Fifth Third Bancorp (FITB) Earnings Call Transcript & Summary

We'd like to get started with our second day at the RBC Financial Institutions Conference. And on behalf of my colleagues, again, thank you all for joining us. We're very fortunate this morning to kick it off with Fifth Third Bancorp. Many of you know Fifth Third, obviously, being headquartered in Cincinnati. But to my immediate left, we have Tim Spence, the current President and CEO. Tim became President and CEO in July of 2022, and he joined the bank in 2015. And prior to that, he was working at Oliver Wyman, the consulting business. And to his left is its face that we all remember, who has been to many of these conferences in the past, Jamie Leonard. He's Executive Vice President and Chief Financial Officer. Prior to that, he was the Treasurer, and he joined Fifth Third back in 1999. A couple of just quick stats on the company. When you take a look at this, the third, they've got about $208 billion in assets and market cap of about $25 billion. And on a book value adjusted and tangible book value adjusted basis, when you take out the AOCI, they traded at about 1.3x book, 1.7x tangible, and they have a forward PE of 9.4x. With that, Tim, we'll have some opening remarks, and then we'll go into Q&A. Tim?

Very good. Thanks to you, Gerard. I can't tell, Jamie, was the face to remember comment a compliment or...

Well, given me, I can be confident for the last year's conference.

Okay. Well, thank you, Gerard. Good morning to everybody. Jamie and I look forward to answering your questions following a few prepared remarks. At Fifth Third, our goal is to be a top-performing bank through the cycle. We believe the best banks differentiate themselves not by the returns they achieve when markets are supportive, but rather by how well they sustain those return levels against a more challenging backdrop. In fact, our business is a test of endurance and not a sprint. That belief shapes our operational priorities of stability, profitability and growth in that order. By stability, we mean generating consistent returns through the full economic cycle driven by a strong credit profile, a balance sheet that will maintain strong margins even in a down rate environment and strong revenue diversification. In an environment like this one, it also means maintaining a defensive posture in how we run the business. By profitability, we mean producing top-tier returns on tangible common equity and efficiency ratios stemming from consistent expense discipline, leveraging technology to improve operating leverage over time and strong unit economics. Our return metrics, which have improved consistently over the past decade and are now at the upper end of our peer group speak to this focus. By growth, we mean sustained organic growth, which comes from investing steadily in the business to take share in existing markets and to tap into secular tailwinds in the economy that will produce above-market growth. Year in, year out, household growth, clear product differentiation and leading market shares in high-growth markets are among the key measures of success for us. Slide 4 highlights several of the factors that will support a strong, stable return profile for Fifth Third. We have a well-diversified balance sheet. In lending, we maintain a roughly 60-40 commercial to consumer split. And in commercial, we are intentionally overweight C&I relative to commercial real estate. Our regional banking franchise achieves a good geographic balance as roughly half of our originations last year came from our Midwest markets and half from our Southeast and middle market expansion markets. Deposits are the inverse. We maintain a roughly 60-40 consumer to commercial split with a focus on granular operating accounts. Our fee revenues are well diversified across major captions, which has helped us to generate top-tier fees as a percentage of total revenue in a range of market environments and also limited the impact of past and proposed consumer fee regulation. Our consistent focus on operating efficiency is evident when comparing our prior 3-year expense growth to peers. Slide 5 provides more detail on our deposit base. We have one of the highest allocations of consumer deposits in the stable retail category among all institutions that report as part of the LCR rule. Our consumer deposit portfolio is anchored by our differentiated momentum product offering now used by more than 1.2 million households. Our commercial deposit franchise is led by our peer-leading treasury management business. We rank in the top 10 nationally in most all commercial payment types, as shown in EY's annual cash management survey. Our strong core deposit base will be a key differentiator for Fifth Third and a higher for longer interest rate environment. Slide 6 highlights key investments that we have made to support profitability and organic growth. Strategy has been consistent for several years now, established strong positions in attractive markets, build high-quality distribution and differentiate and software-enabled products and drive operating efficiency and client satisfaction through automation and digital enablement, which has allowed us to invest consistently through the cycle. Slide 7 highlights the opportunities inherent in our footprint that will come from the resurgence of manufacturing and infrastructure investments over the coming years. 60% of the U.S. manufacturing jobs announced last year were concentrated in our footprint. And the Midwest and Southeast should continue to benefit disproportionately from the $2 trillion of federal legislation passed in late 2021 and given the multimodal logistical advantages, existing manufacturing base and a favorable cost of doing business in our markets. Slide 8 highlights our progress in the Southeast. We are the sixth largest retail bank and growing at 4x the rate of the population growth in our focused metro areas. De novo branches anchor our deposit-led expansion strategy in the Southeast, and no bank other than JPMorgan has opened as many branches as we have in the past 3 years. Our de novo branches continue to exceed internal projections for household growth. We will open 30 to 35 more per year until we achieve our target density levels in all priority markets. Moving to Slide 9. Over the past few years, we have established ourselves as a leader in tech-led product innovation. We've talked frequently about Momentum Banking, which was launched in 2021 and was the first fintech equivalent everyday banking solution among traditional banks. We have continued to improve momentum with new feature releases every 6 months since launch, including extending our 2-day Early Pay feature to include gig work, government payments and retirement accounts. For this upcoming tax season, we've also added the ability for customers to receive their refunds 5 days early. Importantly, momentum checking accounts are noninterest-bearing with the value exchange focus on benefits that help consumers manage their daily cash flow versus focusing on rate paid. Momentum resonates most strongly with millennial professionals with a median age of 36 and average deposit balances of approximately $9,000. Our FinTech lending platforms, dividend finance and provide are another example of technology-led product innovation. Dividend finished 2022 with a #3 national market share in residential solar finance with a focus on super prime borrowers and an average FICO score above 770. The extension of solar tax credits in the inflation Reduction Act, the elevated energy costs and homeowners' desire to insulate themselves from climate-related weather events will continue to support strong growth in dividends business. Provides market as medical practice finance, and they finished 2022 with the #2 national market share. This is a relationship business for us. Over 80% of our lending relationships also have a deposit or a TM product with average deposit balances greater than $100,000. Provide was also recently recognized by Fast Company as 1 of the world's most innovative companies. In our treasury management business, we focused on building software-enabled managed services that automate the order to cash and procure-to-pay cycles for our clients. This has become a very large business for us. Total managed services ecosystem revenue was approximately $175 million in 2022, and we expect to grow it at a double-digit compound annual growth rate going forward. Our goal is to offer a managed service for each of our focused commercial verticals. The acquisition of Big Data Healthcare, which we announced yesterday and which is detailed on Slide 10, will help achieve this goal in our health care vertical. BDHC is a fintech focused on improving the revenue cycle management value chain through intelligent data automation for hospitals and medical practice groups. Their solution replaces a cumbersome, highly manual process with software and should serve as an attachment point for deposits and deeper treasury management relationships. We added a deeply experienced team and a well-engineered scalable product through this transaction. Turning to Slide 11. We highlight our technology modernization journey. We're making strong progress having converted key applications, including our mobile app, our mortgage loan origination system and our commercial loan origination system to a cloud environment and have now virtualized more than 95% of total bank applications. We expect that most of our remaining core systems, including our general ledger, our deposits platform and treasury management billing, will convert to modern cloud environment between the second half of 2023 and the end of 2025. In summary, even against a more challenging backdrop, we believe the future is bright at Fifth Third. Our strategic and operational priorities remain consistent. The focus on stability, profitability and organic growth to generate strong returns through the full economic cycle. With that, Jamie and I are happy to take your questions.

Thank you, Tim. Maybe we could follow up on something you said in your prepared remarks about the onshoring in your marketplace. You gave a few statistics. Everybody knows about the big Intel plan going up in Columbus. What are some of the other things that you guys are seeing in your footprint?

Yes. That is an important question because I think as we have talked about in the past, the global financial crisis and the global health pandemic have caused people to forget that virtually every other recession in the U.S. prior were regional in nature, right? They were driven by either geographic clusters of industries or property markets that got overheated and otherwise. And I personally, just given the jet wash in the environment right now, have been wondering whether this next recession will, in fact, return to that sort of a model, right? Because you think about the things that we read in the news that we worry about, the tech [ lay-offs ], the empty offices the overheated property markets, they're all concentrated in the large cities in the West Coast and in the Northeast. When you look at the areas where there are tailwinds, in particular, those that are supported by federal spending, right? They are going to be in the midsized markets in the Midwest and the Southeast disproportionately. That stands on 60% of manufacturing jobs having been added in our footprint last year is notable because our footprint represents about 30% of the U.S. population. So there's a 2:1 ratio there. And those manufacturing jobs historically have always generated 2 to 3 additional service jobs as well. So whether it is South Carolina, South Carolina has essentially become the manufacturing base for the German auto industry, right? The BMW plant that is being built down there being expanded will actually produce electric vehicles for the European market. VW announced in the last 2 days that they're going to locate in the same corridor and produce the electric vehicles for Europe as well as the U.S. there, where the battery plants, which Kentucky and Tennessee have won disproportionately, or the advanced manufacturing companies like GE Aerospace, who recently announced that they're going to locate their headquarters post the full dissolution of GE in the Cincinnati area. There is a lot of evidence that we're going to see a tailwind or at least a support -- a level of support in these midsized Midwest and Southeast markets that maybe you don't see in some other places across the country.

Yes. Just coming back to something that you said about the cost office markets. You guys obviously don't have a lot of exposure in the big cities, but is that the markets that you look at as being maybe most stressed?

Yes. I think if you look at the data on badge swipes, right, cities with long commutes or high reliance on public transportation are doing worse than cities with short commutes and more drivers just in general. So you can see it in most of the midsized cities in the Midwest and the Southeast. The cores are pretty vibrant. And in our particular case, in addition to having very little office in total, about $1 billion of the total exposure there, a lot of it is suburban office buildings, where certainly, at least based on our portfolio, the attendance and leasing and otherwise have been more resilient than some of the large projects and large cities.

Got it. Maybe we could shift and go to an update on the outlook for the first quarter or for the full year [indiscernible] over to you guys. Only took you 15 minutes to get to that one.

And that's because I earned 13 of the prepared remarks.

We actually feel good about the quarter. It's shaping up nicely. From a balance sheet perspective, everything is exactly as advertised in terms of the guide, loans. The guide was stable, will be stable, maybe 0.5 point. Deposits, we had said stable to down 1, will be stable to down 1. EPS, we're comfortable with where consensus is lining up. Revenue, we're comfortable with the guide, reaffirmed the revenue guide. I think the challenge in this environment will continue to be the deposit repricing. And so at this point in time, we would expect NII to be 1 point soft, but we would expect fees to be a couple of points better so that revenue ends up netting out. And then just given the fulfillment and incentive costs that come with higher fee revenue expenses, might be a touch higher and then charge-offs are a little bit better. When you add it all up, a very nice quarter for us for the first quarter. And then in terms of the year, it's a consistent theme with the competitive deposit dynamics that as the Fed continues to raise its expectations on terminal Fed funds rate and the market's acceptance of that, you have a phenomenon within the DDA migration as the Fed rates are higher, your earnings credit is higher, you then have more free cash flow in the commercial DDA and that migration from DDA into other products, whether it's IBT savings or off the sheet into money market mutual funds, that is the dynamic that the industry is facing right now. And for us, we had modeled going from a 38% total DDA to total core deposits at the start of this hike cycle. We said we'd expect to be around 32%. So given what we're seeing in the first quarter, we've taken it down 31%. So that's about 1 point of softness in NII. But like I said, we've got some very good activity on the fee side. And net-net, revenue will be in line.

Very good. Coming back to loans for a minute. You guys have taken a more defensive position. When I look back at some of the loan portfolios that you've actually actively kind of reduced. Maybe you can give us some color on where you stand, whether it's leveraged loans or autos, credit cards, et cetera.

So let's take the consumer categories first. When it comes to credit card, that was an asset class that early on in COVID, we felt could have some challenges. So we tightened minimum FICO scores to 720 or better. We continue to be very tight on consumer unsecured. I think if you look at the different financial balance sheet line items, we're one of the worst growing credit card companies in the industry. Ultimately, we think that's the right play, given that these 2020, 2021 vintages are having some pretty high loss rates across the industry, not for us, but across the industry. The other comment I'd make on consumer would be that when we sliced our deposit book, and we're always looking for, okay, what could go wrong or where could we have missed something where we thought we were being defensive and it hasn't played out that way. And what's been interesting is we were going through our February close and looking at the average deposit account balances, what we had was in the pre-COVID era, our average deposit account balance was about $2,200 and then rose to about $4,500 at its peak, given all of the stimulus payments, and then it's come down to about $2,800 per account. So somebody would look at that and say, "Gee, you're 27% higher than where you started." But when you look at 2 cuts of that data, that is where we continue to say we have some concerns. And the 2 cuts are, if you're a FICO sub-660 depositor, your average balance is actually exactly where it was pre-COVID. But if you're 720 or higher, you're 40% better off than you were pre-COVID at this point. And then the other cut, as Tim talked in his prepared remarks, our focus on homeowners. If you're a homeowner, your average deposit balance is 40% higher than pre-COVID. But if you're a renter, you're right back to pre-COVID levels. So when we look at managing the consumer credit, we've been very focused on obviously avoiding the subprime sector as well as being very focused on homeowners, and that's why we have such a high concentration of homeowners on the consumer lending side.

In the auto, you've kind of brought that back down from 2 years ago. I think you originated over $10 billion...

$11 billion if you count the RV marine. We've pulled back there from $11 billion 2 years ago to $7 billion. This year, we're forecasting right now about $6 billion in total production. And that's a business that we know well. We've been in for a long time. And we will dial up or dial down the volume based on both the credit profile as well as the return profile. And frankly, right now, the returns have been pretty solid in auto, at least through the first quarter.

Yes. I think philosophically, in particular, when it comes to credit or believers that it's better to be early and miss a little bit of opportunity extend it is to be late and to look back and wish you hadn't done some of the things that you did. So you're right. I think 1 year ago, one of the questions we were getting is why was it that everybody else could grow loans faster than Fifth Third could, right? And we still have one of the most, if not the most conservative loan guides this year. But the irony of what's happened in the auto business is when we pulled back a year ago, spreads were really tight, residual values were at their high points, right? And today, the credit unions are coming out of that market because they have funding issues. And in the third and fourth quarter, a lot of other banks announced they were going to start pulling back and the spreads are widening. And we found the 4, at least for the time being, on many. So the opportunities in that business, if you're willing to run it elastically do start to materialize again. You just have to be willing to run it at $11 billion 1 year and $5 billion the next and the deal with the loan growth dynamics.

Speaking of the consumer, maybe we could talk a little more about dividend finance. That is one of the growth areas that you do have, and there are some interesting dynamics to that business that maybe not all investors understand.

Yes. Dividend is a great business. And I'm not just saying that because we have the founder of dividend here today. We have been interested in the home improvement sector for many years now, right? That's a well-known thing. And we had the opportunity, either directly through lending partnerships or through looking at the various home improvement properties that were sold over the course of the past few years to get a handle on the different sectors there. The DIY home improvement lending, the lending for whole home renovations, the pools and the water softeners and some of the other things that we saw from the market. And ultimately, we concluded that the best slice of that market was the residential solar market. Part of that is there is a total addressable market that continues to grow, and it's well supported now by a long-term extension of federal tax credits, energy issues and increasingly people's desire to island themselves from Power Grids just given on reliability on that point. And part of it is because it's the only -- it's a very unique lending type. In the short of mortgage refinance, it's basically the only loan that you can make where the customer actually saves money, right? Their total expenses to total income ratio actually improves once they put solar panels on their roof and they substitute a loan payment for what they would be paying back to the energy grid. So that, coupled with the fact that you have positive selection by doing business with homeowners who have signaled that they are conscientious, is really, really good from a lending characteristic perspective. It's also a unique category because the merchants, the contractors themselves pay a platform fee in exchange for arranging financing. And the byproduct of that is you get both the coupon that the borrower pays, plus the benefit of the amortization of the platform fee. At the end of this year, we're going to have $1 billion. We estimate we're going to have $1 billion in unamortized platform fees on the balance sheet. So if we get faster prepayment, the Fed starts cutting, people who have put solar panels on their roof elect to roll them into a first mortgage refinance. You actually get a countercyclical benefit in the form of the acceleration of the recognition of that on the amortized platform fee, which we think adds a really nice countercyclical characteristic. And owing to the complexity of the solar project installation and activation process. There are some defensible competitive moats that you can build around that category that you just can't build the same way around financing a pool or something like that.

Maybe shifting over to credit for a moment because with CECL dividend finance growing so much requires you to build up the reserves. So maybe, Jamie, you share with us what the outlook for credit is credit quality and how this dividend finance is influencing, obviously, the provisioning for this year.

At this point in time, charge-offs continue to be benign. NPAs, we continue to do very well in that space. And so it really comes down to the economic scenarios and loan growth in terms of the CECL build. And this quarter, at least through February, the Moody's scenarios are relatively unchanged from the fourth quarter scenario is a little bit better on unemployment and equity markets and fairly similar on HPI and GDP. So I would not expect much movement in the economic forecast impact. So therefore, you're just left with providing for loan growth. And as we have said for Fifth Third, that typically would be in the $100 million a quarter level, given the strong growth that we have from dividend and the long-lived contractual maturity of that instrument. So we would continue to expect an ACL build in that level.

And on the Moody's comment, last year, each quarter, like second, third and fourth quarter, actually, the outlook deteriorated, which forced the industry where this is the first one in a while to, like you said, be benign, which is interesting. Though we still have March to get.

I was going to say that's true.

That's true.

Worries like the third quarter in a basketball game, not the fourth.

They're a very good point. Mainly just to come back to Momentum, another differentiated product that you folks have. Maybe you could give us a little more color on how you created it? And what are some of those services that the customers appreciate and do they see the value of those services?

Yes. I think one of the underappreciated consumer deposits for the past 3 decades have been the most underappreciated business in banking, right? But in particular, in the last 15 years because rates were low, people just haven't understood the value there. And we have been fielding questions for years about whether checking money would move off of traditional banks and into online banks or off of deposit products entirely and into other sorts of cash management and liquidity platforms. And there is a -- the people psychologically draw a big distinction between who they're willing to borrow money from, which is basically anybody who's going to give it to them, and who they're willing to give their money to and what they expect. So the value in consumer deposits has always been in the operating accounts, the place where you get paid, the way that you manage day in, day out expenses. And when we set out to build momentum a handful of years ago, the reason that we got active was because we were looking out at the fintech landscape and you could see fundamentally better solution for doing the things that people needed to do at least monthly, getting paid, right, and early pays a benefit to that. Stashing away small dollars into short-term savings vehicles, whether that's a rainy day fund or saving for a holiday purchase or an extended vacation or otherwise, managing liquidity in an environment where you had unexpected expenses. And that's where the MyAdvance feature has been really valuable to our customer base and then helping people to avoid unexpected fees because they make a mistake, right? So last year, the Momentum customers avoided like $37 million, $38 million in overdraft fees that they otherwise would have experienced. And they got $27 billion, I believe $25 billion to $30 billion of paychecks credited 2 days early. Those are immensely valuable things to people who are trying to manage their finances on a day in, day out basis. And the quid pro quo for us as a bank is that momentum is a noninterest-bearing account. So you build the value around the things that people do on a day in, day out basis. You help them to understand why it's better to be using a product like Momentum from the banks that also has people in the local market who can help you out if you run into a problem, you got fraud that you got to deal with or otherwise. And they're willing to pay for that service in the form of not capturing higher interest rates on their operational dollars. And I think that's a big part of the reason why the deposit betas on the retail side of the equation that's been much better for Fifth Third than certainly we anticipated on the way into the hiking cycle.

Very good. The betas are really [ barbelled ] right now, where commercial is running very high. And retail continues to be a mid-teen type of beta and therefore, it really emphasizes the value of having a good retail franchise and good retail products, and that's what we're focusing.

We're just about out of time, but 1 quick last question. Maybe, Tim, what's your view about returning capital to shareholders? And how do you approach that?

We didn't start out trying to achieve 1/3, 1/3, 1/3 capital return, but it certainly is easy to remember. Jamie, you don't have to rehearse the answer on that one very frequently. I mean, our goal has been to pay a strong dividend, right, and to run in that sort of 30% to 35% payout ratio on an ongoing basis. Then what we do is we look at the business and we're deliberate about how we think about achieving what we have talked about, which is this sort of strong level of profitability, but a level of profitability that's driven by factors that can be sustained even in an environment where the Fed is cutting and maybe credit is more challenging across the industry. And we do our bottoms-up build and determine what that means in terms of capital that's required in particular to fund balance sheet growth. And then what is left there, we evaluate actively, right? And in environments where we're confident that total loss absorption is sufficient and that we're making the right level of investments in the business. The intent is always to return that capital back to shareholders. And that is the reason that this year, as we got through with the financial planning process, we concluded the $1 billion of buyback capacity was the right thing to be doing. We think it's a very good entry point for the bank. We're very comfortable about the way that we're positioned, and we think we're going to get a good outcome.

Great. Well, please join me in a round of applause. Thank you, Tim and Jamie. And Zions Bancorp is up next. Thank you. Please stay in your seats.