Fifth Third Bancorp (FITB) Earnings Call Transcript & Summary

Thank you, everyone, for joining. Thank you, Tim, most of all. Delighted to have Tim Spence, CEO of Fifth Third joining us. This is his first year at our strategic decisions conference, but he's been in leadership positions at Fifth Third for almost a decade, including the past several years as CEO. And over that time, he's done a great job of navigating the pandemic with the stock now at a premium multiple, at least for regional banks. I don't know that any regional banks at a high multiple, but you are less...

Not high enough.

He has been passionate about technology throughout that time and has helped spearhead the Southeast build-out, which is one of the more successful de novo expansions among regional banks. So I'm sure we'll talk about all those topics in due course. But first, thank you for joining.

And maybe to kick things off, you spend a lot of time speaking and meeting both with internal and external constituents, get a lot of different views on different industries. Let's just start here what you're hearing from customers and how that's informing your macro view?

Yes. Here's what I would say. I think customers, in general, are very internally focused right now. I use the second quarter as an opportunity to get out into our markets. I spent time probably 150 different customers over the course of the past 90 days. And when you ask them what they're working on, it's all internal stuff. So they're very expense focused right now. They're not letting go of staff because it was hard to get them, but they're looking at processes. They're looking at the way they operate, they're looking at pricing. What they're not doing a lot of is talking about expansion with the exception of places where there's a lot of federal stimulus available. And where there is federal stimulus available, there is a fair amount of activity. I think interestingly, if you just look at our new loan production, there's about 30% less hedging activity going on right now than there would have been in 2019 just as a point of comparison. So it tells you they think the Fed is at the peak. They're very clearly not worried about rates rising. But they also appear to believe that there are at better entry points for larger investments if they just wait here going forward. And the byproduct of that is, I don't know how many people are sailors in the room, but it's a little bit like sitting with the [ Bauer ] your boat windward, the sails are just luffing. There's not a lot of movement one way or the other, and we're going to need a catalyst here to see a lot more in the way of economic activity.

And maybe sticking with the bigger picture. As we think about industry structure, I know we hear a lot of banks talk about the importance of scale generally and maybe specifically on technology. Can you talk to us about how you think about that, the importance of scale generally and then the importance of tech investments?

Yes. And there's no question that there are benefits to scale. I think the more relevant question has always been, is scale the most important thing? And that in our view definitively has been no. Density matters a lot more than scale does, right? If you look at our franchise, I think we're the 13th largest depository in the U.S. nationally, but we only compete in 11 states in terms of what we do in retail, and we compete in 13 states in terms of what we do in our middle market franchise. And in the markets where we compete in retail, we're the #2 largest bank in the Midwest and now #6, up from #8 in the prior year in the Southeast. And that market position matters because the cold reality is that for somebody who sits in Cincinnati, Ohio or Greenville, South Carolina, they may be concerned with the share we have in connected markets to where their home is, but they're not at all worried about the market share we have in Spokane, Washington, right, or in Peoria, Illinois versus what we're doing in Chicago. So the focus for Fifth Third has been where we're going to compete, get dense and use the fact that we are limiting the market definition as a mechanism to obviate the national marketing scale advantages that somebody like a JPMorgan would have. I actually think one of the things that's interesting about what we're seeing in technology right now is that it contravenes a lot of the established wisdom on the benefits of industrial scale for our industry. So if you look at the announcements that are being made by the largest financial institutions us included, like we're all buying cloud compute from the same 3 cloud providers. We're all signing up to pay by the API call, which is a purely variable cost from the same hosted software providers. And at some point in the future, we're all going to be paying by the prompt for the access to the best large language models. So if the modern technology architectures variablize technology costs, there really isn't a big difference in being our size or being twice the size. What I do think, though, the other side of the equation to that is the large language models and our ability to get access to essentially unmetered intelligence through these AI tools that will become available are going to turn human capital into more of a fixed cost. So we're going to have more variable costs on the basis of core processing and more fixed costs in terms of a limited number of people being able to have a much larger impact. And both those things are probably beneficial for people our size relative to being much smaller or necessarily much larger.

I definitely want to come back to that tech discussion. But before we do, maybe just kind of expand on your sailing analogy and how that translates to loan growth. Obviously, it looks like industry data is a little subdued off late. Where are you starting to see the tailwinds emerge? And what are the biggest headwinds remaining in your minds?

Yes. I mean, I think in the most literal sense, it doesn't translate to loan growth. And I know you're hearing that from others. And in general, we're seeing very tepid loan growth across the industry. If we have an outlook, if the outlook shifts and our clients view that or believe that the market will get more difficult, you tend to see more utilization, so you get loan growth because people start hoarding liquidity. If they think things are going to be much better, they take on debt to support expansion. But in an environment where there's a lot of uncertainty, and it's unclear which direction we're going to go. They tend to be internally focused, which is where they are. I think the benefit for us, that, of course, is not good for revenue growth. I think the benefit for us of having done the things that we did last year in terms of positioning the balance sheet with a lot of liquidity and in doing the work to adapt to the new -- for the proposals on capital rules is it gave us a lot of optionality. So we continue to feel very confident in our ability to grow NII as we talked about in our first quarter earnings call because the large amount of liquidity we've got allows us to manage trade-offs between rate and volume, even if we don't see really robust loan growth. I think secondarily, we actually achieved the 10.5% capital target in April. So if the loan growth outlook doesn't improve, we have the ability to start buying back stock sooner than we originally anticipated. And we indicated when we said the second half of the year as a focus. So the focus on stay liquid, stay neutrally positioned, be broadly diversified is going to give us the ability to navigate this environment even we don't get a pop in the second half in terms of loans.

And just to make sure I understand the liquidity point, so you've got $25 billion-ish of cash. Maybe that's double what you need long term. You're saying if the loan growth doesn't emerge, it's pay down high-cost debt or...

And reprice deposits. Manage deposit pricing.

Yes. Well, maybe let's use that as a natural transition. I mean hopefully, 2023 was the toughest year for deposits any of us will ever have to live through. I think one thing it proved was you're laser focus on managing the primary relationships, primary operating accounts for both consumers and commercial. So what are you seeing now in the short term? Is the deposit storm finally passed? And talk us through a little bit more what's the next step of that primary account related to journey.

Yes. I mean there's so much -- narrowly on deposits. There's so much more liquidity in the banking system right now that the competition for deposits has softened a little bit. It's still competitive in pockets. You still have folks who've made commitments around balance sheet growth who have to find a way to fund it. But in general, I would say the level of competition is lower because there isn't a desperate bid in the market, the way that there might have been at different points last year. I think you hit on the more salient point though, which is the focus for Fifth Third has at any given point in time, maybe more deposits or more energy on loans or more energy on fee income. But the North Star for us has always been primary relationship growth. And the reason for that is that if you look at the economics of our customer base, they look a lot more like either a subscription software contract or the way that you might think of a fixed income instrument in the sense that you bear a cost to acquire the relationship, whether that is a marketing cost or sales cost, a combination of both of those things. And then if you do a good job of providing high-quality service, you retain those relationships a long time. Like if you look at the vintages, the last several years of new consumer relationships, after the first year, they season out to about a 6% annualized attrition rate, 6% to 7% annualized attrition rate. So if you look at that in an inverse that's a 16-year sort of an average life of our relationship. And as long as you're able to keep them engaged, you have the ability then to bid for more business when you need it. So the majority of our deposit growth last year actually came from existing relationships. It was this stock of primary operating accounts that we had built up over time that we were able to go back to and say, we want you to move more liquidity on to Fifth Third. And while that can be a more expensive way to build liquidity in the short term, it's a much better way to build liquidity from a total cost of deposits through the cycle because those are also the people who have a reason to bank with you other than you being the highest rate in market. So you're able then to do some of the things that we were able to do in the first quarter when we were able to manage interest expense in ways that other people just weren't able to manage interest expense. So this year, because we have all that liquidity, there's more focus on household growth in terms of our marketing and sales activity. Comparatively a little bit less focus on deposit growth. I still think we'll grow deposits year-over-year as we indicated in the first quarter. So there's no change to the outlook on that front. But household growth is running above 3% and the consumer side of the equation continues to be very strong in the middle market.

And maybe the other big differentiator for deposits for Fifth Third has been the Southeast expansion.

No doubt.

I think you mentioned on the call, you're now over $30 billion of deposits, which is a mid-sized regional bank in and of itself that you've grown organically. What does the next phase look like in those markets?

Yes. We -- by the end of this year, we're effectively going to have grown to MB Financial, which is the last bank we acquired on a purely organic basis. I feel very excited about what's going on in the Southeast. Clearly, we benefited from being in a position to be able to invest at a period of time when a lot of other folks were just cutting branches. And the byproduct of that is we have excellent high-visibility locations and have been able to build our way into a top 5 position and about 1/3 of the original focus markets with a path to being able to get the other 2/3 done here over the course of the next few years. Part of what's exciting there is that our branches, if you just look at them over time, tend to mature over about a 7-year cycle. And the weighted average life of the branches we built down there is about 2.5 years. So even if we didn't build another branch in the Southeast, we still have several years of deposit growth tailwind and relationship growth tailwind that will come from those investments. But we are continuing to build. And the benefit of having done it organically, the way that we have as opposed to inorganically is we didn't like buy 100 branches. We built 1 branch 100 times, and we learned a few things along the way about what makes a branch most successful, whether that's location selection, the actual physical format, the relation that how we hiring staff and launch those branches and how quickly we can get them out of the ground. So I think we're going to move from building, call it, $25 billion to $35 billion a year to more like $35 billion to $50 billion a year over the next 4 or 5 years and being able to nose our way into some of the adjacent midsized markets down there that we aren't even in, in some cases today.

Maybe to round out the more macro discussion. Hopefully, we're in for a soft landing here. How is your outlook for credit evolving? If you had to pick out the parts of the book, you worry or watch the most closely right now, what would they be?

Yes. Our full year guidance for credit was 35 to 45 basis points. We continue to expect to be right in that range. So no concerns or change. Consumers effectively normalized. Like you can see that across the industry data. We don't really have a subprime lending business. I think we have a lower share to sub-680 FICOs than any of the banks that disclose that measure. So we're not really exposed to some of the continued softening that we're seeing in that segment. And actually, as we continue to mature dividend, finance and some of the other lending businesses, we got to actually think that there is a reason to believe that credit will continue or will get better as opposed to going the other direction. The commercial side of the equation is maybe the more interesting one right now because we're still running at like 30 -- call it, 33%, 1/3 lower annualized charge-offs today than we were in 2019. And we're not exposed to what's going on in commercial real estate in the same way that others are, as I know we've talked about. So the byproduct there is your outcome in a given quarter is literally a function of do you take the charge on a credit this quarter? Does it go into the next one because we're just sort of bumping along the bottom. So I expect there to be not just for us, but certainly for us sort of more episodic credit that over the course of the year lands us right in the middle of that 35 to 45 range until we see more normalization.n.

That's helpful. And maybe on the dividend finance comment, can you just flesh that out? I mean it's not a huge business in the context of Fifth Third, but it has been meaningful on the provision line item and the reserve building for growth. Why do you expect charge-offs to, I think you said, flattened to maybe even a little bit improve going forward?

Yes. So we talked about the fact that I think one of the things that we bring to that market is an expectation around client care and that when customers need support because they have an installer who's having a hard time fixing the job, we go in and fix it. So we talked about in the first quarter earnings call, the fact that we had set aside provisions associated with what will look like nonperforming loans because we're doing modifications to help get customers to PTO. And that will not be an area of growth going forward. That's one thing. I think secondarily, dividend does a really excellent job of picking good borrowers and in driving the installer network in a way that ensures high-quality client outcomes, but it was still a nascent company. So there are a lot of things that we know how to do, whether it relates to installer management, the way that we've managed auto dealers forever or collections activity or otherwise that are going to be net positives for credit performance over time.

And then you mentioned commercial real estate, thankfully, is not a big exposure for you, 10% to 15% of the loan book. Your IR team was kidding me that I'm not allowed to say you've had 0 charge-offs so far because it's like talking about a no-hitter in the middle of the game, but you've actually had 0 charge-offs so far, which is pretty remarkable. So recognizing that it's not a huge business for you. What do you do different? What did the team focus on because it's a pretty different outcome than those banks that are kind of 2%, 3% charge-off right now?

I have -- I'm very fond of our head of commercial real estate or even more so now. But I have been fond of referring to him as the [ EOR ] of our commercial team, and he's been taking a victory lap over and I know I was just realistic. I wasn't our. Listen, like any commercial lending business client selection is the name of the game, right? And if you bank developers with deep pockets who are willing to put real skin in the game in terms of equity and recourse and who recognize that we may not always be the cheapest or the most willing to press on terms, but that because of that, we're going to be able to support them at every point in the cycle, you can do really well. If on the other hand, you look at commercial real estate as the primary driver of loan growth and you're willing to compete with some of the nonbank sources of capital that tend to make terms and risk spreads more volatile, you can get yourself into a lot of trouble, right? So in our case, we're almost exclusively a recourse lender. We never moved our LTV targets. So we have had 60% LTV target in terms of the new properties. We're focused on large national developers, not to say that we don't have treasured relationships in some of the markets with very well-established local developers. But the principal focus of the business is banking well-established companies who have the ability to put equity into properties that they need to. And because we didn't stretch, we're not having to bear the challenges that a lot of others are facing.

Maybe one natural follow-on. I mean, given the position you're in, is there a point in the cycle where you could see be more offensive in the commercial real estate book, not to imply you don't play offense with your clients, but is there a time when you'd be more opportunistic?

No. I think that what's made us successful is the fact that we're steady Eddie. So you don't want to diverge from the strategy that's worked well. I am optimistic about segments of that portfolio. I think the homebuilder market is a great point of -- that's a big point of focus for us, the thing that we're exceptionally good at and is going to be a good market for us and for the banking industry in general over the course of the next several years, we're still structurally short, something like 5 million single-family housing units across the U.S. And at the moment, because the developers are well capitalized, they're not borrowing a whole lot to support existing development. So if we get some relief on interest rates, a little bit more activity in terms of home buying, and better affordability. You'll see that market move, and that will be a source of growth for us. But otherwise, we're sticking to the folks that have been great clients and continuing to invest in the business where it makes sense.

Let's come back to technology. I know it's a place that's been really core to a lot of your career in banking in some places you've been very passionate about. Maybe 3 questions, and I'll start with first. Payments is a big area of investment. A lot of banks talk about it. You've talked about your commercial payments up 11% year-over-year. What's driving that growth? And how do you think about the future opportunities in commercial payments?

Yes. If I were an investor, I'd have a hard time sorting through what I hear from different folks. There is a lot of activity in the payments.

Every bank I cover is better than average in technology. I'm waiting for that one bank because like, yes, we stand.

I spent a few years living in Minnesota, and they're very familiar with Lake Wobegon. So not everybody can be beautiful and above average, we contrary to what Prairie Home Companion may tell you. And here's what I'd say. Like we're #13 in deposits nationally. EY does an annual cash management survey that virtually everybody in the industry participates in, and we're #6 in terms of fee equivalent and as big as #2 in several major commercial payment categories. So -- and I'll talk about why that is. But just in terms of the facts here, we're growing at 2x the rate of the market, and we have effectively 2x the share relative to the size of our balance sheet, which I think says we're good at it. Why our sales folks tell me that we win because we have differentiated solutions. I hear from you and others that all banks say they have the same stuff. So we either are differentiated or we're doing 2x as good a job driving the execution of the business one way or the other. I'm pretty happy that we're getting the growth that we are. And I think the truth is probably somewhere in between. We -- the core of the business today is this focus on managed services. So a recognition that we tend to think of payments inside the banking sector based on the rail like the infrastructure rail we use to process it, whether it's an ACH payment or a wire. And customers organize payments around tasks, whether that's managing the order to cash cycle, so you get your days sales outstanding into a reasonable spot or managing your payables so that you're stretching vendor contracts, routing payments through lease cost methods or otherwise. And the value you can create and having a different sort of a product is not in your access to the ACH trails, but rather your ability to build software around your payments, your payment rails, so that you can help them do those tasks better, right? That was the focus of Expert AP, which was one of the core managed services that we launched several years ago. It's the focus of the things that we do in Expert AR, which is the managed receivables product. It's the thing that we're doing in health care with big data health care, which is very focused on provider networks in terms of an individual solution. And of our total revenue, more than 35% now is attached to clients that are using those managed services, and it's north of half the total pipeline right now of opportunities. So we'll continue to grow. And because we can essentially shift the conversation with customers away from like, let's price out your analysis statement and talk about what everybody else could talk to you about and into how much operational cost can we reduce because we can eliminate courier routing, reduce the amount of float that's necessary in your retail store, cut your payment acceptance cost by routing transactions for a lease cost routing on the payable side of the equation or otherwise. Like you're in a realm now where you're reducing costs by encouraging them to switch, which has then allowed us to drive north of 1/3 of all our new TM relationships with TM as the lead product, like decoupled from any extension of credit whatsoever, which is the only way you can outgrow your balance sheet. The thing that is going to be exciting, that's a more nascent part of the business today but will grow is dating back to the spin out of Vantiv then Worldpay then FIS now Worldpay again. We had to be in the business of provisioning payments infrastructure to third-party software developers because of the separation of Vantiv into what's now Worldpay essentially created an independent entity that was wholly reliant on Fifth Third's access to the network rails to process payments. So we got really good at the risk and compliance layer and had to configure technology to be able to support third-party providers. And then with the addition of Rize acquisition we made last year, on the way to having north of 200 individual micro services that will be available via API with a modern SDK and all of the developer support to be able to add third-party software developers onto our scaled payments rails. And that is going to continue to be a very exciting catalyst for growth. I mean if the overall business is growing at 11% at the moment, the mature businesses would be growing at, call it, 3% to 4%. The managed services would be growing high teens and the embedded business would be growing much faster than that.

So you're saying this gives customers the ability to generate their own payments products on your systems and rails and using your...

It's to embed payments into their software offerings. So think about a company that is in the business of providing management software to not-for-profits, who needs to be able to allow those not for operates to accept donations through their website, right? Their product, their core competency is in the development of the tools to host the website, the management of the reporting behind the scenes. They want to be able to offer payments as a service in that particular case. They can embed Fifth Third code, so Fifth Third APIs directly into their product, their hosted software solution and enable merchants or individual not profits in that case to sign up for the ability to accept payments via the website and the work then gets done behind the scenes, we process the payments, generate the revenue and settle the balances to those nonprofits.

So you've been very clear on the payment side, the investments you're making, the success you're having, what is another area or 2 in the broad concept of technology that you're most excited investing?