Fifth Third Bancorp (FITB) Earnings Call Transcript & Summary

All right. Good morning, everyone. Welcome back to the Morgan Stanley Financials Conference in 2021. Our next presentation, we're very excited to have Fifth Third presenting. We have Greg Carmichael, Chairman and CEO. We also have Jamie Leonard, Executive Vice President and Chief Financial Officer. So both of you, welcome to being here. Before we begin, I do have to read very important statement that if you want important disclosures, please see Morgan Stanley's research website morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Before we jump into Q&A, I know Greg has some prepared remarks. So we're going to turn it over to you, Greg, and then go to Q&A right after it. So Greg, it's all yours.

Thanks, Ken, and good morning, everyone. I hope you're all doing well. I'm joined this morning by our CFO, Jamie Leonard. I'll start on Slide 3 of our presentation. At Fifth Third, our purpose is to improve the lives of our customers and the well-being of our communities. We work hard every day to be the one bank people most value and trust. Our culture is reflected in our core values to work together, be respectful, be accountable and always act with integrity. Our purpose, vision and core values got our commitment to generating sustainable value for all stakeholders. Slide 4 provides select proof points of how we live our purpose every day. The right half of the page shows several third-party accolades that support this commitment, which reflect our strong corporate culture, our dedication to acting in the best interest of our customers, a robust compliance program and our overall ESG actions. We'll be publishing our second annual ESG report at the end of the month, which will include expanded employee demographic data as well as our gender and minority pay equity ratios. Fifth Third has always made inclusion and diversity a priority, and our results reflect our actions. Additionally, as a leader in environmental sustainability, we understand that our impact on the environment extends beyond our own operations to include our customers. We recently joined [ SERIES ] and PCAP to further our efforts to measure and manage climate risk in our portfolio. We will be providing enhanced disclosures in our ESG report, including physical and transition risk, as well as our progress in providing sustainable financing opportunities to help our clients. Just as we have consistently delivered on our ESG-related commitments, we have also delivered on our financial commitments, as shown on Slide 5. My commitment to shareholders since becoming the CEO in late 2015 was that Fifth Third would generate strong financial results and perform well through this cycle. The proof points on Slide 5 reflect those outcomes. In late 2016, we formalized our plans under project North Star, articulating several key strategic priorities aimed at generating strong and sustainable long-term financial results, including differentiating our customer experience, optimizing our balance sheet, growing and diversifying our fee revenues and maintaining expense discipline. Over the past several years, you have seen our entire organization rise to the challenge, delivering results and accelerated pace of play in a high-performing and collaborative culture. As we have discussed before, we believe our success ultimately comes down to generating strong customer relationships, which eventually leads to improved returns. Our continued focus on taking care of our customers continues to result in top quartile retail and commercial customer satisfaction scores in tangible, consistent and peer-leading household growth. As an example, we have consistently generated strong consumer household growth over the past 5 years, outpacing the U.S. average by over 5x annually, with growth in both our Southeast and Midwest markets. Results of our efforts over the past 5 years are also evident in our financial returns, with our core ROTCE and ROA metrics improving from the bottom third to the top third among peers. As we continue to drive the company forward, I couldn't be more excited for the opportunities ahead of us as we build upon our success. Now turning to Slide 6. We continue to leverage technology, including our data analytics capabilities to improve our resiliency and better serve our customers. We are prioritizing investments that improve the customer experience, grow households and further drive operational efficiencies. As we have discussed before, we are investing in lean process automation throughout the organization in order to generate $100 million to $150 million in additional annual savings in 2022. Slide 7 provides another great example of how we are leveraging technology and data analytics to deliver solutions that improve the customer experience, increase revenue and drive efficiencies. Our in-house patent-pending analytic capabilities have fundamentally changed how we engage with our customers. Our proprietary approach combines over 200 machine learning algorithms with customer transactional data to personalize hundreds of millions of engagement opportunities across channels, while maintaining customer privacy. This includes using propensity models to provide tailored solutions for our customers. To that end, we have been deploying this technology throughout our retail footprint since the end of last year to help our bankers prioritize their efforts to onboard, follow up and source new opportunities through a portal we call myday. We're very excited about the customer feedback so far, and our bankers love it. Our total retail sales deployments are up over 50% and overall customer relationship strength continues to improve as attrition remains very muted. Additionally, we achieved year-to-date household growth of 4% compared to last year. We've only begun to scratch the surface for what is to come. We will scale this to include nearly 1 billion annual customer interactions across all channels. We are expanding our recommendation engine to all our digital channels and to our direct mailing to further personalize our marketing efforts. With a dedicated team of in-house data scientists, we believe our commitment to innovation through advanced analytics will remain a competitive advantage for Fifth Third. Now turning to Slide 8. We recently rolled out Fifth Third Momentum Banking, which is now our flagship mass market offering in our 11-state retail footprint. Momentum Banking is unparalleled in the industry, combining the best of traditional bank offerings with fintech features. First off, there are no monthly service fees and no minimum balance requirements. Additionally, we offer the broadest array of short-term liquidity solutions in the industry to our customers, including free access to their paycheck up to 2 days early with a qualifying direct deposit through our new feature called early pay, extra time to cure an overdraft until midnight the following business day, immediate access to funds from digital check deposits, algorithm-based smart savings, and short-term on-demand liquidity advances through My Advance formerly referred to as Early Access, all aimed to help customers avoid unnecessary fees. Additionally, Momentum Banking bundles these features with the existing services, including our newly enhanced secure mobile app, the largest U.S. network of fee-free ATMs, and personal, local and high-touch advice systems through our call center and branch network. Turning to Slide 9. I'd like to spend a moment discussing our Southeast branch strategy. As discussed before, we have had a strong and growing presence in a majority of our key Southeast markets for over a decade. We have strong leaders in these markets who have demonstrated results that had outpaced the industry performance. We are the sixth largest bank in our Southeast MSAs by location share, but plans to continue to grow our market share by adding de novo branches in these markets, which have expected population growth rates double the U.S. average. Our Southeast expansion efforts remain focused on deepening our market share primarily in high-growth, midsized metro markets that we know very well. In order to optimize our overall branch network, we leverage our proprietary geoscience capabilities. As a result, we have plans to add 125 Southeast end market de novo branches from 2021 through 2025. These branches are state-of-the-art, with a smaller footprint and a more efficient staffing mode. The vast majority of de novos are focused in markets where we have a clear path to achieving an 8% share or greater. We currently expect to consolidate approximately 85 branches in 2021, which includes an incremental 42 branches in the second half of this year, in addition to the 43 branches we have already consolidated this year. We have experienced limited household attrition from our recent consolidations, which are primarily in our midwest markets, where we have a dense network of branches. We believe that allocating capital to our high-growth markets on an organic basis will generate smart scale and primary customer relationships continues to be the right decision compared to bank M&A opportunities. In fact, we are benefiting from the overall market disruption caused by the recent wave of merger activity in the industry across all businesses from both a customer and talent standpoint. We continue to focus a significant portion of our company-wide hiring and wealth and commercial middle market in the Southeast to accelerate growth and improve our returns. Slide 10 provides more information related to our commercial middle market strategy. We are focusing in areas where we have a proven track record of success, including in our current Southeast markets in California and Texas and in the health care industry. In summary, Fifth Third is a different bank today compared to the Fifth Third from a decade ago. We have significantly improved our financial performance over the past 5 years and are equally excited about the opportunities in front of us. We are committed to generating sustainable value for all stakeholders, continuing to improve the digital experience and deepening relationships, investing for our future, maintaining our discipline throughout the company and deploying capital to maximize long-term profitability. With that, Jamie and I will be happy to take any of your questions.

All right. Great. Thank you, Greg, for going through that. I appreciate it. I guess why don't we start off, sort of a little more big picture. So the Fed HA data suggests that loan balances across the industry are very flat, I mean, basically 0. How do you guys feel about your 1% to 2% sequential loan growth guidance at this point?

Ken, let me tell you, right now, we would be at the lower end of that guidance at 1% to 2%, probably closer to 1% right now. When you look at our business right now, what we're excited about is production is extremely strong, actually over pre-pandemic levels in 2019. So we're excited about the production. Obviously, we're seeing some signs on the lower side of our book business banking and so forth, so that's picking up a little bit. We're also seeing some slight pickup in our diversified portfolio, our FIG portfolio, but that's being offset by pressure on retail, entertainment, lodging, leisure and our dealer floor plan. So line utilization, payoffs, paydowns are still strong, but we believe we'll be at the lower end of our guidance, but, once again, optimistic about our production and the strength of our pipelines right now across our businesses.

Got you. Okay. Now one of the things that, I think, we're -- we -- seems a growing percentage of people on the street are kind of concerned with is that loan growth in the back half of the year might not pick up nearly as much as what the consensus was sort of 1 quarter or 2 ago, especially given all the excess liquidity in the system. How do you guys feel about sort of that back half of the year ramp-up in loan growth?

Well, we're slightly optimistic. I think we're hopeful and expect to see line utilization tick up maybe 1%. We're at historical lows right now at 31%. We would -- normally, we would be at 36%, 37%. Every 1%, it's about $750 million in assets, so you can do the math real quick and the stress that's putting on us. But we expect that to start to tick up. But I'll tell you, Ken, big charge when we talk to our customers is supply chain disruption and labor shortages are creating inventory challenges right now. So hopefully, that starts to mitigate itself over the next couple of quarters, 2, 3 quarters, not a couple of years. So we're optimistic that, hopefully, we'll start to see that pick up in the second half of the year. But once again, I will revert back to production is strong, pipelines are strong. But hopefully, as some of the liquidity runs out -- starts to run out of the system in the later half of this year and next year that potentially we'll start to see some pickup in line utilization and so forth.

And Ken, just to add on to that comment. When we were on the April earnings call, our guide for the year on loan growth was stable to up slightly. I think, today, we would say, given that line utilization lowering from 33% to 32%, our guide, as we sit here today, would be stable to perhaps down slightly given that 1% of line utilization is about $750 million of loan growth. So to Greg's point, production remains strong, but the back half of the year remains a little uncertain.

Yes. I'll make a comment about the -- on the consumer side of the house, where we're seeing some strength. Obviously, our indirect secure portfolio and direct auto, specialty lending is performing well. But typically we do between $5 billion to $7 billion in indirect auto lending. That will go up to close to $9 billion this year. Obviously, with our asset purchase from Jenny May, we'll see about 6% increase sequentially on our mortgage portfolio, all stressed by interest in our credit card portfolio continues to be a challenge for us. So net-net, consumer is going to hold up fairly well. And as I said before, on the commercial side, we'll be at the lower end of our guidance for the quarter. And as Jamie mentioned, for the full year, fairly muted growth over 2020.

All right. Great. Just a follow-up question just on the supply constraints that we're hearing a lot more about that across the industry. Are you seeing any signs that, that's actually getting better, like that is starting to turn or could it actually get worse before it gets better? I'm just kind of curious on how that's playing out.

Ken, it's a good question. I don't know the answer. I suspect it may get worse before it gets better, to be honest with you. I don't -- right now, I don't see a clear path to deal with it. Hopefully, when the enhanced unemployment benefits are running off and the last states are stepping up, it'll be interesting to see how that creates a different trajectory on what we're seeing from a labor perspective. But in the supply chain shortages that we're seeing in semiconductors and so forth, that's keeping hotels and a lot of autos offline right now. We think, hopefully, second half of the year, that chain gets a little stronger, and we start to see that overcome. But it could get worse in the third quarter before it gets better, quite frankly.

Yes. No, it's something we're all watching. That's for sure. All right, Greg. I appreciate the update on the loan portfolio. Maybe switching over to Jamie for a moment. Do you mind also giving a rundown of how the income statement is coming together? Maybe just start with revenues, go through revenues, expenses, credit would be great?

Yes, sure. You don't want to sound too negative with the outlook in terms of all of the uncertainty in the back half of the year. But the reality is the current quarter is shaping up very nicely. Relative to our April expectations, NII will be better. We guided stable to up 1%. We should be up 2% sequentially. That improvement is driven by really 2 factors: one, PPP forgiveness is proceeding at a little bit faster rate, which is good both for our customers and for the company; and then secondarily, the investment portfolio positioning, with the bullet and locked out cash flow structure, has resulted in some prepayment penalties, and that's one of the benefits of how we've positioned our balance sheet. So NII looks to be very good for the second quarter. On a full year basis, we still maintain the down 1% guide. And then from a fee perspective, you do see the underlying activity that is increasing in the economy starting to shine through in the fees. So most of our fee categories are better than what we had expected in April so much so that our guide was down 3% to 5%. I would expect them -- fees to come in around down 1% as card, debit, credit activity, wealth and asset management transactions, capital markets continues to be robust, treasury management. So a lot of positives. The one negative on the fee side would just be mortgage margins are compressing at a little bit faster rate. So mortgage will be a little softer, but net-net, I think a very strong performance from our fee businesses. And so for full year expectation, we would expect fees to be growing at about a 7% rate ex our TRA. But then 1 of the impacts of that is that we'll run at a slightly higher expense level, that expenses would be up 2%. And again, the important factor for us that we're focusing on is that fee to expense growth rate differential of 5 points. We continue to maintain that. So fee should be up 7%, expenses up 2% and overall, really shaping up nicely. We'll have a couple of noncore items impacting the second quarter: one, just given the Visa share price, the total return swap will have a negative impact on the quarter. And then as Greg mentioned, we do have another slate of branch closures for the fourth quarter that there'll be $5 million to $10 million of impairment there. So all of the guide are exclusive of those 2 noncore items. And then in terms of credit, given all of the stimulus as well as the derisking that the company has done over the last several years is really paying off in this environment. And right now, our charge-off expectation is actually below the 25 basis point low end of the range. And as we look out on the year, credit, just given how strong the first half of the year is, I would expect the full year charge-off level to be sub-30 basis points or 30 to 35 basis points for the year. So really, things are shaping up nicely in the near term. And I think the big item is just the uncertainty for the back half of the year.

That's very helpful. Sorry, did I miss expenses in second quarter? Previously, you were down 5% to 7%. Is that unchanged?

Given the strong fee performance, we should be down 5%, so the lower end of the range in terms of expenses, but again, driven by incentive compensation and fulfillment costs. So overall, I think, shaping up to be a good quarter.

All right. That's perfect, very comprehensive. Maybe stepping back from the quarter just a little bit. You've talked about wanting to be a top 5 bank in the Southeast in terms of, I guess, retail deposit perspective. Is that something you can do organically? I know you mentioned, Greg, that you're opening 125 branches. Like how do you think about the organic versus inorganic needs in the Southeast?

Yes. I think we can do it from -- with a de novo approach and organic growth as we've already demonstrated, I think, over the last couple of years. If you look by 2025, we hope to have the majority of our MSAs. We have 8% location share, which will put us as a top 5 bank in many of these markets. So absolutely doable over the next couple of years. And if you think about it, and you look at the markets that I'm referring to, Charlotte, we're going to be there this year in Charlotte, North Carolina; Sarasota, Florida by 2022; Raleigh, we'll be there by 2023; Orlando, '24; Tampa by 2025; Greenville by 2025; Nashville by 2025; and Jacksonville. So we have a plan to get there. Assuming that other banks continue to thin back their networks as we've seen the trend, and if we hit on all cylinders, we think absolutely we could achieve that organically. So we're comfortable with our strategy. As I've said before, we've got great bankers in these markets. We know the markets right now. Household growth in these markets is 6%. You look at de novos we brought on recently, they are 12% of our new household production, and attrition has been very low. So we're very excited about the capabilities that we've demonstrated, the products that we have to offer in those markets and our ability to be very, very competitive on the win relationships. And we've been able to do that, and we're going to do more of that as we become more relevant in these markets that we're structuring for right now.

All right. I'm sure you get asked a lot more about Southeast, but in the interest of time, I'll skip over a few for now, and we can go back to them if we have extra time. Looking at fees, you guys have done, I think, a great job of growing fee income pretty steadily over the last couple of years. Where do you see the most opportunity to grow fee income from here? And how do you get there?

I think it's continue to invest in the nonbank acquisition strategy. There's additional opportunities that are out there in the fintech space that improve and increase our distribution capabilities and product opportunities. So you're going to see more of that from Fifth Third as we advance forward here, as we have done with [indiscernible] our capital markets. I think capital markets is an area you're going to continue to see us elevate and grow in. Our treasury management product set, and you look at some of the offerings we have there, like Expert AR and Expert AP, that's a lead product for us in a lot of our core middle market relationships versus what you would have seen years ago where there was always a credit facility. So that's been impressive. I expect to see that to continue to improve and elevate. Wealth and asset management, we have a tremendous leader and a tremendous team assembled there, and the progress they've made has just been fantastic in the whole transition of intergenerational wealth, in helping small business owners and business owners' transition their businesses from an M&A perspective and wealth perspective. We are extremely confident and excited about what we're seeing in our wealth and asset management side. So wealth and asset management, we got a good deposit base in our retail side house. Deposit fees should hold up extremely well. But really capital markets, treasury management, wealth and asset management, we're very bullish on.

Perfect. Now we always get the question as a sell-side analyst, which banks have the best technology, right? And honestly, that's incredibly hard to answer from the outside. Can you just give us some examples like what's Fifth Third doing in terms of technology to help prove the point that one bank, that you guys in particular, may have better technology than, say, another bank?

Yes. And [indiscernible] back to best technology. Where the proof points are in a couple of new features into the marketplace. Our strategy is by partner build. If the opportunity is there, the technology is there, we acquire that. You've seen us do that on numerous occasions. If not, we partner, companies like GreenSky. I'll probably go down a list of partnerships that we put in place. Then we build it as a third option if we can't buy it or we can't partner with it. And that's allowed us to accelerate a lot of our capabilities into the marketplace. Our new product platform called Momentum, which I mentioned in my opening remarks, is competes against any of the fintech players, all the larger players, and we offer the strong banking capabilities of a traditional bank of branches or ATMs and so forth. So we've been able to introduce technology at a very good pace. In addition to that, leveraging that technology to make it more efficient. We've got over 40 lean process programs in place right now. We're leveraging that technology to take out costs in our operation. We're also starting to change how we -- the discussion. I mentioned a new platform called myday for our bankers out there, which talks about the next best opportunities for discussion, putting that through all of our channels. They said, "whole data analytics, how do we use that information to create outcomes." So where are you going to start to see that is in household growth, you're going to see it in the value of revenue per relationships. You're going to see it in the new relationships on the commercial side of the house. And then you're going to see us be able to serve our customers at a different cadence with respect to new capabilities and opportunities versus some of our peers. That's what you should be looking for. All that has to happen on not the old technology, but when you have to replatform your legacy portfolio of applications to be more digitally enabled into the cloud. So we've been on a journey for the last 3 or 4 years to replatform the majority of our legacy applications. We'll complete that journey in the next 3 years. That allows us to accelerate our capabilities with respect to supporting our commercial customers and our consumer base customers. Once again, with new products and capabilities help them be more efficient and able to bank anywhere anytime and make sure that we have the opportunity to be competitive, extremely competitive against the fintechs and the larger banks, which we believe we are.

Got it. Yes. No, the fintechs come up at time in terms of our conversations. And I know it sounds like -- obviously, you just said your strategy is partner build or buy, but like how -- there's still fintechs that want to take your share. They want to like disrupt the banking industry. Like how meaningful of a risk do you think that is sort of next essential risk to the banking industry versus just eventually those fintechs just more merging or partnering with the banks and so, therefore, becomes less of a risk to the banking industry?

I would tell you, first off, I think you're going to see a lot -- as you listen to our story going forward here and watch some of the actions we take, so you're going to continue to see that partnership or the acquisition of fintech entities being acquired by banks, you're seeing that. And you're going to continue to see that. So I think that's an end game for some of the fintech players to be part of a bank. You also see some fintech players to have that go after acquiring a small bank to get a banking charter. They're a real threat. They are nipping a lot of our profit pools. But I would tell you one thing, the competition makes us better. I think -- at the end of the day, I think the consumer wins. We've got to step up to that challenge. We've got to be able to provide the same features, functionality, capabilities that they're offering, but we have something they can't offer in the fintech space. They can't offer the opportunity to walk into a banking center when you have an issue or a problem, which we know our customers want to do. They don't offer the capabilities to go to 53,000 fee-free ATMs, like our customers are looking to do. So that's important. We have those traditional capabilities very, very efficiently deployed, and we have the digital capabilities of the fintech players like the chimes and so forth that we go head-to-head with those guys. So if you're looking for a holistic bank relationship, you're looking for your primary bank relationship, I think, if a bank is doing the right things, which is advancing our digital capabilities, and are competitive with the fintechs, we're going to win in that discussion, if not immediately, we'll win over time for that consumer.

And Ken, when you look at both sides of the balance sheet, I think, from a deposit perspective, with the rollout of momentum and all the work we've done on digital enablement from customer deposit activity level, I think we compete very well or better. So not that concerned about the existential threat there given all the actions we've taken. But where we do see, to Greg's point, the profit pool is being diminished is point-of-sale or loan origination platforms where fintechs have disintermediated the banks. And so that's something we continue to evaluate.

All right. Perfect. And I guess just going back to expenses just for a minute. A few quarters ago, you announced an expense saving initiative, where you're going to eliminate, I think it's $300 million to $350 million by 2022. Can you just give an update on how that initiative is progressing?

Yes. So the parts -- the 2 components of the initiative were $200 million of savings being generated in 2020 in order to either be reinvested into the company with some of our growth strategies were dropped to the bottom line in 2021. And so those were completed. And I think you see that in the numbers as we have now a fee growth guide significantly higher than the expense guide. So, as Greg mentioned, several of the growth strategies, including the de novo strategy in the Southeast, the hiring of bankers in the Southeast, absorb probably 80% of the savings, and that and the tech -- continued tech investments, but the rest dropped to the bottom line. And then as we look ahead to 2022, we think there's another 1 point or 2 on the efficiency ratio that we can harvest from the lean process automation, intelligent operations and other savings, whether it's branch closures or vendor negotiations that can get us the $100 million to $150 million of savings for 2022, and we're well on track to deliver that for next year.

Perfect. And in the interest of time, I say we've got time for about 1 or 2 more questions. But going back to credit quality, thanks for your update on the charge-off guidance, obviously, better than what we were looking for. But in terms of provisioning, can you just talk -- I don't know if you know this yet or not, but in terms of the macroeconomic variables that, obviously, drive your CECL reserve, has that meaningfully changed since the end of last quarter?

So we use Moody's for our economic scenarios, and we use the Moody's baseline in particular as the primary driver of the CECL reserve. We do use an upside and a downside case, but the primary driver would be the base. The base scenario does continue to improve as the environment plays out with successful rollout of government stimulus and then the rebound in economic activity. So GDP is better, unemployment outlook is better. So those factors would, all things being equal, lead to a reserve release if they hold up through the end of June. And then given the credit outlook that we've had continuing to improve, I think those would point to certainly not a need to increase the reserve.

All right. Perfect. And then if I can squeeze in one last one. We have one come in on the web. Obviously, the -- sorry, MB Financial, Fabulous Steel, are there any inorganic bank opportunities today or similar bank opportunities, too, before rates go up?

We don't -- once again, MB accomplished a critical objective for us is to have the scale in a very, very attractive market where we can win in. We don't see that opportunity in front of us right now. Our focus will be on the Southeast. We don't see an actionable opportunity down there today. So we're focused [indiscernible].

All right. Great. Well, I think that takes us right to time. Greg, Jamie, I want to thank you very much for being here. I really appreciate you participating in the Morgan Stanley Financials Conference.

Thanks, Ken.

Thanks, Ken. Take care. We'll see you.

Thank you.