Fifth Third Bancorp (FITB) 2004 Q4 法說會逐字稿

Good morning. My name is Elizabeth and I will be your conference facilitator today. At this time I would like to welcome everyone to the Fifth Third Bancorp fourth quarter 2004 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer period. [Operator Instructions]. Thank you. I would now turn the call over to Mr. Brad Adams, Investor Relations Officer for Fifth Third Bancorp.

Good morning. This call contains certain forward-looking statements about Fifth Third Bancorp pertaining to recently completed acquisitions and financial conditions, results of 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. At this time I would like to turn the call over to George Schaefer, President and CEO of Fifth Third.

Good morning and thanks for taking the time to listen in. I'll have a few comments and then Mark will review some of the income statement and balance sheet trends before we open it up for your questions. In 2004 the rate environment proved very challenging for us and our results for the year were well below our expectations. With our funding mix and the prolonged nature of low interest rates, net interest income had failed to keep pace with asset growth for the last 2 years. New asset growth did not provide the types of coupons we were expecting and deposit growth was below our expectations for much of the year as well. Because of these factors additional leverage into this trend was not attractive as we felt the returns were not in line with the risk.

In response to these conditions Fifth Third took the following actions in the fourth quarter. We sold 6.4 billion or about 20 percent of our securities portfolio with realized losses of 79 million. We had the early termination of approximately 2.8 billion in long-term debt with prepayment charges of 247 million. We had a corresponding reduction in other wholesale borrowings and we terminated about 2.8 billion in received-fixed swaps. These actions resulted in pretax charges of about 326 million, as well as some give up from the third quarter net interest income levels. The decision was based on simple economics. The return we were receiving was out of line with the level of capital that was being leveraged. And a reduction in both lower yielding assets and higher cost debt and the current interest rate environment will improve our returns.

We feel that we have significantly improved the profile of our balance sheet and that we are positioned to generate growth and net interest income in 2005 that we expect to be in line with our earning asset growth. In the release this morning we also announced the repurchase of 3.9 million shares in the fourth quarter and an additional 35.5 million shares in January. Or approximately 7 percent of the outstanding shares since September 30th. The decision was based on both the attractiveness of our stock compared to alternate investments and our prospects for improved performance in 2005 and the years to come. With the addition of First National Florida earlier this month and recent repurchase activities we expect our tangible capital ratio to approximate 7 percent at the end of the first quarter and for it to continue to improve with earnings growth throughout the rest of the year.

Regarding other trends in the quarter, first loan growth remained very strong and we expect to maintain low double-digit growth in the near-term. I would also say that December was a very good month for us in terms of commercial loan growth and commercial activity in general. I think our commercial results for the month of December were as good as we've seen. Secondly, deposit growth continues the trend we saw last quarter and remains strong also with 12 percent average transaction account balance growth on an annualized basis from last quarter. Average demand deposits were particularly strong at 18 percent annualized. We expect the deposit business to become increasingly competitive as rates continue to rise and relative value increases. This is a good environment for us. Service income trends are probably best characterized as mixed and below our expectations.

Our processing business had another strong quarter and a very good year. We processed about 12 billion electronic transactions in that business last year. Mortgage banking remains a challenge. And although the overall deposit growth rate was very good our retail deposit service charges and revenues continue to be sluggish. Our commercial service charges were very good but our retail service charges, like I said, were sluggish. Investment advisors was down for the quarter largely in brokerage but we are excited about the momentum in 2005 in this business. We did significantly improve the margins in this business as we also installed several new systems here that we think are going to help us in the future.

Credit quality remains well behaved at this point and expenses continue to be within the range of our expectations given our level of investment in salespeople and new banking centers in 2004 and continuing in 2005. A couple of additional comments before I turn things over to Mark. First, revenue growth in 2004 was not where we would like it to be. Some of that is due to some tough comparisons in mortgage banking and more broadly the interest rate environment in general. As most of you know we have been taking a hard look at expenses but that has not stopped us from investing meaningfully in the franchise. We have made some significant investments in the Company. We're still hiring salespeople in all of our markets and across all of our lines of business.

We are continuing to invest in new banking centers. In the fourth quarter we opened 17 new centers. The returns for us on our de novo efforts have been very strong here in the midwest. And this continues to be our most attractive growth opportunity in the midwest. We've also made some very significant investments in new technology in the recent past. First National Bankshares of Florida closed earlier this month and we are excited about how things are progressing thus far. We looking forward to building a very profitable and large affiliate in the Florida market. Our Nashville affiliate is now double the size of what we bought to enter the market just 6 months ago and we are continuing to expand our presence in Tennessee. In conclusion we are still focused on building share and upgrading our sales teams within each of our existing markets and we are working hard to improve the bottom line profitability throughout all segments of our businesses. With that I will turn it over to Mark to go over some details.

I'll start on the balance sheet and the net interest income side. Fourth quarter net interest income increased by 1 percent on a year-over-year basis and decreased $14 million linked quarter. The net interest margin decreased by 7 basis points linked quarter, continuing to be driven by spread compression of 13 basis points. This compression is attributable to a couple of factors including continued flattening of the curve from the front-end and timing of trades within the quarter. Specifically, in the balance sheet restructuring securities were sold relatively early in the quarter and high cost debt eliminated in the latter half. As George mentioned deposit growth was very good across transaction deposit captions with some continued drag in interest checking from higher balance accounts. Across checking products open to close ratios remain very good and I'm confident it will begin to show up in interest checking as effectively as the other captions. On the asset side consumer loan growth remained good and commercial loan growth was excellent.

Overall we remain pleased with the level of loan growth we've seen this past year and believe it will continue in 2005. Looking forward, as things stand right now, we expect to see net interest income trends increase at low double-digit sequentially annualized rates through 2005. Our expectations for 2005 are earning asset growth at levels similar to recent periods and including the acquisition of First National and the stock repurchases we expect first quarter margin to approximate 340 to 345. Generating deposit growth continues to be very important to fund new assets as well. We are continuing to work closely with the business lines in order to make certain they have the pricing and marketing that they need to compete aggressively. On a credit quality front net charge-offs as a percentage of average loans and leases were 44 basis points versus 40 basis points in the third quarter. On an overall basis charge-off trends improved significantly compared to 2003. NPAs now stand at 51 basis points with relatively good recovery rates expected.

Delinquency trends including greater than 90 days pass due improved throughout 2004 and we expect 2005 credit performance to be very similar on an overall basis. Within the commercial portfolio specifically, delinquency levels improved over 2003 and will stay relatively constant around the current levels for the next few quarters. We will continue to evaluate these trends quarterly and maintain reserve at appropriate levels to the expected loss rates on the portfolio. Moving quickly through some of the business line detail. On the commercial side, as George noted earlier, we had a great quarter for commercial with strong growth in loans, international revenues, loan and lease fees and cash management. The retail front we saw much improved trends on the deposit side and consistent performance on the lending side as George made reference to. Deposit revenue remained sluggish in the quarter, however.

Fifth Third Processing Solutions was up 8 percent year-over-year and 28 percent on a comparable basis adjusting for our third party business that we sold earlier in the year. Merchant revenue was down year-over-year but up 29 percent, again excluding the impact of sold contracts. Financial institutions revenue was up 27 percent year-over-year showing benefits from new customer revenues. On the I. A. front was down modestly on slower retail brokerage revenues relative to last quarter. The first half of 2005 should show improvement. At this point that concludes our comments and we would like to open it up to any questions you may have.

[Caller Instructions]. Your first question comes from the line of Fred Cummings of KeyBanc Capital Markets.

Yes, Mark, can you touch on your run rate for expenses? My quick math suggests that core expenses are about 688 million this quarter when you back out the expenses associated with the balance sheet restructuring. And I'm just wondering if you can touch on that and then the outlook for core growth in terms of what type of salary increases did you put through on average for 2005?

I think, Fred, I'd probably address both questions in one fell swoop and just kind of give you a sense. For 2005 we expect operating expense growth to be in the mid single-digit range. The fourth quarter was impacted, as George noted in his comments, by the addition of about 600 full time equivalent employees in the fourth quarter alone, over 90 percent of which were sales related heads. Only 53 of those heads were not directly sales related. And in addition we opened 17 new banking centers, as George noted earlier. So that coupled with the, as you noted, the extraordinary items in the quarter kind of caused the optics to be a little bit muddy. But as you look forward I'd be looking for mid single-digit expense growth.

And then 1 question related to this 35.5 million share repurchase. Now, was that bought back from a group of institutional investors or was it done via some accelerated repurchase activity with an investment bank where they would short shoot the stock.

It was done on an overnight share repurchase transaction. I would say that given where our stock has performed of late, Fred, and the confidence we have and the actions we've taken, and the fact that ultimately we'd end up taking it all out in the first quarter any way, the opportunity presented itself and we took advantage of it.

Okay. Thanks, Mark.

Your next question comes from the line of Mike Mayo of Prudential.

Just a couple general questions. Seems like you are buying back pretty aggressively here. You're looking for double-digit sequential growth and net interest income. Are you sticking to your guidance for 2005? I guess that was 320 to 330 or is there a change upward because of those positive factors.

No, I think at the end of the day we feel that the actions we contemplated as we entered into that and gave the guidance in the fourth quarter are kind of what we have gone through here at this point in time so we feel pretty good about that.

With regard to your interest rate posturing, I think I asked the question on the last conference call, are you now done? And specifically with the 100 basis point increase in Fed funds what is the impact on your earnings?

I would say -- I'm happy to say we are asset sensitive across all the metrics we look at. That includes curve flattening trades, both from the long end and the short end, primarily focused on short end runs as well as ramps and shocks both up 100 and up 200 basis points.

What will you have in your Q or 10-K, in this case.

There will be a pretty copious disclosure as consistent we've had and it will show all the ramp analysis as well as the flattening scenarios.

So no more exceptions for securities or curve flattening or no noise in the numbers this year due to interest rate scenarios under a reasonable scenario.

No, I think I'd say we're very -- it would be safe for me to say at this point in time we're extremely bullish on the balance sheet. We're seeing loan growth that's tremendous and did throughout all of 2004. That's continuing. On the deposit side of the equation I think 2004 is a tale of 2 years, really. The first half of the year our deposit growth wasn't what it needed to be, Mike. But as you look at the second half of the year we kind of knocked the cover off the ball pretty well and that trend is continuing through the first couple of weeks of the quarter here. Also as we move forward. So we feel pretty good about the organic actions that's generating. In addition, I think we've dealt with some of the issues that we had to contend with and as witnessed by the profile I shared with you there, or outlined for you there, we feel very, very bullish on the balance sheet.

Then last question, your operating leverage looks pretty negative any way you slice it and I know that's not something Fifth Third likes to have. How long should we expect to see negative operating leverage? It seems like you're investing for the future, so are you going to keep investing for the future and have negative operating leverage for how long?

I would tell you I wouldn't expect to see negative operating leverage for an extended period of time at all. For the full year 2005 I clearly would not expect to see negative operating leverage.

But that's all incorporated in your assumption for your EPS for the year?

Absolutely correct.

All right, thank you.

Your next question comes from the line of Denis LaPlante of Keefe, Bruyette & Woods.

Your margin behaved better in the fourth quarter than you were advertising at the time of your prerelease. Can you talk about the things that impacted that, please?

First and foremost, Dennis, it was deposit growth. We continue to see deposit growth that was just incredibly strong and while clearly we are doing what we need to do to give our lines the marketing fire power they need the pricing was also very well controlled, very well contained on that front. So at the end of the day that almost exclusively is responsible for the margin outperformance.

Now, in terms of the quarter, Fred already touched on the expense items, the item that seemed out of whack compared to my numbers was not the staff line where all the additions was but it was in other expense and that number seemed to be about $30 million higher than forecast. Were there any other non-recurring or special items in there that we are talking about?

No, the only non-recurring things were the items that we detailed in the release.

Okay and that was 247 million in total related to the long-term debt.

That's correct.

Okay. The electronic payment processing also compared to beginning of the quarter, or should say the beginning of December, you were suggesting a number that was a little lower than expectations going in and then you reported a number that was very strong at the end. Can you talk about the volume numbers in December and any special drivers there?

December volume, our retail merchant base provided us very good merchant volumes through the month of December. There is no question about it. FTPS, of all of our fee businesses, continues, Dennis, to feel the best by far. We're very confident it's a 20 percent plus grower over both the near and the intermediate term. And it's tough for you guys to get the optics on this piece, too, but I think it's important for you to know that the profitability is actually going to grow at a faster pace than that revenue growth number that I noted earlier.

Anything related to a new contracts that kicked in in December that might have helped that?

Not particularly, no. Just a little bit of a lag in terms of when that kicks up.

Your next question comes from the line of Gary Townsend of Friedman Billings Ramsey.

You've talked a lot about your strong deposit growth. I was hoping to just get more color on that. Can you talk about just the underlying market factors that seemed to be particularly helpful in the latter part of the year.

Sure. I wish I could say it was underlying market factors. I think -- I think we have to be intellectually honest enough to say that we just took our eye off the ball a little bit in the first part of the year, Gary, and we are back focused on it in a big way and it's paying results. We continue to see the momentum. It's critical for us. We expect the value core deposits to continue to increase to us as rates rise. We are going to continue to be heavily focused in the area both with promotional activity as well as new advertising campaign we will be kicking off very shortly as well. And as noted, with average transaction deposits up 12 percent annualized over the third quarter and DDAs up 18 percent annualized over the third quarter we think it's really starting to pay some results.

Could you discuss -- .

Gary, this is George.

Hi, George.

One other thing that's a current out there right now is the recent changes, the purchases that have occurred here in the midwest, the Bank One changing its name to Chase, big competitor out here. Provident Bank in the Cincinnati market changing its signs to National City. Charter One being acquired by Citizens, Union Planters over in Indianapolis, major player over in there, being acquired by Regions. All of those acquisitions are occurring right now. That has not hurt our deposit growth at all. As you know when the signs change generally there is some reduction in those deposits for the competitors there and that hasn't hurt us at all.

And in Chicago can you describe any late year trends?

I would say deposit trends in Chicago late year are actually quite good, very strong results.

That's good news. Finally, with respect to the share repurchase, it appears to me to have been an accelerated plan but you didn't use that word. Is that true?

I did not use the word accelerated. It's what referred to as an overnight repurchase agreement. All the shares were delivered to us on the 10th of January.

I don't mean to cut hairs, split hairs, but it sounds effectively the same. Is that true?

There are some subtle nuances but effectively I would say from your perspective it's the same.

Your next question comes from the line of Kevin St. Pierre of Bernstein.

I was wondering back on the loan side if you could give us a little more detail around the commercial loan growth and where you're seeing it. Is it blocking and tackling or what are you seeing in pricing or to what extent is it being driven by price? What's behind the C&I loan growth?

A lot of it is coming out of the our 17 different affiliate markets. It's coming from Chicagos and Clevelands and Detroits, the markets where we have low share and are just getting in there. A lot of it is coming from the additional salespeople that we've added. We've added some 82 commercial marketing people. These are middle market lenders for the most part out there and they are generating books of business. Our leasing business was very good in the fourth quarter. So it's coming across all segments out there and generally the manufacturing economy out here is generally holding its own. So, we are seeing a little bit of pick up on that side.

I would say it's concentrated very much in the middle market segment. It's not elephant hunting. It's not getting a bunch of bank books and buying syndicated loans. It's relationship lending to our core customer base.

How would you characterize spreads and pricing?

Spreads actually a little bit better than expected. That being said, I would say pricing is still very tight and very competitive out there. There's no question.

Thank you.

[Operator Instructions]. Your next question comes from the line of Denis LaPlante of Keefe Bruyette Woods.

Good morning. The tax rate looked a little on the low side this quarter. Can you talk about that a little bit?

Yes, Dennis, it's primarily due to the losses realized on the restructuring. There's a few other minor items as well. But, you're absolutely right, it is artificially low as a result of those. We would, going forward, expect to see the tax rate pretty much in line with the prior periods this year.

How much of the tax rate was beyond, over and above the restructuring charges? Were there other tax benefits that you had over and above that?

There were some minor ones none of which was any consequence individually.

Thank you.

[Operator Instructions] Your next question comes from the line of Jerry Benson of Level Global.

Hi, guys, just a quick question. On that share repurchase, the overnight deal, what were the nuances? I mean is there stock to buy right now, did someone short the stock to you?

This is Brad Adams, Gary, the actual details of the transaction are not something that we can go into in a great detail. As Mark said, the shares were delivered on this day. There are some lagged effects to that transaction but it's not very complicated and we certainly apologize for making it sound that way. In terms of actual details, nuances don't really drive that here but there is some commitment that does occur over a lag period of time.

Okay, thanks.

Your next question comes from the line of Fred Cummings of KeyBanc Capital Markets.

George, you guys have had a number of senior management changes over the last year or so.

Yes.

And I wanted to ask George, are there going to be additional changes? And most of the people who have been promoted seemingly come from the outside. Are you concerned at all about there being any kind of cultural clash and how much comfort can you give us that that unique Fifth Third culture will survive despite the number of senior managers leaving this Company due to the size -- ?

No, I think, Fred, we are up to 22,000 employees now so the number is getting a lot bigger. And for us it's a little bit unusual because we have 17 affiliate banks. Most people don't have those so any time there's a change in any one of those there is going to be a lot more changes just because of the way we are structured here. But if you look at the changes that were made, if you look at Bob Sullivan, taking Steve Schrence(ph)'s place about a year ago. Steve had announced his retirement 2 or 3 years ago and stayed on throughout the written agreement and Bob was, certainly -- has been very capable. He ran our bank up in Toledo, had run his own bank and is doing an excellent job in the commercial line of business. In the FTPS side with Neal Arnold running that. In the I.A. side Neal had run the I. A. business prior and then the FTPS business we've got a real pro in Charles Drucker running that business for us.

If you look over on the retail side Bob Niehaus retired after 34, 37 years of service. Kevin Kabat, who spent a lot of time at Old Kent, certainly knows the culture, had run an affiliate bank for us 4 years up there has kept that right in line. On the financial side Neal is still here, Mark Graf's here and he's got a trustee assistant, Ron Marks, who has been the Treasurer up at Comerica, that our financial side is very, very excellent. Paul Reynolds on the legal compliance side, our whole regulatory team, Malcom Griggs on the risk side, Dan Poston on the audit side, are very excellent. In the IT area Greg Carmichael and that team we've put a lot of new people in there. The former -- our former head of IT is still with us and still working here. And there've been some changes out in the affiliates but as people are here with 30, 35 year careers and also, Fred, a lot of wealth. One of the things we've created for a lot of these guys is a whole lot of wealth. When it gets cold up here a number of those guys do like to go down south and play golf and spend some more time with their family and that's expected.

So, yes, you might see some more but the basic underlying Fifth Third culture of going out and hustling and selling and keeping an eye on the expenses and everybody communicating with each other, we think if anything that's getting much, much stronger. In fact we are right now in the process of going out to all of our affiliates and all of our lines of business with Company meetings just reiterating the whole culture of Fifth Third, where we're headed, where we're going and those are being very, very well received out there. I don't think the culture has been diluted. We are trying to keep it as strong as ever. And our affiliate structure allows a lot of that, also, Fred. The fact that we are staying small with each of these affiliates and we are not just one big $100 billion monolith where nobody knows anybody. In these affiliates we're really staying aggressive.

Thanks, George. That's good color.

At this time there are no further question. I will now turn the call back over to Mr. Adams.

Thank you all very much for calling in. It concludes our conference call today. We'll see you next quarter.

Thank you. This concludes today's Fifth Third Bancorp fourth quarter 2004 earnings conference call. You may now disconnect.