Fifth Third Bancorp (FITB) 2003 Q2 法說會逐字稿

Good morning, Ladies and Gentlemen. Welcome to the Fifth Third Bank Corp. Second Quarter 2003 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode, and the floor will be open for questions following the presentation.

It is now my pleasure to turn the floor over to your host, the investor relations officer, Brad Adams. Sir, you may begin.

This Conference Call may contain certain forward-looking statements about Fifth Third Bank Corp. pertaining to the financial condition, results of operation, plans and objectives of the bank (inaudible). These statements involve certain risks and uncertainties. A number of factors could cause results to differ materially from the stock of performance and the forward-looking statements. Fifth Third undertakes no obligation to update these statements after the date of this call. At this time I'd like to turn the call over to Mr. George Schaefer, president and CEO of Fifth Third Bank Corp.

Thanks Brad and Good morning and thank all of you for taking the time to listen in. Neal and I will take a few minutes to review what we feel the highlights of the quarter and then we'll quickly open it up for some of your questions. I hope that most of you had a chance to look at our results released earlier this morning. Loan growth was very strong, revenue growth continues to show sizable strength despite the low rate environment, deposit growth remains robust, and credit quality continues to be manageable despite the lack of a meaningful recovery.

From my perspective, the highlights for the quarter were, number one, loan growth. Overall, loan growth was very strong with average loans and leases increasing by 12% annualized from last quarter, and 13% over last year. Commercial lending was very strong with period end balances up $960 million from last quarter, and annualized increase of 15%. Retail installment lending remains strong with balances increasing by 17% over the second quarter of 2002.

Number two, second highlight is the continuation of strong deposit growth trends. Average interest checking balances and average demand balances increased 16% over the same time last year. Sequentially, average demand deposit balances are up 22% on an annualized basis, and average interest checking balances are up about 7%. This type of deposit growth in the quarter was a substantial improvement in the equity markets, a little bit surprising for us. We just kicked off a new checking account campaign. We call it "the heat is on" a few days ago, and that will run through July and August with a $1.2 billion goal. In the first two weeks of the campaign, we opened up over 27,000 new checking accounts and have over $250 million in new deposit balances.

The third highlight is our strong revenue and service income growth. Net interest income was up 9% over last year, showing some of the benefits of our emphasis on lending. And giving us some comfort in the latter half of this year. Next fee income was up 22% over last year, showing some of the benefit of Fifth Third's diversified mix of fee sources. As you know, we're in the commercial business, the retail business, the IA business, the processing business and all of those contributed to our fee increases. Next the credit trends continue to be manageable with charge-offs up somewhat on a few leverage leases, and non-performing loans trending downward modestly. I'll let Neal go through some of the details on the credit trends.

Overall we're still seeing some mixed signals here in the Midwest, but small business looks good, very healthy to us, and consumer activity certainly picked up a little bit in the quarter. With that in mind, we're going to continue approaching the business the same way we always have. It's our goal to continue to focus on building market share within each of our 17 existing markets.

Secondly, we want to improve our cross-selling of both our loan and fee-based products and take advantage of the large retail and commercial customer base we have out there. We think we've got about 5.5 million retail customers out there, and there's plenty of opportunity to sell into that base and third, we want to maintain a low risk profile on our balance sheet. Our balance sheet continues to be in good shape out there, and we want to maintain that low risk profile there. Now I'd like to turn it over to Neal for some additional review of our businesses and some trending to expect for the future quarters. Neal?

Thank you, George. I'm going to spend a moment on each of the lines of business talk a little bit about what's going on within those and then spend a little bit more time on credit and the balance sheet.

First of all on Fifth Third Processing Solutions, up 16% year over year, which is in line with I think some of the guidance we'd given. Our new customer flows continue to be quite encouraging. I think several of those significant names were in the release that we had and we continue to see a lot of activity there. The growth rates are a little more modest than we've seen in the past, really driven by consumer activity. We have a lot of large retailers, no concentration in one retailer, so I think that's more a function of overall activity. Transaction volumes increased 10% over the second quarter of last year, and almost all this growth representing new customer volume. So I think it's still the core of what we're focused on. Beginning July 1st, FDPS will be impacted by the Master Card Visa settlement. I think we've been given guidance that that's somewhere in the $12 to $14 million of revenue over the remainder of the year. Everybody is still trying to sort through all those numbers, but I think that's still a good number that I would use as it relates to top line revenue. Still I think we're very optimistic. We see a lot going on within this segment across the industry, and we feel very well positioned to continue to attract new EFT customers as well as on the merchant side, and we expect to continue to make new customer relationships there.

On the investment advisor side down year over year, the equity markets make us certainly more optimistic on a link quarter basis, we're up 17% from last quarter, and I think we see some momentum there. We've spent a lot of time on both personnel and on the product side, and expect to see that continuing to improve. Clearly our ongoing focus is, as George said, continuing to cross-sell on the customer side, both on retail customer side of the branches as well as the focus on the institutional side. As money goes back in the equity market, we want to make sure we get our fair share.

On the commercial side, excellent quarter here. Commercial banking revenues up 12% over last year. We continue to see good momentum in each of the individual markets. Our deposit growth, very strong as George already mentioned on the demand deposit side, commercial had a big hand in that, up over 20% year over year on the commercial deposit balances.

Also I'd say across the board on the commercial segment, we've had excellent loan growth, straight C and I loans up better than 20% year over year, deposit as I already mentioned, and also fee income in the quarter on the commercial side was very positive. A lot of this, people are trying to read into what's going on in the economy. I would attribute a big piece of this to the hiring in all our newer markets, and we're starting to see some of that come on line across the board.

On the retail side as George alluded to, our loan and deposit growth remains very strong. We did kick off a new deposit campaign and expect to stay focused on that side. The loan growth coming out of the branches is very heartening. These are some of the best coupon assets that we have with good quality, good new customer relationships. We will continue to have a campaign focus. We think in the low rates, given certainly a tougher operating environment, our focus on all 940 branches is what makes the difference, and clearly that's where we'll keep our focus.

Mortgage, incredibly strong quarter for mortgage. Good fee revenue. I think you see the breakdown of all the details on the second page of the narrative of the earnings release. I won't go into each of the details. I will point out that we had very strong origination for us, and I think if you look back over the last three years, I think we now have in the quarter originated as much in mortgage origination dollars as we did with Old Kent with about 35 more states. So clearly haven't trimmed it, given it focus on our footprint.

MSR amortization impairment, we took $72 million in the quarter versus hedging gains of $30 million. I would tell you we feel very good about where our MSR valuations are at. You can see that if you look at the supplemental information, that's come down markedly, and we feel very good about where we're at.

Let me spend a moment on the balance sheet and net interest income. Some of the trends we're seeing there. Margin was down modestly in the quarter. Certainly attributed to good mix on the asset side, strong loan growth across the board. Net interest income was up 9% over the second quarter of last year. I think we've been giving guidance that we still think that net interest income will continue to average in the 8 or 9% over the second half of the year, and certainly we feel very fortunate to have the kind of asset origination that we've had and the deposit trends continue to keep our balance sheet in good stead. If you look at net interest margin and maybe step back more broadly, we're certainly impacted by the 45-year low on interest rates. Overall yields on assets are down into the 5% area, so certainly all banks are challenged here, but I think we feel very good. We stay very focused on that particular area in our company. We have seen net interest margins in the 370. Again, if you look at the supplemental information, two years ago, we were in the 370 area on net interest margin, so while it's down, I still feel like the net interest income trends will continue quite strong.

Credit quality, for a moment, spending a little time on it, net charge offs, I think in line with the guidance we gave you in the 8-K 64 basis points in the quarter, which is up slightly from last quarter. Couple of trends underneath that total number. Consumer net charge offs were flat versus last quarter with residential mortgage back down, I think as we said last quarter, we expected those to return to a more normal level, so we feel very good on the consumer side.

Commercial charge-offs, the predominant piece of that was leverage leases. I think we signaled earlier in the quarter there are a couple of miscellaneous credit spread out across our footprint, the largest of which is $5 million, so I feel pretty good on the commercial side. We continue to watch that pretty closely. I will point out that we've provided for $31 million in excess of our charge-offs in the second quarter. We continue to try to very aggressively make sure that our reserve levels, given our loan growth, are where they need to be, and we will continue our policy of paying for loan growth. As George mentioned in his comments, non-performers were essentially flat to last quarter, and again, we're watching that carefully but feel very good, very mindful of what's going on in the economy. Couple other quick highlights.

Obviously, some noise in the quarter with regard to on-recurring items. We have concluded our review of the third quarter of last year's charge off of $82 million. There was a recovery in the quarter of about $31 million. We don't expect any ongoing recoveries or liability in that particular case, but I think that's behind us. The Federal Home Loan Bank, we believe part of our looking hard at our funding costs, we've done some restructuring of the long term debt. Most of you remember we did a debt issuance in the quarter of some 50 near subordinated paper and allowing us to continue to bring down any of the funding costs across the board. I think those are kind of some of the highlights. With that, I will open it up for questions if anyone has questions for George and I.

Thank you, sir. The floor is now open for questions. Our first question is coming from Chris Marinac of FIG partners.

Hi, Neal and George. Good morning.

Good morning.

Can you talk about the use of wholesale funding and to what extent you will use that additionally in the future?

Yeah, I would say broadly within what people call wholesale funding, obviously long term debt, a variety of large CDs and the like, but I would tell you, Chris, what we're very wedded to is our 10% capital philosophy. Given the loan growth that we've had up some very strong 20-plus % kind of levels, we certainly recognize that it's our job to manage the total balance sheet. So I think you'll see more robust deposit growth going forward, but I would say given where we're at -- about where some of those levels are.

Great. Thank you.

Thank you. Our next question is coming from Betsy Graseck of Morgan Stanley.

Hi, Neal. Hi, George. How are you?

Very good.

Very Good.

Good. Couple questions. One on the margin and then one on the forward look for net charge-offs. On the margin, actually I was pretty impressed, I thought that the margin fell less than I would have expected, and I'm just wondering when in the quarter you did the flub retirement and did that have a meaningful impact on the margin this quarter?

Yeah, Betsy, the home loan bank debt extinguishment happened in May, so it had probably a modest impact, certainly wasn't for the full quarter. We continue to look at all of our debt within any of those pieces.

Ok. And can you give us a sense of what the yield was on those home loans that you retired?

Most of them, I think, had coupons in the 6 category.

Ok. Great. And then on net charge-offs you highlighted the kind of results that you posted this quarter were in line with what I think expectations were, it would be useful to get a sense as to what kind of trends you're seeing in non-performers in the portfolio and trends in net charge-off as a result of that going forward.

Let me take a shot and then maybe George will give you some of the overall trends. I think what we're seeing out here right now is that on the consumer side, we continue to be very pleased with the credit performance. I think on the commercial side, what we have dealt with is really around the leverage lease side. Otherwise what you're seeing are ones and twos, and I think, our small credit appetite continues to hold us in good stead. I'm not a very good forecaster on the economy. I think we're optimistic that credit quality will improve, but I think what we're really at this point -- we certainly don't think it's going to get any worse certainly.

Thank you. Given the increase that you had Q on Q and given the fact that was largely related to two lumpy credits?

Yeah. It's possible it could come back down, but I would tell you, we have an economy that everybody is trying to figure out depending on the week what's going on, so we are very cautious, but I'd also say -- I think we've tried to deal with the credits as we see them, and beyond that, I don't see looming problems.

Ok.

Betsy, the other thing here is we've always stayed at the highest end of the credit spectrum. We're not in any sub-prime lending, we're not down in the B and C and D scale paper anywhere on the consumer side, or for that matter even on the commercial side. We've always tried to extend top tier credits out there. So that gives us a little bit of comfort out there, and we obviously do a lot of forecasting and look at it, but like Neal said, some of these credits are lumpy coming through here. One, airplane lease at 10.5 million in the quarter can really skew the numbers, but pretty good number of basis points there, given our low level of charge offs. The other thing I think compared to our peers out there, if you look at where we stand in terms of whether it's NPAs at 62 basis points compared to our peer group at 112, or our charge off even at 64 the peer groups at 81 or the allowance at 240, I think our peer group is at 164 basis points, all of those continue to stay pretty strong.

And I think as we've said before, Betsy, we feel good about balance sheets. Low rates, people are worried about economic activity, but I think debt is about as close to free as you can get. You know, so there's -- I think we feel optimistic on the commercial side of the house.

Got it. Thanks.

Ok.

Thank you. Our next question is coming from Katherine Murray of Neuberger-Berman.

Good morning, Katherine.

Good morning. I was wondering if you could elaborate a bit on your outlook for interest rates and how your balance sheet is positioned accordingly.

Yeah. Gosh, I wish I had great answers there. I think a couple things. Prolonged low rates are still the most difficult thing in our balance sheet given the amount of refunds we have both on the DDE and the equity side. We have what I would describe as a short average life balance sheet, and if you look at our repricing, our repricings happen quicker in a lot of cases because we put on more volume. I think our net interest margin over the remainder of the year is going to be pretty stable. It may tick down modestly, but I think we certainly are not a company that's grown used to a 4.5% margin anywhere in our history. So I think that's something that helps us, I would say, Katherine, we certainly believe rates have to go back up at some point. The curve has gotten a little steeper. I think that benefits good strong retail origination banks, but I don't think you're going to see a quick snap back in interest rates overnight until people see stronger economic activity.

Ok, great. And then somewhat related, could you elaborate then on the outlook for mortgage banking, just where you're at with booking new originations late this quarter, and it looks like your MSR is in good shape, but anything you could elaborate on that front or on the hedging front?

Yeah, I would tell you, as it relates to mortgage activity, we've seen a little slower apps in the last couple of weeks. I would tell you it's hard to know whether or not people went on vacation or certainly a little steeper curve slows some of that down, but, you know, I think I've been wrong three or four times already on when people were going to slow down on mortgage origination. I would say on the MSR side, we're very, very proud of all the hard work our folks have done on that side. I think from where we started when we first did Old Kent, I think the MSR was over $600 million. Today it's under 240. Our servicing portfolio is essentially flat, and I think our folks have worked very hard -- we've taken a very aggressive approach to hedging it, and I think we're happier today that we didn't think we were that smart two years ago.

All right, great. Thank you.

George Thanks.

Thank you. Our next question is coming from Mike Mayo of Prudential. Mike Mayo: Good morning.

Good Morning, Mike.

First in your press release, you said you see a modest increase in commercial line usage. I'm trying to figure out if your commercial loan growth is due to market share gains or the economy getting much better, and that line seemed to imply a better economy.

I think most of what we've seen, I think the majority of it is market share gains, Mike. You know, if you would look around in this 16, 17 markets that we operate in, I think it's more indicative that we're picking up share there. I think I mentioned on the last call or one of the conferences that in the last four or five years here in Cincinnati, where we've been for 145 years, our commercial market share has gone from 26% about five years ago to 31% three years ago, and earlier this year, we're up to a 38% share in the greater Cincinnati market, which has been pretty stable. There hasn't been a lot of growth there.

What is the commercial line usage now, and how does that compare to the start of the quarter or the start of the year?

The actual number is in the mid 30's. It's up probably 1 to 2 percentage points on that utilization. As George was saying, Mike, here in Cincinnati where we far and away have the largest market share, we're up 14% on straight C and I loans, so --

And where is that utilization rate historically going back in time? George Schaefer: To be honest, given all the acquisitions, that number would be one I wouldn't trust oh a bunch. I would tell you utilization is probably pretty much at a trough.

Ok. And then separately, your operating leverage is still kind of flattish when historically you've had stronger positive operating leverage.

Yeah.

When do you think that might change? How do you think about that?

We've had a little third party help, so obviously, you know, the last two quarters, we've had in our mind probably $10 to $12 million worth of consulting expenses. I think that that comes out of the numbers, is certainly what we're signaling over the next couple of quarters.

Ok. So starting third quarter?

Yes.

And then last question, you keep saying the low interest rates hurt the margin, hurt the margin, and then your outlook is for a stable margin.

Yeah, I know. A couple things there, Mike. The margin is wholly predicated on the kind of loan growth that we're seeing. I think as you look around the industry, if you don't have loan growth, there's some pretty ugly numbers. And so what we sound tentative on is, given the loan growth, I think I'm optimistic that the margin holds in there. We're at very unusual times when you're quoting 45 years, you know, that goes back quite a way through my career.

Ok. Thanks.

Thank you. Our next question is coming from Gary Townsend of Friedman, Billings and Ramsey.

Good morning, gentlemen.

Good morning, Gary.

Just quickly, the deposit growth was impressive. How much might have been account analysis as opposed to market share expansion?

I think actually because the earnings rate credit is a lot lower now, and it's continuing to be, I don't think that's nearly the factor that you would think out there. Most of this is new account growth.

Okay.

Our Treasury management services, we've really expanded those. Our business service charges out there, we're doing a lot more, we're cross selling a lot more to our customer base out there, and generally that does help the deposits increase, but it's not due to the -- you know, when the earnings credit is -- that's pretty nominal right now. I think we're still paying an earnings credit, but it's got a zero in front of it, I think.

Thanks very much.

And I would say, Gary, we've run a lot of Treasury management campaign weeks, so I think it's more focus on the product line.

Very good. Thank you.

Thank you. Our next question is coming from Fred Cummings of McDonald Investments.

Yes, good morning.

Two quick questions. George, can you just elaborate on your head count growth, give us a sense for how much of it is coming from production versus support, and then are you continuing to hire loan officers in here?

Yes, we have continued to beef up our middle market lending officers. In places like Chicago, we've hired about 80 new commercial market lenders because of the tremendous opportunity we have up there. In the last month or so, I know we've hired 120 people, Fred, just to process mortgage applications. Our volume, we're up 180% in originations over last year. That's 180%. And just to keep the loans flowing through that pipeline, we recently hired an extra 120 people there. Overall, our head count number everywhere is up about 4%. I think we're looking -- we currently have a head count of just under 20,000. 19,830, to be exact, at the end of the --

Full time equivalents.

Yeah, FFTE kind of number here. A lot of that is process, but a lot of it is also middle market lenders, some mortgage originators, some IA people out there, mostly sales people in our product lines.

Ok. And then related to that, George, how about in your enterprise risk management area and internal audit, I know you have a new person running enterprise risk management. Has this person billed out or have they hired their staff?

Let me answer the audit side. I think we're up to about 100 audit people, increase pure audit side, that would be an increase probably of 60 or 70 people that we've added to our audit team in the last 12, 15 months out here.

And Malcolm Griggs, our new risk officer, is just putting that team together, and the additional new people in that group is probably 10 maybe so far there. We've shifted some of our compliance functions and some of our loan review functions and some other fraud management types of functions over to that area, but the net new in that area is probably about 10, Fred. And we are continuing to look for some pretty high quality risk people to work formal come in that area now.

One last question for you, Neal. The $72 million amortization and valuation adjustment, can you break that out, give us that $72 million, what portion was for the valuation adjustment for MSRs?

It's 20 million, Fred. In fact, if you walk through the narrative in the earnings release, you had about $136 million in net service revenue, ok? From that, you had security marks of 29 and about $72 million in net valuation adjustment, which nets down to 94, which is what we disclose in that paragraph on page 3.

Ok.

20 million in amortization, 50 some odd in valuation.

Oh, 50 some odd in valuation?

Yeah.

That's how you get to the 72. Twenty in am, 52 in valuation gets you to 72, which is what we disclose in the middle paragraph on page 3.

Yes. Ok. Thanks, Neal.

We'll move on to the next question which is coming from Brad Vander Ploeg of Raymond James.

Good morning. I'll try to guess what Jed was going to ask. Just a follow-up on your Chicago comment. You had put out some thoughts earlier about some fairly aggressive expansion plans here in Chicago on the de novo (ph) basis, and I'm just wondering where that stands. It sounds like you're staffing up maybe first, and I'm just wondering how the branch expansion thought process is going, and if some of the other expansion plans that have been announced by others here in Chicago have changed or altered your thinking about that in any way?

I think up in that market in Chicago, we have about 105 offices as we speak here. I think that's about the right number. And that's a pretty good distribution of branches up there right now, and just to fill out our normal complement of loan officers and small business calling officers and treasury management people and people in the international side up there would require that kind of an increase.

As you know, the commercial piece of that business in Chicago wasn't staffed fully, and that's what we're trying to do. The couple of offices that we've opened up there have been very positive. Our Lake Forest office that we opened is over 100 million in core deposits up there, and a couple of the other offices have done very well. The one in Schaumburg in particular was an excellent opportunity up there. And we're just finding a lot of opportunity in the middle market lending in that market that we're just feeding.

Can you give any color to where you see most of the talent coming from if not by name, just is it fallout from mergers, is it people that are just unhappy where they are, or -- ?

Can we wait a couple, three years to tell you?

Sure.

They work for us now.

It's been from -- a pretty broad range of other institutions up there in that Chicago market up there.

And that has been very successful. Their profitability up in Chicago, number I think year over year, we're up about 34% bottom line net income in our Chicago market up there, which includes those 100 or 105 offices up there. And that has been an excellent bottom line growth.

A lot of that is driven by the commercial side, but our retail, our level of loans up there has been -- has really been excellent up there. So we're trying to feed this 34, 35% bottom line growth up there, and it seems to be working pretty well.

But to make sure I understand, the new people are local people. They're not coming from other parts of the organization and moving to Chicago?

No, generally not. Initially we moved some people from our other markets there, but of these 80 or so people that we've hired, 99% of those are from the market and know the market up there.

Ok. Great. Thanks very much.

Thank you. Our next question is coming from Joe Stieven of Stifle Nicholas.

Morning, guys. In your Treasury, I guess on your review, you had a $31 million recovery. That's almost 37, 38% of the original charge. Can you talk about that and how that impacts the agreement? And I would have to think that would only help with the regulatory agreement? Thanks, guys. Good quarter.

Thanks, Joe. Let me take a shot at it. We've expended a considerable amount of effort around this Treasury process. I think everyone's been quite patient with us.

I would tell you what we have gone through is both a diligent internal review, we've had numerous third parties go through that work, specialists that focus just on the investment portfolio part of the world. We've had other accounting parties come in and, at the request of our regulators, have reviewed that work.

I would tell you that in the way of percentages, we reviewed over a time period as we disclosed earlier, we went back into -- I believe it was March of 2000 and reconstructed transactions. I think we looked at something in excess of 98% of the items and 99.9% of the dollars. That has all been shared with the regulators, and, you know, while we have continued to work closely with them, you know, I don't expect any additional recoveries or impacts as a result of that.

Ok. Thanks, Neal.

Gentlemen, do you have any closing remarks?

No.

See you in 90 days.

Thanks, everyone.

Thank you. This does conclude today's teleconference.