Fifth Third Bancorp (FITB) Earnings Call Transcript & Summary

Good morning. This is Gerard Cassidy from RBC Capital Markets. Kicking off our second day of the RBC Capital Markets Global Financial Institutions Conference. Thank you, everybody, for attending. I'm very pleased and privileged to have with us today Fifth Third Bancorp. Fifth Third is led by Chairman, President and CEO, Greg Carmichael. Also joining us from Fifth Third is their Chief Financial Officer, Tayfun Tuzun; and then also their Chief Credit Officer, Richard Stein. As many of you know, Fifth Third's headquartered in Cincinnati, Ohio. It has a market cap of about $13 billion. And it has the total assets today of almost $170 billion with loans of about $110 billion, deposits of $127 billion. Last year, they had a return on assets of 129 basis points and a return on average common equity of almost 11%. The management team has some prepared remarks, which I'm going to turn it over now to Greg Carmichael, again, Chairman, President and CEO. Greg?

Thanks, Gerard, and good morning to everyone listening on the webcast. I'd like to thank the entire RBC team for your flexibility and hosting us remotely in light of the circumstances. Before going any further, I want to spend a moment to address the recent enforcement action filed by the CFPB related to unauthorized account openings. We strongly reject the enforcement action. We believe this was completely unwarranted because after an investigation spending more than 3.5 years and almost 0.5 billion data items, the CFB has not informed us of any unauthorized accounts beyond the fewer than 1,100 accounts that we self-identified out of 10 million or approximately 0.01% of accounts opened between 2010 and 2016. While even a single unauthorized account is one too many, we took appropriate and decisive action to address each situation. We intend to defend ourselves vigorously and are confident in the outcome. Given the nature of the legal process, our decision to take this course of action indicates our level of confidence in our case. This was not a decision that was taken lightly. Since 2010, we have been through multiple exams with multiple prudential regulators focused on our sales practices and we remain in good standing, which should speak for itself. You can find more information about our sales practices and other relevant information on our Investor Relations website. Moving to the conference presentation. I would encourage you to please review the cautionary statement on Slide 2. As shown on Slide 3, we have taken proactive steps over the past several years to improve our resilience and outperform peers to the full economic cycle. The last 2 weeks have undoubtedly created a lot of uncertainty with respect to the path of the U.S. economy, with the market signaling a high likelihood of persistently low interest rates. We believe we are well positioned relative to peers in that scenario. While lower short-term rates will certainly affect profitability returns, the early cycle actions we have taken should work in our favor. Reflecting on the past year, as Fed lowered rates 35 basis points in 2019, our NIM resilience stood out among peers. This relative outperformance before any meaningful benefits associated with $11 billion in cash flow hedges that will now provide significant NIM support going forward. We also remain very well capitalized with our CET1 ratio of 9.75%, now 75 basis points above our year-ago target of 9%. We have grown capital over the past year, while most peers have reduced their capital levels. In this uncertain environment, we expect that we will maintain relatively steady capital levels compared to today, until the direction of the economy becomes clear. From a credit risk management perspective, we expect to benefit from the actions taken since I became CEO in 2015. Since that time, we optimized the balance sheet, which reduced our highly monitored leveraged lending exposures by approximately 50%. We also limited our exposures to sectors that are stressed in the current environment, including airlines, hotels and restaurants. We are in constant dialogue with our clients to assess the business impacts from potential disruptions, both the possible near-term revenue challenges and their ability to weather a prolonged downturn. We realize there will be knock-on effects throughout the U.S. economy, including supply chain disruptions. We are working with our clients to provide advice and support and continue to monitor the situation very closely. Slide 4 highlights early cycle actions within our hedge and securities portfolio that should provide long-term NIM protection against lower interest rates. Our $11 billion worth of cash flow hedges are priced at very attractive levels including $8 billion in received fixed swaps at a blended rate of 3.02% and $3 billion in floors at a 2.25% strike against 1-month LIBOR. With LIBOR below 1%, these hedges will generate well over $200 million in annual protection for the next few years. We added hedges earlier than most peers when the 10-year was around 3% and also structured them to provide protection for much longer than most peers with hedge protection against lower rates through 2024. As we have discussed before, our securities portfolio is also structured in a way that is meaningfully different than our peers. This differentiated approach has led to peer-leading yields for 6 consecutive years, which we expect to continue even in a persistently low-rate environment. In fact, in addition to our absolute yields performing better than peers, we believe that the rate of decline expected in this environment will also be less than peers. As you can see, our securities portfolio tends to generate less than half the cash flows compared to the next lowest peer, reflecting our significantly lower mortgage-backed securities portfolio in our investments in bullet and locked-out structures. Our mortgage rates approaching -- with mortgage rates approaching record lows and almost all mortgages soon to be refinanceable, we expect our peers' security cash flows to continue to significantly exceed Fifth Third's. As of yesterday, our unrealized gains from our securities and hedge portfolios was approximately $4 billion on a pretax basis. This is indicative of the strength of the underlying future earnings power in the current market environment. Slide 5 highlights our strong NIM performance relative to peers over the past 12 months. We know that investors often use rate risk disclosure tables to assess future asset sensitivity and frequently compare banks based on those disclosures. While we are not immune to the impact of lower interest rates over the past year, our rate risk disclosures wound up being slightly conservative, whereas almost all of our peers' NIM performance deviated materially in the opposite direction relative to their year-ago risk disclosures. The average peer underperformed their expected NIM by a staggering 14 basis points. Consistent with our actions over the past year, we will continue to proactively manage our liabilities to help offset the impact of lower interest rates. Having a top share of deposits in most of our markets gives us the positive pricing flexibility. To that end, we expect a substantially lower deposit cost while continuing to grow core deposits. We are aggressively repricing CDs as they mature with approximately 90% of our portfolio maturing in the next year, including approximately $6 billion in the first half of 2020. The CD portfolio repricing should provide meaningful NIM support. In addition to the CD portfolio, we have been proactively shifting more index-based pricing to more index-based pricing with 12% of the deposit portfolio now indexed to Fed funds. Slide 6 shows the diversification within our commercial loan portfolio. Our C&I manufacturing portfolio is well diversified across many products, including metal, chemical, food, electronics and apparel. Another portfolio that is well diversified is leveraged lending. We remain very focused on disciplined client selection in this environment. As I mentioned earlier, our highly monitored leveraged lending portfolio has declined by approximately 50% since 2015 to $4 billion in outstanding balances. We do not expect to grow our leveraged lending exposures in this environment. We have maintained a -- we have remained disciplined in our commercial real estate portfolio and have continued to maintain an underweight position relative to peers. We also have, by far, the lowest exposure to high-volatility CRE compared to peers. Over the last few years, we have maintained a cautious approach in this environment, favoring both national and large regional developers who have large and diversified balance sheets. As I mentioned earlier, we have limited exposures to stressed sectors, as shown on Slide 7. Our oil and gas portfolio is approximately $3 billion. More than 80% of this portfolio is in reserve-based lending, less than 7% in oilfield services, which was the area that faced the most pressure during the last oil crisis. In addition, over 90% of our clients are hedged for the impact of lower energy prices. Slide 8 highlights our well-diversified and growing fee revenues, which should help partially mitigate the impact of lower interest rates. In this environment, we expect to benefit from stronger mortgage banking revenues, stable deposit fees and strong financial risk management revenue, which should help offset the declines in areas like wealth and asset management. In summary, we are closely monitoring the current market dynamics and are cognizant of the increased likelihood of persistently lower interest rates. We will continue to allocate resources and capital in a prudent manner. We have spent several years taking proactive steps to make our balance sheet more resilient and our revenue streams more diverse. We have performed numerous stress tests under severely adverse scenarios for more than a decade, which has shown we can withstand deep downturns. Our 4 strategic priorities, accelerating our digital transformation, invest organically for future growth, expanding the market share in key geographies and maintaining our disciplined approach throughout the bank, remain intact. That being said, clearly, in the same type of environment, certain growth initiatives will be under review. We'll put the appropriate level of prioritization and focus on the areas that have the highest probability of driving long-term financial success. We have been focused on maximizing our returns to the full cycle rather than generating lower quality short-term balance sheet growth. Our continued philosophy of focusing on improved performance through the full economic cycle positions us well for this environment. Now with that, Tayfun, Richard and I will be more than happy to take any of your questions.

Greg, thank you very much for that presentation and the level of detail showing us the different risk parameters for Fifth Third. Possibly, we can start off with your interactions with your customers in the last month, let's say, since the coronavirus has started to spread here in the United States. Can you share with us what are you hearing first-hand from some of these customers? And how are they handling it?

I think everyone is reacting to the situation with abundance of caution. Obviously, there's a lot of concern out there to the impact of their employee base, their ability to serve their clients. In addition to what it means to their business financially...

You mentioned...

There's a feedback.

Can you hear us now?

It's difficult.

Okay.

That's better right there.

Is that better? Okay. Good.

That's better right there. Yes. So obviously, a lot of our customer -- or some of our customer base has a direct exposure to China, pipelines and so forth is concerned. We're starting to see that pick up a little bit better. But net-net, as this rolls into United States, which is a large portion of our customer base, obviously, is U.S.-based, is the concern about making sure they take care of their employees, identifying where the risks are and making sure that they're protecting their capital and liquidity also as they manage through a very difficult environment. I don't know, Richard, if you have anything you want to add on that.

No, I think that's right. Certainly, customers -- the sort of the good news about the [ Third Momentum ] Bank, people had a chance to look at supply chain, really start to assess where they get product and what are the options they have. And I think it helped to prepare for something like this, not that there's not stress out there, but they're certainly better prepared than they were.

More of the concern is what it will do [indiscernible] for the economy. This virus, at what level of debt we end up? And then would that be a catalyst for potential prolonged negative growth? So that's the concern out there, just what it's going to look like longer term as they deal with [indiscernible].

Okay. You sound like you broke up. Are you still there, gentlemen?

Yes. It's a little static, though.

Yes. Okay. Greg, maybe this is for Tayfun. In your prepared remarks, you mentioned about the amount of CDs that are coming up for repricing. I think you said in the first 6 months of 2020, there's almost $6 billion of CDs coming up. I think the yields or the cost of those CDs, according to the slide, were between 188 basis points to 198. Can you guys share with us, as those reprice down, what level of rate of interest do you think they'll reprice down to?

Sure, Gerard. So what we have done is, so far, we have reduced the rates from the 4- to 5-month CDs. We reduced the rate from 1.25 to 75 basis points. And for the 9-month CD offering, we reduced it from 1.15 to 50 basis points. And we are also in the process of moving those terms, the 5- and 9-month terms to 3 and 6 months, to shorten the duration of the portfolio even more. And that's all in addition to, obviously, the rate reductions that we are executing on the savings and money market products. So we had anticipated about 8 to 10 basis points of reduction in the first quarter in our deposit rates. Clearly, these actions will move the dial a little bit more. That's all on the retail side. On the commercial side, we are taking similar actions based upon both the current rates as well as the anticipated further moves by the Fed.

Sticking with funding. And as you guys pointed out, the hedging strategies position you better than most of your peers to handle this rate environment. Tayfun, is there anything that can be done today for additional or future pressure that may come if rates continue to fall at the long end of the curve and the short end of the curve from here?

It can be done. I think the answer is yes. But at this point, we are -- we haven't done or we haven't taken any actions. My team has been around for a long time. So we've been this multiple times, every period is unique. But the principle that we always sort of come back to is the worst time to execute an action is when you need to, when you have to execute that action. So we've prepared ourselves well 1.5 years ago for the eventuality of a rate downturn. Clearly, the trigger here is a different trigger in the current period. We are evaluating our views in the long term, what happens to the rate environment and our business going forward. We're not done yet. We may take action depending upon how we decide to move. We are not necessarily sitting still in terms of the actual balance sheet pricing decisions and portfolio growth decisions that we are making. So those are happening as we speak. We like where we are today. And if we feel the need to execute additional actions, we will do so regardless of the current environment. But so far, we haven't done anything yet.

I see. And have you guys seen with the lowering of rates here any deposit activity, whether inflows or outflows for the bank in this new rate environment?

The deposit side, going into February, we had better deposit growth than we anticipated. That continues to be the case in the current environment. And we suspect that is going to continue for a while as well. We are also making sure that we keep that liquid position to make sure that we stand by our clients as some of the loan clients may increase their draws on their lines. But from a liquidity perspective, we anticipated that a period like this would result in higher liquidity levels, and we are seeing that currently.

Very good. Richard, you talked a little bit about the credit with China and the way we manufacture our goods these days. You guys gave very good details about -- in Slide 7 of the different portfolios that may be vulnerable due to this coronavirus situation in the leisure and hotel, et cetera. When do you think you'll actually start to see evidence that maybe some of your borrowers are starting to struggle a bit? Or have you already seen it? Can you give us some color there?

We haven't seen evidence yet. We've certainly seen -- we've had a number of conversations with our customers. And if you look at public data about airline -- the expectations about air travel and what's going to happen from a tourism perspective, we can certainly speculate. But in terms of actual activity and financial results, we haven't seen that from our customers yet. We're in active dialogue with them to make sure we understand both what's happening on the ground from an activity perspective, their liquidity positions, working with our customers to make sure that we understand the downside that they are facing and then we stress that as well.

Very good. Greg, in your prepared remarks, you talked about reappraising the growth initiatives that are underway. I know there's been an interest on Fifth Third's part to grow organically in some of the faster-growing markets of this country. Can you expand upon that? What you're considering, if anything, to change that strategy and any other types of growth initiatives?

First of all, there's no change in this strategy. The 4 key strategic initiatives are the same as they have been. We think they are the right strategic initiatives for the bank. We think they create the right outcomes long term for our investors. So -- but when you step back a little bit and look at the environment we're faced with, it's quick -- it really is about the pace of what we could do and when we could do it, and looking at the priorities that create the greatest value for long-term success and trying to protect those. So we're going to continue to look at those opportunities. Some are maybe paced, some of it may be we're going to put on hold for an extended period of time. But we're looking at that. Now it's still early in the storm, so to speak so -- as things continue to play out. But right now, we're looking at every one of those initiatives and reassessing, trying to understand what the impacts would be if we decide to pull back a little bit. That's underway. But the strategic priorities are going to be the same. When you think about our high-growth markets in the Southeast, I'll remind everybody, we've been in those markets for a long, long time. They're strong depository markets for us. What we're continuing to look for is creating more distribution capabilities and more bankers in those markets to serve the clients. Now that's also under review right now as we think about a potential slowing economy. That pace is under review. So those are things we're looking at. In addition to that, we have expense levers we're going to continue to look at in this environment that -- as I mentioned in other forums, that we will continue to find ways to protect our bottom line and expenses are always on the table for opportunities for improvement, and we'll continue to look for those opportunities also.

Yes, the expansion plans, Gerard, as Greg said, have been deposit-led expansion plans. And we're obviously hearing a lot of commentary about how the low-rate environment is going to put some pressure on the profitability of the deposit franchise. But at the same time, I'd like to point out that a lot of our nonbank competitors, especially on the fintech side, would kill to have a deposit franchise like ours today, especially today. So the core profitability of our institution, similar to all of our peers, is very much tied to the retail franchises' success, and we like what we're doing there. And that's not necessarily a periodic evaluation.

Tayfun, you made me smile. I wonder if you read our report, imagine 2025 because we talk about this issue about the depositories having the advantage over the non-depositories, and you just laid that out. And speaking of depositories, I know you guys in the past have been able to acquire some depositories. Greg, in this environment, not literally today, but we may see some shakeouts of companies not wanting to go at it alone, they want economies of scale. Can you just share with us your views on mergers and acquisitions of depositories?

First off, our focus hasn't changed from nonbank opportunities in organic growth. So we're still focused, once again, on how do we add products and services that enhance our capability to better serve our customers. The nonbank sector, as we have in the past with acquisitions in the capital market space, acquisitions in the wealth space, and that's played out extremely well for us, and it continues to allow us to diversify our revenue streams. When it comes to bank acquisitions, those opportunities, it's way too early to assess what those opportunities might look like. But at the end of the day, that's not our focus, that's not our priority, and that's not where we're putting our energy at right now. Will things materialize over time? That remains to be seen, but our focus is organic growth and continue to focus on nonbank acquisitions as our top priorities.

And within the nonbank, Greg, is there a product type that you're looking to enhance something that you already have? Or just to -- expense -- yes, go ahead.

No, I think on the capital markets side, we've -- our capital markets has been a really strong growth area for us. We've invested in both the product set, acquisitions like Coker Capital that aligns right with our health care vertical, so we'll keep doing that. We've been very successful. We're looking for more of those types of opportunities on the capital markets side. When you get to the business banking side, there's opportunities to engage in some other partnerships and potentially acquisition opportunities on the business banking front that allow us to create more of a distribution beyond our current model. Those are things that we're looking at to continue once again to enhance our products and services, but it's capital markets, it's wealth and asset management, and then it's the fintech plays that allow us to accelerate our digital transformation where it makes sense. And those opportunities could become more attractive also in this environment for us from a pricing perspective.

One of the areas we're seeing benefit from lower interest rates, of course, is residential refinancing activity -- residential mortgage refinancing activity. Can you guys share with us what's going on in your residential mortgage area with these low rates?

Sure. Let me start, then I'll turn it over to Tayfun because he'll be more granular than I will. First off, we've invested heavily in our mortgage platform, putting in Black Knight. We have a very, very talented workforce over there and strong capabilities in multiple channels. So this refi opportunity is significant for Fifth Third. We're looking, -- obviously, it's all hands on deck, staffing and support for the volumes that we're seeing right now. And as you would imagine, the bulk of that's refi. So it's an opportunity because of, once again, a diversification of our revenue streams, this is an area that should do extremely well with the rates where they're at. And we expect to see a tremendous amount of refi volume, and job #1 is catching that opportunity.

Yes. Gerard, going into the year, we were expecting -- last year, we originated about $11 billion. We were expecting a similar year going into the year. But now obviously, with rates coming down, that volume origination level is going to increase potentially 30%, 40%. What we're also obviously seeing is given the capacity constraints, originators have kept mortgage rates at sort of above expected levels, and the margins are increasing. I suspect that first quarter is going to have widening margins both on the retail and direct side as well as on the correspondent side. So we are optimistic that we will continue to see that wave coming through. We also feel pretty good about sort of the MSR hedging side that we've taken the appropriate actions there. So overall, the mortgage business looks very healthy at the moment.

This may sound odd, I've seen some of the credit unions here back in the Northeast talk about refinancing auto loans. I know you guys are an auto lender. Do you -- is that type of business -- is that a business that is out in your market, a refinancing of an auto loan?

If it is, I have not heard about it, and we have no plans to get into it.

Okay. And speaking, just quickly, of auto loans, we've got a couple of minutes here. Again, a couple of years back, you put it on pause, you now are growing the portfolio, how is that business going?

It's doing well. What we are seeing, very typical of these types of environments, is widening spreads. If you remember, right after the previous crisis, for about a year or 2, auto loan spreads have widened to almost about 400 basis points. Now we're not there, obviously, yet, but we've seen a 50, 60 basis point widening in origination spreads at...

Very good.

At similar levels of originations.

Very good. We're running out of time here. So maybe, Greg, I don't know if there's any last wrap-up comment you'd like to make before we sign off.

No. I think, obviously, we're in a very dynamic situation right now, and what I'll assure everyone on this call is that we're looking at every opportunity to make sure that we're successful in navigating through the wars ahead of us. We've talked about being good through the full cycle. This is the time we demonstrate that with all the actions that we've taken, whether it be on our -- the hedges we put in place, the repositioning of our balance sheet. We've done a lot of work to be ready for an environment like that, and we are. I'll also tell you the first 2 months of the year, we've jumped off to a pretty solid start. We feel really good about what we saw in January and February. Obviously, the environment is very fluid right now. But our focus is on, one, making sure that we take care of our customers and we do it the right way, and we perform well through a downturn cycle.

Well, with that, Greg, Tayfun and Richard, thank you so much for joining us. And again, it's been -- we're lucky to have you and a real privilege to have you as part of the conference. Thank you again.

Thank you, Gerard.

Thank you, Gerard.

Take care.

This concludes today's program. You may now disconnect.