Fifth Third Bancorp (FITB) Earnings Call Transcript & Summary

Good morning, everyone. This is Gerard Cassidy from RBC Capital Markets. We're very pleased to have Fifth Third Bancorp as our next fireside chat. As many of you know, Fifth Third is the 12th largest bank in the United States, with about $211 billion in assets. The market cap is around $29 billion, $30 billion, and the stock trades at about 1.5x book value. It has a dividend yield of approximately 2.7%. We are very pleased that we have today with us the Chairman and CEO, Greg Carmichael. Some of you might recall, he was President of Fifth Third back in 2012, and became CEO in 2015. Also, joining us is Jamie Leonard, the CFO. Jamie was the Chief Risk Officer back in the spring of 2020, and became the CFO in November of 2020. They have some opening remarks, and then we'll go into a fireside chat. And with that, I'll hand it over to you, Jamie and Greg. Take it away, gentlemen.

Thanks, Gerard. 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 4 of the presentation. My commitment to shareholders since becoming CEO in 2015 was that Fifth Third will generate strong financial results and perform well through the full business cycle. We have consistent delivery on that commitment, as evidenced in our peer-leading household growth, top quartile credit metrics, growing and diversifying fee revenues as well as the additional outcomes shown on the slide. With a culture of excellence and accountability, I'm confident that we will continue to drive the bank forward by delivering strong financial results, also focusing on long-term outperformance. Turning to Slide 5. We continue to provide you with a time series of our consumer household growth, highlighting our consistent market share gains. We are gaining share in every market where we compete against firms of all sizes. Growth in our Chicago and Southeast markets has been especially strong, and we continue to strengthen our position in the Midwest. While it's possible for a bank to generate short-term household growth in any one geography or any one quarter through the use of elevated marketing and cash offers, our household growth rates have run 4 to 5x higher than the overall population growth for several years now. It is important to note that our focus is on primary banking relationships. Our success generating outsized household growth comes down to 3 main factors. First, we are focused on generating smart scale in our key growth markets which have favorable demographic trends. Second, we are focused on delivering an outstanding customer experience, as shown by leading third-party surveys. We have improved on the bottom quartile 5 years ago to top quartile today, and have been recognized as the #1 large bank for taking care of customers during the COVID pandemic. And third, we offer differentiated products and services such as Momentum Banking. The success factors in resolving organic household growth all support sustained financial outperformance versus peers. Slide 6 highlights the composition of our deposit fee revenue. We have been delivered about proactively reducing our reliance on consumer deposit fees for several years, not just when it became a focal point in the industry. As a result, we have the lowest concentration of overdraft revenue as it pertains to deposit fees among peers. Our Momentum Banking product will further enhance those efforts through a range of liquidity solutions, to avoid punitive fees such as Early Pay, Extra Time, MyAdvance, free overdraft protection, and immediate funds availability, all with no monthly fee. It appears that most of the recent announcements from other institutions are trying to catch up to the customer value proposition that Fifth Third is delivering. We will continue to enhance our Momentum product offering, including providing additional digital capabilities. We also recently enacted additional policy changes, including eliminating NSF fees, which will have a negligible impact on our revenue. We have also been deliberately investing in our TM business for several years, with a focus on providing digitally-enabled managed services, including automation services like Expert AR, Expert AP and currency processing solutions. We already were well-positioned heading into the pandemic. The demand has accelerated in the past 24 months, as our clients have faced the increasing need to digitize and automate their back-office functions. Our TM revenue as a percentage of total revenue is the highest among peers and the fastest growing on a organic basis. These solutions drive new quality relationships to the bank, and provide a source of significant growth in operational deposits. We continue to invest in commercial payments, providing value-added services to support our key industry verticals. Turning to Slide 7. Our commitment to providing value-added client solutions in all of our businesses is evident in our growing and well-diversified fee revenues, which now make up approximately 40% of our total revenue. Our total fee mix has remained above the peer medium for the past 5 years. Over that time, we have generated strong fee growth across most captions, with success led by Commercial Banking, Treasury Management and Wealth & Asset Management. We will continue to look to add fee-generating capabilities where it complements our key industry verticals, including capital markets, TM, and Wealth & Asset Management. We recently exit a small nonstrategic business acquired from MB Financial called LaSalle Solutions, which provides lifecycle asset management services. The impact of the sale on our fees and expenses was included in our January guidance. Slide 8 highlights our industry vertical strategy and our commercial franchise. Dating back to the launch of our health care vertical in 2008, we have invested in talent, technology in the full suite of banking, capital markets and payment services to provide clients with industry-specific expertise, insights and solutions. These investments have enabled us to generate strong financial returns with consistent and disciplined risk management. As a result of our ongoing investments, the share of our debt capital markets transactions with favorable economics has consistently improved over the past several years. For instance, just a few years ago, the percentage of transactions where we were the deal book runner was around 20%. Today, it's around 40%. Similarly, our loan syndication business. A few years ago, we were the lead arranger on just over half of our transactions. Today, we're the mandated lead arranger on over 80% of our transactions. You can see on the slide that the financial performance from our industry verticals has been outstanding, including the total fee revenue, which has increased at a 17% compound annual growth rate since 2015. We continue to elevate additional growth opportunities in Commercial where we can provide industry-specific expertise. For instance, we plan to expand our residential mortgage warehouse financing business over the next several years. We have hired an experienced relationship team, as well as key sales, operations and credit personnel. We will share more about this business later this year. Slide 9 provides more information related to our commercial middle market strategy. Our California middle market portfolio has the highest percentage of manufacturing loans among all of our regions. Additionally, approximately 2/3 of our relationships are bilateral. Across all our expansion markets, our credit quality is strong, with criticized asset ratios significantly below the firm average. We remain focused in areas where we have a proven track record of success, including in our current Southeast markets in California and Texas and our industry verticals. We have excellent regional leadership with deep local market knowledge. Our middle market growth strategies are centered around growing and deepening relationships within our credit risk appetite or to improve long-term profitability and overall portfolio diversification and granularity. As we show the bottom of this slide, coming off a record 2021, we expect continued growth in middle market loan production in all of our geographies. Slide 10 summarizes the key aspects of our balance sheet management, and our focus on long-term outperformance. First, we are highly asset-sensitive and well-positioned to outperform, with a near certainty that the fed will raise interest rates next week. At the same time, as prudent risk managers, we always focus on mitigating downside risk over the long term. Second, we have been patient with the excess liquidity we have generated over the past 2 years. In fact, it was during this RBC conference last year that we highlighted that we would be willing to wait a significant period of time before growing our securities portfolio in light of the record low yields on investment opportunities available at the time, sacrificing current income in order to wait for a better opportunity. The past month has absolutely validated our patience in managing securities portfolio as rates achieved are targeted entry points. Third, we continue to maintain a differentiated securities portfolio, which has allocated approximately 60% the bullet and locked out structures. When we purchased bonds with these features, we sacrificed current period income for stability over various rate scenarios over a long duration. Our persistent focus on maximizing long-term value rather than current period income has led to our peer-leading securities yield for 8 consecutive years in counting. Last, we focus on managing our credit exposure and our loan portfolio with continued discipline on structure and client selection. Slide 11 provides more context on our asset sensitivity, which is perhaps not fully appreciated, given differences with various outflow disclosures. Considering our current balance sheet and forecast, we expect that each 25 basis point rate hike will add approximately $120 million to $140 million to annual NII, or approximately 6 to 7 basis points to NIM. We expect deposit betas to be lower than past cycles. We forecast a beta of approximately 13% for the first 100 basis points compared to 22% during the last rate hike cycle, where the first couple of hikes beta should even be lower, and largely reflecting just the index deposits of approximately $7 billion. Our projection of lower deposit betas is supported by our successful improvement in the quality of our deposit base in the consumer and commercial lines of business, as well as the overall excess liquidity in the financial system. Slide 12 compares some of the key balance sheet ratios to our peer group. We have been patiently deploying our excess liquidity over the past 2 years. As a result, we have one of the highest interest-bearing cash positions. Similarly, we have held one of the lowest security balances as a percentage of earning assets, while the median peer has grown the portfolio around 30%. Since the onset of the pandemic, we have maintained relatively stable balances. This quarter, we began to put the excess liquidity to work, and we'll grow the investment portfolio this quarter. We also continue to deploy liquidity through strong loan growth, organic asset generation and acquisitions like Provide and Dividend Finance. Slide 13 highlights some key aspects of our current -- of our recent securities purchases. We have grown the securities portfolio by approximately $5.5 billion in the first quarter, with purchases yielding around 2.2%. Given our overall balance sheet composition and taking into account our prudent interest rate risk management, we have been intentionally underweight mortgage-backed securities. We continue to favor securities which have predictable cash flows, especially in the current environment, with the high likelihood that mortgages will significantly extend. Slide 14 highlights our disciplined credit underwriting and client selection. In the Commercial portfolio, our C&I manufacturing portfolio was diversified across many subsectors and geographies, and our CRE allocation is the lowest among peers. Additionally, our criticized assets have declined more than 50% from the COVID peak. In the consumer portfolio, we have a prime and super prime focus with a weighted average portfolio of FICO score of 765. In summary, Fifth Third is a different bank today than the Fifth Third of a decade ago. We have delivered on our commitments and remain focused on generating long-term through-the-cycle outperformance. We have significantly improved our franchise and financial performance, and we'll sustain the management discipline and commitment to customer-focused investments in our markets, products and platforms. We will continue to deploy capital prudently, where it fits our strategic objectives to maximize long-term profitability. And with that, Jamie and I'll be more than happy to take your questions. Thank you.

Great. Thank you very much for those opening remarks. Maybe we can start off with a macro view where the pandemic seemingly is behind us, but there's still lingering supply chain issues, of course, and labor issues. And with the rising concern of inflation, very likely, to your point, we agree with you. The Fed is very likely to move on rates next week, with the likely -- another rates coming up this year, possibly more than 2x or 3x, but we'll have to wait and see, and of course, the conflict going on in Ukraine. Can you share with us what are you hearing from your customers? What's the current state of affairs amongst your customer base?

All the factors you mentioned are playing into the thinking and the considerations that our customers are having today, and creates more uncertainty out there. And that's what we're hearing from them. Just the uncertainty concerns them. Some of them pausing to wait to see how the environment unfolds here. When you think about commodity prices, especially gas prices, you look at the significant labor shortage. Supply chain disruptions are being exacerbated by the Ukraine situation. How does that play out, when does it play out, what's the impact on their business, what's the impact on economy -- We're also with inflation on a 4-year high, with the certainty the Fed is going to raise rates with pace to a level of disruption. So there's a lot of uncertainty out there and not a lot of clarity. So, some of them pause and thinking through what might -- how the centers might play out, and being very cautious and thoughtful. Think about the environment today than what we thought -- and how we thought about just 60 days ago. very different. We are very optimistic on GDP growth, very optimistic on a thoughtful rate increases through the year. We are very bullish on how the economy would play itself out. Right now, there's more uncertainty. So we're being very cautious. They're being very cautious.

Yes, I totally agree with you that the optimism themes have shifted to cautious optimism. Greg, you pointed out about you're investing some of the liquidity. You and Jamie have done a very good job in managing that balance sheet. And as we enter into this period of fed tightening, again, we're not certain how far they're going to go. But when you think about it, what they may pursue even with quantitative tightening, where they actually shrink the balance sheet, can you give us a sense of how you guys are managing the balance sheet going forward, under the assumption that there will be further rate increases, and the possibility -- maybe it's not highly likely, but the possibility of quantitative tightening and shrinking the fed's balance sheet?

Thanks for the question. And certainly, you're hitting on the biggest risk facing the industry, and facing Fifth Third is what are the fed actions going to be during 2022. And will the quantitative tightening occur at such a pace, both from a rate hike perspective as well as a sell-down, or shrinking of their balance sheet, and ultimately the pace and the magnitude of those actions, will it be too much and therefore, roll over the economy into a recession. And so as Greg mentioned in his prepared remarks, really the biggest change we've had from a balance sheet management perspective between the start of the year and today, was the fact that we do view that chance of a recession as being a higher probability than we did earlier in the year. And ultimately that a curve steepening and the ultimate apex of rates, as we sit here today, we think is going to be lower. And therefore, we have put a significant amount of liquidity to work in the investment portfolio. And we'll grow the portfolio on an average basis about $3 billion or so, maybe a little more versus our guide at the start of the year was $1 billion of growth. We thought this would be the right environment to leg into $1 billion a quarter. But certainly, the events -- the geopolitical events that have gone on have caused us to accelerate the deployment of that, in order to protect the balance sheet to a higher probability of a downturn. Certainly, from a rate hike and revenue perspective, that's going to be productive. Our balance sheet is very asset-sensitive, and we will have a very good year from a NII outcome standpoint. And so the challenge becomes in a high inflationary economy, can you manage your expense base and can you manage the credit. And those are the 2 things that we've been very disciplined on over the past several years. And so we're comfortable with our ability to maintain expense and manage through the wage pressures, while also being good through the cycle from a credit perspective. Our consumer portfolio, consumers continue to be well-positioned, given that we are a prime, super prime consumer portfolio. And then from a commercial standpoint, obviously, our focus has been on credit selection and underwriting. We underwrite to various rate scenarios, and we feel good about how the balance sheet is positioned, regardless of the path of the economy. And given that uncertainty, if rates go up, we think we'll be well-positioned relative to peers, and then the same is true to the downside being good through the cycle.

Very helpful, Jamie. If we dig a little deeper on the credit aspects of your commentary, are there any particular sectors that you're especially just keeping your eye on in an environment where the fed may have to raise rates, or the economy really slows down because of these -- the price of oil being so high? What sectors do you kind of really focus on to make sure you guys really know what's going on with those customers?

Yes. Let me start, then I'll throw it over to Jamie for any additional color around it. And first off, as Jamie mentioned, we've been very focused on performing well through the cycle, and that's been my commitment since I became CEO. So when we think about our underwriting standards, and we have reached through -- over the last 5 years. We're very disciplined here. We want to make sure that we will perform well through this cycle. So nothing has changed there. But we're always watching certain sectors, as you might imagine, especially with the uncertainty and some of the challenges that we're seeing out today. Leveraged loans are always a higher risk sector for us, which we're down. We'll leverage from a percentage perspective 50% versus where we were in the 2015 time frame on leverage loans, but something we watch. On the CRE, even though we have a lower concentration of CRE, not only occupied, especially in the pandemic sectors, we're watching that very carefully. And as you think about rent rates and so forth, as you go into on certain parts of our market, West Coast, East Coast, go down the list, we're concerned about the rate of those rate increases outpacing wage increases and so forth. So we're watching that very carefully. As Jamie mentioned, on the consumer side, we're a prime -- super prime lender, as I mentioned in my prepared remarks. The stress will show up on the lower end of the FICO spectrum than it will on where we're at. But we're watching our consumers very carefully also. And I think for the next 12 to 18 months, our credit performance, we're going to hold up extremely well. If you look at this year, our guidance on the first quarter, I think, Jamie, we were 15 to 20 basis points. We'll be at the lower end of that range, 20% to 25% for the full year. We think that plays out pretty comfortably. But after 18 months, it gets harder to predict where things are going to trend. But we're very comfortable with our client selection. But the areas of focus, the leveraged loans, CRE, non-occupied, the pandemic sector, and we're going to watch that carefully. They've been weakened, obviously, coming to the pandemic. And with all the other factors we're talking about, labor, commodity prices, supply chain disruptions, how they're going to perform, and are we going to see another variant of COVID. So we're just very mindful of how that sector is performing. Jamie, if you want to add anything?

Yes. I think the non-owner occupied we've talked about, and the Central Business district hotels, our asset classes within CRE that we'll continue to monitor. And then, given the strength in collateral values on the consumer side, we're mindful of the volatility and the risks that could occur with fluctuations there. And I think we've done a nice job being prudent on consumer unsecured.

And maybe you guys can share with us -- Greg, that, when you look back at past credit cycles -- and certainly, we really shouldn't use what we saw in 2020 since that were quite unusual with what the federal government did in the Federal Reserve, the bullet sound of that pandemic-induced recession -- but it seems to me that, going into a typical downlink of a credit cycle, we have excesses in the system. Lending standards are very aggressive. Just -- it's overdone, which contributes to the losses during the credit cycle. But even though we may get into an economic slowdown due to what's going on right now, is it fair for us to say that we just don't see the excesses ahead of time? So even if we do go into a downturn -- and yes, you guys are -- you changed your book completely, I understand that. But shouldn't you -- the industry and yourselves maybe get through a little -- not easier, but better, because we just don't have the crazy lending going on? Or am I wrong in saying that?

No, I think you're absolutely right. I mean, listen, I lived through the financial crisis. I saw what bad looks like, and that formed a lot of how we think about our business. That's why when we talk about being good through the cycle, we know we're going to operate this bank in a lower rate environment, we know we're going to operate this bank in a recession. So what do we have to do to make sure we hold up well, perform well and come out the other end at the top quartile performance of the peer group? So, when loan growth was tough, we didn't reach. You watched us manage through that. We were not going to come off our disciplined approach of how we select clients. We were going to bank -- you've watched us exit certain industries. You've watched us push out $7 billion of commercial C&I loans that didn't meet our risk to return profile. And we're very, very selective on how we think about our clients, both on the consumer and on the commercial side of the house. So, I think the industry as a whole will fare better. We're all sitting on a lot more capital, liquidity is extremely strong. You go back and you credit the CCAR process and everything. We're very, very strong. We'll be a source of strength through those challenging environments versus where we were in the last financial crisis. So, I'm very optimistic that the banking sector itself will hold up well. Business stress, so we stress. The way we build Fifth Third, and the blend that we are on the consumer side, on the commercial side, we're going to perform well during the downturn in the credit cycle. I think banks will perform better, but I think we're going to perform extremely well.

That's good to hear. That really is. Maybe pivoting for a minute, and kind of coming back to some of the highlights of your presentation, Greg. When we look at loan growth, the HA data through the end of last year, really the loan growth picked up nicely in December. Then the start of the year, things have slowed down a little bit prior -- even prior to this current situation over in Ukraine. Can you guys give us some color on -- your further color on what you're seeing and what's driving loan growth? And what some of your business customers are telling you about them drawing down lines to maybe increase your utilization rates in certain areas?

Gerard, we put in the presentation in the appendix, some of the line utilization details. But at a high level, walking through the balance sheet for the quarter, our loan guide was -- total loans will grow 1% to 2%. We'll be at the upper half of that range because we had such a strong pipeline heading into the year. And you can see in that appendix, an uptick in line utilization, and that's predominantly in the corporate banking book. As we had talked about previously, middle-market and Business Banking had a nice uptick in the fourth quarter, and we were waiting for the larger corporate book to have a little bit of a lift. And given some of the capital markets disruption in the first quarter, you're starting to see a little bit better line utilization, which is a nice outcome. So we'll be in the upper end of the 1% to 2% range on loan growth, with C&I being better. We had said up -- perhaps as high as 6%. Right now, we're tracking to 6% to 7% on C&I, but resi-mortgage in this environment is lower, and therefore, offsetting that strong C&I growth. So, from a loan perspective, feeling good. From a deposit perspective, deposits are growing even with the commercial seasonal runoff. So, deposits will be up just a little bit, 0.5 point to 1 point. And then as we talked about -- really the big change in the balance sheet will be more securities deployed, and as Greg said, on a point-to-point basis, $6 billion on an average basis. Maybe it's in the $3 billion range, but overall, really, the balance sheet is off to a nice start, even with all the volatility that's gone on.

Very helpful, Jamie. One of the things you guys have done well over the years, Greg, is that, you've managed your capital very effectively. You've monetized some of your assets, and have taken that monetization and purchase, repurchase your shares, of course. So maybe when you look at capital going forward, and the choice between buying back your stock, raising the dividend, can you give us an update on just how you guys are thinking about the deployment of your capital on an annual basis?

Absolutely, Gerard. It's been very consistent over the last 6, 7 years, how we think about capital deployment. First off, it's organic growth, is what we're focused on, our expansion in the Southeast, our expansion on the West Coast, our investment in our people, technology, products and services. That's the best all we can spend is our organic growth. We have great talent in the marketplace. I couldn't be more proud of the team that we've assembled. We're taking market share, and we talked about the consumer household growth. You look at the net new relationships, quality relationships we're bringing on the commercial side. Those investments are paying off in a large way for us. So that's #1. We'll get that right. And then, nonbank M&A bolt-on opportunities that make us a better provider to our clients, both consumer and commercial. So acquisitions like Provide, announcement on Dividend Finance that we'll be closing here shortly. H2C, Coker [indiscernible], Franklin Street Partners, those opportunities that just make us a better bank, provide additional fee capability for us, also lending capabilities, asset generators for us, where if you look for those opportunities that make sense for us, I think we've been very, very thoughtful about those opportunities. We've done a nice job of integrating them, and we like the outcomes that we're getting. And we couldn't be more excited about our recent acquisition of Provide and its performance in the first 5 or 6 months. So that's felt really good. And then, it's paying a strong dividend. We want to make sure we continue to pay a strong do. We're focused on that. It's very -- we know how important that is for all of our shareholders. So we're going to continue to focus on paying a strong dividend. And then it would be share repurchases -- would be the next focus of opportunity. With bank M&A being the lowest area of focus for us, it's very disruptive. It's tough to do. We don't see M&A as a strategy itself, some of our -- some of the banks do. We don't believe M&A is a strategy. We think M&A is a mechanism and a vehicle we wish to achieve your strategies. So we're extremely thoughtful. We're extremely selective in how we think about bank M&A, and who we want to partner with and what opportunities might be out there. So it's very low on our priority list right now.

And with the bank M&A, with a bank your size, of course, with the regulatory changes underway in Washington, does that kind of also factor into your thinking on depository transactions being low on the list, or no, that's really not a factor at this time?

Well, they were low on the list to begin with. I think it's a factor for the industry is to consider good bank transactions. Banking -- the transaction will get done, may take a little bit longer as you're seeing from some recent transactions, but those transactions get done. So it does factor in, but I'm less concerned about that, about how we think about our business. If there was a transaction that fit into the lens in which we put a transaction through, the regulatory environment would be something to consider, but we would -- that wouldn't stand in our way of doing something that was right for the business.

Got it. Yes. I've just seen we've run over a little bit here, but well worth it. Greg and Jamie, thank you so much for joining us once again. It's always a pleasure. And hopefully, next year, we'll see you in person should you be kind enough to come back. So thank you again, gentlemen.

Thank you, Gerard. Take Care. Bye.

Thanks, Gerard.

Bye-bye.