Fifth Third Bancorp (NASDAQ:FITB) Q4 2023 Earnings Call Transcript

Fifth Third Bancorp (NASDAQ:FITB) Q4 2023 Earnings Call Transcript January 19, 2024

Fifth Third Bancorp beats earnings expectations. Reported EPS is $0.99, expectations were $0.9. FITB isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello and welcome to the Q4 2023 Fifth Third Bancorp Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I’ll now turn the conference over to Matt Curoe, Director of Investor Relations. Please go ahead.

Matt Curoe: Good morning, everyone, and welcome to the Fifth Third’s Fourth Quarter 2023 Earnings Call. This morning our Chairman, President, and CEO, Tim Spence; and CFO, Bryan Preston will provide an overview of our fourth quarter results and outlook; our Chief Operating Officer, Jamie Leonard and Chief Credit Officer, Greg Schroeck have also joined for the Q&A portion of the call. Please review the cautionary statements in 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 January 19, 2024, and Fifth Third undertakes no obligation to update them. Following prepared remarks by Tim and Bryan, we will open up the call for questions. With that, let me turn it over to Tim.

Timothy Spence: Thanks, Matt, and good morning everyone. At Fifth Third, we believe that great banks distinguish themselves based on how they navigate challenging and uncertain operating environment. 2023 was certainly a challenging year for the industry, but I am very pleased with how we measured up. A defensive balance sheet positioning, strong execution, and multiyear strategic investments produce top-quartile profitability, the best core deposit growth, and the best total shareholder return among all regional peers who did not participate in an FDIC-assisted transaction. We generated an all-time record full-year revenue of $8.7 billion. Deposits grew 5% compared to an industry-wide decline of 3%. Credit performance was strong with net charge-offs remaining below historical averages.

And although it would be foolish to expect it to repeat forever, in commercial real estate we experienced zero net charge-offs in 2023 and only two basis points in delinquent loans as of early January. These strong outcomes combined with our multi-year expense discipline produced a full-year adjusted return on assets of 1.25% and adjusted return on tangible common equity ex-AOCI of 15.9% and an adjusted efficiency ratio of 55.9%. All among the best of our peers. We also continue to take market share organically by growing our customer base and deepening relationships. We grew consumer households by 3% overall punctuated by 6% growth in the Southeast. In commercial, we added a record number of new quality middle market relationships up 11% over the prior year.

As a result, we grew or maintained our deposit market share position in all 40 of our largest MSAs. As we turn the page to 2024, we remain focused on differentiating Fifth Third based on the strength and consistency of our financial performance by prioritizing stability, profitability, and growth in that order. Bryan will take you through the detail on the fourth quarter and our outlook for the year shortly. But before that, I would like to touch on a few points. The first of these is the strength of our balance sheet. Our defensive positioning and decision to move quickly to adapt to proposed regulatory changes have put us in a position to play offense in 2024. Having achieved full Category 1 LCR compliance on August 31st and maintained it since, our liquidity position is very strong.

We completed our RWA diet in the fourth quarter and accreted nearly 50 basis points of CET1, putting us on pace to reach a 10.5% CET1 ratio by mid-year 2024. Given our strong earnings profile and the significant rally in interest rates in December, our tangible book value per share grew nearly 30% during the fourth quarter. At the beginning of January, we moved $12.6 billion of securities to held-to-maturity, representing roughly one quarter of our AFS portfolio. We expect this move will de-risk potential AOCI volatility to capital by about 30% in the event that market rates rise again. If the economic outlook remains stable and the capital rules are finalized, no worse than the current NPR. These actions put us in a position to resume share repurchases of up to $300 million to $400 million in the second half of 2024, including $100 million to $200 million as early as the beginning of the third quarter.

Should the final rules prove less stringent than the initial proposals, we’ll have additional flexibility in deploying excess capital and liquidity to further improve profitability and position Fifth Third for growth. The second point I’d like to highlight is profitability. Expense discipline, strong returns, and positive operating leverage remain core areas of focus for Fifth Third. Supported by our technology modernization investments and a focus on leaning out key value streams, we reduced full-time equivalent employee headcount by 4% from our peak in 2023 to the end of the year without the need for a company-wide expense program. The run rate benefits of these efforts put us in a position to sustain the peer-leading annualized expense growth that we have averaged the past several years, even as we continue to invest for growth.

While the carryover effect of the RWA diet makes it unfeasible for the full year, we do anticipate returning to positive operating leverage in the second half of 2024. The third point I’d like to highlight is about growth. Our strategies have been consistent, building out our Southeast markets, producing a strong fee to total revenue mix, and leveraging software that differentiates our product offerings and improves productivity. These are multi-year investments that cannot be replicated easily by competitors to one to two years of hiring a few new branches or small tuck-in acquisitions. In 2023, we opened 37 new branches concentrated in the Southeast, bringing us to 107 opened over the past five years. We plan to open another 31 branches in the Southeast in 2024.

As a portfolio, these branches have continued to outperform our expectations on both household acquisition and deposit growth and should provide a tailwind for several years forward. We also continue to invest in treasury management, wealth and asset management, and capital markets. All three of these businesses grew for us in 2023. We expect mid-to-high single-digit growth in each in 2024. In treasury management, our acquisitions of Rize and Big Data Healthcare and the launch of Newline, our embedded payments business, should continue to support peer-leading performance. In wealth and asset management, Global Finance recently named our Private Bank as the Best US Regional Private Bank for the fifth consecutive year and Best Private Bank for Entrepreneurs globally for the first time.

In our capital markets business, we have seen more robust activity levels to start the year, including an M&A pipeline that is 1.5 times the full-year revenue target embedded in our guidance. Overall, we expect 2024 to be a solid year of improving revenue trends and continued to expense discipline. Given what we believe to be a less certain outlook than the markets would imply, we are positioned to perform well under a range of economic and interest rate scenarios. Before, I hand it over to Bryan, I want to say thank you to our employees for hustling to deliver great results in 2023 and for the job you do every day to take care of our customers and communities. You make our company a special place for this. With that, I’ll now turn it over to Bryan to provide additional details on our fourth quarter results and our current outlook for 2024.

Bryan Preston: Thanks, Tim, and thank you to everyone joining us today. 2023 was a very different year than what we were expecting 12 months ago. For Fifth Third, our success in outperforming this year was driven by our intentional actions to create and maintain flexibility for navigating uncertainty. As we enter 2024, we are very pleased with the results from 2023 and how we continue to be well-positioned for a wide range of economic outcomes. We have optionality in our balance sheet and diversification on our business mix that will allow us to adapt to changing environments. As Tim mentioned, achieving this positioning requires discipline and years of deliberate investments. Our full-year financial performance in 2023 benefited from this long-term investment.

Fifth Third delivered industry-leading deposit growth of 5%, record revenue of $8.7 billion, and 100 basis points of capital accretion during the year, all while maintaining expense and credit discipline. We delivered another solid quarter to end the year. Adjusting for the FDIC special assessment and the other discrete items listed on page two of our release, return on assets was 1.3%, RoTCE was 17%, and our efficiency ratio was 55%. Additionally, we completed our risk-weighted asset diet in the fourth quarter, which reduced RWA by 3%, which was a little more than we previously estimated. The diet combined with our strong earnings led to a nearly 50 basis point increase in CET1 during the quarter, which ended at 10.3%. This capital accretion combined with the rally in market rates during the fourth quarter resulted in our pro forma CET1 ratio including the AOCI impact from unrealized losses on AFS securities, increasing to 7.7% at year-end, well above the 7% minimum.

Net interest income for the quarter was $1.4 billion, which was consistent with our expectations. While NII continues to be impacted by the increasing cost of deposits, due to higher market interest rates. We’ve been able to build a robust liquidity position by generating peer-leading core deposit growth. Our core interest-bearing deposit costs increased 24 basis points sequentially, reflecting a cycle-to-date interest-bearing core deposit beta of 54% in the fourth quarter. We believe maintaining significant liquidity on balance sheet. It’s a prudent decision given the uncertain economic and regulatory environments. Our short-term investments, which are primarily comprised of our cash at the Fed increased $8.6 billion in the fourth quarter on an average basis and drove all of the 13 basis points sequential decrease in NIM.

Excluding the impacts of securities gains losses and the Visa total return swap, adjusted non-interest income increased 3% sequentially due to the growth in commercial banking, mortgage, wealth, and card and processing revenues. As well as the normal fourth quarter impact of the CRA. The growth in commercial banking fees was driven by strong institutional brokerage and improved corporate bond fees, partially offset by lower lease from marketing revenue. Fourth quarter non-interest income was also impacted by the decision to eliminate our extended overdraft fee, which was the driver of the decrease in service charges on deposits. Compared to the prior year, non-interest income decreased 3%, primarily due to a $25 million reduction in CRA revenue.

Adjusted non-interest expense increased 2% sequentially, primarily driven by the impact of the non-qualified deferred compensation mark-to-market, which is mostly offset in securities gains losses. Excluding the impact of the NQDC mark, which was a $17 million expense in the fourth quarter compared to a $5 million benefit in the prior quarter, expenses were flat sequentially. Compared to the prior year, fourth quarter expenses were down 1%, which reflects our ongoing commitment to expense discipline, Tim mentioned earlier. Moving to the balance sheet. As expected, total average portfolio loans and leases decreased 2% sequentially. Most significantly driven by the 3% decrease in average total commercial loans. Our corporate banking business experienced the biggest reduction due to the RWA diet.

With period-end, corporate banking total commitments decreasing 6% and unused commitments decreasing 4%. Period end, the commercial revolver utilization rate was 35%, a 1% decrease from the prior quarter. Average total consumer portfolio loans and leases decreased 1% sequentially due to our intentional pullback in indirect auto and the overall slowdown in the residential mortgage originations given the rate environment, partially offset by growth from dividend finance. Average core deposits increased 3% sequentially, driven by the growth in interest checking, money market and customer CD balances. DDA migration is showing signs of deceleration with fourth quarter showing the smallest dollar decline in DDA balances since the onset of the rate hiking cycle, even when adjusting for normal seasonal strength at year-end.

DDA as a percent of core deposits were 26% for the quarter compared to 28% in the prior quarter. In addition to the migration impact, this measure is negatively impacted by the strong interest-bearing core deposit growth from new consumer and commercial relationships. By segment, average commercial deposits increased 5% sequentially while both consumer and wealth deposits increased 1%. As a result of our balance sheet positioning, RWA diet and success growing deposits, we achieved a loan to core deposit ratio of 72% at year-end, which continues to rank as the best compared to our regional peers. As Tim mentioned, we ended the year with full Category 1 LCR compliance at 129%. The strong funding profile provides us with great flexibility as we enter 2024.

Moving to credit. Asset quality trends remained strong and below historical averages. The net charge-off ratio was 32 basis points which was down nine basis points sequentially and consistent with our guidance. 30 to 89 day delinquencies are flat compared to the end of 2022, the NPA ratio increased eight basis points to 59 basis points, but remains below our 10-year average of 65 basis points. We will maintain our credit discipline, focusing on generating and maintaining granular high-quality relationships. In consumer, we remain focused on lending to homeowners, which is a segment less impacted by inflationary pressures and have maintained our conservative underwriting policies. However, we are beginning and expect to continue to see normalization of delinquency and credit loss trends from the historically low levels experienced over the last couple of years.

From an overall credit risk management perspective, we continue to assess forward-looking client vulnerabilities based on firm specific and industry trends and closely monitor all exposures where inflation and higher for longer interest rates may cause stress. Moving to the ACL, while our reserve coverage increased one basis point sequentially to 2.12%, the ACL balance decreased by $41 million due to lower period-end loans, which was the primary driver of the release. We continue to utilize Moody’s macroeconomic scenarios when evaluating our allowance and made no changes to our scenario weightings. Our capital build is pacing ahead of the expectations we set at the beginning of the RWA diet. We are highly confident in our ability to build our CET1 ratio to 10.5% by June 2024.

As Tim mentioned, on January 3rd, we made the decision to hold $12.6 billion of securities until maturity, resulting in the reclassification to HTM during 2024. This decision reduces the risk of potential capital volatility associated with investment security market price fluctuations under the proposed capital rules. We continue to expect improvement in the unrealized losses in our remaining AFS portfolio, resulting in approximately 32% of our current loss position accreting back into equity by the end of 2025 and approximately 66% by 2028, assuming the forward curve plays out. After the transfer to HTM, 65% of the remaining AFS portfolio is in bullet or locked out securities which provides a high degree of certainty to our principal cash flow expectations.

We continue to believe that 10.5% is an appropriate near-term operating level for our capital. And as Tim mentioned, we expect to resume share repurchases during the second half of 2024, assuming the economic environment remains stable and the capital rules are finalized, consistent with the NPR. Moving to our current outlook. We expect full year average total loans to be down 2% compared to 2023, with the decrease primarily driven by the impact of the RWA diet on commercial loans and indirect consumer as well as lower mortgage production due to the higher rate environment, partially offset by the continued growth of dividend and provide. While we expect full year average total loans to decrease, we expect average total loans in the fourth quarter of 2024 to be up 2% compared to the fourth quarter of 2023.

Commercial balances are expected to be up low single-digits by the end of 2024 and dividend originations are projected between $2.5 billion and $3 billion for the full year. We are also assuming commercial revolver utilization remained stable. For the first quarter of 2024, we expect average total loan balances to be down 1%, again, driven by the full quarter impact of the RWA diet. Both commercial and consumer loans should be down around 1%. Dividend finance originations are projected to be $400 million to $500 million in the first quarter. Total loan balances should be relatively stable throughout the first quarter. We expect deposit growth to continue during 2024 with full year average core deposits increasing 2% to 3%. While we expect DDA migration to continue given the high absolute level of interest rates, the pace of migration will be sensitive to the path of the Fed funds rate in 2024.

If rates remain at current levels, we could see the DDA mix dip below 25% by the fourth quarter of 2024. However, we would expect to show a more stable composition if the more aggressive rate cut forecast were to be realized. Shifting to the income statement. Given the impact of the RWA diet on average loan balances, and the impact of higher deposit costs, we expect full year NII to decrease 2% to 4%. Our forecast assumes our security portfolio remains relatively stable and our cash levels began a slow, but steady decrease throughout 2024. This outlook is consistent with the forward curve as of early January, which projected six total rate cuts. Given the uncertainty regarding the rate outlook, our balance sheet is positioned such that even with fewer rate cuts, such as the three cut scenario being projected by the FOMC, we would expect to see only a modest deterioration in our NII outlook and would still fall within our full year guidance of down 2% to 4%.

We expect NII in the first quarter to be down 2% to 3% sequentially, reflecting the impact of the lower average loan balances, a lower day count in the quarter and higher deposit costs. Our current outlook assumes interest-bearing core deposit costs, which were 289 basis points in the fourth quarter of 2023, increase 5 to 10 basis points in the first quarter, a deceleration from the 24 basis point increase experienced in the fourth quarter. With rate cuts forecasted to begin in late March and continue through the end of the year, we would expect deposit costs to decrease throughout the remainder of 2024. Under this outlook, the terminal beta for the rising rate cycle would be in the mid-50s for interest-bearing core deposits. We continue to believe we are at our NIM trough in the fourth quarter of 2023.

However, another quarter of outperformance in deposit growth resulting in a higher-than-expected cash position, while a good outcome could impact NIM by a few more basis points. Barring a significant change in economic outlook, we would expect NII to stabilize and then begin growing sequentially during the remainder of 2024. We expect adjusted noninterest income to be up 1% to 2% in 2024, reflecting continued growth in treasury management revenue, capital market fees and wealth and asset management revenue partially offset by the full year impact of the elimination of our extended overdraft fee. We expect mortgage origination will remain muted in 2024 and net servicing revenue to decrease modestly as the servicing portfolio UPB continues to amortize lower.

Adjusted other noninterest income, which excludes the impact of the Visa total return swap, is expected to decline by over 15% as TRA revenue will decrease from $22 million in 2023 to $10 million in the fourth quarter of 2024, and we are not including any large onetime private equity gains in our forecast. We expect first quarter adjusted noninterest income to be down 3% to 4% compared to the fourth quarter excluding the impacts of the TRA, largely reflecting seasonal factors. Normal seasonal items include lower capital markets activity and M&A activity partially offset by seasonal strength in wealth from tax planning. We expect full year adjusted noninterest expense to be up around 1% compared to 2023. Our expense outlook assumes continued investments in technology with tech expense growth in the mid to high single digits and sales force additions in middle market, treasury management and wealth.

We will also close 29 branches in 2024 to offset costs associated with the 31 new branches opening in our high-growth Southeast markets. We expect first quarter total adjusted noninterest expense to be up around 8% compared to the fourth quarter. As is always the case for us, our first quarter expenses are impacted by seasonal items associated with the timing of compensation awards and payroll taxes. Excluding the seasonal items, expenses would be flat in the first quarter. In total, our guide implies full year adjusted revenue to be down 1% to 2% and PPNR to decline in the 4% to 5% range. This outcome will result in an efficiency ratio of around 57% for the full year, a modest increase relative to 2023, driven by the decrease in NII. As Tim mentioned, we expect positive operating leverage in the second half of 2024 compared to the second half of 2023.

Moving to credit, we continue to expect 2024 net charge-offs to be in the 35 to 45 basis point range as credit continues to normalize with first quarter net charge-offs in the 35 to 40 basis point range. As we return to loan growth, we expect to resume provision builds. Assuming no change to the economic outlook, loan growth and mix is expected to drive a $100 million to $150 million of provision build for the year, with the first quarter being in the $0 to $25 million range. The provision build over the last three quarters of the year should be fairly even. In summary, 2024 is expected to be a year of transition as we begin the shift to a rate cutting cycle with our well-positioned balance sheet, disciplined credit risk management and commitment to delivering strong performance through the cycle, we will continue to generate long-term sustainable value for shareholders, customers, communities and employees.

With that, let me turn it over to Matt to open the call up for Q&A.

Matt Curoe: Thanks, Bryan. 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 for Q&A.

Operator: Thank you. [Operator Instructions] Your first question comes from the line of Scott Siefers of Piper Sandler. Your line is open.

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Q&A Session

Scott Siefers: Good morning, everybody. Thank you for taking the question. A lot of good color on the NII expectations, so I appreciate that. I guess just within there, I think, Bryan, you noted your comment about deposit costs decreasing through the course of this year. Maybe a thought or two on how those trajectories will differ in your view between the commercial and the consumer portfolios.

Bryan Preston: Thanks, Scott. Great question. We tell you that obviously similar to what we’ve seen from a rising rate perspective. The commercial and the wealth betas in particular, were — have come through recently at a much higher level. We’re in the range of probably low to high 80s from a beta perspective in both of those businesses. Cumulative betas have started to reach that point. So we’re going to get a lot of repricing out of those portfolios as rates move lower. To give you a little bit of perspective, our indexed commercial deposits right now are up around $30 billion. So that gives us a lot of confidence in our ability to get some price out of that book. The consumer book is one that the betas — the cumulative betas in that book is kind of in the mid-30s right now.

It certainly moved up from a marginal perspective and we continue to have a lot of optionality between our promos and exceptions as well as what we’ve done from a CD perspective. We’re going to be able to get rate cuts out of those portfolios as well. Our CD book, which is $10 billion now is fairly evenly laddered across the year with about 25% maturities across each quarter. We’ve been very careful as part of our pricing strategy to make sure that we could be able to reprice those down quickly as the rate environment were to change.

Scott Siefers: Perfect. Thank you. And then separately, so given that you’re done with the RWA mitigation efforts, it sounds like you’ve got the option to be on your front foot to the extent that you choose to be going into the year. Just sort of curious what your expectation is in terms of loan demand as the year plays out.

Timothy Spence: Yes. Scott, it’s Tim. I’ll take that one. I mean, look, when we talk to customers today, I think in general, they’re cautious but not pessimistic. So rates in the election uncertainty are definitely weighing on the appetite for new investments in the near term. I don’t know of anybody who stopped an existing program or an existing investment, but they are being very careful about new expansion. So I don’t expect that we’re going to see a big pickup in loan demand. And I’m sure we’ll get a question later on the economy. We’re not expecting robust growth to drive the top line there. It’s going to have to come from market share gains. So — in our world, the key areas of investment there are very clearly in the middle market, where we have been very focused in driving more granularity into the C&I portfolio.

Our middle market loan production this past year was nearly 50-50 split between the Midwest markets, including Chicago and then the Southeast markets and our expansion markets in California and Texas. And our sales force in those locations across the entire footprint is going to be up about 20% over a three-year period here for 2024. So we’ve got a good pent-up sales capacity there and high activity levels that will drive the outcome. And then I think the other area of strength has been in the health care and telecom, media and technology verticals. And then in the fintech platforms, right, the continued seasoning in of both provide and dividend portfolios. The last thing is the absence of a negative here, which is the auto business, our deliberate rundown of the outstandings in the auto business have created a little bit of a drag on loan growth.

And the combination of credit unions being a little bit more funding constrained than all the banks who exited have created a much more favorable environment for auto originations. So we expect volumes there to come up. We’re generating volume today with a weighted average FICO north of 780 and very attractive risk-adjusted spreads and that should stop the headwind and give us a more stable platform from which we’ll get growth through the rest of the year.

Scott Siefers: Perfect. Okay, great color. Thank you very much.

Timothy Spence: Absolutely.

Operator: Your next question comes from the line of Gerard Cassidy of RBC. Your line is open.

Gerard Cassidy: Hi, Tim. Hi, Bryan.

Bryan Preston: Good morning.

Gerard Cassidy: Congratulations, Bryan, on a new role. And if Jamie is listening, congratulations to him as well.

Bryan Preston: Worse than that, Gerard, Jamie is here.

Gerard Cassidy: I hear that laugh. That’s great. Here’s like and you touched on it Tim about the economy — many of the banks, you as well, are following the forward curve for rates, which is understandable. And there continuing to be signs that the US economy is proving more resilient than we all expected. And so the question is this for the upcoming year, what if we’re all wrong — and all of a sudden, we see 2% plus real GDP growth, the Fed doesn’t move on rates, maybe one or two cuts like what we saw in ’95. And credit remains even better. How does that affect the way you approach what you’ve set up for ’24? I know Bryan gave us some color on the different interest rate scenarios. But wants just come into this year, at the end of this year, it proves to be much stronger than any of us are expecting and inflation stays around 3%.