Fifth Third Bancorp (FITB) Earnings Call Transcript & Summary

All right. Good morning, everybody. I'm Ken Zerbe, the midcap banks analyst at Morgan Stanley, and I want to welcome you to our 2020 Morgan Stanley Financials Conference. Before I begin, I do need to tell you that for important disclosures, please see Morgan Stanley's research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales rep. Now our next presentation is Fifth Third. With us today, we have Greg Carmichael, Chairman, President and CEO. He's going to give some opening remarks, and we also have Tayfun Tuzun, Chief Financial Officer, who's going to be available during the question-and-answer period a little bit later in the call. I'm really excited to have both of you with us today. I do want to remind everyone in the audience that if you do have any questions that you would like me to ask on the webcast for either Greg or Tayfun, please submit them through the Morgan Stanley conference portal. All right. With that, let me turn it over to Greg, who has some prepared remarks, and then we'll do Q&A right after. So Greg?

Thanks, Ken, and good morning to everyone listening on the webcast. Before going any further, I want to address the events occurring across the country. We are deeply saddened by what is unfolding. And to be clear, racism and discrimination of any form are not tolerated at Fifth Third. We will continue to stand for diversity, inclusion and equality for all. And I personally stand with the black community against racism, violence and hate. Moving to the conference presentation, I would encourage you to please review the cautionary statement on Slide 2. Slide 3 provides an update on Fifth Third and customer actions taken since the onset of the pandemic. Given the timing of the shutdowns throughout the U.S., hardship requests began to rise in mid-March through April. As you can see on this slide, consumer hardship relief requests have declined significantly since then, down approximately 80% from the peak. In commercial, borrowers are utilizing a combination of deferrals and other relief such as covenant waivers assessed on a case-by-case basis. In terms of the Paycheck Protection Program, we successfully originated $5.4 billion worth of loans, benefiting 36,000 small and midsized businesses, which ultimately may have impacted up to 550,000 employees. We are very proud of the positive impact we have made on the economy and society. For context, we were the 53rd largest SBA lender last year by volume, naturally underweighed in small business lending given our skew toward larger clients with more diversified and resilient balance sheets. So for us, becoming the 12th largest PPP lender is a testament to the tremendous efforts of hundreds of Fifth Third employees throughout the bank in our lines of business in legal and compliance in our technology division. They worked very diligently to automate and streamline the application process and get it right for our customers in an efficient and operationally sound manner. With respect to the broader economy and the underlying data we track, we are beginning to see early signs of a rebound in consumer spending and in some areas of our Consumer Lending portfolio. For instance, although year-over-year spend volumes were down as much as 35% at the end of March, activity has steadily increased since then, with total consumer spending currently down just 5% from a year ago. Additionally, there has been a noticeable improvement in auto originations since the April trough while staying within our targeted risk and return profile. Consumers appear to remain in generally good health, reflecting stimulus and unemployment benefits, which has led to stronger consumer deposit growth and lower utilization on revolving lines of credit. Also, mortgage applications have started to increase, consistent with the usual buying season growth rates we normally experience. However, given the low starting point, we expect mortgage production for the second quarter to be down from the first quarter and stable relative to the year ago quarter. As we discussed before, taking care of our customers or taking care of our employees is our top priority. We have continued to emphasize remote working arrangements for employees wherever it is feasible and efficient to do so. The timing of a larger-scale return to our corporate offices will commence only when it is safe. As other banks have noted, we may ultimately allow a more flexible work arrangement for certain employees given productivity levels we are seeing so far in this environment. For our customer-facing employees, we have transitioned to normal operations, including in most of our branches. We continue to implement stringent health and safety standards for our employees and customers. As shown on Slide 4, we are entering this downturn from a position of strength with robust levels of capital liquidity. Our CET1 ratio at the end of the quarter was approximately 9.4%. We will likely see an RWA benefit during the second quarter from declines in C&I revolver rates and overall loan trends. We expect the RWA impact to benefit CET1 by approximately 10 basis points compared to last quarter. Also, as a reminder, our current common dividend is only about 50 basis points of capital per year. We continue to run stress tests on an ongoing basis for our Board to make forward-looking and data-driven decisions about the sustainability of the dividend. Under the current stress scenario, we are comfortable that we will be able to maintain our dividend. We will provide additional thoughts on our capital plans once we learn more from the regulators, including through the CCAR process. From a liquidity perspective, we are currently holding record levels of excess cash and have nearly $100 billion in total liquidity sources. Our short-term liquidity position has swelled since quarter end and is approximately 15x higher compared to 2019, reflecting surging deposit growth and tepid loan demand outside of PPP. Given our liquidity position, we have taken action on the liability side, including aggressively lowering deposit costs through multiple rate cuts and extinguishing $3 billion in home loan advances this quarter. Slide 5 highlights our early cycle hedge and investment portfolio actions to provide long-term NIM protection, which we think will provide meaningful benefits in this rate environment. Our $11 billion worth of cash flow hedges are very attractively priced, as we have previously discussed. With LIBOR around 18 basis points, these hedges will generate nearly $300 million in annual protection for the next few years with continued benefits beyond that. We added hedges earlier than most peers. And while many peers added 18- to 24-month protection, our hedges were all struck with 5-year terms, with some being forward starting. These provide longer-term support given the low likelihood for higher rates over the next several years. And 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, especially in this environment. In fact, we believe that the yield spread between us and peers will likely widen in this environment. As you can see, our securities portfolio continues to generate about half the cash flows compared to the next lowest peer, reflecting our underweight MBS portfolio and our focus on bullet and locked out structures. This provides a valuable shield against reinvestment risk in this environment. As of the end of May, our unrealized hedge and securities portfolio gains were approximately $3.6 billion pretax. All that being said, with the historically high cash levels and the uncertain timing of PPP forgiveness, we expect near-term NIM volatility, with the second quarter likely being the trough for NIM this year, assuming our excess cash position begins to normalize. Setting aside the near-term noise, we believe we are positioned very well relative to peers in this rate environment. Now turning to Slide 6. In addition to proactively hedging against lower rates, we have taken proactive steps over the last several years to strengthen our balance sheet and improve our credit resilience. We have consistently communicated our through-the-cycle principles of disciplined client selection, conservative underwriting and an overall balance sheet management approach focused on a long-term performance horizon. We continue to deemphasize CRE. Since the last downturn, we have maintained a cautious approach focusing on national and regional developers with diversified balance sheets and a strong track record. And we have virtually no land loans. As a result, our CRE as a percentage of total capital continues to be the lowest among our peers. We have also limited our leveraged lending exposures, reducing balances approximately 50% over the last few years. Our highly monitored leveraged loan portfolio is conservatively defined and well diversified by industry and geography. We essentially underwrite our transactions, focusing on client selection. Given the current environment, we are not inclined to add new clients to our leverage book. Our energy portfolio also remains very well positioned in this environment. This portfolio is less levered and more hedged, and before the last oil price downturn, with nearly 80% of portfolio in reserve base structures. Our ongoing stress tests indicate that the level charge-offs in our energy portfolio under stress conditions would not meaningfully deviate from the rest of our commercial portfolio. We are at the later stages of the spring redetermination process. And so far, we have reduced approximately 50% from the RBL portfolio aggregate borrowing base. As shown on Slide 7, in addition to taking prudent steps over the last several years to improve our current credit results, we are also taking proactive measures to improve our credit outcomes going forward. As we navigate the fall off from COVID-19, in commercial, we have developed cross-functional credit advisory forums. They include senior members in credit risk, the line of business and others in the organization with in-depth industry knowledge to drive consistent credit decisions in a holistic manner. We are also reallocating and augmenting resources in our dedicated workout function. In terms of commercial hardship request, we are offering relief where appropriate. This has mostly been in the form of covenant waivers and other modifications and to a lesser extent, principal deferrals. The relief we are providing gives our clients the benefit of time and in many instances, comes with compensating amendments for the bank. We also proactively re-rated commercial credits in the first quarter in response to the economic fallout from COVID-19. Rather than take a wait-and-see approach, we believe in times like these, it's better to take prudent and proactive measures. Given the continued impacts of COVID-19, we expect to see additional downgrades in the second quarter. In consumer, we have enhanced our underwriting standards across almost all products and are also working to augment our collections efforts. Slide 8 provides a snapshot of our exposures to COVID-19 high-impact sectors in the context of the total commercial loan portfolio. The amounts on this page represent about 12% of our total loans, which accounts for 1/3 of our total leverage loan portfolio of just over $4 billion. We are also sharing portfolio level risk mitigants for some of the areas most affected by impacts of COVID-19. And more broadly across these portfolios, we have maintained our disciplined client selection with a focus on larger companies that have access to capital in stressed environments like the one we are in. 75% of our C&I loans in the high-impact industries are Shared National Credits. Turning to Slide 9. We are focused on maintaining a strong PPNR base in this environment. This includes investing in areas of the company that generate long-term efficiencies and scale benefits in areas such as digitization and automation. The pandemic has obviously forced many customers to modify how they interact and transact with Fifth Third. As a result, we're seeing a noticeable channel shift with about 35% of all transactions today taking place in our digital channels. In a digital-first world, we're delivering a banking experience that's simple, seamless and secure. Customers can schedule branch appointments if they need advice from our bankers, engage in asynchronous messaging with us and self-serve in more ways than ever before. These will all produce a better customer experience and generate efficiencies for the bank. We are also digitizing all core consumer and commercial products, including in mortgage, which will streamline the experience for all parties and significantly reduce processing times. This will also generate added efficiencies for the bank. Furthermore, we are investing to automate processes in order to generate long-term efficiencies. This includes call center automation and other improvements in our middle market and back-office functions, including enhancements in our commercial origination platform. We will continue to leverage the technology and generate efficiencies throughout the organization while also providing a differentiated customer and employee experience. Our focus on automation and digitization will support long-term PPNR growth. In addition to technology investments in this space, we expect to support PPNR in other ways in the more immediate term, including through branch and non-branch real estate optimization, vendor management and overall expense management throughout the organization. We are very mindful of the environment we are in and expect to take action to help offset the impact of lower revenues. In summary, we closely monitor the current market dynamics and will continue to allocate resources and capital in a prudent manner. We have spent several years taking practice steps to make our balance sheet more resilient and our revenue streams more diverse. We will put the appropriate level of prioritization and focus on the areas that have the highest probability of driving long-term financial success. We remain focused on maximizing our returns through the full economic cycle, which gives us confidence as we navigate this environment. With that, Tayfun and I will be more than happy to take your questions. Thank you.

All right. Great. Thanks, Greg. Definitely appreciate the prepared remarks. I guess why don't we go ahead and start off on margin, if that's okay. Looking at specifically on Slide 5. Clearly, you guys have been very aggressively hedging portfolio to help protect against lower rates, including swaps and floors that you mentioned on the slide there. And with the sharp movement in LIBOR more recently combined with PPP and the excess cash dynamics, which seem to be having a pretty big impact on your NIM this quarter, can you just walk us through how you see NIM and net interest income progressing through the rest of the year and beyond if rates do stay lower for longer?

Sure. This is Tayfun, Ken. Clearly, obviously, in this environment, we're not assuming any change in the rate outlook. So as we predicted in April during our call, second quarter is truly a transitionary quarter for us. We have -- quarter-to-date, so since the end of March, we've grown our deposits by nearly $21 billion and about $16 billion, $16.5 billion of that is in commercial. So our customers love us. We love our customers, but that clearly has resulted in an outsized cash position. And at this point, we have no plans to invest the cash. So that has about a 30 basis point impact on NIM. And when you combine that with the impact of the PPP loans and continued contraction during the quarter between LIBOR and Fed funds, our second quarter NIM is going to be roughly 50 basis points, maybe even a little bit more than that inside the first quarter number. Now what that does, though, is from a longer-term perspective, clearly, the highly liquid balance sheet gives us the ability to move a lot faster on the deposit side. So we gave a fairly aggressive deposit rate outlook in April. I think we're going to exceed that for the quarter. And I suspect that, that's going to continue throughout the year. And we are predicting that we will be inside the trough deposit rates that we experienced in the last downturn. So from a longer-term margin perspective, as we manage down this cash position that -- even in this rate environment, I think sort of as we approach the year-end and as we look into 2021, that gives us, including the hedges that we have in place and the strong investment portfolio that we were able to construct over the past 2, 3 years, exiting this current abnormal balance sheet composition gives us, I think, a fairly optimistic NIM outlook. It's very difficult to predict here very long term, but I think once we exit this current situation, it should be fine. I don't know if that's going to -- we're obviously remodeling the PPP program now that they've extended the maturity. So once we get through all of that stuff, I think the NIM levels will remain potentially stronger than we may have anticipated even in this very low rate downturn. Clearly, they're shrinking compared to last year, but I think there's good support. From an NII perspective, we guided the second quarter to a fairly stable NII outlook, but we have experienced a much faster paydown on the credit lines. Our utilization rates came down nearly 5 points -- 5-plus points to low 40 -- about 42% or so. Actually, it's even down below that now. So our NII is going to be lower than we expected. Compared to the first quarter, we're probably going to come down about 3%, 3.5% on NII. And -- but again, we always thought that this quarter was going to be a little bit volatile given all the movements on the balance sheet. But I think we clearly see more stability in the rest of the year. Although we've refrained from making long-term predictions on NII, that sort of is more the short-term perspective. And -- but again, we're pretty -- we feel pretty good about where we stand with respect to the hedges, the protection of the balance sheet. And then once we get through these very volatile periods, we feel pretty good about where I think the NIM is going to end up.

All right. That's very helpful. And I guess just maybe a small clarification. You said NIM could be a little bit higher than what you expected longer term given your ability to reprice deposits. But given -- on the NII side, obviously, if that's coming down a little bit in 2Q, can you make the same statement that NII could be better longer term or is that affected?

The comment that I made, we were concerned when the Fed took rates down to 0. Remember, I think in the last rate cycle, our NIM, I think, approached 2.85%. So we were looking at that and trying to see where we would end up. So my comments are relative to the trough at the last downturn in terms of NIM. I'm not quite ready to necessarily provide color on NII because I just want to see and get a little bit more confidence around the loan activity as we manage through this current period. As time goes by, we'll be able to update you with a little bit more better direction on the NII over the next number of quarters.

All right. Perfect. Maybe in terms of loan growth, can you just update us or talking about business sentiment in your footprint, obviously, I think we're saying that we're in a V-shaped recovery, which is going to be great for the economy. Is that what you're hearing from your borrowers in terms of their loan demand?

Ken, this is Greg. I would say today, as we sit here today, we're feeling much better, and I think our customers are feeling better than they were a couple of months ago. So I think that's positive. Obviously, with the reopening varying by states and with some of the latest data that came out on job reports and so forth, give people more optimism that this is going to be more of a V-shaped than an L or a deep U type of recovery, or W. So I think the sentiment is shifting more positive, which is great. And our recent trends that we're looking at and the data that we're looking at suggests that, that's happening. Consumer loan production has ticked up a bit since the crisis, but remain about half the 2019 production levels in many categories. Looking at mortgage refi being the exception, of course, given where rates are and the size of our servicing book, so we've done extremely well there and doing well there. And it appears also that the auto has rebounded quite a bit. So we're pleased to see that. If you look at our card utilization, debit and credit card utilization, definitely trending better. I think our debit transaction is only down 5% year-over-year. So that's positive, that's better than where we were before. The same on the credit cards. So consumers are getting out. They're spending. On the commercial side of the house, shorter PPP, which was obviously very positive, and I gave you some numbers of how many loans Fifth Third has done. Shorter PPP is still fairly muted right now on the loan demand side. There's some activity. But once again, I would definitely characterize it as muted.

All right. Great. Maybe switching to technology. I'm just trying to hit a lot of different topics in the time we have left with, but in terms of technology, obviously, this pandemic has really changed how people think about working, about banking. And Greg, I think you even mentioned that you're considering allowing more people to work from home just given their productivity has been fairly high. Can you just talk a little more broadly about like how are you thinking about the need for Fifth Third to change its business model or just change how it operates or interacts with customers given the pandemic and as we come out of it? And can any of these sort of drive sort of meaningfully improved profitability of the bank or lower efficiency ratio, perhaps?

Yes, I think we can do both. First off, we've been involved and underway in this digital transformation for quite some time, whether it be all our deposit products, loan products, how we serve our customers, mobile capabilities, some of the corporate banking technology that we've deployed, all-around digitization and creating efficiencies and value for our customers, and how we operate our business, whether it be in our operations, AI investments and so forth that we made to continue to reduce our cost to serve our customers. So we've been doing that. What I would tell you the pandemic has done is kind of accelerated digital adoption by our customers, and in some cases, our employees, by about 5 years. If you can look at the charts, and I'll give you a data point, 69% of our transactions were digital. Financial transactions were digital going into the pandemic. And right now, we're about 74%. That's a pretty meaningful jump in transaction -- digital transaction volumes. So you think about the consumer, their comfort level with technology. I think they're going to continue to be very, very supportive of other digital channels and banking through their digital channels. So that starts to bring up other opportunities and we think about our branch network, branch designs and so forth. And Ken, we've been obviously consolidating in that in our branches. I think we've reduced our total branch count by close to 25% over the last 5 years. So we've been very aggressive there. Are there more opportunities when we come out of this? I think when we see what the new normal looks like, we'll continue to assess those opportunities. And then when you think about just our employee base and how we operate as a company, we've been investing heavily in digital capabilities, but we haven't been the best in adopting and using those digital capabilities. I think this pandemic will accelerate the usage of our own technology in-house and also give us some opportunities for efficiency and how we manage our workforce.

All right. Great. I guess just staying on the efficiency topic. I believe your guidance for 2Q obviously is just, let's say, it looks like it was down in the high single digits, low double digits sort of the $1.1 billion base. When we think about expenses and sort of the digitization, is -- like when we think about longer-term expenses, like how -- I don't know, is there a way to quantify sort of that impact? Or I mean -- or do you need, for example, on the other side of it, need to spend more to say, "Okay, digital is here. We know it, so we need to invest." And it almost accelerates some of your digital or technology investments to put you in a better position, at least accelerates in a near-term basis?

Yes. I think what you're going to see and what we've seen is just a shift in how we will we invest in and the pace in which we continue to invest, and more and more, obviously, is going to digital. You look at our technology budget over the last 5 years has gone up significantly year-over-year because of our investments in technology. Now we fully expect to get paid and are getting paid for those investments through efficiencies and new opportunities with our clients. So it's just a shift on our expenses, but there's some big line items out there, so to speak, and we're very mindful of the environment we're operating in. There's some big opportunities around our facilities, contracts, vendor relationships, vendor contract, long-term expensive contracts that we can -- that we're looking at. And we're looking at -- quite frankly, we're going to continue to look for every opportunity to be mindful of the demand that's out there in our business and making sure our resources are appropriately aligned and we're efficiently leveraging our resources. So you'll see more investments in technology. And then when you think about the brick-and-mortar and other areas of the bank, you can expect that we will be very, very aggressive in reducing our costs in those areas.

All right. Perfect. And then just I guess one last question since we're almost out of time. In terms of capital, obviously, you mentioned CCAR is coming up. I think it's the 25th, if I'm not mistaken, of June, when we find out. Has -- so the sort of the revised CCAR process, the pandemic, has any of that changed how Fifth Third thinks about where you want to be from a capital perspective? I think you're at 9.4% last quarter. Your target is roughly around 9.5%. So you're kind of where you are -- you're in line with your target today, but how might that change going forward given what we've just gone through?

Yes. Overall, our thoughts on capital has not changed. I mean, clearly, there's going to be -- depending upon the dip here in the economic environment, capital ratios, I think naturally will come down. But where we have entered this current period is at strength. We obviously apply various scenarios in our credit outlook and performance outlook. We feel very comfortable with where we are. I think from a dividend perspective, we feel comfortable with our dividends. There are some very severe scenarios under which dividends may need to change. But right now, as we look at the size of this downturn, the change in the business environment, we feel very comfortable where the payout ratios are. And given the strength that we have in the franchise in terms of organic capital generation capabilities and the entry point, I think we feel pretty good with where we are.

All right. Perfect. Well, we're out of time. Greg, Tayfun, really want to thank you for taking part in the Morgan Stanley Financials Conference this year. So thank you very much. I'll also say thanks to the audience for listening in.

Thank you, Ken.

Have a good day, everyone.

Thank you, Ken. Appreciate it.