Fifth Third Bancorp (NASDAQ:FITB) Q3 2023 Earnings Call Transcript

Fifth Third Bancorp (NASDAQ:FITB) Q3 2023 Earnings Call Transcript October 19, 2023

Fifth Third Bancorp beats earnings expectations. Reported EPS is $0.91, expectations were $0.81.

Operator: Good morning. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the Fifth Third Bancorp Third Quarter 2023 Earnings Conference Call. [Operator Instructions] Chris Doll, Head of Investor Relations. You may begin your conference.

Chris Doll: Good morning, everyone. Welcome to the Fifth Third’s third quarter 2023 earnings call. This morning, our President and CEO, Tim Spence; and CFO, Jamie Leonard, will provide an overview of our third quarter results and outlook. Our Treasurer, Bryan Preston; and Chief Credit Officer, Greg Schroeck, have also joined us for the Q&A portion of the call. Please review the cautionary statements on our materials, which can be found in our earnings release and presentation. These materials contain information regarding the use of non-GAAP measures and reconciliations to the GAAP results as well as forward-looking statements about Fifth Third’s performance. These statements speak only as of October 19, 2023, and Fifth Third undertakes no obligation to update them. Following prepared remarks by Tim and Jamie, we will open the call up for questions. With that, let me turn it over to Tim.

Timothy Spence: Thanks, Chris, and good morning, everyone. We believe that great banks distinguish themselves not by how they perform in benign environments, but rather by how they navigate challenging ones. That is why we focus on stability, profitability, and growth in that order. It is also why I am so pleased that our key return and profitability metrics remain resilient despite the market-related headwinds that all banks are facing. Earlier today, we reported earnings per share of $0.91 or $0.92 excluding a one set impact from our Visa swap, reflecting strong PPNR results and favorable credit outcomes. We generated an adjusted return on tangible common equity ex-AOCI of nearly 16%, which increased 50 basis points sequentially, and a return on assets of 1.26%.

We generated strong fee growth compared to the year ago quarter, supported by a more diverse range of fee income streams than peers, and our investments in treasury management, capital markets, and wealth management. Our third quarter total non-interest expense increased less than 2% compared to the year ago quarter, and we generated an adjusted efficiency ratio below 55%. In the last four years, we have managed expenses to the lowest growth rate among peers, despite also investing in growth by building more new branches, raising our minimum wage, modernizing our technology platforms, and acquiring four fintech companies. Expense management at Fifth Third is a continuous process and not a program. Since March of this year, full-time equivalent employee headcount is down 3.5%.

Turning to the balance sheet, we generated 4% average deposit growth compared to the year ago quarter versus a 5% decline for the industry. New relationship growth remains strong. Consumer households grew more than 2%, led by 6% growth in the Southeast, a continuation of our multi-year growth base. New middle market relationships added year-to-date remain 25% ahead of last year’s record base. Thanks to the release of the annual FDIC summary of deposits, the third quarter provides a unique opportunity to understand market share gains and losses on a metro area by metro area basis. This year, Fifth Third maintained or improved our market rank in every single one of our 40 largest MSAs. In the Midwest, we maintained our #2 overall position behind JPMorgan Chase.

In the Southeast, where we are just 4 years removed for opening our first next-gen branch, we have reached or are approaching target locational share in 8 of our original 11 focused markets. We intend to continue to open approximately 35 branches per year through 2028, at which time nearly 50% of our branches will be in Southeast markets. These market share gains are the byproduct of multiyear strategies that are not easily replicable by competitors. They include innovative operational deposit-oriented products like Momentum Banking, AI-driven customer acquisition strategies and the top quartile customer service model in addition to our investments in new branches. Our key credit metrics remained strong during the quarter. Charge-offs were in line with our July expectations in both early stage delinquencies and non-performing assets improved sequentially.

The ACL increased 3 basis points given slight changes to Moody’s macroeconomic forecast. Turning to liquidity and capital. We made significant progress against our goal to adapt early to expected changes in the regulatory framework. Our focused efforts throughout the bank enabled us to end the quarter with $103 billion in total liquidity sources and to achieve full Category 1 LCR compliance at the end of both August and September. During the quarter, we also made significant progress on our RWA optimization initiative. Total RWA declined 1% compared to the prior quarter. Our exercise should be complete by the end of the fourth quarter, so we can return to growing loans next year. We created over 30 basis points of CET1 capital during the quarter, reflecting our strong earnings power while we also raised our quarterly dividend by 6%.

With respect to the economy, while aggregate figures on spending and employment remains strong and market sentiment has shifted more in favor of a soft landing. We continue to be more cautious given concerning signals disguised beneath the aggregates. For example, while the most recent headline payroll numbers were strong, most, if not all, the job growth is a byproduct of more people working part-time jobs. Real average weekly earnings slipped every month during the quarter and the lower end of the consumer spectrum now maintains deposit balances below pre-COVID levels. Anecdotally, the last time Google searches for soft landing was this high was in May of 2008. Before I turn it over, I want to say thank you to our employees for everything you do to take care of our customers, strengthen our communities and support one another.

Your efforts are why Time Magazine recently recognized Fifth Third as one of the world’s best companies, and why I am as confident as ever in Fifth Third’s ability to outperform through the cycle and to deliver innovations that improve lives for all our stakeholders. With that, Jamie will provide more details on our third quarter financial results and outlook.

James Leonard: Thank you, Tim, and thanks all of you for joining us today. Our third quarter results were once again strong despite the market headwinds. We continue to strengthen our capital and liquidity levels ahead of pending regulations while also managing our business very efficiently. We achieved an adjusted efficiency ratio below 55%, reflecting ongoing expense discipline throughout the bank and the continued diversification and resilience of our fee revenue streams. Net interest income of approximately $1.45 billion decreased 1% sequentially. Our NII and NIM results reflect our proactive and continued defensive positioning given the uncertain economic and regulatory environments. Our short-term investments, which primarily represent our cash held at the Fed, increased $5 billion on an average basis and increased $8 billion on an end-of-period basis to $19 billion.

This increased level of cash was the primary driver of our 12 basis point NIM decline. Adjusted noninterest income increased 1% compared to the year ago quarter, driven by growth in capital markets and deposit service charge revenue, partially offset by a decrease in mortgage revenue driven primarily by lower origination volumes. Our ability to produce strong capital markets revenue in a volatile market has become a key distinction for Fifth Third compared to many peers. Adjusted noninterest expense increased just 2% compared to the year ago quarter, reflecting growth in compensation and benefits, occupancy and technology expenses partially offset by continued expense discipline across the company. Moving to the balance sheet. Total average portfolio loans and leases decreased 1% sequentially and due to softening customer demand and our RWA optimization efforts.

Average C&I balances decreased 2% sequentially. As Tim mentioned, clients remain cautious with respect to their growth plans. Consequently, production was muted in corporate banking. Also, average CRE balances decreased 1% compared to the prior quarter. The period-end commercial revolver utilization rate of 36% increased 1% compared to last quarter, partially due to our exit of certain lower returning unused commercial commitments. On a sequential basis, total corporate banking commitments and unused commitments decreased 3% and 4%, respectively, while total middle market commitments and unused commitments increased 5% and 7%, respectively. This trend highlights our capital optimization efforts while we continue to grow share in the middle market.

An empowered woman in the boardroom leading a discussion on the company’s wealth & asset management strategy.

Average total consumer portfolio loan and lease balances decreased 1% sequentially due to our intentional decline in indirect auto and the overall slowdown in residential mortgage originations, given the rate environment, partially offset by growth from dividend finance. Our card balances increased just 1% this quarter, reflecting our conservative risk culture and focus on transactors. Balances have increased 3% relative to the year ago quarter compared to 11% for the industry. Average total deposits increased 3% sequentially as increases in CDs and interest checking balances were partially offset by a decline in demand deposits given the mix shift we have seen for several quarters. DDAs as a percent of core deposits were 28% for the quarter compared to 30% in the prior quarter.

The 2-point decline was primarily due to the strong deposit growth in the denominator that Tim highlighted from our net new relationship growth in both consumer and commercial, which are obviously skewed to interest-bearing products in this environment. As a result, we added more than $4 billion in core deposits during the quarter, the most since the fourth quarter of 2021. Additionally, the DDA migration continued to show signs of deceleration this quarter and marked the smallest dollar decline in DDA balances since the onset of the rate hiking cycle. By segment, average consumer deposits increased 2% sequentially, and commercial deposits increased 4%, while wealth and asset management deposits declined 2% and reflecting clients’ alternative investment options.

As a result of our balance sheet positioning and success adding new deposits, we achieved a loan to core deposit ratio of 74% and at quarter end, which should be one of the best, if not the best, compared to our regional peers. We also achieved full Category 1 LCR compliance at 118% at quarter end. Moving to credit. As Tim mentioned, credit has remained resilient. The net charge-off ratio of 41 basis points increased 12 basis points compared to the prior quarter as we expected, reflecting two credits, which had been fully reserved. Early stage delinquencies decreased 7% compared to the prior quarter, while loans 90 days past due, of just 2 basis points or a record low for Fifth Third. Non-performing loans decreased 9%. This quarter marked the lowest inflows of commercial NPLs since the second quarter of 2022.

From an overall credit management perspective, we have continually improved the granularity and diversification of our loan portfolios through a focus on generating and maintaining high-quality relationships. As many of you know, we tightened underwriting standards during COVID, which limited our growth but improved the stability of our balance sheet. In consumer, we have focused on lending to homeowners, which is a segment less impacted by inflationary pressures and have maintained conservative underwriting policies. In commercial, we have maintained the lowest overall CRE concentration as a percent of total loans relative to peers for many years. Our criticized non-performing and delinquent CRE loans have all improved sequentially and remain very well behaved.

And within that, the same is true for our office exposures. For instance, criticized office loans represented just 5.4% of total office CRE, which improved 180 basis points sequentially. Additionally, we have zero delinquencies and zero charge-offs. We also decreased loan balances by 8% in the office book without any loan sales. These credit quality metrics are significantly better than peers who have reported their office exposure so far this quarter. While credit quality in the office portfolio has remained very strong, and we continue to believe the overall impact on Fifth Third will be limited. We nevertheless continue to watch it closely given the environment. Our shared national credit portfolio also remains very strong from a credit quality perspective, with criticized assets, non-performing loans and net charge-offs consistently lower than the overall commercial portfolio across a multiyear period.

Our credit resilience highlights our proactive risk culture. We continue to closely monitor all exposures where inflation and higher rates may cause stress throughout the entire portfolio as well as the fallout from the ongoing labor strike in the auto manufacturing sector, where we think our exposures are very manageable. Moving to the ACL. Our reserves decreased $5 million, but the coverage ratio increased 3 basis points sequentially to 2.11% as the impact of lower period end loans was offset by a slightly worse overall base case economic outlook. As you know, we incorporate Moody’s macroeconomic scenarios when evaluating our allowance. Both the Moody’s base scenario and the downside scenario used for the third quarter ACL assume a slightly worse average unemployment rate compared to the prior quarter.

We maintained our scenario weightings of 80% to the base and 10% to each the upside and downside scenarios. Moving to capital. Our CET1 ratio increased 31 basis points sequentially ending the quarter at 9.8%. Our capital position reflects our ability to build capital quickly through our strong earnings generation, combined with the impact of our RWA diet. Our tangible book value per share, excluding AOCI, increased 10% compared to the year ago quarter. We continue to expect improvement in our unrealized securities losses resulting in approximately 35% of our current loss position accreting back into equity by the end of 2025 and approximately 2/3 by 2028, assuming the forward curve plays out. Looking forward, we expect to build capital at an accelerated pace given our RWA optimization initiative and our continued deferment of share buybacks.

We anticipate accreting capital such that our CET1 ratio ends this year above 10%. Moving to our current outlook. We expect fourth quarter average total loan balances to decline 2% to 3% sequentially with consumer loans down 2% and commercial loans down 3%. The reflects our overall cautious economic outlook combined with one more quarter of our RWA diet as we are responding quickly to higher risk-adjusted return thresholds throughout the bank considering the economic and regulatory environments. We expect average deposits to be up slightly on a sequential basis. Within that, we expect core deposits to increase 1% due to our multiyear investments in the franchise to add households and primary commercial relationships, along with the benefit from seasonality.

While we continue to expect modest migration from DDA into interest-bearing products in a higher for longer interest rate environment, specifically for the fourth quarter, we expect the mix of DDA to core deposits to remain relatively stable given those seasonal benefits. Shifting to the income statement. We expect fourth quarter NII to be down approximately 1% to 2% sequentially due to the continued impacts of the balance sheet dynamics I mentioned. Our NII guidance assumes no additional rate hikes and a cumulative beta, which includes CDs and excludes DDAs of 55% by the fourth quarter. Excluding brokered deposits that we have been using as a replacement for other wholesale funding, given the pricing considerations, our cumulative beta expectation continues to be 53%.

This outlook translates to total interest-bearing deposit costs increasing 15 basis points to 20 basis points in the fourth quarter. Our guidance assumes that our securities portfolio balances remain relatively stable through year-end. As a byproduct of our strong deposit growth, combined with our loan outlook and stable securities balances, we expect to hold closer to $20 billion in cash and cash equivalents by year-end. Given these balance trends, we expect our loan to core deposit ratio to continue to move lower through the end of the year, which will keep Fifth Third in a strong liquidity position in anticipation of more stringent regulatory requirements, including remaining compliant with the full Category 1 LCR. We expect fourth quarter adjusted noninterest income to increase 1% to 2% compared to the third quarter.

We expect revenues to remain resilient across most captions driven by our multiyear focus on growing a diverse portfolio of fee businesses that should perform well in different economic environments. We expect fourth quarter TRA revenue of $22 million compared to $46 million in the fourth quarter of 2022. We expect fourth quarter adjusted noninterest expenses to be stable to up 1% compared to the third quarter. Our guidance excludes the pending FDIC special assessment, which we currently estimate at $208 million for Fifth Third. With respect to credit quality, we expect fourth quarter net charge-offs to be 30 basis points to 35 basis points. We do expect to gradually normalize from here. We continue to believe that are through the cycle, annual charge-offs will be in the 35 basis point to 45 basis point range given the credit risk profile of the bank.

Given our reduced loan outlook, we expect the change in the ACL for the fourth quarter to be stable to up $25 million, assuming no significant changes in the underlying Moody’s economic scenarios. This considers production from dividend finance of around $700 million in the fourth quarter, which as you know, carries a higher reserve level of around 9%. In summary, with our proactive balance sheet management, disciplined credit risk management and commitment to delivering strong performance through the cycle, we believe we are well positioned to meet the proposed regulatory requirements while continuing to generate long-term value for our shareholders. With that, let me turn it over to Chris to open the call up for Q&A.

Chris Doll: Thanks, Jamie. Before we start Q&A, given the time we have this morning, we ask that you limit yourself to one question and a follow-up and then return to the queue if you have additional questions. Operator, please open the call up for Q&A.

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Q&A Session

Operator: [Operator Instructions] And your first question comes from the line of Scott Siefers from Piper Sandler.

ScottSiefers: Jamie, I was hoping maybe you could expand even a little more on your thoughts on bringing in so many deposits in the third quarter. I know you’re trying to get your liquidity to a certain very high level and you achieved it. But it was just a kind of astonishing number. So just curious as to what the thinking throughout the quarter was. I guess additional forward look though you provided some of the deposit commentary or expectations in there. But just any additional thoughts would be helpful, please.

JamesLeonard: Thanks, Scott, for the question. We were certainly bringing the Victory bell on deposits this quarter. Really, when you take a look back, coming out of March Madness, one of the biggest drivers of our deposit success in the second quarter and the third quarter was really transitioning our customer recommendation engine from household growth to deposit growth. And while that sacrificed a little bit on the household growth numbers instead of our typical up 3% or up 4%, we were up 2% on households, but that translated to very strong consumer deposit growth. And so within the deposit growth we did have during the quarter of almost $4.8 billion, about 60% was commercial, 40% was consumer. And within consumer, 70% of that growth was in the Southeast markets, while 30% of that growth was in the Midwest.

So again, the retail franchise at Fifth Third is just performing at an extremely high level. And on the commercial side, the growth was surprisingly high given the corporate banking book growth within the commercial deposit growth. About 80% of the growth was in corporate banking. So at the time, we were targeting, let’s get LCR, full LCR north of 100%. We actually came in at 118%. So definitely did better than we initially expected. But when we were dissecting the quarter end results, it really makes sense that the corporate banking book did better. And as one of sort of hidden benefits of the RWA diet is that we are getting better share of wallet within that corporate banking book, and that also helped drive the deposit growth. So overall, a very strong quarter.

Again, for us on the deposit side, we expect continued growth in the fourth quarter, albeit at a little bit lower growth rate but still up a bit in the fourth quarter.

ScottSiefers: That’s very helpful. And then if I could switch gears for just a second. The securities portfolio remarks, I guess you all might come out looking a little heavier than some others. But by the same token, you guys have been more hesitant to use the HTM classification as well. I guess just any updated thoughts on sort of how you’re thinking about that. It at least optically, would help out levels, if not in terms of real world. But just curious to hear your updated thoughts.

JamesLeonard: If you break it down between real world and regulatory world, that’s really how we are looking at this in the real world with really the economic risk. Whenever you have a fixed rate asset, whether that’s in AFS, HTM or in the loan portfolio, you have that economic risk to higher rates. We have elected to hold our securities in AFS, and we’ll continue to do so, given that it gives us better flexibility and opportunity to reposition as the environment changes. But when you are in the real world managing the balance sheet, how we approach balance sheet management is in totality. And you can look at our strong NII results, our interest-bearing liability results, any of the measures relative to peers, the total balance sheet is performing very well.