Fifth Third Bancorp (FITBI) 2002 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Fifth Third Bancorp fourth quarter 2002 earnings conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question and answer session. If you wish to ask a question at that time, please press the star followed by the 1 on your touch-tone phone. If anyone has any difficulties hearing the conference, please press star zero for operator assistance at any time. I would like to advise everyone that this call is being recorded. I will now turn the call over to Mr. Brad Adams, investment relations conference call.

This call may contain forward-looking statements pertaining to the financial condition, results of operation, plans and objectives of the Bancorp. These statements involve risks and uncertainties. There are a number of factors that can cause numbers to differ materially. Fifth Third undertakes no obligation to update these statements. At this time, I'd like to turn the call over to Mr. George Schaefer, president and CEO.

Neal and I are going to keep things brief this morning. We'll just take a couple of minutes to review what we few are the highlights of the quarter and then we'll give you a brief update on a few pending issues and then quickly open it up for your questions. I hope that most of you have had a chance to take a look at our fourth results released earlier this morning. I feel very good about these results for the quarter and for the year, given the external environment and the great number of things that we've had on our plate this year.

Revenue growth was strong across all of our business lines. Checking account growth continues to be very, very good. Loan growth was very strong, and I think any of you that have seen our credit quality will know that this is very management despite a difficult economic environment. From my perspective, the highlights for the quarter were three or four things. Number one, loan growth. Overall, our loan growth was very strong with period and loan leases increasing from 16% annualized from last quarter and 11% over last year.

Retail installment lending produced strong results all year, evidenced by the 20% increase over last year. Commercial lending had a very strong second half of the year with fourth quarter showing the most strength, and this strength was shown across all of our market areas. Next the continuation of strong deposit growth trends. Average interest checking balances increased 42%, and average demand deposits are up 14% over last year. Sequentially, transaction deposits are up 13% on an annualized basis. 2002 was an amazing year for transaction account growth at Fifth Third, and we remain optimistic heading into 2003 but we're not expecting these types of elevated growth rates in these transaction accounts as we saw in 2002.

The next point was our strong revenue and service income growth. That interest income was up 11% over last year, showing some of the benefits of our increased emphasis on lending, and giving us comfort heading into 2003 in this low rate environment. Fee income was up 19% over last year, showing some of the benefits of Fifth Third's diversified mix of fee services. As you know, we're in four different businesses, and all of these showed pretty good progress. Finally, we feel very fortunate to have had good credit performance throughout the year, and I think what everybody has recognized as a difficult credit environment.

The metrics for our credit remain very stable in the quarter, with net charge-offs at only 43 basis points and NPA's, non-performing assets, at 59 basis points. Total accrual leases are only $247 million on an $81 billion balance sheet at the end of the year. Let me say that again. We only have $247 million worth of non-accrual loans and leases on an $81 billion balance sheet. The balance sheet overall continues to exhibit very strong capital levels with $8.5 billion of equity capital, and total capital ratio of nearly 11% at the end of the year.

Overall economic conditions in our Midwestern footprint have been a great deal more resilient than most of the national forecasts that I've been reading lately. With that in mind, Fifth Third is going to continue approaching the business the same way we always have. Our focus for next year remains maintaining a very low risk profile, building market share within each of our existing markets, and improving the cross selling of both our loan and fee-based products and taking advantage of our larger retail and commercial customer base out here in the Midwest.

Now I'd like to turn it over to Neal for some additional review of our businesses and some trends to expect for the future quarters, and an update on some other pending issues. Thank you.

Thank you, George. I'm going to spend a little time walking through the line of business results and also the trends that you'll expect in 2003 by each of those lines of business. First of all, Fifth Third processing solutions, formerly our MPS business, up 30% year over year, 37% on an annualized sequential basis during the fourth quarter, which is, as most of you know, typically our seasonally strong time of the year with retail and holiday sales.

The customer flows continue to be very encouraging in 2002, and I think probably the biggest thing we continue to point to is we're fortunate to have a nice mix of business, both on the customer side and also as it relates to the pieces of the business, both on merchant and the type of merchant, but also on the financial institution side, so we feel very good on that side. Transaction volumes were up 26% from last quarter, so I think we continue to see very strong new business trends here in this line of business.

Secondly, investment advisors, up 6% over the fourth quarter of last year. 10% for the full year. Those are not numbers obviously that we'd like to continue to roll forward. We'd like to do a lot better. This continues to be an area of expansion opportunity for us, and we continue to work hard there. I would tell you in 2002, the bulk of our positive performance came out of the retail brokerage side, and our private banking areas across our markets, and that continues to be an area of emphasis.

On the commercial side, commercial banking revenues were up 11% over last year, and I'll talk a little bit about some of the markets, but we're gaining momentum in a number of the new markets, both on the deposit growth strategies and on some of our fee product sales, and I think that's some of the heartening trends we see that George spoke to. I'd also say that demand deposits in our commercial deposit base, cash management revenues were up 20% year over year, so again, I think we see that. I would tell you as it relates to our markets, we've seen nice market share increases in a lot of our new markets, both in Detroit, Cleveland, Indianapolis, and in Chicago, and we continue to see our middle market focus continue to carry through, so we see good new customer activity and also more product sales as we broaden the product line within the commercial footprint across our markets.

On the retail side as George alluded to, loan and deposit growth continue to be very strong, and we're very pleased with those trends in a low-rate year, but I would tell you retail continues to do real well. On the campaign side, we continue to focus on direct loans, as was mentioned, direct lending up 20% and, in fact, our direct lending portfolio now larger than the indirect side, and I think that's something that -- a result of a lot of years of hard work. Let me spend a moment on credit quality on the consumer side.

Our consumer loans originate in the fourth quarter, we saw FICO scores well up over 730. I think that continues to stay in line with the overall portfolio levels, and on the home equity side, we actually saw slightly higher, almost 750 kind of scores, again, staying very much in line with the overall portfolio averages that we've seen on those portfolios. So the retail side of the customer base, we think continues to have a lot of strength here in the Midwest, and we certainly feel fortunate about that.

On the mortgage side, obviously very strong quarter for mortgage. A lot of activity as people continue to refinance. You can see the breakdown of the revenue within the text, but I'd say obviously 2002 has been certainly driven by refinance origination activity and certainly we've seen that in the fourth quarter, and we think that's going to carry over into the first half of 2003.

The other thing I'd point out as it relates to mortgage banking, mortgage banking represents 8.5% of our 2002 fee income, and I think if you look across a broad mix of institutions, you'll see a much higher number, so we feel very good about the diversity of our fee income sources, and we think mortgage had a great year but we also think a lot of other areas led to our 19% growth on the fee side. Let me spend a moment on the balance sheet. Net interest margin was down 11 basis points from last quarter.

Probably modestly, a little more than some of you might have expected, but I think really the result of a couple things. If you look at the growth rate in loans, given today's low rates, I would tell you, we had more repricing happen than probably some others, but I think we're seeing net interest income trends up over 11%, and that's a trend both in the fourth quarter, and we think that carries over into the first part of the year, so again, I think low rates and more robust growth on the loan side has made repricing probably a little more rampant for us, but we feel good about where we're at.

Let me spend a moment on credit quality. As George said, we would describe credit quality as stable, and certainly as we roll forward into the first half of 2003, we're quite optimistic. I think our overall size of the numbers, as George said, $247 million, is very manageable. If you look at our non-accrual trends and the dollars that rolled into non-accrual, almost all but one, I think we had one non-accrual that rolled in that was of the $6 million size.

Everything else was $3 million or lower, so I think we feel very good about the granularity of the credit quality. We don't have big industry pieces rolling through. On the charge-off side, 43 basis points, I think again, still well below our 10-year average items that we feel very good about. Courtesy of our loan growth and our reserve posture here, I would tell you within the quarter, we provided $22 million in excess of our charge-offs, and $59 million more for the year, so again, we think we've added to the overall balance sheet and the credit positioning of the balance sheet.

Spend a moment on a couple other items. The biggest in the fourth quarter, I think we announced earlier that we are in the process of selling our property and casualty portion of our insurance agency. That rolled through in the fourth quarter. We closed on that, I think we had just over $20 million pretax gain, and that's something that flows through in fourth quarter numbers.

We also provided to you an update as it relates to the regulatory side. I think hopefully most of you have had a chance to read that as it relates to the general categories, I will say first of all, we continue to make very good progress as it relates to the reconstruction work around the Treasury items.

Secondly, we gave you an update as it relates to the regulatory side. We expect that the regulatory process and their findings will be complete here in the first quarter, and we think we have ongoing discussions there. Obviously we don't know where the ultimate resolution of those items will be, but we expect that to be resolved in the first quarter. As we've said all along, we will be very open on that. As it relates to the SEC side, we have responded to their initial request for information at this point. We don't have any further update there, but again, don't expect any material items coming out of that. With that, I'll open it up to your questions and any items you want to cover.

Thank you very much, sir. Ladies and gentlemen, we will now conduct the question and answer session. If you have a question, please press the star followed by the 1 on your touch-tone phone. You will hear a three-toned prompt acknowledging your request. Your questions will be polled in the order they are received. If you wish to decline from the process, please press the star followed by the 2. Please ensure that you lift the hand set if you're using a speakerphone before pressing any keys. One moment please before the first question. Our first question comes from Adam Compton from KBW.

Good morning, gentlemen. When I look at the fundamentals, clearly you guys are still doing really well there. I guess just when I'm looking at the wording on the regulatory issues, and I understand the ability to predict regulators over time is probably a pretty difficult task, but the wording seems to imply there could be further regulatory action beyond the supervisory letter. Could you clarify that for me or help me understand that?

No, I think what we're saying, Adam, is, is that we expect a resolution in the first quarter. I think people have wondered about the timing. We'd said early in the first quarter, we've said -- I think if we had to guess today at sometime during the first quarter, probably the middle part of the quarter is the signaling they've said to us. But I would say as to any final outcome on that, I wish I could help you more, but it is something that's evolving as they complete their process.

Okay. Thank you.

But I don't expect -- I mean, there's no way I can say supervisory, I don't know anything about that.

Okay.

Our next question comes from Betsy Grascek. please go ahead.

One follow-up on what Adam asked and a second question on the consumer. As you highlighted in the release, you anticipate the complete with the review process during the second quarter, and that, I would assume, is your own actions?

Yeah, that is our internal reconstruction activities.

Right. And then you also highlighted that you remain optimistic that a portion of the third quarter charge-off can and will be recovered and that's going to be a function of obviously the end of your review, which would come in the second quarter?

Yeah. You know, obviously we're working our way through all these transactions. We have said to people we don't believe, as we sit here today, that there's any ongoing financial negative, any impact as it relates to that. Those things are obviously point in time, but as we wrap up the last of that activity, we still think that there will be some recovery.

Okay. And then on the consumer, you indicated that p FICOs had been improving and the new loan growth you're getting was of a higher quality than had been on the balance sheet, increment incrementally better?

They might be up modestly, but I think what we're trying to tell people is, and I know people are watching the consumer side closely, that's what we're trying to tell people, is just give them a feel for new volume versus the portfolio.

Right, and then the charge-off activity during the quarter on the consumer side indicated a little bit of an increase in net charge-off?

Yeah, this is the time of the year where you both see upticks in delinquencies and the like. I think it's very hard to extrapolate trends during these two quarters. I think I've told people that consistently in the past, but as we sit here today, we're very comfortable with the trends that we're seeing on that side.

Right, I mean, third quarter charge-off rate in consumer was unusually low.

Yes.

All right. Thanks.

The next question comes from John Balkind from Fox-Pitt. Please go ahead, sir.

Morning, guys.

Morning.

Just a couple of quick questions. One, on the fee side, could you discuss why service charges were down linked, and two, in terms of inflows into NPAs, is it mostly manufacturing, is there any real estate, anything going on there?

Okay. Good question. First one as it relates to the service charge income, if you look at the deposit items, and you go back through our supplemental data, you will see there is some seasonality to deposit. We tend to see a plateau and then upticks. I think that's most visible in the supplemental information we provided you. Let me try to give you a page number. But you tend to see it stairstep (ph). I would also tell you that that's driven by some of the day count activities that go through that as to when holidays fall abandon and the like, but I would tell you, if you look at the detailed activity, I think it's on our -- I guess it's the quarter-ended trends, probably fourth from last in the supplemental activity, I think that's where you'll see it. And it pretty well delineates that you do kind of a flattening out and then it steps back up in that kind of time period.

Okay. And then on the ...

If you look at a year ago, it went from -- this is 2001. It went from 619 million down to 504, third quarter to fourth quarter.

Okay.

That's very similar. This year it was 619 -- I mean, 2002, to 569.

Yeah, and like I said, it's followed that pattern the last couple years and it's just a mix of the way the deposit service fee income happens. The other thing as it relates to the non-accrual trends, I would describe it as there are about 18 different commercial credits. I would not describe it as commercial real estate. I would say it's predominantly a middle market, and a couple other recognizable names, if you will, but our dollar amount of non-accruals here are -- all but one of them are 3 million or less.

Sounds good. Now, did the drop in 90 days past due, was that sort of a reshuffling of where you put some of those credits, or was the mix different there?

No, I think that has tended to be more something that flows through as a result of as you're working through credits.

Sounds good.

And again, because these numbers are so small, you know, $5 million credit or something can have a big -- can really have a big impact there. But in terms of like the big numbers, we didn't have any UAL exposure or what's in the paper this morning, Kmart or something, we had no direct Kmart exposure or UAL exposure at all.

Yeah, I would describe ours as granularity. That's certainly what people are used to expecting from us.

Sounds good. Thanks, guys.

The next question comes from Ken Puglisi from Sandler O'Neill.

Good morning, guys. Nice quarter as always. Actually my questions have already been asked, but on this regulatory issue, I kind of get the sense that somebody in Washington just picked on the wrong gorilla, and they're spending a lot of the taxpayer's money here, now they have to save face and do something to you. Can you give us some kind of indication what kind of actions might be taken and what effect that might have on your earnings going forward?

Yeah. You know, I don't believe that any of the actions will be financial in nature, Ken, so I think as we've tried to tell people, there certainly is a risk management theme, there is a review of both internal audit, we've significantly added to those kinds of things, so I think we've tried to signal the things that both we have been strengthening and what I would describe as ongoing discussions, but as to where those all roll out, it's very hard for us to predict.

What about the moratorium on acquisitions, Neal?

Yeah, that part, quite honestly, is impossible for us to predict. We've spent our time really focusing on the operating items.

Okay. Thanks.

Yeah.

Thanks, Ken.

The next question comes from Michael Mayo from Prudential Securities. Please go ahead, sir.

Good morning.

Hey, Mike.

What percent of the transactions have been reviewed at this point? I thought were you almost done.

Yeah, dollars and transactions are items that we've made our way through, Michael. I would tell you, in the past, we have told people that we're well up over 95% of the transactions. It's not quite there on the dollar amounts, but I would say, again, it's working through that activity, so, you know, we're trying to give ourselves leeway to make sure we get all the way through the activity.

And not to beat the dead horse too much, but the potential regulatory action, that could be anything from an MOU to a written agreement to nothing? Is that kind of the way you're thinking?

Yeah, I mean, the dynamic we deal with is, there's a whole different gradation obviously of what they may or may not do, but it's really hard for us to predict that at this point, Michael.

Michael, I don't think the "nothing" option, in all honesty, we would like that, but I think based on our release, we're saying we believe some form of action will come. Now, whether it's formal, informal or it's MOU, whether it's supervisory ...

Whether it's public or not is also something we don't know at this time.

And I'm still amazed about the merger moratorium. Was the problem caused by the old Kent (ph) integration or do you not know or are you not saying?

No, I don't think we can specifically say it was related to that. There were a number of current items. September 11th occurred in there, changing systems occurred in there, increasing our volume in that investment portfolio occurred in there, just the absolute size of that, if you look at the size of our investment portfolio over the last couple years has grown. At the end of the year, that portfolio, Michael, is now $25 billion in size. In fact, if you look in there, there's an interesting point that sometimes goes unnoticed in our summary detail. At the end of the year, there was a $674 million gain in that portfolio at year-end also.

I guess, Michael, you know, we got a lot larger. I would describe it as the company, you know, has gotten a lot bigger and we're certainly looking at fundamental, those things, the infrastructure, that's what we're working on.

And then completely separate, middle market loan growth was better than expected.

Yes.

How much of that is coming from Chicago, and then separately, those four markets you named? Is that half, three-fourth or a fourth? How much is that?

I would call it broad-based. Those are certainly the largest of the markets that we're seeing that activity, but I would tell you it's quite broad-based here in Cincinnati we see very good loan growth. We continue to take market share even here in Cincinnati, so ...

Yeah, Michael, we just had a big national survey on middle market lending here in Cincinnati, and just to give you a feel for that, five and a half years ago, we had 26% of the middle market business in Cincinnati, our Cincinnati markets. Two and a half years ago, we had 31%, as right now we have -- it's up to 38% here in Cincinnati. That's almost a 50% increase in middle market penetration here in Cincinnati, so it's not just Chicago. It's in Cleveland, Ohio and Columbus and in Detroit and Louisville, Kentucky and generally across the markets that we operate in. We've had very good success in middle market lending.

And we've hired good middle market lenders, we continue to gain new opportunities, you know, so, you know, we're heartened by those kinds of trends, and I would say the loan growth side, you know, I think as we told people, you know, in a low rate environment, a lot of it came down to loan growth p and a lot of it came down to getting the kinds of mix shift on the asset side, so as we sit here, you know, I think we were signaling that was what we were focusing on. I think what we're seeing in the numbers, that's starting to show up.

So it's market share more than the economy?

Yeah, but I'd also say, you know, this part of the middle section of the country, I think, has continued to do well even though sometimes you get false signals from other people.

Yeah, Michael, there's a lot of auto and auto-related out here, and as you know, that's good. Housing out here has been very strong. Those are the two big components out here. We didn't have a lot of Silicon Valley kind of stuff or the movie industry out here. This is the old -- as you remember, the old rust belt out here, and it's very stable, and we've continued to just stay focused on basic good quality credits out here.

Okay. Thank you.

The next question comes from Chris Marinac from SunTrust Robinson Humphrey.

Question on the mortgage fees. Is there any timing differential there?

No, think the bulk of that, there are some pieces obviously that didn't hit the bottom line in there, so I think if you look at our mortgage servicing activity, I think we tried to spell it out in the context of the release for everyone. It's sometimes hard to separate out the parts and pieces, but I think if you look at page -- I think it was on page 3 ...

Yep, I see it.

That that's kind of where we're trying to spell out for everybody the activity going on there. And I think we are still quite pleased with where that's going.

Did you retain more mortgages on the balance sheet this quarter than in past? Would that impacted the mortgage fee number?

No, only modestly. We did not purposely -- there would have been held for sale obviously is a function of origination volume that's the category that drives that.

Okay. Is there further pipeline of refinancing in this new loans in Q1?

Yes.

The pipeline is still pretty strong.

Yeah. Yeah. And obviously, you know, we have the year over year comparisons to auto footprint prior to this. Think we reminded people early frequently, but I think mortgage has done a great job both -- we like its mix today, we think we've not, if you will, accelerated earnings in that part of the business, and I think that gives us a great platform. We don't have a spectacularly high number that you're going to have to look at year over year numbers on for 2003.

Neal, do you have an expectation for how much the originations should change as this year unfolds?

No, I mean, we always like more.

Right.

But I would tell you we're certainly coming off of two very strong years. I think most people are going to be cautious, but I think as you look at our numbers, you kind of have to recognize where that lands.

Fair enough. Thank you much.

Thanks.

The next comes from Jason Goldberg from Lehman Brothers. Please go ahead, sir.

Thank you. Could you maybe just give us more color in terms of the insurance acquisition? Were there any offsets to that gain that you had, and just any revenue and expense impact going forward or do you make up for the revenue side given the venture with them in

I would tell you that there are about 220 people that went with that very narrow operating profit margins in the business given where we were at. It is a -- as it relates to fee revenue, I think its total fee revenue contributions, if you look at that piece of it in isolation, was somewhere between 15 and $20 million, but its actual impact on the bottom line is de minimus, and that's part of why we decided to spend those 220 heads elsewhere.

And then were there any offsets to the gain that you realized?

I don't think that's -- I mean, obviously we had some increases in expenses. Assumptions, things like that. I don't know that I'd characterize them as offsets.

Okay. Thank you.

The next question comes from Fred Cummings from McDonald Investments. Please go ahead.

Good morning.

Good morning, Fred.

Good morning. Neal, can you speak to your margin outlook? I know it's somewhat dependent on loan volume, but -- and your interest rate sensitivity position?

Yeah. I would tell you as it relates to the interest rate sensitivity, we feel very good about our posture. We are well within our policy guidelines as it relates to that. The thing I would point out, if you go to the page 12 of the margin items, if you look at for 2002, earning assets went down by 130 basis points. Funding costs went down by 166 basis points, but the margin went down just because of the level of interest rates. Spread actually picked up.

The other thing that gives me some encouragement as we go into this year, our liability funding costs are still 261, and if you look at the core deposit pieces of that, we're still -- we still have some high 180 to 200 basis point kind of numbers in there, so I still think we have repricing capability if rates were to go lower or, you know, that that piece of it. I think we have more flexibility on the liability side than any of our competitors.

We've always been aggressive on the liability side, so I would tell you that it's pretty hard to forecast margin for a full year, but as we go into the first half of the year, I think given the loan growth trends we're seeing, Fred, I think -- we think margin will be stable to maybe some modest improvement.

Okay. George, can you comment on how successful you are at cross-selling, at these new commercial customers you're getting? Sounds like you're certainly willing gathering some deposit relationships with them.

Yeah, this data I gave, Fred, was based on a big national company that does surveys in middle market lending and all of our markets. This includes the Clevelands, Columbus, Toledos, and I think if you look at our Treasury management growth that Neal referenced up 18, 19, 20%, you look at our international fee businesses, you know, the trading on the international side, you look at some of our underwriting and some of the corporate finance stuff and you put that all together with the lending, you can see the effects, the positive effects of that cross-selling on the commercial side.

We really feel very good about our growth in those markets. And like I said, if Cincinnati, where we've been around here for 144 years, our penetration here is up by almost 50% in the last five years. That really makes us feel pretty good. It's not just a Chicago or a Detroit or a leave land -- well, you probably see the effects up in -- you know, up in the Cleveland market up there. You can see what's going on. But if you go to Toledo, Indianapolis or Louisville, you see the same -- we're picking up in all of those markets, and we're cross-selling also.

George wants to make sure that Cincinnati numbers are high enough that he can keep beating up Bob King in Cleveland and Bob Stanford up in Chicago.

Got to keep Bob honest there.

If the home base guys can even grow market share, we obviously think the guys in new markets ought to do better than that.

One last thing, Fred. You better watch out, we got a new football coach here for the Bengals.

We're looking forward to that.

We'd like it to become a rivalry again.

With respect to the buyback, Neal, it looks like the fourth quarter, you guys were more aggressive. Can you talk about the outlook, how aggressive might you be here in the near term and even extending your authorization?

Yeah, I mean, obviously the balance sheet is in great shape. 11% capital ratios even by our standards feel pretty good, so I would tell you as the market has softened, we've tried to be opportunistic, and I think we'll continue to do that. You know, I think as we get into this year, we'll continue to play that bay ear. We sort of make that decision in six-month intervals, we review that with our board, and I think that's kind of been our operating philosophy. We feel very good about our operating trends, and we're in a nervous market, you know, obviously we'll take advantage of those things.

Okay. Thank you.

Thanks, Fred.

There are no further questions. Please continue.

Thank you, all, for joining us. We appreciate your attention, and we'll obviously keep working.

Thank you.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. Please disconnect your lines