The Fifth Third Bancorp Second Quarter 2023 Earnings Conference Call was opened by Chris Doll, Head of Investor Relations. Tim Spence, President and CEO, and Jamie Leonard, CFO, provided an overview of the second quarter results and outlook. Additionally, Bryan Preston, Treasurer, and Greg Schroeck, Chief Credit Officer, joined the Q&A portion of the call. Tim Spence also welcomed Greg Schroeck to the call, noting his many years of experience in credit risk and the line of business. Despite market volatility, Fifth Third has maintained consistent top quartile financial results while investing strategically for the long term.

Fifth Third reported second quarter earnings per share of $0.87, a 10% increase from the year before, and adjusted revenue increased 9%. Credit quality was strong, as net charge-offs and early stage delinquencies remained low. Return metrics also improved, with an adjusted return on assets of over 1.2% and an efficiency ratio below 55%. Deposits increased 1% sequentially and 2% year-over-year, outperforming the industry. Fifth Third has implemented strategies such as launching innovative operational deposit-oriented solutions and opening 70 de novo branches in its Southeast footprint since 2019.

In consumer banking, the company saw 3% year-over-year net household growth and 7% year-on-year growth in the Southeast. Commercial banking saw a record number of new quality middle-market relationships, with the embedded payments business, Newline, driving deposit growth. The company is taking steps to adapt its balance sheet in anticipation of higher capital and liquidity requirements, as well as reducing its indirect auto lending origination volumes and trimming outsized lines. Despite the more optimistic outlook, they remain vigilant on the potential for a recession in 2024, with commercial clients being cautious by slowing their growth plans.

Fifth Third Bank has been around for 165 years and has withstood a variety of challenges. Employees have volunteered 117,000 hours and have contributed $30 billion to affordable housing, essential services, and renewable energy. The company has adapted to technological innovations such as the telephone, electric white bulbs, the automobile, and the internet. It has also adapted to new regulatory regimes such as the OCC, the Federal Reserve, and the FDIC. Currently, many are watching the impact of regulation on credit availability and pricing.

Fifth Third Bank's character is rooted in hard work, ingenuity and excellence, and a sense of responsibility for the communities they serve. In the second quarter, their adjusted efficiency ratio was just below 55%, with adjusted PPNR growing 8%. Net interest income was $1.46 billion, a 9% increase year-over-year, though it decreased 4% sequentially due to deliberate actions to grow on-balance sheet liquidity. Interest-bearing deposit costs increased 54 basis points to 2.3%.

Noninterest income increased 2% compared to the year ago quarter, while noninterest expenses increased 10%. Excluding certain impacts, underlying expenses increased 4%. Total average portfolio loans and leases were stable, while corporate banking production was tempered due to a focus on optimizing returns and lower customer demand. Average total consumer portfolio loan and lease balances reflected growth from dividend finance, offset by declines in indirect auto and residential mortgage.

Fifth Third Bank's deposits were flat compared to the previous quarter, with consumer deposits increasing 1% and commercial deposits decreasing 1%, and wealth and asset management deposits declining 12%. Credit trends were stable, with the net charge-off ratio and NPA ratio increasing slightly from the previous quarter. The bank has focused on lending to homeowners and has maintained one of the lowest concentrations in nonprime consumer borrowers and the lowest CRE concentration relative to peers. Fifth Third has deemphasized office CRE originations and has been cautious in its economic outlook.

The company tightened underwriting standards during COVID, resulting in 90% of the commercial portfolio being re-underwritten and a stable criticized asset rate. The company's reserves increased due to dividend finance and Moody's macroeconomic forecast, resulting in a nine basis point increase in the ACL ratio. The CET1 ratio increased 25 basis points, resulting in a tangible book value per share increase of 11%. The company expects to build capital at an accelerated pace and will postpone repurchases until they have more clarity on the regulatory environment.

The company expects loan growth to be between 1-2%, with commercial loans increasing in the low single digits and consumer loans being stable to slightly down. They anticipate needing $4 billion in dividend loans and expect deposits to increase in the back half of the year as they take market share and maintain high levels of core operating relationships. The mix of demand deposits to total core deposits is expected to decline from 30% to 27% by year-end.

Fifth Third Bank expects loan balances to decline 1-2% sequentially in the third quarter of 2023, with deposits increasing 1% on a sequential basis. They estimate full year NII to increase 3-5%, with total interest-bearing deposit costs increasing 40 basis points in the third quarter and 15 basis points in the fourth quarter. They expect their loan-to-core deposit ratio to end the year in the mid-70s, with third quarter NII down 2-3% sequentially. Lastly, they expect adjusted noninterest income to remain stable for 2023.

We expect fourth quarter TRA revenue to decline from $46 million in 2022 to $22 million in 2023. We expect third quarter adjusted noninterest income to be down 3% to 4% compared to the second quarter. We expect full year adjusted noninterest expenses to be up 4% to 5% compared to 2022, excluding the FDIC assessment and NQDC impacts which would be up 3%. We also expect technology expense growth in the low double digits and marketing expenses to increase in the mid- to high single digits. Our guidance also factors in the run rate benefits from the severance expense recognized in the first half of the year.

Bancorp expects their efficiency ratio to be around 56% for the full year, with total net charge-offs in the range of 25-35 basis points. They anticipate loan growth to be lower in the third and fourth quarters, and are expecting a lower quarterly build to the ACL in the $25 million to $75 million range. They are confident that their proactive balance sheet management, disciplined credit risk management, and commitment to performance through the cycle will generate long-term sustainable value for customers, communities, employees, and shareholders.

James Leonard responds to Scott Siefers' question about what could allow NII to find a bottom. Leonard explains that it depends on the rate environment and the Fed reaching 5.5%, which would allow them to get through the repricing lag. He also mentions that June was strong, but they are going to remain cautious due to liquidity conditions, trade issuance, student loan repayments, and competitive dynamics.

James Leonard, CFO of the company, states that the company is positioned to benefit from potential rate cuts in the future. He notes that a decrease in rates could cause an increase in credit costs and a recession, making it difficult for banks to manage their earnings profile.

Fifth Third Bank has worked hard to put itself in a good position, and is not planning to take expenses down or lessen RWA. They are focusing on liquidity, deposits, and asset classes, and have made investments in these areas that will benefit them in the current environment. Tim Spence believes that these investments will continue to be valuable in the future.

James Leonard clarifies that the $25 million to $75 million build in the back half of the year for dividends is for growth expected in dividend stance, but there is no change in the reserve ratio that is assigned to that business. He also states that the build is for the total Bancorp balance sheet, and the primary driver of that ACL build is dividend.

Dividend payments are expected to be around 9%, resulting in a balance sheet that is lower than what it has been this year. This is due to exiting certain states, shrinking the corporate banking book, and reducing the ACL coverage. The C&I portfolio is performing well, with total Bancorp charge-offs in the 25 to 35 basis point range and commercial charge-offs in the 20 to 30 basis point range. Greg Schroeck will provide additional color on the re-underwriting of the shared national credits.

Jamie Leonard and Greg Schroeck both agree that the portfolio monitoring for C&I loans remains the same and there are no significant trends in the shared national credit book. However, they acknowledge there will be some lumpiness due to two credits in the professional services and manufacturing industries, which will cause an uptick in charge-offs in the third quarter. Nevertheless, they are confident that the fourth quarter charge-offs will be back in line with the first and second quarters. In response to a question about the securities book, Leonard expressed confidence that the portfolio structure would meet any push down requirements to category 4.

In order to be compliant with the Liquidity Coverage Ratio (LCR) and other capital rules, the company expects to hold higher levels of cash and rotate more into Level 1 securities. Additionally, the company is expecting to see the securities book shrink and cash build, and they are currently letting $600 million in portfolio cash flows roll off and not get reinvested. Depending on the day and the opportunities, the company may let the cash run down or rotate into treasuries.

The speaker is asking about the company's outlook for the next 12 to 24 months and whether they are expecting a recession. He is also asking about the company's reserve levels and their base case of an unemployment rate of 4.3%. The speaker mentions that in the past, the company has discussed 2024 being worse in terms of debt and a delayed recession.

Timothy Spence believes that while a soft landing is possible, there are a number of indicators that suggest a recession is likely. He notes that the yield curve is more inverted than ever, same-store sales are negative, consumer spending is flat or down, the ISM is negative, and freight levels are depressed. He cautions that while it could be a mild recession, it is not one that is characterized by high unemployment. He also clarifies that he is talking about an RWA diet, not balance sheet optimization.

James Leonard mentioned that the scenario weightings were anchored to an 80-10-10 distribution according to Moody's probability assignment. Timothy Spence then confirmed that there was a softening in demand from clients due to their conservatism and lack of visibility into the future economy. He also mentioned that the reserve is adequate and the coverage is at 208 basis points.

The clients that Timothy Spence spoke to in the past 1.5 weeks reported that banks have allocated all their capital to invest in the second half of the year, or have real constraints on the way they can spread ancillaries. This could lead to a dynamic where demand for credit is lower due to the higher cost of credit. Michael Mayo asked if there was a chance for positive operating leverage this year, and Tim responded that they are working on expenses.

Timothy Spence explains that the company has been focused on reducing expenses and growing revenue over the past three years, and plans to continue to do the same over the next three years. He also emphasizes the importance of finishing projects to ensure success, referencing the phrase "One Robin does not make a spring." Michael Mayo then clarifies the timeline of the three-year period.

James Leonard noted two opportunities in June for the back half of the year to be better than initially expected, including the credit spread widening and the C&I coupon expansion. There was also positive news in the form of deposits, with June being a good month for the industry and the bank experiencing a 2% year-over-year increase. Despite this, the bank is still cautious about the liquidity environment and is prioritizing stability. Bryan Preston added that the bank is comfortable with their NII guide and that it is an entry point for thinking about 2024.

The Federal Reserve's hiking cycle ending and the deposit repricing lags playing out will have a quarter or two of impact on NII and NIM, but Jamie and Greg feel they are well-positioned to manage the balance year. They have a robust structure in place for reviewing the portfolio and staying ahead of emerging trends, such as stressing the portfolio across the board and looking at softening rental rates in the real estate portfolio.

Fifth Third has been proactive in responding to the last crisis, bringing solutions to their clients before covenant defaults occur. They have also developed proprietary systems to monitor real-time liquidity metrics, and are making select shared national credit decisions. Greg Schroeck mentioned that there could be a little pop in the third quarter due to one or two loans, one of which is a shared national credit.

This summary was generated with AI and may contain some inaccuracies.