Fifth Third Bancorp (FITB) Earnings Call Transcript & Summary

Good morning, everyone. I'm Gerard Cassidy here at RBC Capital markets. And with -- and I want to welcome everybody to our 25th Annual Financial Institutions Conference. And we have today presenting Fifth Third. Fifth Third, as many of you know, is the 11th largest bank in the United States with over $200 billion in assets. Its franchise coverage is about -- over 11 -- or it covers 11 states. They have just over 1,100 branches. Market cap is about $26 billion. Stock trades is at about 1.2 to 1.3x book value and they have a dividend yield of just over 3%. The CET1 ratio, common equity Tier 1 ratio, which is always very critical, is at 10.3%. And in the first quarter, they plan or have announced that they could buy back up to $180 million worth of common stock. With us today, I'm very pleased to have Greg Carmichael, the Chairman and CEO of Fifth Third. He will be presenting initially with some slides that you see on the screen. He became the Chairman and CEO of Fifth Third Bancorp back in early 2018, and he joined the company back in 2003. Greg, thank you so much for joining us.

Thanks, Gerard, and good morning, everyone. I hope you're all doing well and staying healthy. I'm joined this morning by our CFO, Jamie Leonard. I'll keep my prepared remarks brief to allow more time for Q&A. I'll start on Slide 3 of the presentation. At Fifth Third, our purpose is to improve the lives of our customers and the well-being of our communities. In times like these, this is more important than ever. And we work very hard every day to be the one bank people most value and trust. Our culture is reflecting our core values to work together, be respectful, be accountable and always act with integrity. Our purpose, vision and core values support our commitment to generate sustainable value for all of our stakeholders. Slide 4 provides select proof points to how we live our purpose every day. The right half of the page shows several third-party accolades which support this commitment. One of the most recent awards I'd like to highlight is that we were once again honored as one of the world's most ethical companies by Ethisphere, reflecting our strong corporate culture, compliance program and ESG actions. We focus on doing well by doing good and be a responsible company, deeply connected to the communities in our 11 state regional footprint, which is shown on Slide 5, where our footprint covers an economically diverse mix of manufacturing, healthcare, technology and service industries from the Midwest to the Southeast. Our Midwest markets have performed exceptionally well since the pandemic, given the concentration of professional workers and less reliance on tourism. As you can see, the unemployment rate of our overall footprint is lower than the national average and has improved at a faster rate since the pandemic, leading to better credit outcomes. We have had a strong and growing impact on our key southeast markets for over a decade. And as we've discussed before, our expansion efforts over the past several years have been primarily focused in these MSAs. We are now the sixth largest bank in our Southeast MSAs by location, but plan to improve our market share by adding an additional 70 de novo branches in these markets by the end of 2023. We continue to believe a strong retail branch network, combined with leading digital capabilities is the best model to serve our customers. In addition to our retail expansion, the Southeast is also where we are focusing a significant portion of our company-wide hiring in our other businesses, including plans add an additional 30 experienced bankers this year in commercial middle market and wealth management to accelerate growth and improve our returns. Now Slide 6 highlights additional actions we have taken to acquire, deepen and retain customer relationships. This has led to a strong household growth over the past 5 years with growth in both our Southeast and Midwest markets. We are excited that our ongoing focus on keeping the customer at the center, including through our digital investments, continues to result in top quartile customer satisfaction scores, intangible, consistent, and peer-leading household growth. We are building on this success. We recently announced a new banking product called Momentum Banking, which has fintech features, including immediate access to funds from digital deposits, short-term on-demand borrowing within our app, free customer access to their paycheck up to 2 days earlier with a qualifying direct deposits starting in June and no monthly service fees. This is now our flagship mass market banking offering, which adds some features we already had, including the largest U.S. bank network of fee-free ATMs, digital messaging, advanced fraud controls and local device and assistance through our branch network. We are also improving the banker and customer experience through an improved recommendation engine. We are leveraging advanced analytics to tailor our customer interactions across channels, similar to Netflix recommendations. We are seeing positive outcomes in our retail channel and are scaling this in our digital channels to provide a relevant and valuable client advice and offers. Now turning to Slide 7. We continue to be optimistic that the U.S. economy has a lot of potential for a robust 2021 and beyond, given the vaccine rollout, pent-up consumer demand, additional stimulus benefits and business investments throughout our footprint. Therefore, we remain disciplined with our balance sheet management strategies in order to generate top quartile returns. Through our balance sheet positioning, we do not have to stretch on credit or interest rate risk to deliver strong financial results. I know we sound like a broken record, but that is easy since we have had the highest investment portfolio yield among peers for the past 7 years. From the second to the fourth quarter of 2020, the markets experienced the lowest interest rates ever with an average 10-year treasury yield of 72 basis points in historically low credit spreads. Unlike others, our portfolio cash flows remain manageable, and we did not need to make long-term investments at these poor entry points. Thanks to our deliberately positioned portfolio of bullet and locked-out securities, new investments added since April constitute just 8% of our year-end securities portfolio. We continue to believe our disciplined approach to the securities portfolio will result in a sustained yield advantage versus peers. As a result, Fifth Third stands alone when comparing portfolio income stability without need to aggressively grow securities. Every other peer either significantly increased their portfolio to try to maintain their income levels or they experienced a significant decline in income. Our stable securities and loan balances, combined with record deposit growth, have led to a significant excess liquidity position, as shown on Slide 8. We have successfully generated core deposit growth 5 points above the industry since the start of 2020 with more than 2/3 of the growth coming from commercial customers, reflecting our ability to capture deposits from our long-standing client relationships. We believe the deposits will remain sticky over the medium term and will increase as more stimulus is implemented. As you can imagine, given our current balance sheet, we are often asked, why don't you invest the excess liquidity. As I have previously discussed, we continue to be bullish on the economy and growth. We also continue to be in a distorted fixed income market due to the Fed's bond buying program. We expect that the yield curve to steepen from the levels experienced last year, and is now up over 100 basis points from the lows of 2020. We believe yields could continue to move higher as the economy emerges from the pandemic. As such, we continue to believe the prudent approach is to not lock into long-term duration positions with yields well below long-term inflation expectations. Assuming no meaningful changes to our economic outlook, we will likely be investing with another 30 to 40 basis points increase in yields. While we are maintaining our investment discipline, we have not been sitting on our hands. We continue to look for alternative ways to prudently deploy liquidity. In early March, we added an additional $600 million in Ginnie Mae forbearance pools from a third-party servicer, along with the $2.1 billion purchase at year-end. Even with our optimism regarding economic growth, we remain cautious on loan growth for the first half of 2021, given the significant levels of liquidity in the system. One benefit from this current environment is that credit outcomes continue to improve. We currently expect first quarter net charge-offs in the 30 to 35 basis point range, which is a 10 basis point improvement from our previous expectation. In full year 2021, net charge-offs, sub 40 basis points. As some of you must have noted, Fifth Third has significant earnings potential in a rising rate scenario, given both our excess liquidity and the belief that we will experience deposit betas well below our modeled 70%. The sensitivity table on Slide 8 shows the potential outcomes in a plus 100 basis point rising rate scenario, assuming different deposit betas and investment levels. We experienced the same 38% deposit beta from the last rising rate cycle and invest about 1/3 of our current excess liquidity over a 12-month period. We expect annual NII to be about 15% higher compared to a static environment. In addition to the strong earnings potential from the combination of higher rates and deploying excess liquidity, we also have meaningful EPS accretion opportunities over the next several quarters from our buyback capacity. Slide 9 shows that under the Fed's current 12-month net income look back test, we expect to have $1 billion plus in 2021 buyback capacity without any change in reserve coverage. Furthermore, under the SCB framework, using our 9.5% CET1 target, consensus earnings estimates and stable dividends in RWA, we could potentially return over $3 billion in total capital over the near term. As we have always done, we will look to thoughtfully and prudently return capitals to our -- capital to our shareholders. As shown on Slide 10, we remain focused on organic capital deployment opportunities, maintaining a strong dividend, non-bank opportunities and share repurchases. As we have said before, bank acquisitions remain a lower priority. In summary, Fifth Third is a significantly different bank compared to the Fifth Third from a decade ago. We are committed to generating sustainable value for stakeholders, continually improving the digital experience and deepening relationships, maintaining our discipline throughout the company, and deploying capital to maximize long-term profitability. And with that, Jamie and I will be more happy to take any of your questions.

I apologize, Greg, I had the mute on while you were speaking. Thank you for those remarks. They're quite bullish, similar to the way we feel about the outlook for the banks. And maybe you could touch on what do you believe will happen for loan growth opportunities in light of your bullishness on the economy? Do you a sense because of the liquidity that corporations and individuals have here over the near term, that it might be slower in the beginning of the year and then pick up momentum as the economy expands? How do you see it shaping up?

It's a good question, Gerard. And it's something we talk about quite often, as you would imagine. First off, we think the first half of the year, we're going to continue to be in a very sluggish loan demand situation. You're looking at unprecedented line utilization rates, payoffs, pay-downs have been extremely strong. We are pleased with the production, as we talked about our footprint. We're pleased with the production we're seeing right now, which is better than what we saw in 2020, maybe not quite where we're at in 2019, but we're starting to see a nice pickup in production. So that's encouraging. We also think with the now liquidity system, it's going to take some time to work that through. So we're hopeful and a little bit more bullish on the second half of the year, we'll see a better pickup. And hopefully, start to see line utilizations pick up a little bit and maybe a slowing of payoffs and pay-downs, but that remains to be seen.

When we look out into a bank's profitability, positive operating leverage is always one of the metrics that can really accentuate profitability. In view of how you see the outlook for your company, including -- it looks very likely we'll get another stimulus plan possibly today or any day now and the economy recovering as we all anticipated this year. Can you share with us your thoughts on achieving positive operating leverage? And what are the levers that you focus on to do that?

First off, Gerard, our expectations, our intentions and our goals are to achieve positive operating leverage in the second half of this year and the levers we're pulling, and we took aggressive action on our expense base at the end of last year, first quarter this year. So we take actions, which are extremely important. Our focus on our fee-based businesses, the outcomes that we're getting right now in our mortgage capital markets, wealth and asset management businesses we feel really good about. So if you think about the levers we can pull to our continued expansion into our new markets, our high-growth markets, are paying off extremely well. And we continue to, like I said, focus on managing the bottom line very well, and we're optimistic that we'll be able to achieve those objectives in the second half of the year. Jamie, if you want to?

Yes. And Gerard, maybe a good place to start in terms of how the second half of the year is shaping up is looking at the first half of the year and, in particular, in the first quarter. Right now, loan growth is shaping up in line with our guide. I think we were one of the more cautious banks. We're at the lower end of our guide in terms of loan growth, right now, where average loans, we expect to be up 2% or so. But then, as Greg mentioned, as that momentum continues throughout the course of the year, will be a big driver in our ability to drive positive operating leverage in the second half of the year. And so from an NII and NIM perspective, I know folks thought we were perhaps a little conservative in our outlook and it turns out we were. NII will be better by a couple of points than our guide. So we'll be down 1 or up 1 but for day count. And so then obviously, NIM will be better. And then, as Greg mentioned, charge-offs are better and fees and expenses are in line. So we really are off to a good start for the year. And I think as that momentum continues, it should continue to build for a very successful second half of 2021.

Very good, Jamie. And a lot of good information there. Possibly, you could tie it in, Greg, to profitability in terms of, as you know, the classic Graham-Dodds analysis of return on equity to price the book or return on tangible common equity to price the tangible book value is already highly correlated. So can you share with us what do you think your optimal ROE, or if you like to talk about ROTCE, that's fine. But where do you think under the way you've transformed this company from 10 years ago, what do you think that could get to? And what kind of environment would we need to support that optimal ROE?

First off, we've talked about since I've been a CEO in 2015, about being good through the cycle. And we initiated Project North Star, took significant balance sheet actions and really reengineered how we think about our business and how we operate our business. When you think about ROTCE, the targets we have out there and our expectations, we will be hopeful of that 14% to 16% range would make most sense, understanding that we can deploy our excess capital. We're not hindered from doing that. As with no additional reserve releases and no significant changes to the tax environment, we think 14% to 16% ROTCE is reasonable for a bank like us, and that would be our objective going forward. Jamie, do you want to add anything on that?

Yes. I think for the near term and the medium term, Gerard, 14% to 16% is what I would call our expectation. And as Greg mentioned, a few caveats there with the environment, the biggest one being that we'd be permitted to operate the company under the Fed capital regime for the 9.5% CET1, which we think is reasonable. But for this year and next year, we see 14% to 16% is achievable for us.

Very good. You did highlight in your opening remarks and you touched on it as well, Jamie, about credit. You're looking at better credit net charge-offs, you revised your estimates as you pointed out, Greg, which is great. Maybe can you share with us your thoughts on your reserve to loans are amongst the highest in the regional bank space and you look at where you are today versus January 1, day 1 CECL reserves, clearly, you and your peers are much higher than that. That this economy really picks up the momentum that many of us expect. It would appear that loan loss reserves are too high. So maybe can you share with us what you're thinking about in loan loss reserve releasing? And is there a day where you could ever get back to the January 1, 2020, CECL reserve levels?

Yes. When it comes to the reserve, I think the biggest challenge is, people ask about it, is that the reserve is really a range of different scenarios and probability weighted in terms of those outcomes. And if you want to pick a path on a single scenario and a single probability, that is above the trend line. Then certainly, all things being equal, you would ultimately have reserve releases. But as we sit here today, we would like to see more data before we would guide to a reserve release. I think when it comes to getting back to the day 1 levels, I think that could take a longer period of time than just several quarters because, again, you're back to needing to have the type of outlook in your underlying economic assumptions that was equal to the view on the economy in the fourth quarter of 2019, which was quite positive. So I think if you pick the baseline scenario or a better than baseline scenario, over time, you would see the industry have reserve releases, but I think we'll talk more about that as we get into earnings season.

Very good. No, it's one of the themes, as you guys know, of why investors are looking at bank stocks today in anticipation of earnings -- better-than-expected earnings. And more importantly, the buildup of capital and what thing could be given back to shareholders in buybacks. I'd like to pivot on another theme that investors are focused on, and you guys talked about it already, but maybe to expand upon a little further, which is interest rates. We've seen the steepening of the curve. Obviously, you're asset-sensitive, especially with that liquidity that you've built up, as you've explained. Can you share with us if the yield curve continues to steepen, there's some talk about the 10-year getting to 2% possibly by the end of the year or sooner. Right now, the forward curve is calling for 2 Fed fund rate increases in 2023. Possibly, if inflation heats up, that may come in sooner. So if you could approach it from 2 parts, please. First, just continued steepening in the curve, what kind of benefits do you think you'd see? And then second, what if the Fed does move faster on the short end of the curve and we get a surprise in '22? You already touched on your betas, which I agree with, and they were very low last time. We think betas in general will be lower for the industry this time due to the liquidity. But what are your guys' thoughts about the steepening? And then again, should we ever see a rise in the short end of the curve?

Yes. I -- we agree with you that we would expect betas worst cases to be in line with the last tightening cycle, we think they should be lower given the liquidity, as you mentioned. So any pull forward in the front end of the curve in terms of Fed action to raise rates would be very beneficial to us. Hopefully, that happens at least in '23, and we would certainly appreciate it in 2022. In terms of the curve steepening, we would like to see another 30 to 40 basis points before we would start to deploy our liquidity. That's the current view, always subject to change based on our view of the environment. But as we sit here today, we think 2% or better entry point would be one that's compelling enough to start deploying the capital. And as Greg mentioned in his prepared remarks, our patience, thus far, has paid off. And so we just want to continue to be thoughtful with deploying that excess liquidity. And in the meantime, the curve steepening that has occurred has obviously helped improve our NII. When you look out -- if you took this year out of the equation, just the curve steepening from January to now, should it persist, that's 1% to 2% pickup in NII post this year. So again, very productive and helpful for an asset-sensitive bank like Fifth Third.

Very good. Greg, you touched on the uses of capital and organic growth, of course, is very important. And you kind of put acquisitions really not on the front of the list, if you will. Can you share with us how you've done with the acquisition MB Financial in Chicago? It appears to have done well. And how does that play into your thinking of maybe not using that strategy to expand maybe further in the southeast, if you want to do that?

First off, we couldn't be more pleased with the performance of the acquisition of MB Financial, the integration it had into the rest of our business, the value-added capabilities that were provided by MB Financial, and it just would differ us in that market from a growth perspective and looking at our ability to be second largest core middle-market company in that market was extremely opportunistic for us. So we're very pleased with the acquisition. We feel really good about the integration. I mentioned that bank acquisitions were lower in our priority list and they are. Our focus is on organic growth. And we talked a lot about that and the investments we've made in the southeast and what we're doing out west. And then our continued investment in our technology and digital capabilities and some of fintech place that we're being aggressive after. I don't see an opportunity right now that in front of us today, that creates the opportunity that MB Financial will create for us in Chicago. But if we were to do something in that space, you would expect that we'd be focused on our core southeast markets where we're already in those markets. We're doing a good job. If we can accelerate our growth in those markets through a smart acquisition that was strategic in nature. We would consider that. But once again, that's low on our priority list. I don't see that right now. So we're very comfortable to continue our path, and we think we're doing a great job. And we think our earnings capability and investments we made are very strong and very -- strong opportunities in front of us.

Very good. I'm interested, Greg, that you have this de novo plan as some of your peers do in opening up, obviously, new branches in growth markets and existing markets that you're in today. Can you share with us how you tie that into your digital strategy, which you just touched on? Can you share with us what you expect to achieve from the digital side and how that is complementary to the branch build-out that you're considering.

As I said in my prepared remarks, Gerard, I think it's a combination of both. You need to have strength in both of those areas. You do need the distribution. We think branches are important and will continue to be important. You don't need the large branches, 4,200 square feet, 3 drop-up windows. I mean we [Audio Gap] staffing model, higher tech branches open some by 24 with the vestibules. So we think branches are important, but you also don't need the density that we once needed, okay? Because people aren't visiting the financial centers as frequently as they once were. We're looking at 70-plus percent of our transactions are now going through our digital channels, but people still want to visit a branch or be close to a branch. It's a big marketing opportunity for us. So that's important. The digital capabilities have to be first rate. And I think we've done a great job, and our team has done a great job of putting up a tremendous platform out there for our consumers, the bank. And we see that, we look at the ratings and how we're going, we're about ready to refresh another version of our mobile app. So those digital capabilities combined with the rightsized distribution in a market makes a lot of sense to us. That's why we're also able to glean back our legacy markets, all right, optimize those markets and reinvest that expense into our higher growth southeast footprint markets.

Very good. Maybe finally, we've got a minute here left for last question, Greg. We share your optimism for the banks, and we're bullish on your company as well as your peers. And I don't know if it's my Irish Catholic upbringing that I was always told, you can't be too optimistic. But can you share with us what are the risks that you -- when you drive home at night and when you leave the office at night, what are the risks that you kind of think about on the horizon in view of a setup for a pretty -- could be a really good year for Fifth Third and others?

Gerard, once again, we are bullish, as we've stated on many occasions recently. But there are growth challenges out there and potential risk. Let's say, there's other mutations of the COVID-19 that the vaccines aren't effective against, that can slow things down and expect that to be the case, but you never know that could be a challenge for us out there. I'm also concerned about the fintech space that competing against the fintechs where we're not on a level playing field from a regulatory perspective and capital requirements, and you go down the list of things that, that's challenge, giving them access to the payment rails is something I'm concerned with if they aren't at the same regulatory requirements that we're at in capital requirements. So the fintech space potentially derailing the recovery with other mutations of the virus will be the concerns in front of you right now. And as we go into next year, obviously, the debt situation, it creates future risk for us, so we've got to be mindful of. So those will be the 3 things on my mind today, but that could change tomorrow. But that's what's on my mind today.

Yes. No, those are very good insights. And Jamie and Greg, I really thank you for joining us. You always have great insights to what's going on at your organization as well as the banking industry. So thank you again.

Thank you, Gerard. We appreciate it.

Thanks, Gerard.

Have a good day.

Yes.