Fifth Third Bancorp (FITB) Earnings Call Transcript & Summary

Thanks, everybody, for joining us on day 3. We are thrilled to have with us today Tim Spence, President, Fifth Third Bancorp; and Jamie Leonard, CFO. Thank you so much for joining us. I have a quick research disclosure, and then we're going to go into a presentation followed by Q&A. For important disclosures, please see Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. All right. Thank you.

Great. Thank you very much, Betsy, and good morning, everybody. I'll go through our presentation. And then, as Betsy said, after prepared remarks, Jamie and I would be happy to answer any questions that you have. First, I'd like to say that it is an honor to serve as Fifth Third's next CEO. For those of you whom I haven't had the opportunity to meet, I've been a part of Fifth Third's executive team since 2015, helping to develop the strategies we're executing today with a focus on profitability, organic growth and tech-enabled innovation. I've been our President since 2020 with direct responsibility for all our business lines and regions as well as our corporate strategy. Moving to Slide 3 of our presentation. At Fifth Third, everything we do is rooted in our purpose, which is to improve the lives of our customers and the well-being of our communities. We believe we can only be successful over the long term if we generate sustainable value for all our stakeholders. We activate our purpose every day through our core values and our vision to be the one bank people most value and trust. It's what makes our culture unique and allows us to fully support our customers, communities, employees and shareholders. Before we turn to the next slide, I want to briefly address the ongoing litigation with the CFPB that has garnered recent attention in the press. Frankly, I was surprised that the most recent events were deemed newsworthy as they are covered standard procedural hearings associated with the legal process and our efforts to get to adjust outcome in the case. These contain no new allegations, no different data and just the hard facts that we've shared since the beginning of the process, which were validated by a third-party auditor and which you can still find on our website. I guess it was a slow news day. I'm very proud of the company we run and the job we do taking care of our consumers. As shown on Slide 4, we have some of the highest customer satisfaction scores of any large bank in the country. And our Net Promoter Score among retail banking customers is a 70, which is unusually good for a bank. We've been consistently voted as the top bank in the country for the job we've done in taking care of customers during the COVID-19 pandemic. And we have the lowest revenue concentration from punitive fees among any of our peers with meaningful consumer operations. We were pleased to be recognized once again in 2022 as one of the world's most ethical companies. Our core products and services like Momentum Banking, our Bank On-certified Express Banking product, our savings accounts and our consumer credit cards carry 0 monthly or annual maintenance fees and generate no value to the bank if they aren't used by the customers who open them. Accordingly, we have 0 mandatory sales quotas or product-specific targets that would encourage someone to sell a product that a customer doesn't need. I am personally very proud of the fact that the company self-identified, remediated and installed systemic controls well before the CFPB filed that suit. And I believe we have been very forthright about our position on this case and the underlying facts. I look forward to having the matter behind us. Slide 5 summarizes the key messages we'd like to cover today. First, with a balanced footprint as the second largest bank by market share in the Midwest and the sixth largest bank in the Southeast, we're well positioned for growth. We have the scale we need to compete in a large addressable market. And we continue to take market share in both our high-growth Southeast markets and in the Midwest. Second, we are growing households through digital products innovation. We believe the digital capabilities can change the customer value proposition in a meaningful way. And we don't think of digital simply as a sales channel but rather as a way to help customers solve problems through software-enabled services like the Momentum Banking ecosystem. Third, our recent fintech acquisitions of Dividend and Provide accelerate high-quality growth -- asset growth of the bank. And fourth, we have a balance sheet management philosophy focused on generating strong and steady results through the cycle. We have an established track record of doing what we say we'll do, executing well to deliver strong financial results and investing in the future. For all of these reasons, we believe Fifth Third is an attractive long-term investment and steward of your capital. Slide 6 provides some additional details on our Southeast footprint and the high priority metro markets. We are the sixth largest bank in these markets with $30 billion in deposits. We generated household growth of 7% in the Southeast last year, which is 8x the industry average in those markets and was led by 11% household growth in North and South Carolina. We expect to expand our presence by adding 25 to 30 branches annually for the next several years until we achieve a top 5 locational share in most of our Southeast markets. Slide 7 highlights our Midwest footprint. Manufacturing clients in these markets possess skilled labor, access to major research universities, logistical advantages and a low cost of doing business that will enable them to benefit disproportionately as companies strengthen supply chains and onshore production. Two recent examples of this trend are just around the corner from our headquarters. In Central Ohio, Intel recently announced plans to build what is expected to be the world's largest semiconductor fabrication facility. It's also expected to bring over 10,000 jobs to the market. In Northern Kentucky, Amazon recently completed a $1.5 billion Prime Air Hub facility, which is the center of Amazon's U.S. cargo network. We're seeing similar investments from the auto industry as major manufacturers retool supply lines for electric vehicles and for domestic battery production. With longstanding experience banking U.S. subsidiaries of foreign firms and as one of the only regional banks in one of -- in -- with offices in key international cities, Fifth Third is uniquely positioned to capitalize on these sorts of opportunities. As Slide 8 highlights, we are leaning into the digital transformation of banking with our award-winning Momentum Banking offering. Momentum is unparalleled among peers, combining the best of innovative fintech product functionality with the strength, access and human touch of a traditional bank. It offers the broadest array of solutions to get access to your money, including free access to your paycheck and other recurring ACH payments up to 2 days early, free overdraft protection, on-demand short-term advances through MyAdvance to help you out in the pinch and algorithmic smart savings to help customers build up a nest egg. Our Momentum product has resonated with our customers and most strongly with millennial professionals with a median age of 37 and average deposit balances of $10,000. As shown on Slide 9, we also have invested through acquisitions such as Provide, a fintech health care practice finance firm tailored to small and medium-sized companies. Provide focuses on dental, veterinary and vision segments and delivers a best-in-class experience through its digital capabilities. We're very excited about the opportunities for growth in front of us with Provide with very strong origination volumes expected this year, reflecting a strong pipeline, added product capabilities and key talent hires. This is a relationship business for us with over 70% of Provide customers also signing up for a deposit or payment service and a high-quality source of loan growth. Slide 10 highlights another strategic fintech acquisition of Dividend Finance, a national point-of-sale consumer lender based on the rapidly growing solar and sustainable home improvement markets. Dividend maintains strong relationships with a robust contractor network, offer sales and product management solutions through a state-of-the-art technology platform and has a customer footprint focused on prime and super-prime borrowers. With 1 month under our belt, Dividend is already generating strong origination volumes exceeding our original targets. We now expect loan originations of around $1.2 billion in the second half of 2022, which is 20% more than our original estimate. Because there are some moving pieces in the balance sheet, Slide 11 provides various components of our estimated loan growth for 2022 that underscore the strength of the company. The slide highlights the commercial organic growth engine. New commercial client growth is expected to contribute 4 points to total Bancorp loan growth this year, all within our existing credit standards. We generated a record level of new quality relationships last year, which has continued at a similar pace through the first half of 2022. We also expect total loans to benefit approximately 1% from the 3.5% increase in line utilization year-to-date. As balances ramp up, Provide and Dividend will contribute 1% to total loan growth this year. We expect these portfolios to improve loan growth by around 2.5% next year. In Consumer, despite our decision to throttle back auto originations, the growth over the past 5 quarters should result in auto and specialty lending contributing around 2% to total loan growth in 2022, offset by the headwinds from the Ginnie Mae portfolio and the GreenSky portfolio runoff. Therefore, we continue to expect total loan growth of 5% to 6% this year relative to 2021 or around 10%, excluding PPP and the Ginnie Mae headwinds. Slide 12 summarizes how we manage the balance sheet to produce differentiated long-term performance. First, we are asset sensitive and well positioned to outperform most banks in the industry from a net interest income perspective. We now expect NII to increase 14% to 15% in 2022, which is a 1-point improvement from our prior expectations. This reflects an additional 25 basis point rate hike compared to our April guide, slightly faster deployment of excess cash into securities and the change in approach with respect to Dividend's existing loan portfolio. We continue to expect net interest margin to expand approximately 70 basis points by the end of the year. At the same time, as prudent risk managers, we always focus on mitigating downside risks over the long-term. During the second quarter, we added $10 billion of additional forward starting swaps to provide long-term protection into 2031. Second, we have been waiting to deploy excess liquidity generated over the past 2 years. During the first quarter, as we achieved our targeted entry points, we grew our securities portfolio by $13 billion. We continue to maintain a differentiated securities portfolio, improving our allocation to bonds with structural protection against reinvestment or extension risk. We believe our prudent approach and persistent focus of maximizing long-term value rather than current period income will result in a continuation of our peer-leading yields for years to come. Last, we focus on managing our credit exposures with continued discipline on underwriting standards and client selection. In the consumer portfolio, we have a prime and super prime focus with a weighted average portfolio FICO score of 765. In fact, our consumer portfolios remain extremely resilient from both a credit and a deposit balance perspective. Deposit balances per household remain elevated well above pre-pandemic levels across all wealth segments, which has not eroded over the past few months despite elevated inflation. Furthermore, the allocation of our loan originations to super prime customers continues to grow. In commercial, our C&I manufacturing portfolios diversified across many subsectors and geographies, our CRE allocation is the lowest among our peers and we have a much smaller leveraged loan portfolio. While credit quality remains benign, and we don't see any particular portfolios of concern at the moment, we're mindful that the Fed's rate hikes could lead to an accelerated normalization of industry credit losses. We have maintained our credit discipline and expect to outperform peers if and when the cycle turns. In summary, we will continue to focus on generating relationships and growing organically throughout our business. We will continue to manage the balance sheet with a through-the-cycle lens. We will maintain our disciplined approach to deploying capital in order to support organic growth, pay a strong dividend, fund nonbank acquisitions to produce profitable growth and accelerate our digital efforts and then execute share repurchases. Bank acquisitions continue to be a lower priority as they have been for many years. We will continue to diligently manage expenses. We have a great culture of accountability and operational discipline and continue to reengineer expense savings while investing for the future. We will continue to streamline and automate processes in order to generate efficiencies. And we will continue to deliver innovative and digitally enabled products and services to our customers. We significantly improved our franchise and financial performance. We're strategically positioned to capitalize on macro trends. And we are intently focused on taking market share through differentiated products, superior service and our unique One Bank delivery model. I'm really excited about the future of Fifth Third and humbled and honored to serve as its next CEO. And with that, Jamie and I are happy to take your questions.

Okay. Tim, thanks so much for that presentation. There's quite a bit to unpack. Maybe I could kick off with just asking a question on how the transition is going and when that official title will be yours.

Thanks for asking. I think the transition has gone very well. I am fortunate to be following an incredible leader in Greg Carmichael, who oversaw really a transformation in the profile of the bank, right? If you just think about the structure of our business, the allocation of our credit portfolio, the focus on returns and stability through the cycle, the bank is really probably in the best shape it has been certainly in the last decade and probably even longer than that. So from my perspective, I have the benefit of inheriting a great institution and the byproduct of that is I've been able just to focus on continuity, right, continuing to ensure that we maintain the expense discipline and continuing to ensure that we're prudent about the way that we manage the balance sheet and then continuing to ensure that we lean in on the opportunities that we see to drive strategic growth in the business like the Southeast, like the digital product innovation, like the focus on the One Bank model.

Super. All right. Thank you. Maybe we could kick off a little bit from a general perspective on understanding what is happening within the commercial footprint. You indicated in many parts of your presentation about the increase in CapEx that's going on in your footprint. Is this a normal course recovery cycle? Or is this a sea change in your footprint there?

I think from my point of view, it is normal at the aggregate level. But there are some differences underneath that Jamie can cover. When we go out and talk to clients, I have had the opportunity to be in, I think, 10 of the 15 markets that we cover over the course of this quarter and to talk with clients there. What we're hearing from folks is that most of the draws right now are either designed to support inventory builds. I think there's a big focus on the movement from just in time to just in case, or they are electing to run the business with more liquidity than they maybe would have operated with prior to the pandemic, just given the uncertainty and the macro backdrop. And they want to have the liquidity available to take advantage of opportunities if they can buy more raw materials or where they see the potential to invest. But it's not broadly distributed, if you look across the business, and probably good to take it from there.

Yes, I think the undercurrent and what we're seeing at the corporate bank level, we're actually seeing higher line utilization, maybe a point higher than pre-pandemic levels. Whereas in middle market, while the second quarter, we've had a nice uptick in line utilization of 2 points, it's still 2 points below pre-pandemic levels. And that's being driven by the inventory builds that Tim mentioned. And then the business banking segment continues to be well below pre-pandemic levels, 7 points below and only at a 25% line utilization rate. So while in total, we've had a 1.5 point increase this quarter, our NII guide assumes a stable line utilization over the rest of the year. Really what's happening is very different within each business segment and for different reasons.

Okay. Got it. And do you think there's anything in that statement you just made about client concerns about the economic outlook?

I think it's more client concerns on access to inventory and ensuring the ability to get through fall and Christmas selling, not necessarily a stockpiling due to a recession scenario.

Got it. Okay. And a little bit on the consumer, you were mentioning how in your book, consumer looks great. And you're not seeing any effects from the increase in inflation that the people have been experiencing in the last 6-plus months. Why do you think that is?

I mean, I think from our perspective, some of it has to do with the composition of our customer base, right? So if you look at the credit book as an example, 85% of total consumer loans at Fifth Third are to homeowners. And if you just separate out auto and credit card, it's about 75% for both of those portfolios. So our customers have the opportunity in the last 24 months to lock in historically low fixed rate mortgage. And the byproduct of that is they effectively corralled housing costs. So if you're a consumer of Fifth Third who owns your home, locked in a low fixed rate and is getting, call it, a 3%, 4% annual merit increase, that's enough to cover a 7%, 8% CPI without a lot of incremental pain. We do hear and we do read when we look at notes across the industry that there is comparatively more stress in, call it, the bottom decile of the credit spectrum or the U.S. population as it relates to deposit balances. And otherwise, that just doesn't happen to be an area where we do much business at all.

And would you underwrite to nonhomeowners, I mean, 15% is non-homeowner, but is that a higher standard that you're applying to them?

Yes, absolutely. We have lending relationships with non-homeowners. It's just the profile of the credit that we elect to originate has a bias to folks that own their homes, right, because you have the mortgage business, the home equity business, previously GreenSky and now Dividend, which are home improvement business lines and then in auto and card. It's primarily existing customers on the card side of the equation and all prime, super prime and on the auto side of the equation it's a super prime book.

Right. That's really interesting. We did some work a few years back and homeowners had a much better credit results in their -- in the credit books than nonhomeowners. Maybe that's not a knowhow statement, but it was back then, so it's useful to know.

Yes.

And thank you for that. Not everybody gives us that percentage. So 85%, that's a good number.

I think Chris will correct me. I think it's technically 86%. I like round number.

Can we talk a little bit about the fee guide? I wanted to just understand what you're saying about the fee guide for second quarter and particularly as it relates to the more capital market sensitive, market-sensitive parts of that business. I know 1Q was a little slow. And I'm just trying to understand, in 2Q, what you're seeing? Is there going to be some return of normalcy or not?

So on the fee guide, certainly, the quarter is going to play out a little bit softer from a fee perspective. The good news is PPNR is right on the guidance that we talked about in April. So how we're getting to what I think will be a very strong quarter for Fifth Third is just turning out to be different. And the biggest driver on the softness in fees is actually in the mortgage book with margins -- retail margins down about 20 basis points, obviously volume declining on the retail and direct channel and so that's about half of the erosion in the fee guide. There's one element that we talked about in May at the London conference, which was the nonqualified deferred comp plans create a little bit of noise in the fee and the expense. So that's about $15 million erosion. And then the other components come back to the capital markets and a little bit of softness in the bond fees. But that's actually a smaller driver relative to the other 2. And then obviously, within the mortgage number, we have the MSR valuation, which we shall see as we get to the end of June, how that plays out. But we feel good about customer acquisition, both in commercial and consumer. We feel good about the prospects for PPNR for the year. It's just the second quarter didn't have the resolution in the capital markets that we were hoping for.

And that capital markets resolution that you're hoping for is really a function of pipelines not being finalized or?

It's more about pipelines being strong. But on the M&A side, deals being kicked out to the back half of the year or when it comes to our bond business, more than a little bit of on-balance sheet lending as opposed to access to the capital markets.

Got it. Okay. And then, the other side of PPNR expenses. So maybe you could give us some color on how you're managing that line, especially as you've been able to -- not able to, but you decided to increase your minimum wage.

Yes. We're going to have a very good quarter on expenses. And to Tim's prepared comments, Greg has really built within the company a culture of expense discipline. And so you look at our numbers for the quarter, from a headcount perspective, all the work that we've put into lean process automation as well as just being a leaner, more efficient company. We closed on dividend, finance acquisition on May 10. We picked up about 235 FTE. Even with the 235 FTE, our headcount will still be down in the quarter. And that's a proof point on just how efficient we've been focusing on automation and leaning out the organization. And then certainly, there's a little bit of a benefit on the expense run rate, just given the softness in fees. But I think overall, the expense outlook for the company continues to indicate that Tim will continue a very expense-minded culture.

Got it. Okay, great. Right. So can we switch to credit for a minute here. Just wondering if you're seeing any impact from inflation on your book of business?

I mean empirically, no, not yet. That doesn't mean we don't worry about it. I think we're naturally pretty paranoid. But again, I think we have the benefit of a slightly different business profile. So we talked about consumer earlier. If you look at the commercial book, the bank does maintained, as I said in my prepared remarks, the lowest allocation to commercial real estate of any of its peers. And we know there are some stress in those sectors that just make up a smaller share of Fifth Third. I think the other thing that's happened over the course of the past 7 years is our leveraged loan portfolio is down about 60% during a period of time when total assets of the bank are up, call it, a rounding year to 80%. So we have very limited exposure to the sectors of the economy that we expect to feel it. Now idiosyncratically, what you see when you talk to clients and what our Chief Credit Officer would tell you, is that sectors where you have -- you do not have control over your input costs or you have a labor shortage. And you can't pass the pricing on to the end customer quickly are starting to see some strain in margins. So a good example of that would be senior living facilities, where you have a shortage in skilled nursing, inflation in terms of labor costs. But the government reimbursements lag in terms of their ability to adjust. I think it's that characteristic that is the thing that we're looking out for on a borrower-to-borrower basis.

Okay. But at this stage nothing that we would see?

No.

And then just give us a sense of your confidence level in net charge-offs being able to remain low here?

I think for the year -- in the quarter, the 20 to 25 basis point range. We're very confident in our ability to deliver that. Certainly, the wildcard to me from a credit perspective is not necessarily going to be the charge-off number, but rather the ACL build and what is required as economic forecasts erode, but we shall see.

And yes, that's a function of does your bear case increase in that CECL reserve?

Right. And we are anchored to the Moody's scenarios. And so the May Moody's scenarios had erosion in the severe scenario. The June scenarios are not out yet. So we shall see what June 30 brings. But right now, if the quarter were to end that severe scenario has certainly gotten a little bit worse.

Okay. Then when it was in April?

Right. Or March for us for quarter end. Yes.

Yes, got it. Okay. And any changes in your view of the economy and what you're faced with since April?

Well, I think we were hopeful in April of a soft landing. I think now we're prepared for a bumpier ride. And certainly, we'll see this afternoon with the Fed announcement. But moving in bigger chunks on the rate side certainly is a little more disruptive. And we're seeing that play out in the fee guide as well as you see some of the asset sensitivity and balance sheet positioning in some of the peers. And then for us, we're still really leveraging the strength of our deposit franchise and feel confident in our ability to manage. Right now, we're expecting a 9% deposit beta for the quarter. So the strength of that deposit book is really showing through in our ability to keep costs down. I know we're -- you have a contrarian view to us in terms of the beta, the cycle versus our cycle -- so it always makes me pause a little bit when someone is smart as you are saying, you think things will be higher. But for now, we're seeing the strength of that deposit franchise play out with a lower beta.

Okay. So I want to get to deposits. But first, I want to finish up the conversation on the reserve ratio. So the 2 other questions I had were just how should we be thinking about the reserve ratio going forward? I know this is a very basic question, but we have CECL and CECL should be and on average over -- you're looking at life of loan in your current reserve level and life of loan includes some normalization. So as net charge-offs normalize, i.e., go up. So as the reserve ratio go up or doesn't stay flat until there's a shift in expectations in your bear case scenario?

So I think the theory behind CECL would be as charge-offs go up, you don't necessarily have to have an increase in your CECL reserve because you should be building the reserve prior to experiencing the charge-offs or that loss event. I think how the reserves ultimately play out over the next couple of years will be interesting to see, given that we believe loss content is actually going to be well controlled. And that's what we see in our CCAR modeling and our ACL modeling is that while there could be disruption and loss events, ultimately, that lost content, at least in our portfolio should be a better experience. With that said, we pick a 3-year reasonable and supportable period. And that's a little bit longer than some of the peers and that can drive differences in the ultimate level of the ACL.

And Dividend and Provide, they are fully reflected in the reserve ratio today?

So Provide is and they roll into the C&I category and they have a very good loss experience. I mean, you can count on one hand, I think the number of charge-offs they've had since their formation. Dividend, on the other hand, we expect $550 million to $600 million of loans at the end of June and versus March 31, that was 0. So there will be -- if you just pick that portfolio on its own there would be a CECL implication for just the dividend loans to the tune of -- right now, we're estimating $35 million to $40 million. But that does not include all of the other movements on the rest of the portfolio.

Okay. And now on your point of deposit betas' being very low, that adds to your asset sensitivity. Can you talk a little bit about adding the fixed swaps Q to date? Why did you decide to do that?

So we have a large portfolio, I think, a very well-positioned portfolio from several years back that mature in '23 and '24. And so we -- call it $11 billion of derivatives. And so our focus has been extending that protection out for perhaps as long as another decade. And so what we've done this quarter, we started last quarter and then have accelerated our plans here. We have been adding about $10 billion of received fixed swaps that actually extend that protection into 2031 because we did 7-year swaps, but 1 to 2-year forward starting. And so we really wanted to make sure that we have that protection should there be a recession '24-'25 that we've protected NII. And as Tim mentioned, we're very focused on being good through the cycle. And certainly, the best way to do that is protect that NII and essentially the asset sensitivity that we've been harvesting as we look at our NII guide and then continue to be a very lean company and generate best-in-class PPNR and RWA outcomes.

So the other question that we had was just around what should we be expecting as we go into earnings season with regard to the AOCI impact from what's going on with the long end of the curve. I would expect that you've got some actions that you've taken during the quarter. Maybe you could give us a sense as to if rates ended where they were -- where they are today or even yesterday or the day before last week would be better to answer, I guess. But anyway, what should we be anticipating here in terms of AOCI has?

So we continue to believe that AFS is the best place for investments to reside. It gives us the ultimate flexibility to take action as needed. It provides -- should we be in a recession, better liquidity channels than something in HTM. So we continue to use AFS. Certainly, the accounting cost to that is the AOCI mark. At the end of May, the number on AOCI would have been about half of the impact as the first quarter. So we were $2.3 billion, $2.4 billion, $2.4 billion swing in the first quarter. So we're, call it, half of that through the end of May. The DV01 in our portfolio is $28 million, $29 million. So depending on where rates are this morning, folks can do the math on where that shakes out.

Yes. Got it. And then I know you managed to CET1. Does it matter where TCE to TA goes? Is there any level that you want to hold or that is irrelevant because you get it back overtime?

Yes, I think the TCE, excluding AOCI, we're in a very good place. We're well positioned versus peers. I think when you include the AOCI being a category for a firm where you don't have to include that in the capital and how we manage the CET1, and frankly, our own internal CET1 targets are our binding constraint right now. So we tend not to use TCE, including AOCI, as a measure as to how we manage the balance sheet.

Okay, great. And then just lastly, on that deposit beta, 9%, did you say is what you're…

For the second quarter, 9%. I think for the first 225, assuming it comes out 225, we'll see, we're at a 25% beta. And we have increased that from the 20% when we started the cycle. But I think we've done a nice job. We've had deposit runoff this quarter exactly in line with what we guided to. We're down $6 billion or so of nonoperational or 100 beta products. And so when you have a strong liquidity position, you can choose to really battle on price as opposed to on volume. And our loan-to-deposit ratio was 70% entering the quarter, call it 74% or so by the end of the quarter and that's still an incredible position to be in.

Right. That year, that can go to how high?

I would like to run the balance sheet in the mid-80s. We've been certainly in the mid-90s. I'd rather not go that high. But I think the mid-80s would be a nice place to be.

Okay. Super. Well, thank you so much for your time this morning, Jamie and Tim. Really appreciate it.

Thank you, Betsy.