Fifth Third Bancorp (NASDAQ:FITB) Q4 2022 Earnings Call Transcript

Fifth Third Bancorp (NASDAQ:FITB) Q4 2022 Earnings Call Transcript January 19, 2023

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 Fourth Quarter 2022 Earnings Conference Call. After the speaker’s remarks, there will be a question-and-answer session. Thank you. Chris Doll, Head of Investor Relations, Fifth Third Bancorp you may begin your conference.

Chris Doll: Good morning, everyone. Welcome to Fifth Third’s fourth quarter 2022 earnings call. This morning, our President and CEO, Tim Spence; and CFO, Jamie Leonard will provide an overview of our fourth quarter results and outlook. Our Chief Credit Officer, Richard Stein; and Treasurer, Bryan Preston have also joined 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 January 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. To start, I would like to thank our employees for the job they did, supporting our customers, communities and shareholders in 2022. You really held true to our core values and our vision to be the one bank people most value and trust. JUST Capital and CNBC recently released their annual study of America’s Most JUST Companies, a comprehensive ranking that recognizes companies who do right by all stakeholders has defined by the American public. Fifth Third ranked 23rd out of the roughly 1000 companies covered in the study and was the highest ranked category four bank. It’s a great achievement. Thank you for it. Earlier today, we reported financial results for the fourth quarter and full year 2022.

The strength and quality of our franchise are evident in the numbers. We generated record full year revenue of $8.4 billion, up 6% over the prior year. We managed expenses down 1% year-over-year, producing positive operating leverage of 700 basis points and an efficiency ratio of 56%. Net charge-offs for the year were below 20 basis points. As a result, we achieved a full year return on tangible common equity ex AOCI of 16.5%, which places us in the top quartile of our peer group. Just as importantly, we did what we said we were going to do. We have a culture of accountability Fifth Third, and it makes me proud that our full year results exceeded the guidance we provided you last January in every major caption, including total revenue, expenses and net charge-offs.

As a result, PPNR increased 18% compared to our original guide of 7%. We also made important progress on our growth strategies in 2022. We grew consumer households at a peer leading organic growth rate of around 2.5%, led by our Southeast markets at 7% and surpassed last year’s record for new quality relationships in our Commercial segment. We opened 18 new branches in the Southeast in 2022, bringing our three-year total to over 70 new branches in those markets. During the year we also made meaningful progress in our technology modernization initiatives and enhanced our peer leading, digitally enabled treasury management managed services, and our momentum banking product offerings. You may have seen that most recently we extended momentum’s early pay feature to include income tax refunds.

Our FinTech platforms, dividend finance, and provide continue to scale and achieve top national market shares with dividend ranking third and provide ranking second in their respective markets. Our fee generating businesses are better diversified than most peers and continue to be a key focus for investment. Strong performance in our capital markets business related to helping client hedging activities, mortgage servicing and treasury management, all helped to offset market headwinds that all banks faced as did continued net AUM and flows in our wealth management business. During 2022 we remained focused on delivering stable long-term results instead of chasing short-term earnings. We maintained our discipline in our credit underwriting with continued focus on granularity and diversification.

The outcomes of this are evident in our NPA, NPL and early stage delinquency ratios, all of which have remained well behaved and well below normalized levels. Our balance sheet management approach remains centered on providing strong and stable NII performance across various rate environments. We extended our advantage in our securities yield by waiting to deploy excess liquidity until we were able to earn positive real yields and we added derivatives to provide hedge protection through 2031. These actions will provide significant long-term benefits in the event of a lower rate environment. With respect to capital, given our strong PPNR growth and benign credit losses, we exceeded our target CET1 ratio in the fourth quarter and resumed share repurchases.

Our capital priorities for 2023 are to maintain a 9.25% CET1 ratio and support organic balance sheet growth, pay a strong dividend, and continue our share of purchase program. We expect repurchases to steadily increase each quarter for a total of approximately $1 billion during the year. Jamie will provide you with the detail on our financial outlook for 2023, but it is a strong one that is consistent with our priorities of stability, profitability and organic growth. We expect to produce another year of strong revenue growth and operating leverage with full year PPNR growth in the mid to high teens, a return on tangible common equity ex AOCI exceeding 17% and an efficiency ratio below 53%. We will continue to invest in organic growth and efficiency initiatives.

We’ll add another 30 to 35 branches in our Southeast markets, including our first three in Charleston, South Carolina, and several more in the Greenville, Spartanburg, South Carolina corridor. We’ll continue to increase investments in marketing and product innovation to accelerate household growth and we’ll invest in scaling dividend and provide. Lastly, we’ll make significant progress on our tech modernization journey and begin to realize savings and improve the client experience by leveraging these investments to drive automation into our most labor intensive processes. You have my commitment that we will continue to make decisions with the long-term in mind to invest where we can strengthen the value and resiliency of our franchise and to hold ourselves accountable for doing what we say we will do.

With that, I’ll now turn it over to Jamie to provide additional detail on our fourth quarter financial results and our current outlook for 2023.

James Leonard: Thank you, Tim and thank all of you for joining us today. Our quarterly and full year financial performance reflect focused execution and resiliency throughout the bank. We generated strong loan growth in both commercial and consumer categories and generated record revenue. NII was positively impacted by higher market rates as deposit repricing has lagged the repricing of our earning assets, combined with the benefits of fixed rate asset generation at higher rates. Fee income has remained resilient despite the market related headwinds and expenses were well controlled while we continue to reinvest in our businesses. We achieved a full year adjusted efficiency ratio of 56%, which improved throughout the year with the fourth quarter adjusted efficiency ratio below 52%.

Our fourth quarter PPNR grew 12% compared to last quarter and 40% compared to last year. Net interest income of approximately $1.6 billion was a record for the bank and increase 5% sequentially and 32% year-over-year. Our NIM expanded 13 basis points for the quarter. While interest-bearing core deposit costs increased 64 basis points to 105 basis points, reflecting a cycle to date interest-bearing core deposit beta of 24% in the fourth quarter. Total non-interest income increased 9% sequentially driven by our TRA revenue and commercial banking fees. That growth in commercial banking fee income was primarily driven by higher M&A advisory revenue and client financial risk management revenue, and it was partially offset by softer results in mortgage banking origination fees.

Non-interest expense increased just 1% compared to the year ago quarter. This expense growth was driven by our acquisition of Dividend Finance during the year combined with continued investments in Provide compensation associated with our minimum wage hike, as well as higher technology and communications expense, reflecting our focus on platform modernization initiatives. Excluding the impacts of Dividend and Provide, total expenses would’ve been down 1% year-over-year. Moving to the balance sheet. Total average portfolio loans and leases increase 1% sequentially. Average total commercial portfolio loans and leases increased 1% compared to the prior quarter, reflecting an increase in C&I balances. Growth was led by our corporate bank and robust in almost all of our industry verticals.

Among our verticals, production was strongest in energy, including renewables, which increased over 50% year-over-year. Healthcare growth was led by Provide with Provide balances up 150% year-over-year. The period end commercial revolver utilization rate remains stable compared to last quarter at 37%. Average total consumer portfolio loans and leases increase 1% compared to the prior quarter, led by Dividend Finance as well as growth in home equity. This was partially offset by a decline in indirect secured consumer loans. Average total deposits increased 1% compared to the prior quarter as an increase in commercial deposits was partially offset by a decline in consumer deposits. Period end deposits increase 1% compared to the prior quarter.

After the deliberate runoff of surge deposits in the middle of the year, we have achieved solid deposit outcomes throughout the second half of 2022 reflecting our strong core deposit franchise. Moving to credit. As Tim mentioned, credit trends remain healthy and our key credit metrics remained well below normalized levels. The MPA ratio of 44 basis points was down two basis points sequentially, and our commercial MPA ratio has now declined for nine consecutive quarters. The net charge-off ratio increased just one basis point sequentially to 22 basis points within our guidance range. The ratio of early stage loan delinquencies 30 to 89 days past due also increased only two basis points sequentially and remains below 2019 levels. From a balance sheet management perspective, we have continually improved the granularity and diversification of our loan portfolios through a focus on high quality relationships.

In consumer, we have focused on lending to homeowners, which are 85% of our consumer portfolio. We also have maintained the lowest overall portfolio concentration in non-prime consumer borrowers among our peers. In commercial, we have maintained the lowest overall portfolio concentration in CRE. Across all commercial portfolios, we continue to closely monitor exposures where inflation and higher rates may cause stress and continue to closely watch the leverage loan portfolio and office CRE. We have focused on positioning our balance sheet to deliver strong stable NII through the cycle. Our strong deposit franchise, our investment portfolio positioning, and our cash flow hedge portfolios will provide protection against lower rates well beyond just the next few years, as well as the addition of the fixed rate lending capabilities from both Dividend and Provide should continue to support our strong through the cycle outcomes.

Moving to the ACL. Our ACL built this quarter was $112 million, primarily reflecting loan growth. Dividend Finance loans contributed $96 million to the ACL build. As you know, we incorporate Moody’s macroeconomic scenarios when evaluating our allowance. The base economic scenario from Moody’s assumes the unemployment rate reaches 4.2%, while the downside scenario underlying our allowance coverage incorporates a peak unemployment rate of 7.8%. Given our expected period end loan growth, including continued strong production from Dividend Finance, we currently expect a first quarter build to the ACL of approximately $100 million, assuming no changes in the underlying economic scenarios. Moving to capital. Our CET1 grew from 9.1% to 9.3% during the quarter.

The increase in capital reflects our strong earnings generation, which was partially offset by the impact of a $100 million share repurchase completed in December. Moving to our current outlook. We expect full year average total loan growth between 3% and 4% compared to 2022. We expect most of the growth to come from the commercial loan portfolio, which is expected to increase in the mid single digits in 2023. We expect line utilization to be stable in the first half of 2023, but then decline slightly to 36% as capital markets conditions improve a bit in the second half of the year. We expect total consumer loans to increase modestly as an expected increase from Dividend Finance and modest growth from home equity and card will be mostly offset by a decline in auto and mortgage reflecting the environment.

For the first quarter of 2023, we expect average total loan balances to be stable sequentially. We expect commercial loans to increase 1% reflecting strong pipelines in middle market and corporate banking, and assuming commercial revolver utilization rates remain generally stable. We expect consumer balances to be stable to down 1%, reflecting lower auto and residential mortgage balances, partially offset by dividend loan originations of $1 billion or so in the first quarter. From a funding perspective, we expect average core deposits to be stable to down a 1% sequentially, reflecting seasonal factors before resuming modest growth in the subsequent quarters of 2023. We expect continued migration from DDA into interest-bearing products throughout 2023 with the mix of demand deposits to total core deposits ending the year in the low 30s.

Shifting to the income statement. Given our loan outlook and the benefits of our balance sheet management, we expect full year NII to increase 13% to 14%. Our forecast assumes our securities portfolio remains relatively stable from the second half of 2022 levels and reflects the forward curve as of early January with Fed funds increasing to 5% in the first quarter and the first 25 basis point rate cut occurring in the fourth quarter of 2023. Our current outlook assumes total interest-bearing deposit costs, which were 112 basis points in the fourth quarter of 2022 to increase in the first half of 2023 before settling in around 2% or so in the second half of 2023. Our outlook contemplates an environment of continued deposit competition, which would result in a cumulative deposit beta by the end of 2023 of around 42%, given the two additional rate hikes in our forecast over our October guidance.

The future impacts of deposit repricing lag combined with the dynamics of our loan portfolio should result in our full year 2023 net interest margin, increasing five basis points or so relative to the fourth quarter of 2022 NIM. We expect NII in the first quarter to be down 1% to 2% sequentially reflecting the impact of a lower day count in the quarter combined with stable loan balances. We expect adjusted non-interest income to be relatively stable in 2023, reflecting continued success taking market share due to our investments and talent and capabilities resulting in stronger gross treasury management revenue, capital markets fees, wealth and asset management revenue and mortgage servicing to be offset by the market headwinds impacting top line mortgage revenue and higher earnings credit rates on treasury management, as well as subdued leasing remarketing revenue.

If capital markets conditions do not improve, we would expect to generate improved NII and lowered expenses in the second half of 2023. We expect our fourth quarter TRA revenue to decline from $46 million in 2022 to $22 million in 2023. Our guidance also assumes a minimal amount of private equity income in 2023 compared to around $70 million in the prior year. We expect first quarter adjusted non-interest income to be down 6% to 7% compared to the fourth quarter, excluding the impacts of the TRA, largely reflecting seasonal factors. Additionally, we expect to continue generating strong financial risk management revenue, which we expect will be offset by slowdown in M&A advisory revenue and the impacts of higher earnings credits and software top line mortgage banking revenue given the rate environment.

We expect full year adjusted non-interest expense to be up 4% to 5% compared to 2022. Our expense outlook includes a one point headwind each from the FDIC insurance assessment rate change that went into effect on January 1st, the mark-to-market impact on non-qualified deferred compensation plans, which was a reduction in 2022 expenses and the full year expense impact of Dividend Finance. We also continue to invest in our digital transformation, which should result in technology expense growth of around 10% consistent with the past several years. We also expect marketing expenses to increase in the mid single digits area. Our outlook assumes we close 25 branches in the first half of 2023 that will deliver in year expense savings and also add 30 to 35 new branches in our high growth markets, which will result in high single digits growth of our Southeast branch network.

We expect first quarter total adjusted non-interest expenses to be up 6% to 7% compared to the fourth quarter. As is always the case for us, our first quarter expenses are impacted by seasonal expenses associated with the timing of compensation awards and payroll taxes. Excluding these seasonal items, expenses will be down approximately 2% in the first quarter. In total, our guide implies full year adjusted revenue growth of 9% to 10%, resulting in PPNR growth in the 15% to 17% range. This would result in a sub 53% efficiency ratio for the full year, a three point improvement from 2022. We expect 2023 net charge-offs to be in the 25 to 35 basis point range with first quarter net charge-offs in the 25 to 30 basis point range. In summary, with our strong PPNR growth engine, discipline credit risk management and commitment to delivering strong performance through the cycle, we believe we are well-positioned to continue to generate long-term sustainable value for customers, communities, employees, and 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: Your first question comes from a line of Gerard Cassidy from RBC. Your line is open.

Gerard Cassidy: Good morning guys. How are you?

Timothy Spence: Morning Gerard.

Gerard Cassidy: Can you share with us, Tim, when you talk to your business customers, it seems like there’s a real disconnect between everybody’s outlook for loan loss reserve building. We understand, of course, at CECL, and you’re going to be proactive life of loan losses. And you and your peers are building up the reserves, but then you look at the spreads in the high yield market, they’re coming in. One of your competitors yesterday pointed out that the commercial loan spreads haven’t widened out. Where is the disconnect? Or are we just going to fall off a cliff possibly in the second half of the year? But can you share with us what are your commercial customers seeing in their day-to-day business? And are they seeing the weakness that everybody is projecting that will happen later this year?

Timothy Spence: Yeah. Sure, Gerard and thanks for the question. I don’t think we’re going to fall off a cliff in the second half of the year. That’s certainly not consistent with what I hear. I was out and went and looked at the calendar the other day. I got to get into eight of our 15 markets in the fourth quarter of this past year. And I think I probably saw 40 or 50 clients while I was out there. I mean, here’s what I hear. Like if you look at the manufacturing clients as an example, they’re all feeling much more optimistic about moderation as it relates to raw materials. And I think by and large, they solved the supply chain issues that they were facing either through inventory builds or through restructuring the supply chain or because the overseas suppliers that they were relying on to come back online or there isn’t an issue in the ports or otherwise.

I think the issues they’re running into are twofold. One, labor continues to be a challenge and it’s labor cost, but it’s also just labor availability. Two, because they solved their supply chain challenges through building inventory. When you think about lower inventory turns, you add in rising interest rates, now debt service costs to revenue or higher proportion. And so, while they got the costs associated with raw materials through this last year in price increases, they’re all looking to the next 18 to 24 months to try to figure out how they pass on just this sort of continued slow grind on labor, and debt service costs. The services clients are having no problem pushing through costs, which I think is like evident in the inflation data and personally to anybody that took a vacation over the holidays this year.

And they continue to be optimistic because demand has remained strong. I think what I hear more than anything else is that we’re going to have a little bit of a slow grind down here in terms of growth, and that if anything, the thing I’m more worried about is not do we end up with plus 5%, 0.5% GDP or minus 0.5% GDP, but rather that the market may be overly optimistic about how quickly the Fed is going to be able to bring rates down. And that the byproduct of that is from an operating standpoint, you have to be thinking a lot more about how you position the balance sheet for the next three to five years and for more tepid growth and higher rates than worrying about the next, call it, 12 months in terms of the outlook.