets at June 30, 2016 and December 31, 2015, respectively. The estimated weighted-average life of the debt securities in the available-for-sale and other portfolio was 5.7 years at June 30, 2016 compared to 6.4 years at December 31, 2015. In addition, at June 30, 2016, the available-for-sale and other securities portfolio had a weighted-average yield of 3.25%, compared to 3.19% at December 31, 2015.

Information presented in Table 21 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 and other portfolio exclude equity securities that have no stated yield or maturity. Total net unrealized gains on the available-for-sale and other securities portfolio were $1.4 billion at June 30, 2016 compared to $366 million at December 31, 2015. The increase from December 31, 2015 was primarily due to a decrease in interest rates during the six months ended June 30, 2016. 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 increases when interest rates decrease or when credit spreads contract.

TABLE 21: Characteristics of Available-for-Sale and Other Securities


As of June 30, 2016 ($ in millions)	Amortized Cost		Fair Value		Weighted-Average Life (in years)		Weighted-Average Yield
U.S. Treasury and federal agencies securities:
Average life of 1 year or less	$	1,057		1,076		0.5		3.92 %
Average life 1 – 5 years		76		79		4.6		1.82
Total	$	1,133		1,155		0.8		3.77 %
Obligations of states and political subdivisions securities:^(a)
Average life of 1 year or less		15		15		0.3		0.11
Average life 5 – 10 years		34		37		6.8		3.93
Total	$	49		52		4.8		2.79 %
Agency residential mortgage-backed securities:
Average life of 1 year or less		46		47		0.9		4.50
Average life 1 – 5 years		9,767		10,118		3.9		3.38
Average life 5 – 10 years		4,983		5,227		6.0		3.38
Average life greater than 10 years		286		302		11.9		3.01
Total	$	15,082		15,694		4.7		3.38 %
Agency commercial mortgage-backed securities:
Average life 1 – 5 years		1,507		1,601		3.6		3.06
Average life 5 – 10 years		6,578		7,010		7.9		3.02
Average life greater than 10 years		304		315		11.6		3.04
Total	$	8,389		8,926		7.3		3.03 %
Non-agency commercial mortgage-backed securities:
Average life of 1 year or less		93		94		0.6		4.51
Average life 1 – 5 years		343		357		2.9		3.54
Average life 5 – 10 years		2,475		2,628		7.9		3.30
Total	$	2,911		3,079		7.1		3.36 %
Asset-backed securities and other debt securities:
Average life of 1 year or less		136		139		0.3		2.71
Average life 1 – 5 years		704		714		3.0		3.19
Average life 5 – 10 years		355		350		6.8		2.28
Average life greater than 10 years		644		646		13.5		2.22
Total	$	1,839		1,849		7.2		2.64 %
Equity securities		698		700
Total available-for-sale and other securities	$	30,101		31,455		5.7		3.25 %

(a)

Taxable-equivalent yield adjustments included in the above table are 0.00%, 2.14% and 1.49% for securities with an average life of 1 year or less, 5-10 years and in total, respectively.

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

Deposits

The Bancorp’s deposit balances represent an important source of funding and revenue growth opportunity. The Bancorp continues to focus on core deposit growth in its retail and commercial franchises by improving customer satisfaction, building full relationships and offering competitive rates. Core deposits represented 69% and 71% of the Bancorp’s asset funding base at June 30, 2016 and December 31, 2015, respectively.

TABLE 22: Components of Deposits


		June 30, 2016				December 31, 2015
As of ($ in millions)		Balance		% of Total		Balance		% of Total
Demand	$		36,137		35	$	36,267		35
Interest checking			24,571		25		26,768		26
Savings			14,356		14		14,601		14
Money market			19,125		19		18,494		18
Foreign office			453		-		464		-
Transaction deposits			94,642		93		96,594		93
Other time			4,021		4		4,019		4
Core deposits			98,663		97		100,613		97
Certificates $100,000 and over^(a)			2,778		3		2,592		3
Other			430		-		-		-
Total deposits	$		101,871		100	$	103,205		100

(a)

Includes $1,308 and $1,449 of certificates $250,000 and over at June 30, 2016 and December 31, 2015, respectively.

Core deposits decreased $2.0 billion, or 2%, from December 31, 2015 driven primarily by a decrease of $2.0 billion, or 2%, in transaction deposits. The decrease from December 31, 2015 included the sale of $511 million of deposits as part of the branches sold in the St. Louis MSA and Pittsburgh MSA during 2016. Transaction deposits decreased from December 31, 2015 primarily due to decreases in interest checking deposits and savings deposits, partially offset by an increase in money market deposits. Interest checking deposits decreased $2.2 billion, or 8%, from December 31, 2015 driven primarily by lower balances per account for commercial customers. Money market deposits increased $631 million, or 3%, from December 31, 2015 driven primarily by a promotional product offering during the first half of 2016 which drove balance migration from savings deposits which decreased $245 million, or 2%, compared to December 31, 2015. Money market deposits also increased due to higher balances for existing customers. The Bancorp uses other deposits and certificates $100,000 and over as a method to fund earning assets. Other deposits increased $430 million from December 31, 2015 primarily due to an increase in Eurodollar trade deposits. Certificates $100,000 and over increased $186 million, or 7%, from December 31, 2015 primarily due to the issuance of institutional certificates of deposit during the first quarter of 2016.

The following table presents the components of average deposits for the three months ended:

TABLE 23: Components of Average Deposits


		June 30, 2016				June 30, 2015
($ in millions)		Balance		% of Total		Balance		% of Total
Demand	$		35,912		35	$	35,384		34
Interest checking			24,714		24		26,894		26
Savings			14,576		14		15,156		15
Money market			19,243		19		18,071		18
Foreign office			484		1		955		1
Transaction deposits			94,929		93		96,460		94
Other time			4,044		4		4,074		4
Core deposits			98,973		97		100,534		98
Certificates $100,000 and over^(a)			2,819		3		2,558		2
Other			467		-		-		-
Total average deposits	$		102,259		100	$	103,092		100

(a)

Includes $1,302 and $1,423 of average certificates $250,000 and over for the three months ended June 30, 2016 and 2015, respectively.

On an average basis, core deposits decreased $1.6 billion, or 2%, from June 30, 2015 primarily due to a decrease of $1.5 billion, or 2%, in average transaction deposits. The decrease in average transaction deposits was driven by decreases in average interest checking deposits, average savings deposits and average foreign office deposits, partially offset by increases in average money market deposits and average demand deposits. Average interest checking deposits decreased $2.2 billion, or 8%, from June 30, 2015 primarily due to a decrease in average commercial customer balances per account. Average foreign office deposits decreased $471 million, or 49%, primarily due to lower average balances per commercial customer account. Average money market deposits and average demand deposits increased $1.2 billion, or 6%, and $528 million, or 1%, respectively, due to the acquisition of new commercial customers and higher average customer balances per commercial customer account. Average money market deposits also increased due to a promotional product offering which drove balance migration from savings deposits which decreased $580 million, or 4%, compared to June 30, 2015. Average other deposits increased $467 million from June 30, 2015 primarily due to an increase in Eurodollar trade deposits. Average certificates $100,000 and over increased $261 million, or 10%, from June 30, 2015 primarily due to the previously mentioned issuance of institutional certificates of deposit during the first quarter of 2016.

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

Contractual maturities

The contractual maturities of certificates $100,000 and over as of June 30, 2016 are summarized in the following table:

TABLE 24: Contractual Maturities of Certificates $100,000 and Over



($ in millions)

Next 3 months	$	525
3-6 months		122
6-12 months		254
After 12 months		1,877
Total certificates $100,000 and over	$	2,778

The contractual maturities of other time deposits and certificates $100,000 and over as of June 30, 2016 are summarized in the following table:

TABLE 25: Contractual Maturities of Other Time Deposits and Certificates $100,000 and Over



($ in millions)

Next 12 months	$	2,290
13-24 months		1,949
25-36 months		459
37-48 months		1,607
49-60 months		473
After 60 months		21
Total other time deposits and certificates $100,000 and over	$	6,799

Borrowings

The Bancorp accesses a variety of other short-term and long-term funding sources. Borrowings with original maturities of one year or less are classified as short-term and include federal funds purchased and other short-term borrowings. Table 26 summarizes the end of period components of total borrowings. As of June 30, 2016, total borrowings as a percent of interest-bearing liabilities were 24% compared to 21% at December 31, 2015.

TABLE 26: Components of Borrowings


As of ($ in millions)	June 30, 2016		December 31, 2015
Federal funds purchased	$	108		151
Other short-term borrowings		3,979		1,507
Long-term debt		16,231		15,810
Total borrowings	$	20,318		17,468

Total borrowings increased $2.9 billion, or 16%, from December 31, 2015 primarily due to increases in other short-term borrowings and long-term debt. Other short-term borrowings increased $2.5 billion from December 31, 2015 primarily driven by an increase of $2.5 billion in FHLB short-term borrowings. The level of other short-term borrowings can fluctuate significantly from period to period depending on funding needs and which sources are used to satisfy those needs. For further information on the components of other short-term borrowings, refer to Note 12 of the Notes to Condensed Consolidated Financial Statements. Long-term debt increased $421 million, or 3%, from December 31, 2015 primarily driven by issuances during the six months ended June 30, 2016 of $2.0 billion of unsecured senior fixed-rate bank notes and $750 million of unsecured subordinated fixed-rate bank notes, partially offset by the maturity of $1.7 billion of unsecured senior bank notes and $744 million of paydowns on long-term debt associated with automobile loan securitizations. For additional information regarding automobile securitizations and long-term debt, refer to Note 9 and Note 13, respectively, of the Notes to Condensed Consolidated Financial Statements.

The following table presents average borrowings for the three months ended:

TABLE 27: Components of Average Borrowings


($ in millions)	June 30, 2016		June 30, 2015
Federal funds purchased	$	693		326
Other short-term borrowings		3,754		1,705
Long-term debt		15,351		13,741
Total average borrowings	$	19,798		15,772

Total average borrowings increased $4.0 billion, or 26%, compared to June 30, 2015, due to increases in average other short-term borrowings, average long-term debt and average federal funds purchased. The increase in average short-term borrowings of $2.0 billion was driven by the increase in FHLB short-term borrowings discussed above. The increase in average long-term debt of $1.6 billion was primarily driven by the issuances in the third quarter of 2015 of $1.3 billion of unsecured senior bank notes and $1.1 billion of unsecured senior notes. The impact also included the aforementioned issuances of unsecured senior and subordinated bank notes, partially offset by the maturity of unsecured bank notes and paydowns on long-term debt associated with automobile loan securitizations. Average federal funds purchased increased $367 million compared to June 30, 2015. The level of average federal funds purchased can fluctuate significantly from period to period depending on funding needs and which sources are used to satisfy those needs. Information on the average rates paid on borrowings is discussed in the Net Interest Income subsection of the Statements of Income Analysis section of MD&A. In addition, refer to the Liquidity Risk Management subsection of the Risk Management section of MD&A for a discussion on the role of borrowings in the Bancorp’s liquidity management.

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

BUSINESS SEGMENT REVIEW

The Bancorp reports on four business segments: Commercial Banking, Branch Banking, Consumer Lending and Wealth and Asset Management (formerly Investment Advisors). Additional information on each business segment is included in Note 21 of the Notes to Condensed Consolidated Financial Statements. Results of the Bancorp’s business segments are presented based on its management structure and management accounting practices. The structure and accounting practices are specific to the Bancorp; therefore, the financial results of the Bancorp’s business segments are not necessarily comparable with similar information for other financial institutions. The Bancorp refines its methodologies from time to time as management’s accounting practices or businesses change. In the second quarter of 2016, the Investment Advisors segment name was changed to Wealth and Asset Management to better reflect the services provided by the business segment.

The Bancorp manages interest rate risk centrally at the corporate level and employs an FTP methodology at the business segment level. This methodology insulates the business segments from interest rate volatility, enabling them to focus on serving customers through loan and deposit products. The FTP system assigns charge rates and credit rates to classes of assets and liabilities, respectively, based on expected duration and the U.S. swap curve. Matching duration allocates interest income and interest expense to each business segment so its resulting net interest income is insulated from interest rate risk. In a rising rate environment, the Bancorp benefits from the widening spread between deposit costs and wholesale funding costs. However, the Bancorp’s FTP system credits this benefit to deposit-providing businesses, such as Branch Banking and Wealth and Asset Management, on a duration-adjusted basis. The net impact of the FTP methodology is captured in General Corporate and Other.

The Bancorp adjusts the FTP charge and credit rates as dictated by changes in interest rates for various interest-earning assets and interest-bearing liabilities and by the review of the estimated durations for the indeterminate-lived deposits. The credit rate provided for demand deposit accounts is reviewed annually based upon the account type, its estimated duration and the corresponding federal funds, U.S. swap curve or swap rate. The credit rates for several deposit products were reset January 1, 2016 to reflect the current market rates and updated market assumptions. These rates were generally higher than those in place during 2015, thus net interest income for deposit-providing businesses was positively impacted during 2016. FTP charge rates on assets were affected by the prevailing level of interest rates and by the duration and repricing characteristics of the portfolio. As overall market rates increased, the FTP charge increased for asset-generating businesses, thus negatively affecting net interest income during 2016. Credit rates for deposit products and charge rates for loan products may be reset periodically in response to changes in market conditions.

During the first quarter of 2016, the Bancorp refined its methodology for allocating provision expense to the business segments to include charges or benefits associated with changes in criticized commercial loan levels in addition to actual net charge-offs experienced by the loans and leases owned by each business segment. The results of operations and financial position for the three and six months ended June 30, 2015 were adjusted to reflect this change. Provision expense attributable to loan and lease growth and changes in ALLL factors are captured in General Corporate and Other. The financial results of the business segments include allocations for shared services and headquarters expenses. Additionally, the business segments form synergies by taking advantage of cross-sell opportunities and when funding operations by accessing the capital markets as a collective unit.

The results of operations and financial position for the three and six months ended June 30, 2015 were adjusted to reflect changes in internal expense allocation methodologies.

The following table summarizes net income (loss) by business segment:

TABLE 28: Net Income (Loss) by Business Segment


		For the three months ended June 30,		For the six months ended June 30,
($ in millions)		2016	2015	2016	2015
Income Statement Data
Commercial Banking	$	226	211	438	372
Branch Banking		132	19	240	91
Consumer Lending		7	41	16	89
Wealth and Asset Management		23	10	48	24
General Corporate and Other		(59)	28	(86)	94
Net income		329	309	656	670
Less: Net income attributable to noncontrolling interests		(4)	(6)	(4)	(6)
Net income attributable to Bancorp		333	315	660	676
Dividends on preferred stock		23	23	38	38
Net income available to common shareholders	$	310	292	622	638

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

Commercial Banking

Commercial Banking offers credit intermediation, cash management and financial services to large and middle-market businesses and government and professional customers. In addition to the traditional lending and depository offerings, Commercial Banking products and services include global cash management, foreign exchange and international trade finance, derivatives and capital markets services, asset-based lending, real estate finance, public finance, commercial leasing and syndicated finance.

The following table contains selected financial data for the Commercial Banking segment:

TABLE 29: Commercial Banking


		For the three months ended June 30,		For the six months ended June 30,
($ in millions)		2016	2015	2016	2015
Income Statement Data
Net interest income (FTE)^(a)	$	466	407	923	804
Provision for loan and lease losses		72	37	137	77
Noninterest income:
Corporate banking revenue		117	112	218	172
Service charges on deposits		72	71	145	140
Other noninterest income		47	49	94	92
Noninterest expense:
Personnel costs		74	75	153	155
Other noninterest expense		281	273	563	541
Income before income taxes		275	254	527	435
Applicable income tax expense^(a)(b)		49	43	89	63
Net income	$	226	211	438	372
Average Balance Sheet Data
Commercial loans and leases, including held for sale	$	55,072	52,839	54,571	52,165
Demand deposits		20,622	20,773	20,518	20,368
Interest checking deposits		8,372	9,272	8,673	9,259
Savings and money market deposits		6,690	6,564	6,711	6,310
Other time deposits and certificates $100,000 and over		1,061	1,268	1,094	1,303
Foreign office deposits		483	950	482	901

(a)

Includes FTE adjustments of $6 and $5 for the three months ended June 30, 2016 and 2015, respectively, and $12 and $10 for the six months ended June 30, 2016 and 2015, respectively.

(b)

Applicable income tax expense for all periods includes the tax benefit from tax-exempt income and business tax credits, partially offset by the effect of certain nondeductible expenses. Refer to the Applicable Income Taxes section of MD&A for additional information.

Net income was $226 million for the three months ended June 30, 2016 compared to net income of $211 million for the three months ended June 30, 2015. Net income was $438 million for the six months ended June 30, 2016 compared to net income of $372 million for the six months ended June 30, 2015. The increase for both the three and six months ended June 30, 2016 was driven by increases in net interest income and noninterest income partially offset by increases in the provision for loan and lease losses and noninterest expense.

Net interest income on an FTE basis increased $59 million and $119 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods was primarily driven by an increase in average commercial loan and lease balances as well as an increase in their yields of 15 bps and 11 bps for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The increase in net interest income for both periods was also due to an increase in FTP credit rates on core deposits partially offset by an increase in FTP charge rates on loans and leases.

Provision for loan and lease losses increased $35 million and $60 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods was primarily due to an increase in criticized commercial loans. The increase for the six months ended June 30, 2016 was also due to an increase in charge-offs of commercial and industrial loans, primarily in the energy portfolio and related to oil field services loans. Net charge-offs as a percent of average portfolio loans and leases increased to 32 bps for the three months ended June 30, 2016 compared to 28 bps for the same period in the prior year and increased to 34 bps for the six months ended June 30, 2016 compared to 27 bps for the same period in the prior year.

Noninterest income increased $4 million and $53 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The increase for the three months ended June 30, 2016 was driven by an increase in corporate banking revenue of $5 million from the same period in the prior year primarily driven by an increase in syndication fees partially offset by decreases in lease remarketing fees, business lending fees and institutional sales revenue. The increase for the six months ended June 30, 2016 was driven by increases in corporate banking revenue and service charges on deposits. Corporate banking revenue increased $46 million for the six months ended June 30, 2016 from the same period in the prior year primarily driven by increases in lease remarketing fees and syndication fees partially offset by decreases in business lending fees and foreign exchange fees. Service charges on deposits increased $5 million for the six months ended June 30, 2016 from the same period in the prior year primarily due to the acquisition of new customers.

Noninterest expense increased $7 million and $20 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily as a result of an increase in other noninterest expense. The increase in other noninterest expense for both periods was primarily driven by increases in corporate overhead allocations and impairment on affordable housing investments partially offset by a decrease in operational losses.

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

Average commercial loans increased $2.2 billion and $2.4 billion for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily due to increases in average commercial and industrial loans and average commercial construction loans partially offset by a decrease in average commercial mortgage loans. Average commercial and industrial loans increased $1.4 billion and $1.5 billion for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year and average commercial construction loans increased $990 million and $1.0 billion for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily as a result of an increase in new loan origination activity resulting from an increase in demand and targeted marketing efforts. Average commercial mortgage loans decreased $250 million and $282 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily due to a decline in new loan origination activity driven by increased competition and an increase in paydowns.

Average core deposits decreased $1.4 billion and $459 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The decrease for the three months ended June 30, 2016 was primarily driven by decreases in average interest checking deposits and average foreign deposits which decreased $900 million and $467 million, respectively, compared to the same period in the prior year. The decrease for the six months ended June 30, 2016 was primarily driven by decreases in average interest checking deposits and average foreign deposits which decreased $586 million and $419 million, respectively, compared to the same period in the prior year. This decrease was partially offset by an increase in average savings and money market deposits of $401 million for the six months ended June 30, 2016 compared to the same period in the prior year.

Branch Banking

Branch Banking provides a full range of deposit and loan products to individuals and small businesses through 1,191 full-service banking centers. Branch Banking offers depository and loan products, such as checking and savings accounts, home equity loans and lines of credit, credit cards and loans for automobiles and other personal financing needs, as well as products designed to meet the specific needs of small businesses, including cash management services.

The following table contains selected financial data for the Branch Banking segment:

TABLE 30: Branch Banking


		For the three months ended June 30,				For the six months ended June 30,
($ in millions)		2016		2015		2016		2015
Income Statement Data
Net interest income	$		433		376		859		752
Provision for loan and lease losses			35		36		69		78
Noninterest income:
Service charges on deposits			66		68		129		133
Card and processing revenue			66		60		126		115
Wealth and asset management revenue			36		41		71		79
Other noninterest income			46		(75)		75		(57)
Noninterest expense:
Personnel costs			130		131		261		266
Net occupancy and equipment expense			59		64		117		124
Card and processing expense			36		36		70		70
Other noninterest expense			184		173		372		343
Income before income taxes			203		30		371		141
Applicable income tax expense			71		11		131		50
Net income	$		132		19		240		91
Average Balance Sheet Data
Consumer loans, including held for sale	$		13,602		14,426		13,752		14,542
Commercial loans, including held for sale			1,893		1,973		1,920		1,982
Demand deposits			13,416		12,699		13,274		12,444
Interest checking deposits			9,660		9,174		9,545		9,143
Savings and money market deposits			25,935		25,637		25,631		25,583
Other time deposits and certificates $100,000 and over			5,229		5,164		5,220		5,109

Net income was $132 million for the three months ended June 30, 2016 compared to net income of $19 million for the three months ended June 30, 2015. Net income was $240 million for the six months ended June 30, 2016 compared to $91 million for the same period in the prior year. The increase for both the three and six months ended June 30, 2016 was driven by increases in net interest income and noninterest income as well as a decrease in the provision for loan and lease losses partially offset by an increase in noninterest expense.

Net interest income increased $57 million and $107 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods was primarily driven by an increase in FTP credit rates on core deposits partially offset by a decrease in interest income on residential mortgage loans and home equity loans driven by a decline in average balances and a decrease in interest income on other consumer loans driven by a decline in yields. The increase for the six months ended June 30, 2016 also included a decrease in interest expense on core deposits driven by a decrease in the rates paid. Additionally, net interest income for both periods was negatively impacted by an increase in FTP charge rates on loans and leases.

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

Provision for loan and lease losses decreased $1 million and $9 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily due to improved credit trends. Net charge-offs as a percent of average portfolio loans and leases decreased to 89 bps for both the three and six months ended June 30, 2016 compared to 91 bps and 97 bps for the three and six months ended June 30, 2015, respectively.

Noninterest income increased $120 million and $131 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily driven by increases in other noninterest income and card and processing revenue partially offset by a decrease in wealth and asset management revenue. Other noninterest income increased $121 million and $132 million for the three and six months ended June 30, 2016, respectively, compared to the same period in the prior year primarily driven by impairment losses associated with lower of cost or market adjustments on long-lived assets of $98 million and $102 million recognized during the three and six months ended June 30, 2015, respectively. Additionally, the increase in noninterest income for both the three and six months ended June 30, 2016 included a gain of $11 million on the sale of certain Pittsburgh branches as part of the previously announced Branch Consolidation and Sales Plan and a gain of $11 million on the sale of the agent bankcard loan portfolio during the second quarter of 2016. The increase for the six months ended June 30, 2016 also included a gain of $8 million on the sale of certain St. Louis branches as part of the Branch Consolidation and Sales Plan in the first quarter of 2016. Card and processing revenue increased $6 million and $11 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily due to an increase in the number of actively used cards and an increase in customer spend volume. The increases were partially offset by decreases in wealth and asset management revenue of $5 million and $8 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily due to a decrease in transactional securities and brokerage fees driven by lower sales and trading volume.

Noninterest expense increased $5 million and $17 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods was primarily due to an increase in other noninterest expense partially offset by a decrease in net occupancy and equipment expense. Other noninterest expense increased $11 million and $29 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily driven by an increase in corporate overhead allocations. The increases were partially offset by decreases of $5 million and $7 million in net occupancy and equipment expense for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily due to a decrease in rent expense driven by a reduction in the number of full-service banking centers and ATM locations.

Average consumer loans decreased $824 million and $790 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The decrease for both periods was primarily driven by a decrease in average home equity portfolio loans of $481 million and $471 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year and a decrease in average residential mortgage portfolio loans of $266 million and $256 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year as payoffs exceeded new loan production. Average commercial loans decreased $80 million and $62 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The decrease for both periods was primarily driven by a decrease in average commercial mortgage loans of $57 million and $42 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year and a decrease in average commercial and industrial portfolio loans of $17 million and $15 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year as payoffs exceeded new loan production.

Average core deposits increased $1.5 billion and $1.3 billion for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods was primarily driven by growth in average demand deposits of $717 million and $830 million, respectively, and growth in average interest checking deposits of $486 million and $402 million, respectively, for the three and six months ended June 30, 2016 compared to the same periods in the prior year. The growth in average demand deposits and average interest checking deposits was driven by an increase in average balances per customer account.

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

Consumer Lending

Consumer Lending includes the Bancorp’s residential mortgage, home equity, automobile and other indirect lending activities. Lending activities include the origination, retention and servicing of residential mortgage and home equity loans or lines of credit, sales and securitizations of those loans, pools of loans or lines of credit and all associated hedging activities. Indirect lending activities include extending loans to consumers through correspondent lenders and automobile dealers.

The following table contains selected financial data for the Consumer Lending segment:

TABLE 31: Consumer Lending


		For the three months ended June 30,				For the six months ended June 30,
($ in millions)		2016		2015		2016		2015
Income Statement Data
Net interest income	$		62		63		122		125
Provision for loan and lease losses			9		8		21		22
Noninterest income:
Mortgage banking net revenue			73		115		151		199
Other noninterest income			7		7		13		52
Noninterest expense:
Personnel costs			50		47		98		91
Other noninterest expense			72		66		142		125
Income before income taxes			11		64		25		138
Applicable income tax expense			4		23		9		49
Net income	$		7		41		16		89
Average Balance Sheet Data
Residential mortgage loans, including held for sale	$		10,277		8,840		10,057		8,935
Home equity			365		434		375		443
Automobile loans			10,365		11,402		10,568		11,412
Other consumer loans, including held for sale			-		15		-		19

Net income was $7 million for the three months ended June 30, 2016 compared to net income of $41 million for the three months ended June 30, 2015. Net income was $16 million for the six months ended June 30, 2016 compared to net income of $89 million for the six months ended June 30, 2015. The decrease for both periods was driven by a decrease in noninterest income as well as an increase in noninterest expense.

Net interest income decreased $1 million and $3 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The decrease for both periods was primarily driven by an increase in FTP charge rates on loans and leases and a decline in average automobile loan balances partially offset by an increase in average residential mortgage loan balances and an increase in FTP credit rates on demand deposits.

Provision for loan and lease losses increased $1 million for the three months ended June 30, 2016 compared to the same period in the prior year primarily due to an increase in net charge-offs on certain automobile loans partially offset by improved delinquency metrics on residential mortgage loans. The provision for loan and lease losses decreased $1 million for the six months ended June 30, 2016 compared to the same period in the prior year primarily due to improved delinquency metrics on residential mortgage loans and home equity loans. Net charge-offs as a percent of average portfolio loans and leases increased to 17 bps for the three months ended June 30, 2016 compared to 15 bps for the same period in the prior year and decreased to 20 bps for the six months ended June 30, 2016 compared to 22 bps for the same period in the prior year.

Noninterest income decreased $42 million and $87 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The decrease for the three months ended June 30, 2016 was driven by a decrease in mortgage banking net revenue of $42 million from the same period in the prior year primarily driven by a $52 million decrease in net mortgage servicing revenue partially offset by an increase of $10 million in mortgage origination fees and gains on loan sales. The decrease for the six months ended June 30, 2016 was driven by decreases in mortgage banking net revenue and other noninterest income. Mortgage banking net revenue decreased $48 million for the six months ended June 30, 2016 compared to the same period in the prior year primarily driven by a $57 million decrease in net mortgage servicing revenue partially offset by a $9 million increase in mortgage origination fees and gains on loan sales. Refer to the Noninterest Income subsection of the Statements of Income Analysis of MD&A for additional information on the fluctuations in mortgage banking net revenue. Other noninterest income decreased $39 million for the six months ended June 30, 2016 from the same period in the prior year primarily due to a $37 million gain on the sale of held for sale residential mortgage loans classified as TDRs in the first quarter of 2015.

Noninterest expense increased $9 million and $24 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year driven by increases in other noninterest expense and personnel costs. Other noninterest expense increased $6 million and $17 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily driven by an increase in operational losses and an increase in corporate overhead allocations. Personnel costs increased $3 million and $7 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily driven by increases in base compensation and variable compensation coupled with the impact from an increase in residential mortgage origination volumes.

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

Average consumer loans and leases increased $316 million and $191 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. Average residential mortgage loans, including held for sale, increased $1.4 billion and $1.1 billion for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily driven by the continued retention of certain conforming ARMs and certain other fixed-rate loans. Average automobile loans decreased $1.0 billion and $844 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year and average home equity loans decreased $69 million and $68 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year as payoffs exceeded new loan production.

Wealth and Asset Management

Wealth and Asset Management provides a full range of investment alternatives for individuals, companies and not-for-profit organizations. Wealth and Asset Management is made up of four main businesses: FTS, an indirect wholly-owned subsidiary of the Bancorp; ClearArc Capital, Inc., an indirect wholly-owned subsidiary of the Bancorp; Fifth Third Private Bank; and Fifth Third Institutional Services. FTS offers full-service retail brokerage services to individual clients and broker dealer services to the institutional marketplace. ClearArc Capital, Inc. provides asset management services. Fifth Third Private Bank offers holistic strategies to affluent clients in wealth planning, investing, insurance and wealth protection. Fifth Third Institutional Services provides advisory services for institutional clients including states and municipalities.

The following table contains selected financial data for the Wealth and Asset Management segment:

TABLE 32: Wealth and Asset Management


			For the three months ended				For the six months ended
			June 30,				June 30,
($ in millions)			2016		2015		2016		2015
Income Statement Data
Net interest income		$		44		29		87		58
Provision for loan and lease losses				1		1		1		3
Noninterest income:
Wealth and asset management revenue				98		102		197		206
Other noninterest income				2		1		5		6
Noninterest expense:
Personnel costs				42		42		87		86
Other noninterest expense				66		73		128		145
Income before income taxes				35		16		73		36
Applicable income tax expense				12		6		25		12
Net income	$			23		10		48		24
Average Balance Sheet Data
Loans and leases, including held for sale	$			3,113		2,709		3,090		2,605
Core deposits				8,357		9,739		8,611		9,765

Net income was $23 million for the three months ended June 30, 2016 compared to net income of $10 million for the same period in the prior year. Net income was $48 million for the six months ended June 30, 2016 compared to $24 million for the six months ended June 30, 2015. The increases for both periods were driven primarily by increases in net interest income as well as decreases in noninterest expense partially offset by decreases in noninterest income.

Net interest income increased $15 million and $29 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The increase for both periods was primarily due to an increase in FTP credit rates on core deposits and an increase in interest income on loans and leases driven by an increase in average balances. The increase in net interest income for both periods was partially offset by an increase in FTP charges due to an increase in average loan balances and an increase in FTP charge rates on loans and leases.

Provision for loan and lease losses was flat and decreased $2 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year.

Noninterest income decreased $3 million and $10 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The decrease for both periods was primarily due to a $4 million and $9 million decrease in wealth and asset management revenue for the three and six months ended June 30, 2016, respectively, driven by a $5 million and $9 million decrease in transactional securities and brokerage fees as a result of lower sales and trading volume. The decrease for the three months ended was partially offset by a $2 million increase in private client service fees and institutional fees compared to the same period in the prior year.

Noninterest expense decreased $7 million and $16 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The decrease for both periods was primarily driven by decreases in other noninterest expense of $7 million and $17 million compared to the same periods in the prior year primarily due to a decrease in corporate overhead allocations partially offset by an increase in operational losses.

Average loans and leases increased $404 million and $485 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily due to increases in average residential mortgage loans and average other consumer loans driven by increases in new loan origination activity.

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

Average core deposits decreased $1.4 billion and $1.2 billion for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year primarily due to a decline in average interest checking balances partially offset by an increase in average savings and money market deposits.

General Corporate and Other

General Corporate and Other includes the unallocated portion of the investment securities portfolio, securities gains and losses, certain non-core deposit funding, unassigned equity, unallocated provision expense or a benefit from the reduction of the ALLL, the payment of preferred stock dividends and certain support activities and other items not attributed to the business segments.

Net interest income for the three months ended June 30, 2016 was a negative $97 million compared to net interest income of $17 million for the same period in the prior year. Net interest income for the six months ended June 30, 2016 was a negative $174 million compared to net interest income of $5 million for the same period in the prior year. The decreases for both periods were primarily driven by an increase in FTP credits on deposits allocated to business segments driven by an increase in FTP credit rates as well as an increase in interest expense on long-term debt. The decreases in net interest income were partially offset by an increase in interest income on taxable securities and an increase in the benefit related to the FTP charges on loans and leases. The provision for loan and lease losses for the three and six months ended June 30, 2016 was a benefit of $26 million and $18 million, respectively, compared to a benefit of $3 million and $32 million for the three and six months ended June 30, 2015, respectively, due to increases in the allocation of provision expense to the business segments.

Noninterest income decreased $41 million and $48 million for the three and six months ended June 30, 2016, respectively, compared to the same periods in the prior year. The decrease in noninterest income for both periods included $50 million of negative valuation adjustments related to the Visa total return swap for both the three and six months ended June 30, 2016 compared with $2 million and $19 million, respectively, for the same periods in the prior year. In addition, the positive valuation adjustment on the stock warrant associated with Vantiv Holding, LLC was $19 million for the three months ended June 30, 2016 compared to the positive valuation adjustment of $14 million during the three months ended June 30, 2015. The positive valuation adjustments on the stock warrant associated with Vantiv Holding, LLC were $66 million for the six months ended June 30, 2016 compared to the positive valuation adjustments of $85 million during the six months ended June 30, 2015. Additionally, equity method earnings from the Bancorp’s interest in Vantiv Holding, LLC increased $2 million and $5 million compared to the three and six months ended June 30, 2015, respectively.

Noninterest expense was $23 million and $44 million for the three and six months ended June 30, 2016, respectively, compared to $6 million and $1 million for the three and six months ended June 30, 2015, respectively. The increase for both periods was primarily due to increases in personnel costs and the provision for the reserve for unfunded commitments partially offset by an increase in corporate overhead allocations from General Corporate and Other to the other business segments.

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

RISK MANAGEMENT – OVERVIEW

Managing risk is an essential component of successfully operating a financial services company. The Bancorp’s risk management approach includes processes for identifying, assessing, managing, monitoring and reporting risks. The ERM division, led by the Bancorp’s Chief Risk Officer, ensures the consistency and adequacy of the Bancorp’s risk management approach within the structure of the Bancorp’s operating model. Management within the lines of business and support functions assess and manage risks associated with their activities and determine if actions need to be taken to strengthen risk management or reduce risk given their risk profile. They are responsible for considering risk when making business decisions and for integrating risk management into business processes. In addition, the Internal Audit division provides an independent assessment of the Bancorp’s internal control structure and related systems and processes.

The assumption of risk requires robust and active risk management practices that comprise an integrated and comprehensive set of activities, measures and strategies that apply to the entire organization. The Bancorp has established a Risk Appetite Framework, approved by the Board, that provides the foundations of corporate risk capacity, risk appetite and risk tolerances. The Bancorp’s risk capacity is represented by its available financial resources. Risk capacity sets an absolute limit on risk-assumption in the Bancorp’s annual and strategic plans. The Bancorp understands that not all financial resources may persist as viable loss buffers over time. Further, consideration must be given to regulatory capital buffers required per Capital Policy Targets that would reduce risk capacity. Those factors take the form of capacity adjustments to arrive at an Operating Risk Capacity which represents the operating risk level the Bancorp can assume while maintaining its solvency standard. The Bancorp’s policy currently discounts its Operating Risk Capacity by a minimum of 5% to provide a buffer; as a result, the Bancorp’s risk appetite is limited by policy to, at most, 95% of its Operating Risk Capacity.

Economic capital is the amount of unencumbered financial resources required to support the Bancorp’s risks. The Bancorp measures economic capital under the assumption that it expects to maintain debt ratings at strong investment grade levels over time. The Bancorp’s capital policies require that the Operating Risk Capacity less the aforementioned buffer exceed the calculated economic capital required in its business.

Risk appetite is the aggregate amount of risk the Bancorp is willing to accept in pursuit of its strategic and financial objectives. By establishing boundaries around risk taking and business decisions, and by incorporating the needs and goals of its shareholders, regulators, rating agencies and customers, the Bancorp’s risk appetite is aligned with its priorities and goals. Risk tolerance is the maximum amount of risk applicable to each of the eight specific risk categories included in its Enterprise Risk Management Framework. This is expressed primarily in qualitative terms; however certain risk types also have quantitative metrics that are used to measure the Bancorp’s level of risk against its risk tolerances. The Bancorp’s risk appetite and risk tolerances are supported by risk targets and risk limits. Those limits are used to monitor the amount of risk assumed at a granular level. On a quarterly basis, the Risk and Compliance Committee of the Board reviews current assessments of each of the eight risk types relative to the established tolerance. Information supporting these assessments, including policy limits and key risk indicators, is also reported to the Risk and Compliance Committee of the Board. Any results outside of tolerance require the development of an action plan that describes actions to be taken to return the measure to within the tolerance.

The risks faced by the Bancorp include, but are not limited to, credit, market, liquidity, operational, regulatory compliance, legal, reputational and strategic. Each of these risks is managed through the Bancorp’s risk program which includes the following key functions:

•

ERM is responsible for developing and overseeing the implementation of risk programs and reporting that facilitate a broad integrated view of risk. The department also leads the continual fostering of a strong risk management culture and the framework, policies and committees that support effective risk governance;

•

Credit Risk Management is responsible for overseeing the safety and soundness of the commercial and consumer loan portfolio within an independent portfolio management framework that supports the Bancorp’s loan growth strategies and underwriting practices, ensuring portfolio optimization and appropriate risk controls. Credit Risk Management is also responsible for the economic capital program and quantitative analytics to support the commercial portfolio and risk rating models, ALLL methodology and analytics needed to assess credit risk and develop mitigation strategies related to that risk. The department also provides oversight, reporting and monitoring of commercial and consumer underwriting and credit administration processes;

•

Operational Risk Management works with lines of business and regional management to maintain processes to monitor and manage all aspects of operational risk, including vendors and information security to ensure consistency in application of operational risk programs;

•

Bank Protection oversees and manages fraud prevention and detection and provides investigative and recovery services for the Bancorp;

•

Capital Markets Risk Management is responsible for instituting, monitoring, and reporting appropriate trading limits within the Capital Markets groups and monitoring liquidity, interest rate risk and risk tolerances resulting from management of Fifth Third’s overall balance sheet;

•

Regulatory Compliance Risk Management provides independent oversight to ensure that an enterprise-wide framework, including processes and procedures, are in place to comply with applicable laws, regulations, rules and other regulatory requirements; internal policies and procedures; and principles of integrity and fair dealing applicable to the Bancorp’s activities and functions. The Bancorp focuses on managing regulatory compliance risk in accordance with the Bancorp’s integrated risk management framework, which ensures consistent processes for identifying, assessing, managing, monitoring and reporting risks; and

•

The ERM division creates and maintains other functions, committees or processes as are necessary to effectively oversee risk management throughout the Bancorp.

Risk management oversight and governance is provided by the Risk and Compliance Committee of the Board of Directors and through multiple management committees whose membership includes a broad cross-section of line-of-business, regional market and support representatives. The Risk and Compliance Committee of the Board of Directors consists of five outside directors and has the responsibility for the oversight of risk management for the Bancorp, as well as for the Bancorp’s overall aggregate risk profile. The Risk and Compliance Committee of the Board of Directors has approved the formation of key management governance committees that are responsible for evaluating risks and controls.

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

The primary committee responsible for the oversight of risk management is the ERMC. Committees accountable to the ERMC, which support the core risk programs, are the Corporate Credit Committee, the Operational Risk Committee, the Management Compliance Committee, the Asset/Liability Committee and the Enterprise Marketing Committee. Other committees accountable to the ERMC oversee the ALLL, capital, model risk and regulatory change management functions. There is also a risk assessment process applicable to every line of business to ensure an appropriate standard readiness assessment is performed before launching a new or changing product or initiative. Significant risk policies approved by the management governance committees are also reviewed and approved by the Risk and Compliance Committee of the Board of Directors.

Credit Risk Review is an independent function responsible for evaluating the sufficiency of underwriting, documentation and approval processes for consumer and commercial credits, the accuracy of risk grades assigned to commercial credit exposure, nonaccrual status, specific reserves and monitoring for charge-offs. Credit Risk Review reports directly to the Risk and Compliance Committee of the Board of Directors and administratively to the Chief Auditor.

CREDIT RISK MANAGEMENT

The objective of the Bancorp’s credit risk management strategy is to quantify and manage credit risk on an aggregate portfolio basis, as well as to limit the risk of loss resulting from the failure of a borrower or counterparty to honor its financial or contractual obligations to the Bancorp. The Bancorp’s credit risk management strategy is based on three core principles: conservatism, diversification and monitoring. The Bancorp believes that effective credit risk management begins with conservative lending practices. These practices include conservative exposure and counterparty limits and conservative underwriting, documentation and collection standards. The Bancorp’s credit risk management strategy also emphasizes diversification on a geographic, industry and customer level as well as ongoing portfolio monitoring and timely management reviews of large credit exposures and credits experiencing deterioration of credit quality. Credit officers with the authority to extend credit are delegated specific authority amounts, the utilization of which is closely monitored. Underwriting activities are centrally managed, and ERM manages the policy and the authority delegation process directly. The Credit Risk Review function provides independent and objective assessments of the quality of underwriting and documentation, the accuracy of risk grades and the charge-off, nonaccrual and reserve analysis process. The Bancorp’s credit review process and overall assessment of the adequacy of the allowance for credit losses is based on quarterly assessments of the probable estimated losses inherent in the loan and lease portfolio. The Bancorp uses these assessments to promptly identify potential problem loans or leases within the portfolio, maintain an adequate reserve and take any necessary charge-offs. The Bancorp defines potential problem loans and leases as those rated substandard that do not meet the definition of a nonaccrual loan or a restructured loan. Refer to Note 6 of the Notes to Condensed Consolidated Financial Statements for further information on the Bancorp’s credit grade categories, which are derived from standard regulatory rating definitions.

The following tables provide a summary of potential problem portfolio loans and leases:


TABLE 33: Potential Problem Portfolio Loans and Leases
As of June 30, 2016 ($ in millions)		Carrying Value		Unpaid Principal Balance		Exposure
Commercial and industrial loans	$		1,416		1,418		2,038
Commercial mortgage loans			135		135		137
Commercial leases			32		32		33
Total potential problem portfolio loans and leases	$		1,583		1,585		2,208

TABLE 34: Potential Problem Portfolio Loans and Leases
As of December 31, 2015 ($ in millions)		Carrying Value		Unpaid Principal Balance		Exposure
Commercial and industrial loans	$		1,383		1,384		1,922
Commercial mortgage loans			170		171		172
Commercial construction loans			6		6		7
Commercial leases			36		36		39
Total potential problem portfolio loans and leases	$		1,595		1,597		2,140

In addition to the individual review of larger commercial loans that exhibit probable or observed credit weaknesses, the commercial credit review process includes the use of two risk grading systems. The risk grading system currently utilized for reserve analysis purposes encompasses ten categories. The Bancorp also maintains a dual risk rating system for credit approval and pricing, portfolio monitoring and capital allocation that includes a “through-the-cycle” rating philosophy for assessing a borrower’s creditworthiness. The dual risk rating system includes thirteen probabilities of default grade categories and an additional six grade categories for estimating losses given an event of default. The probability of default and loss given default evaluations are not separated in the ten-category risk rating system. The Bancorp has completed significant validation and testing of the dual risk rating system as a commercial credit risk management tool. The Bancorp is assessing the necessary modifications to the dual risk rating system outputs to develop a U.S. GAAP compliant ALLL model and will evaluate the use of modified dual risk ratings for purposes of determining the Bancorp’s ALLL as part of the Bancorp’s adoption of ASU 2016-13 “Measurement of Credit Losses on Financial Instruments,” which will be effective for the Bancorp on January 1, 2020. Scoring systems, various analytical tools and portfolio performance monitoring are used to assess the credit risk in the Bancorp’s homogenous consumer and small business loan portfolios.

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

Economic Overview

Economic growth continues to improve, and GDP is expected to maintain its modest expansionary pattern. The U.S. job market and wages are slowly but steadily improving. Consumer spending has been moderate and there are indications that manufacturing is stabilizing. Inflation continues to run below the FRB’s stated objective, but has increased over the past several months. Energy prices and the dollar have stabilized and are moving in a pattern that may continue the improvement in inflation and manufacturing. Housing prices have largely stabilized and are increasing in many markets. However, overall current economic and competitive conditions are causing weaker than desired qualified loan growth that combined with a weakness in global economic conditions and a relatively low interest rate environment, may directly or indirectly impact the Bancorp’s growth and profitability. Economic weakness in developed economies continues, growth has slowed in China and other developing economies and the British vote to exit the European Union has created market volatility and additional economic uncertainty. The FRB noted asymmetric risks to the downside in their latest assessment of the risks to their economic outlook.

Commercial Portfolio

The Bancorp’s credit risk management strategy seeks to minimize concentrations of risk through diversification. The Bancorp has commercial loan concentration limits based on industry, lines of business within the commercial segment, geography and credit product type. The risk within the commercial loan and lease portfolio is managed and monitored through an underwriting process utilizing detailed origination policies, continuous loan level reviews, monitoring of industry concentration and product type limits and continuous portfolio risk management reporting.

The origination policies for commercial real estate outline the risks and underwriting requirements for owner and nonowner-occupied and construction lending. Included in the policies are maturity and amortization terms, maximum LTVs, minimum debt service coverage ratios, construction loan monitoring procedures, appraisal requirements, pre-leasing requirements (as applicable), sensitivity and pro-forma analysis requirements and interest rate sensitivity. The Bancorp requires a valuation of real estate collateral, which may include third-party appraisals, be performed at the time of origination and renewal in accordance with regulatory requirements and on an as needed basis when market conditions justify. Although the Bancorp does not back test these collateral value assumptions, the Bancorp maintains an appraisal review department to order and review third-party appraisals in accordance with regulatory requirements. Collateral values on criticized assets with relationships exceeding $1 million are reviewed quarterly to assess the appropriateness of the value ascribed in the assessment of charge-offs and specific reserves. In addition, the Bancorp applies incremental valuation adjustments to older appraisals that relate to collateral dependent loans, which can currently be up to 20-30% of the appraised value based on the type of collateral. These incremental valuation adjustments generally reflect the age of the most recent appraisal as well as collateral type. Trends in collateral values, such as home price indices and recent asset dispositions, are monitored in order to determine whether changes to the appraisal adjustments are warranted. Other factors such as local market conditions or location may also be considered as necessary.

The Bancorp assesses all real estate and non-real estate collateral securing a loan and considers all cross-collateralized loans in the calculation of the LTV ratio. The following tables provide detail on the most recent LTV ratios for commercial mortgage loans greater than $1 million, excluding impaired commercial mortgage loans individually evaluated. The Bancorp does not typically aggregate the LTV ratios for commercial mortgage loans less than $1 million.

TABLE 35: Commercial Mortgage Loans Outstanding by LTV, Loans Greater Than $1 Million

As of June 30, 2016 ($ in millions)

LTV > 100%

LTV 80-100%

LTV < 80%

Commercial mortgage owner-occupied loans

108

200

1,997

Commercial mortgage nonowner-occupied loans

147

2,288

Total

207

347

4,285

TABLE 36: Commercial Mortgage Loans Outstanding by LTV, Loans Greater Than $1 Million

As of December 31, 2015 ($ in millions)

LTV > 100%

LTV 80-100%

LTV < 80%

Commercial mortgage owner-occupied loans

119

216

2,063

Commercial mortgage nonowner-occupied loans

120

194

2,032

Total

239

410

4,095

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

The following table provides detail on commercial loans and leases by industry classification (as defined by the North American Industry Classification System), by loan size and by state, illustrating the diversity and granularity of the Bancorp’s commercial loans and leases as of:


TABLE 37: Commercial Loan and Lease Portfolio (excluding loans held for sale)
	June 30, 2016						December 31, 2015
($ in millions)	Outstanding		Exposure		Nonaccrual		Outstanding		Exposure		Nonaccrual
By Industry:
Manufacturing	$	10,947		20,882		80		10,572		20,422		70
Real estate		7,120		11,391		36		6,494		10,293		40
Financial services and insurance		6,179		12,462		3		5,896		13,021		3
Healthcare		4,745		6,765		38		4,676		6,879		22
Business services		4,581		6,902		76		4,471		6,765		96
Retail trade		3,896		7,519		2		3,764		7,391		8
Wholesale trade		3,837		6,790		16		4,082		7,254		23
Transportation and warehousing		3,316		4,714		1		3,111		4,619		1
Communication and information		3,017		5,050		1		2,913		5,052		2
Accommodation and food		2,738		4,416		6		2,507		4,104		6
Construction		1,967		3,514		7		1,871		3,403		8
Entertainment and recreation		1,529		2,691		4		1,210		2,066		4
Mining		1,455		2,477		234		1,499		2,695		36
Utilities		1,093		2,598		-		1,217		2,854		-
Other services		813		1,029		25		864		1,188		10
Public administration		471		517		-		495		562		-
Agribusiness		306		470		3		368		527		4
Individuals		97		119		2		139		187		2
Other		10		15		5		7		6		6
Total	$	58,117		100,321		539		56,156		99,288		341
By Loan Size:
Less than $200,000		1 %		1		4		1		1		7
$200,000 - $1 million		3		3		6		4		3		10
$1 million - $5 million		9		8		17		10		8		25
$5 million - $10 million		7		6		22		8		7		25
$10 million - $25 million		24		21		40		24		21		15
Greater than $25 million		56		61		11		53		60		18
Total		100 %		100		100		100		100		100
By State:
Ohio		15 %		16		5		16		17		8
Michigan		8		7		6		8		7		9
Florida		8		7		5		8		7		12
Illinois		7		7		9		7		8		20
Indiana		4		5		4		5		5		4
North Carolina		4		4		1		4		4		1
Tennessee		3		3		-		3		3		-
Kentucky		3		3		2		3		3		1
Pennsylvania		3		3		5		3		3		2
All other states		45		45		63		43		43		43
Total		100 %		100		100		100		100		100

The Bancorp’s non-power producing energy and nonowner-occupied commercial real estate portfolios have been identified by the Bancorp as loans which it believes represent a higher level of risk compared to the rest of the Bancorp’s commercial loan portfolio, due to economic or market conditions within the Bancorp’s key lending areas.

Due to the sensitivity of the non-power producing energy portfolio to downward movements in oil prices, the Bancorp has seen migration in the portfolio into criticized classifications during 2015 and the six months ended June 30, 2016. The reserve-based energy loans that the Bancorp holds are senior secured loans with a borrowing base that is re-determined on a semi-annual basis.

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

The following tables provide an analysis of the non-power producing energy loan portfolio:


TABLE 38: Non-Power Producing Energy Portfolio
													Net Charge-offs for June 30, 2016
As of June 30, 2016 ($ in millions)	Pass		Criticized		Outstanding		Exposure		90 Days Past Due		Nonaccrual		Three Months Ended		Six Months Ended
Reserve-based lending	$	220		466		686		1,171		-		125		-		-
Midstream		305		-		305		1,011		-		-		-		-
Oil field services		158		83		241		411		-		44		2		11
Oil and gas		76		92		168		505		-		22		-		-
Refining		120		-		120		651		-

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