Fifth Third Bancorp (FITB) 2003 Q4 法說會逐字稿

Good morning. My name is Holly and I will be your conference facilitator. At this time I would like to welcome everyone to the Fifth Third Bancorp fourth quarter earnings call.

[OPERATOR INSTRUCTIONS]

Thank you. Mr.

Adams, you may begin your conference.

This conference call may contain certain forward looking statements about the Third Bancorp pertaining to the financial conditional results, operations, plans and objectives of the Bancorp. These statements involve certain risks and uncertainties. There are a number of factors that could cause results to differ materially from historical performance and these statements.

Fifth Third undertakes no obligation to update these statements after the date of this call. This time, I would like to introduce George Schaefer, President and CEO of Fifth Third Bancorp.

Good morning and happy new year. Thank you for taking the time to listen in. I know it's been a very busy morning, so, Neal and I will take just a few moments to review some of the trends we saw this quarter. What happened in 2003 and some of the things to look forward to as we move into next year.

I hope that most of you have had a chance to look at our results released earlier this morning. On the positive side, loan growth remained very strong. This continues a trend that we established over the past several quarters. Deposit growth continued to stay excellent.

At Fifth Third, we spend a lot of time working at deposits and for the risk quarter was no different. We saw double-digit year-over-year growth from our key businesses and expenses were controlled as well. Clearly a heavy quarter as far as charge-off's are concerned, but the last couple of quarters have seen a pretty good decline in our non-accrual loans. We certainly feel like there will be some very measurable improvement going forward in terms of credit quality.

From my perspective, the highlights for the quarter were number one, loan growth. Overall lope growth was very strong out there with 6 billion dollars of balance sheet consumer and middle market commercial loan growth for the year helping to offset the impacts of a declining margin through the year and it helped us achieve an 8% NII growth.

In the fourth quarter period, loans and leases adjusted for any sales, securitization or planned sales increased by 17% over last year. Middle market commercial lending also remained positive with period end balances up almost a billion dollars from last quarter, up 14% annualized in what is typically a seasonally down quarter for us. Installment lending continued to remain strong with originations of $1.6 billion.

Secondly, we had a strong deposit growth trend this quarter. We had strong deposit growth, campaign growth that resulted in over a $1.3 billion in new checking account balances for us in the quarter. Our average demand balances increased 22% and averaged interest checking balances increased 13% on an annualized sequential basis.

Even though we continue to see some run off in the higher balance accounts, our retail staff produced solid growth in both the number of accounts and account balances and very good sales campaign results. Deposits will continue to be our central focus as we move into a rising rate environment and deposit collection has been something that Fifth Third historically has been very good at.

Number three; our operating expenses continue to be well controlled versus some of the trends we saw earlier in the year. I'll let Neal walk through some of the initiatives we are working on here and the opportunities we see for continued productivity improvements next year.

Credit quality is obviously not where we would like it to be, but I feel we have got a number of the problems behind us this quarter and expect 2004 to be a much better year on the credit front. We are not happy with the results of the commercial credit this quarter, but we continue to be pleased with the retail loan credit quality trends. Neal will go through some of these in a minute.

Overall we feel like we over came some significant challenges this year with the level of interest rates at 40-year lows and a difficult year for credit. We were still able to deliver double-digit earnings growth. We also invested significantly with over 58 new banking centers.

We opened 58 new branches since December of last year. We hired 115 new commercial sales FTE's and we made significant infrastructure investments that should continue to reduce our back office expenses.

Going forward we are still focused on building our market share within each of our existing markets by opening more checking accounts and improving account retention. We are working on improving our cross selling of both our loan and fee based products and taking advantage of a large retail and commercial customer base. I think you know we have 5.5 million customers out here in the Midwest and still plenty of cross sell opportunities there.

Third we want to maintain the low risk profile on the balance sheet. Given our core loan and core deposit trends, we expect to see modestly rising net interest margin trends in2004. Then we are going to continue to focus on productivity initiatives, making sure that our capitals invested in the businesses that offer the best returns at the right risk levels I'll turn it over to Neal for some additional review of our businesses and some trends that are expect in the future quarters Neal?

Thank you, George. I'll step through some of the line of business results and talk a little bit about overall balance sheet trends and credit quality. First on the line of business, Fifth Third Processing Solutions, little better quarter. This is seasonally typically a good quarter for us.

We are up 9% year-over-year, 14% if you exclude the 8 million dollar impact of the Visa-Master Card settlement in FTPS numbers. Merchant revenue is up 15 % for the year on new customer volumes. Transaction volumes as we pointed out last quarter, a little low slower in the fourth quarter transaction volumes were up about 6% over prior year. So we feel very good on the merchant side.

On the EFT side an essentially flat year-over-year partly impacted by acquisition of one of our larger customers on the financial institution side. And decreased interchange revenue that we've seen courtesy of the debt settlements. Here we see good new customer sign ups.

We think that will show up in the numbers as we get through the year-over-year comparison by midyear in 04. On the investment advisor side, increased 14% in the quarter versus a year ago. All groups had nice increases. Retirement plan services, institutional asset management and the fund and private client group all up nicely.

We continue to feel good about the direction we are heading here. And the improvements in the overall equity market. We also see very strong growth coming in some of the newer market as we hired a sales force and improved the product offerings in this area.

On the commercial side we are gaining momentum in a number of markets, both on our deposit growth strategies as well as on fee product sales side. I would say commercial deposit revenues were up 13 % for the year.

We think there's nice momentum as we start into this year, given the amount of new customers we are seeing. We continue to work to strengthen the depth of the fee income opportunities on the commercial side. We feel very good about the breadth of the product line offerings that we have today for our middle market customer segments

On the retail side as George said, loan deposit growth remains very strong. In periods of low interest rates, we are delighted with the effort we have coming out of all 950 branches. They've certainly differentiated us on the loan and deposit growth. This is another strong year. Record year for consumer loan origination, up 14 % over last year and 26 on a core basis excluding securitization during the year.

We continue to focus on deposit campaigns. Really executing hard on that side and we think that's one of the things that if we are in a rising rate environment in '04, we think that deposit kind of focus of our company will continue to drive our growth on that side.

As George said, earlier, the deposit side is something we've done for a long time and one of the numbers that stood out in the quarter to us is we now have over 100 branches that have more than $20 million in loans as a result of the focus on the direct lending over the branch side. So we are real pleased with the progress that has happened there.

On the mortgage side, a solid quarter on mortgage banking, given the reduction in refinance activity that we are seeing. We have aggressively gone after the volume related costs as we have seen applications come down. And we think that will help us as we go into a slower revenue year for mortgage banking in '04.

Another thing I would point out is mortgage banking for the full year represents about 12.5% of our total fee income category and in the fourth quarter is about 9.5%. I think that gives us a smaller platform on which to grow as it realties relate to '04 and we feel good about the mix there.

On the operating expense side, very controlled over the last couple of quarters of this year, as a result of less third-party costs and as a result of us focusing on some of the productivity initiatives that George talked about. We are continuing to work hard in this area as we head into '04. I think you can expect that the expenses will be well controlled in our company.

Our focus in 2004 is really driven off of the overall industry that we think is going to see probably mid single digit kind of revenue growth. So we really worked hard on the expense side, the last couple of quarters to prepare for that as we head into '04.

We have used automation to improve overall processes across the company. We focused on line of business productivity and the continuation of focusing of rationalizing any of the non-core businesses that don't fit in the middle market franchise.

Turning to the balance sheet for a moment, probably the thing that stands out on the year, we saw our balance sheet grew by about 6 billion dollars in loan, 5 billion dollars in deposits and long-term debt grew by a billion dollars. So we think we've taken the balance sheet forward. It continues to maintain the high quality that most of you expect from us.

On the net interest income front, increase by 5% in the quarter. That's certainly slower than we would like, but I would say we continue to focus on it. Interest margin up a couple of basis points versus last quarter as a result of better mixed trends on both the loan and deposit side and stable trends on the customer spread side an slow prepayment amortization out of the bond portfolio.

We expect to see the margin trends in the next couple of quarters to improve modestly. We think that general trend of interest rates in '04 will be higher. We think re-pricing will kick in the balance sheet, although it will take time.

Essentially three to five-year part of the interest rate curve is up 70 basis points versus mid last year. So we think that re-pricing will begin to show up, but it's probably more muted in the first couple of quarters of the year. We believe net interest income will grow in line with the overall balance sheet growth if margin stabilizes, as we believe it will.

It has been a quick moment on the credit quality front. As you see, 72 basis points in charge-offs this quarter versus 59 last quarter. That's really driven by two large, large for us, just below 10 million dollar charge-off on the commercial leasing side.

Away from that, I would tell you of the credits that are over a million dollars, I think there were eight of them in that range and they are all in the 2 to 3 million-dollar category. So no concentrations there.

On the non-performer side, I would say pretty well behaved. We sure would like to see it lower. Additions in the quarter, there was about 31 million dollars of additions into the non-performing loan category representing 11 credits. So again we think pretty well distributed and no large pieces to the balance sheet there.

Again, I think we are very proud of a double-digit year given the external challenges that we had and certainly the internal things we were focusing on. As we go forward in '04, I think our general sense is that revenue trends for the whole industry are going to continue to focus us on the productivity initiatives that George talked about. With that, I think we'll open it up to questions and we'll deal with them as they come.

[OPERATOR INSTRUCTIONS]

Your first question comes from David George with A.G. Edwards

Good morning. A couple of quick questions. First, these are both difficult questions to answer but can you talk about what you think the normalized credit cost of Fifth Third Bancorp will be kind of in a normal credit cycle.

Obviously you guys have been impacted by similar airline credits, some leasing credits, etc. So I just want to get some perspective there. And then second, on the processing side over the near to intermediate term, X the Visa-Master Card settlement, what do you think is a reasonable revenue type growth Boeing going forward? Thank you.

Yes let me take a shot at that. On the credit side it's hard to forecast out more than a couple of quarters. But I would say as, as we look at it right now, we think we return to charge-off levels below the 50 basis points level in the next couple quarters. We are pretty confident of that. The good news is retail credit has been very stable.

And I think on the commercial side we feel like we've gotten some of those behind us. As it relates to our processing side, we think adjusted for the kinds of settlement on the Master Card side we think we're in a sort of a mid teens kind of growth given the transaction volumes that we see right now. New customer sign ups continue to be very robust. There's a lot going on, obviously, in that industry right now. But we feel quite good about where we're.

Thanks, Neal. That's helpful.

Very good.

Your next question comes from Fred Cummings with McDonald Investments.

Yes, good morning, Neal and George. Just a couple of quick questions. One, on the -- looking out to next year, how do you decide whether or not you are going to partake in any securitization activity? Say the home equity portfolio.

Then secondly, Neal, in light of your comment about charge-off coming down, it seems to me that you may have some ability to draw down your reserve. I know historically you kept it in a pretty tight range, 145 to say 152 over the last ten or 15 years. Can you comment on the prospects of maybe bringing that reserve to loan ratio down in conjunction with improving charge-off?

OK. I would say as it relates to levels of loan loss reserve, we have a process that we look at. I think most people are, have looked at that area. And specifically, obviously we have had a lot of loan growth. We think credit quality trends are improving but at the same time we have typically not had provision and charge-off. We kind of look at that as a quality of earnings piece. But I would say, we think we have some flexibility and if we get it by gaining a bunch more middle market customers.

I think we would rather utilize some of that flexibility that way. But I guess, Fred, my general belief is usually when people are over reserved and dropping that into earnings, you tend to do things you don't want. I think also Fred we look at the level unallocated reserve that we go through in our process out there. So it's a function of that also. And as credit trends improve, that amount of unallocated reserve has a tendency to rise and we can't let that get too far out of hand.

We watch it pretty carefully. We look at the mix of the portfolio and, you know, I think all of us recognize what is going on.

And the securitization outlook, Neal, for the home equity loans?

Yes, what I would say, Fred, if you look at the balance sheet as I said earlier, we had over 6 billion dollars in loan growth and if you look at our consumer loan category, it's now 17 billion dollars. And so we look at both sides of the balance sheet. So we have 6 billion dollars of loan growth, 5 billion dollars in deposits, and a billion in long-term debt, we kind of look at that balance.

If we don't have the kind of deposit growth we are probably going to use more securitization on that. We also look at the single categories. We kind of like to maintain some balance between retail and commercial and between the categories on the retail side. Not put all our eggs in one basket on credit quality, if you will.

Lastly, George, can you give us any update on the formal written agreement with the said? Any conversations there to suggest that we might get some resolution of that?

As far as that goes, Fred, what we mentioned in the last 10-Q that we sent out, page 19 of the Q is still pretty much the official -- we submitted everything.

We updated them there in the process; the regulators both from the fed and the state are in the process of verifying all the documents that we sent to them.

And you know, like we said, we are targeting to accomplish this verification to be completed this quarter. There isn't really anything new to update there. I think maybe the best news is there is no bad news, Fred, is kind of the way to state that out there.

OK, thanks.

We feel optimistic certainly.

OK, thank you.

Your next question comes from Gary Townsend with Friedman Billings Ramsey

Good morning, gentlemen. How are you?

Very good.

Part of the quarter, absent the income from discontinued operations you reported diluted earnings of 73 cents. I was wondering, with the consensus estimate for 80 cents for the first quarter of this year, it seems as though there is a GAAP there. Can you help me just sort that through?

I would say, Gary, if you look at the versus a year ago, we had the sale of the insurance business. That was not accounted for on discontinued operations. I'm not a good enough accountant to explain the difference between those two.

But I would tell you that if you compare it versus a year ago, I think you don't get to the same, the geography is different, but I don't think the dollars are all that different. And I would say overall, thoughts as it relates, we tend not to do EPS guidance and we certainly recognize the trends that we have.

A year ago in the quarter, it was 26 million dollars gain on the sale of insurance. Another, I think it was $7 million for some branch divestitures that occurred. That amounted to $33 million if you look at Q4 back in '02. I think that's what Neal was referencing.

The geography moves around because of the accounting on it. And like I said, we've gotten out of some of those rural branches. We've gotten out of the corporate trust business. We've gotten out of the insurance pieces that we weren't really; don't believe that they fit with what we're up to.

OK, thank you.

Your next question comes from Jason Goldberg with Lehman Brothers.

Yes, high. I guess, other income, weather it's kind of the lowest level we have seen it quite some time. Is there anything else anything in the picture through that line that is weighing it down?

No, I would say there's a mix of items. Obviously taking out the corporate trust revenue for the year and dropping that down into the other had an impact. There were a myriad of categories that were a little softer seasonally in the quarter.

You know, items that aren't big things, but boldly, commercial fees in a couple of cattle gores that were sequentially down. I feel pretty comfortable you will see it return back to the levels that we have had. But the corporate trust revenue, not net income, obviously in disc ups, that's what is going on there

Secondly, I guess, operating leases, the income revenues were down in the quarter. Do you expect that number to continue to run down?

That I would say has been flat to a little lower, partly because of the level of interest rates. We've focused more on the higher coupon loan paper than the lease side.

Great. Thank you.

OK.

Your next question comes from John Balkind with Fox Pitt.

Good morning guys.

Good morning.

Quick question I had it looks like you did a fair amount of work in the fourth quarter. Is that related to some of the comments you made vis-a-vis sort of exiting non-middle market or non-core businesses? And where can we expect head count to trend in '04?

I think if you looked, there were also some reductions as Neal mentioned with the reduction in the mortgage volumes. We are trying to keep the expense level with the production levels pretty much in line there. So a number of those heads came out on the mortgage, mortgage-processing side. We are trying to keep those costs really variable and not fixed. So some of that will depend on the level of volumes out there.

We are going to pick a little in some of these process improvements out there. But I think its going to be probably stable to what you see out there right now because anything we are bringing out on the consolidation side or the improvement side we are trying to add back in on the revenue producing side.

We are trying to hire more middle market lenders and more institutional sales people and more FX people and more traders out there to improve the revenue lines. So there's a combination of getting out of some of the manual processes and bringing in big revenue producers here. We think we are going to have some pretty good opportunities going forward here in this market.

Great. Thank you so much.

As we have opened more branches, we are adding people there. But in our newer markets we'll continue to drive that.

Thanks, Neal.

Your next question comes from David Long with Robert Baird.

Good morning and thanks for taking my question.

Yes.

In your (inaudible) branching, you said that you have opened 58 branches this year. What was the net impact of just those 58 new openings to EPS in '03?

I wish I was that good. I would tell you, our branches right to date tends to break even in about 11 months. You can see on the occupancy line it's gone up. So obviously as we have added offices you see it there, as well as on the salary and staffing side. But it takes about 11 months for them to cross over to profitability. Again, David, that's an average. Some other ones, some of the offices we opened up in Chicago, up in Lake Forest and Schaumburg and some of those have been less than 6 months profitability and its hit huge deposit targets pretty quickly.

We have opened them up in some of the more traditional markets that we have been and it takes a bit little bit longer. So, eleven is kind of an average, but it has come down significantly. It used to be if you asked me that four or five years ago, it took about three years and now it's come down to less than a year simply in the way we are marketing and using direct mail and using some of the other techniques we have to gain deposits and loans as we go into a new market.

OK. And what is your outlook for (inaudible) branching in '04.

I think we have got on the drawing board right now probably 40 or 50 that we've targeted, have got in some phase of property acquisition we are looking at and that's as we sit here today.

And again depending on, you know, what happens in our market is very dynamic. If there are some sales that are available, if there are some opportunities that could change but I think in places like Chicago, Detroit, Cleveland, Indianapolis, some of the places where we have got small market share, you are going to see us go a little bit quicker there. So, I would say probably at least, what would you say, Neal, 100 but that is a.

We're always rolling that list. As George said, if something happens in a market like a big transaction where somebody gets sold to New York or something, we probably would be more aggressive.

Great. I will look forward to seeing more branches up here in Chicago.

You'll definitely see that. I think we opened five of them on Monday up there in the Chicago market, just to show you the intent up there. We like Chicago. It continues to be good. Yes, there are five new Fifth Third signs up in the windy city.

Great, thanks.

Your next question comes from Katherine Murray with Neuberger-Berman.

Yes, hello. I was wondering if you could elaborate on why there are still in flows at this point into NPA's and what the outline for the pipeline of inflows is at this point.

This is Neal, Kathryn. Yes, I talked just about the new inflows and I would say we think the trend in total is going to be lower.

Obviously, our business is not whip sawed by large syndicate lending world. When you are making loans to the middle market parts of, businesses have tipped over. But I would say there's no one market, it's spread out across our footprint and there's no one in this, Katherine that jumps out at us. Like I said, there were 11 credits and I think they were all in one to $4 million categories predominantly.

Neal, would that be let's say a normal level of inflows, you know, during a cycle or something? Can you help size that for us?

Yes, I would say we see those as slower. I think the last couple of quarters, we see fewer of them coming at us than we have seen.

OK, and then I was wondering if you could estimate for us the contribution from mortgage banking to the bottom line this quarter and how that would compare to recent quarters?

I would say our expectation is that overall net income probably is down 20% to 30% as we go into '04. Obviously revenue is probably trending towards the down 40. We have worked pretty hard on some of the automation side. We worked very hard, as George said, on the temporary labor and that side and some of the other costs to really make sure we are doing all we can there. The overall net income is probably in line with the numbers I gave you. Mortgage banking, we watch pretty carefully, like I said in a pretty robust refinance area, it was only 12.5% of our total fee income category. We probably didn't have as high up on the revenue driven off the mortgage banking, but it is now not in our denominator at the same level. It's heartening to me to see only 9.5%. So that drop off feels a little better to us. Clearly, that's a challenge for the whole industry.

Right. On the other, or on the operating lease income, you mentioned why that was down. But the expenses related to that, should those be moving with the income? How do those two things move?

In general, if a portfolio is flat, you are going to see that bounce around based on credit. That's also what is going on in those. A portfolio that is flat is going to function a little less than that, probably, Kathryn. Growing portfolios you are going to tend to have that going the other way.

OK.

I would say it's really a function of - we de-emphasize some of the consumer leasing given just the absolute rate level. We still like tax, deferred businesses. But I would say that's a, that's what driving it.

OK. Finally, Neal, I missed the comment that you made in the prepared remarks about the size of the balance sheet going forward. Could you just repeat that, please?

Yes. I don't know if that is worth hearing, but I would say the overall balance sheet, I guess what I would point people to is net interest income in 2004, we think it will grow in line with the overall balance sheet given what we are seeing in the way of trends on the net interest margin side, Kathryn.

OK.

I'm not a great economic growth forecaster. The loan growth we have been seen on the last several quarters both on the commercial and retail side carry forward and you have double digit balance sheet growth and we can have a stable margin, we obviously feel that's great news. Re-pricing does not happen overnight. It's still something that probably takes 18 months to work its way through. So right now I would say the balance sheet is probably high single digits and maybe double digit, I think the balance sheet grew nicely in tougher economic environment this past year. But clearly, securities were part of that

Thank you. My last question would be just on the operating environment in your marketplace. Could you comment on whether there has been any improvement or deterioration in the environment for your customers, your corporate customers, and commercial customers over the last quarter?

I think, Kathryn this is George. I think our customers are a little bit more optimistic out here. As you know, we have a very diversified economy out here. Our biggest company out here is Procter and Gamble. They have been knocking the cover off the ball.

At the same time people like department stores Krogers, General Electric, it's pretty diversified out here. There's a lot of auto here. Japanese auto, Toyota, North America headquarters is out here. Japanese auto, foreign auto seems to doing very well here. Detroit continues to plug along here. Housing continues to go very well. This low level of interest rates is helping a lot. The energy prices have been rather subdued out here.

So when you put all of that stuff together, it's generally pretty positive. You have to remember in the Midwest, Kathryn, this is the old rust belt. We are used to these ups and downs. People are used to you know, it's not like we are totally dependent on steel out here or anything. It is much more diversified going forward out here.

And people also like the health care, the professional services are also booming right now out here. If you look at all the hospitals, the docs, the HMOs, everybody in that line of business is doing really pretty well out here. I think it's generally pretty optimistic. The markets have helped out. But these continued low interest rates are helping out also. Most people now see the glass as much more half full than sort of half empty.

OK.

I think one of the other things all of business has learned to live with very low inflation level. So I think the whole business climate has really worked awful hard on productivity. I think if you took a survey, people rather have inflation. I think everybody would loves to see a little price opportunity, but you know, I think we've all had to work on being better operators across all industries. I think if we see more demand I think that's going to pay off for everyone.

Great, thank you.

We have time for one more question. Your final question comes from Matthew Clark with Deutsche Banc.

Good morning A couple quick questions just on with your decision to out-source the HR business. Was there any severance related expense this quarter? What kind of a benefit do you expect going forward? Is it material?

And then secondly, secondarily, can you comment on the tax rate from continuing operations? It appears a little light.

Yes, this is Neal. Let me take a shot. I would say in the out-sourcing specifically on the HR functions, that wouldn't have been the huge number of employees. There is, obviously, some severance. But it probably does not materially alter any of the expense categories. I am quite optimistic that you'll see salary and benefit expense probably down in the first half of the year. So I think you're going to see that coming our way. As it relates to the effective tax rate, we've predominantly targeted around 31% area. I think that's a good run rate sort of thought.

OK.

At this time this concludes our conference call. Thank you all for taking your time. I know there's a lot of things' going on this morning. We will be available for any follow up questions that you have. Thank you.