Fifth Third Bancorp (FITBO) 2005 Q4 法說會逐字稿

Good morning. I will be yourself conference facilitator. At this time I would like to welcome everyone to the Fifth Third 2005 earnings conference call. [OPERATOR INSTRUCTIONS] Thank you. I will now turn the conference over to Brad Adams, Investor Relations officer of Fifth Third Bankcorp. You may begin your conference.

I am here with George Schaefer and Kevin Kabat. This call contains forward-looking statements concerning the financial conditions, results of operations, plans and objectives of the Bank. These involve certain risks and uncertainties. There are a number of factors that can 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.

Thanks Brad and good morning. And thank you all for taking the time to listen in. I will have a few comments and then Kevin Kabat will review some of the trends before we open it up for your questions. Regarding trends this quarter, deposit growth rebounded strongly in the fourth quarter. With transaction deposits increasing by 11% annualized and core deposits increasing by 13% on the same basis. While the fourth quarter is typically a strong quarter on the deposit side, we believe the changes that we made under our every day great rate strategy are producing successes. We are looking forward to continuation of these trends as we move through 2006.

Next, loan growth lends continue to remain very strong and we expect low double digit growth rates to continue in the near term. Commercial lending was very strong in the fourth quarter with period end balances increasing by 14% annualized from last quarter. C&I loans are up now a very strong 19% over the same quarter last year. Average consumer loans increased by 14% over the same quarter last year, or 10% when you exclude the acquired loans. These are solid results.

Net interest income declined by $10 million on a sequential basis due to 5 basis points of contraction in the net interest margin and modest average earning asset growth. The relatively flat level of earning assets was due to a continued run off in the securities portfolio during the fourth quarter and the timing and magnitude of securities sales during the third quarter. Our primary focus remains funding loan growth with core deposit growth . We will talk about the specific moving parts and the things we're working on to improve performance here in just a moment.

Service income trends were good in some areas and mixed in others. Considerable strength remains in our processing business and our commercial banking subcategories. We feel very good with the results and trends that we see in these two areas. Our Investment advisors business was affected by poor performance and brokerage related revenues. Deposit revenues declined modestly from the third quarter levels due to seasonal factors in overdraft related revenues. Typically, the first and fourth quarters are the slowest. Within the other noninterest income categories trends were fairly similar to what we saw last quarter. With significant increases in commercial banking related revenues representing the majority of the $20 million sequential increase here.

Next, expenses were elevated in the fourth quarter at $31 million more than the third quarter. The growth relative to last quarter breaks down as follows. First, equipment and occupancy expenses increased 8 million due to our de novo efforts, we added 15 more branch offices in the fourth quarter, and due to IT related depreciation expense. Other expenses increased by $28 million, primarily due to volume related increases in bank card expenses, this was about $8 million. A fraud in one of our affiliates, which was about $9 million. and higher tax related expenses of about $10 million.

In 2006 our focus will be on improving productivity from the significant investments made in recent quarters and remaining diligent on the expense side given our overall revenue trends. Investing in and expanding our distribution network remains a priority. But we do see opportunities for improvement in a number of areas in order to control expense growth. As previously disclosed in our mid-quarter 8-K, credit quality trends were noticeably weaker in the fourth quarter. We experienced approximately 27 million in losses to bankrupt commercial airlines. In addition, consumer bankruptcy related charges were approximately $15 million above a typical quarter run rate. We do expect modestly higher bankruptcy numbers in the first quarter as compared to the current charge-off trends, due to continued heavy volume.

And total net charge-offs were at 117 million, an increase of 53 million from third quarter levels. A couple of additional comments. The rate environment proved very challenging for us this year with results well below our initial expectations. It is not a secret that Fifth Third's performance in 2005 disappointed investors as well as ourselves.

The most significant challenges we faced for the year were these. First the prolonged and significant flattening of the yield curve throughout the year was our largest challenge. Our primary response involved restraining balance sheet growth throughout the year by orderly reductions in the securities portfolio despite the negative impacts on the growth rate of net interest income. Continuing to leverage into a flat curve would have extended our margin and revenue problems well beyond 2006 and compounded our spread and margin shortfalls. With the limited investment opportunities and a flat curve environment, Fifth Third executed significant share repurchases in order to return excess capital to our shareholders. This action is also consistent with Fifth Third's transition to a less capital intensive and higher return, more de novo focused growth strategy in the current environment.

Second, disappointing deposit growth trends during the first half of the year magnified the problem of the flat curve. In response, Fifth Third de-emphasized the teaser rate deposit strategy and aggressively raised deposit pricing in order to offer customers the convenience of an every day great rate. With this change, deposit growth momentum returned but the increase in deposit funding costs did pressure the margin. And some high balance teaser sensitive money did leave Fifth Third. With these steps behind us, our deposit rates are now competitive in all of our markets and core deposit growth was reinvigorated in the fourth quarter at a 13% annualized right. For the first time in several years, for the quarter, core deposit growth exceeded loan growth.

Third, a flat curve with lagging deposit growth resulted in a declining margin and negative operating leverage through much of the year. With the profit margins available in banking, long-term success will always be a function of your ability to generate revenue growth. However, the temptation to curtail investments and slash costs is extremely high when the margin is under pressure. The benefits of these strategies are generally one time in nature, with costs that extend well into the future. You must invest in order to grow and deliver long term value in this business.

We believe that the numerous banking center and sales force additions we made in 2005 will result in increasing levels of productivity and excellent returns for our shareholders in the years to come. With the acquisition in Florida and the sales people additions across the footprint, we increased the average size of our sales force by about 1,400 people in 2005. All of the challenges I just described are short term in nature and the entire management team is united and committed to appropriately addressing them. Flat curves don't last forever. Deposit costs will level off and the margin is very nearly stable.

Despite the short term costs, we believe the decisions made thus far are in the best long-term interests of our shareholders, our customers and all of our employees. As we look forward to the upcoming year, we believe our core earnings power in the fourth quarter was really in the mid-$0.60 range per share. We expect that we can continue to improve upon that number as we move throughout 2006. Net interest income will be moderated by continued reductions in the securities portfolio through the first half of the year.

With the portfolio down about 13% and the spreads compressed by raising interest rates on the remainder, the first half of 2006 will remain a difficult environment for net interest income. In the future, depending on the environment and the level of fixed rate loans on the sheet, we believe the appropriate securities level for Fifth Third is somewhere between 15% and 20% of our total assets in order to effectively manage interest rate risks.

Overall, 2005 was certainly not easy and the environment remains difficult but we are very enthused with the trajectories we're seeing on the deposit and fee income side. New banking centers continue to produce solid results. And we are working hard to make sure that the new sales people are making progress towards achieving Fifth Third levels of production. With that, I would like to turn things over to Kevin to discuss some more of the details. Kevin?

Thanks, George. I will start with some of the balance sheet trends in general and move through some of the lines of business results and then we will open it up for some questions. On the assets side; loan growth was very good this quarter with the average balances increasing by 1.2 billion on the commercial side and by 738 million on the consumer side. Total average loan growth was 1.9 billion. Earning asset growth was extremely modest in the quarter, however, due to a $1.7 billion reduction in the average securities portfolio from significant security sales at the end of third quarter.

In the fourth quarter, total loan growth was 11% annualized. Earning asset growth just 1% annualized. And core deposit growth at a very strong 13% annualized. Fourth quarter margin compression resulted from 12 basis points of compression in the net interest rates spread from the increasing costs associated with wholesale borrowings, mix shifts within the deposit base and the impact of passing through approximately three quarters of recent Fed rate moves to depositors. With the forward curve indicating Fed tightening nearing an end, we believe the growth generated from aggressive deposit repricing represents tremendous value.

Overall,l we continue to be focused on growing deposits, maintaining strong loan growth, and shrinking the investment portfolio. Success in these strategies will allow us to improve our mix of funding and result in better revenue and margin performance in the second half of the year. Based on the forward curve at this point, we would expect flat to very modest compression in the margin in the first quarter, with sensitivity overall very near a neutral position. The tangible capital ratio was essentially unchanged at 6.87%. We continue to be comfortable at these levels and view share repurchases to be an attractive use of capital as the margin stabilizes.

I am talking about some of the business lines. We'll tell you that fourth quarter was a very good quarter for our commercial banking business. Average loan growth was up 13% annualized, highlighted by 15% annualized C&I growth. Deposit revenues were essentially unchanged despite the impact of increased earnings credit rates. Commercial banking fee revenue was up 37% over last year on strong results in loan syndications and international. And customer interest rate derivative revenues remained very strong, more than double last year's production.

Fifth Third processing solutions had a great quarter also with revenue up 16% over the same quarter last year. Retail sales transaction volumes were a little softer than our initial expectations heading into the quarter. Without a full year basis, core revenues increased by 23% over 2004. And we remain very enthusiastic about the future in this business. We expect revenue growth will continue it be in the 20% range in 2006.

Mortgage banking revenues declined modestly from third quarter levels originations of $2.5 billion, an increase of 25% over last year. Net mortgage banking revenue breaks down with 65 million in gross revenue, less 10 million in hedge losses, 19 million in amortization, plus 6 million in MSR valuation adjustments. Our investment advisors increased 5% over last year and was essentially flat on a full year basis due to poor retail brokerage performance. Deposit growth for the retail bank was consistently strong from September through the end of the year and on into January.

At this point, we feel we've positioned ourselves very well in each of our markets. We intend to continue to be aggressive with each successive Fed rate move. And while our promotional at rates are not the highest, they are competitive with others in the marketplace. And our every day great rates are extremely competitive. We believe they are the - - are better value for our long-term relationships.

While rate remains an important part of our efforts, we are keenly that aware pricing alone is not the answer. We continue to engage customers through frequent surveys and the results indicate that we're continuing to improve. Our service provider indicates that Fifth Third service measures are currently out performing two-thirds of the banks under their coverage. While we're pleased with, we are not satisfied, however. And we're developing a number of initiatives to continue to improve our overall customer experience. Our initial efforts at meeting success with total retail account openings increasing by 13% and attrition rates improving by 20% on a full year basis in 2005. Small business within the retail line of business was a big success story for Fifth Third as well in 2005. For the year, small business loans and deposits both increased by 19%.

In retail overall, we made significant strides in 2005. We have a great deal of momentum heading into 2006. We expect to selectively add about 50 net new banking centers in 2006. And believe that every day great rate strategy will allow us to move market share. In '05 we gained share in 15 of our 19 markets. But we would tell you the magnitude of those moves was in most cases less than our goals, and we think we can do much better this year. At this point, we would like to open up to any questions that you have.

[OPERATOR INSTRUCTIONS] Your first question is from the line of Keith Horowitz with Citigroup Global Market.

Actually this is George Nissan. I have a couple of questions. Given the rise in recently publicized events surrounding data theft and security breaches, what are you guys doing to ensure customers, shareholders and employees that you are taking the necessary precautions to prevent an eventual security breach?

I think you'd know in the last two or three years we've significantly beefed up our IT area in this regard. Both because of our processing business that we do, we do a lot of processing, and also because of our own just internal security. Our risk people, our audit people, our compliance people have all been very involved in this. And I think we're at an industry leading standard when it comes to watching and monitoring these fraud occurrences that occur. We have been fortunate so far. But the crooks out there, as we all know, are getting smarter. And so we're constantly upgrading all of our systems. We've also purchased some of the latest fraud software that's out there to make sure we're on top of this. But so, far we've been pretty fortunate here.

Have you guys seen these efforts affecting your ability to meet the regulatory compliance guidelines or impacting your business.

No, not at all. We're trying to stay well ahead of the regulatory curve on this item.

How are you seeing these efforts? You sound like you have a lot of things in place, that you put in place to ensure customers satisfaction. How are you seeing those efforts you've put in place to affect your ability to meet the regulatory compliance guidelines?

I think we're seeing these efforts by the fact we haven't had significant issues in this area and the proof is always in the pudding.

Okay. And what would you say for the remainder of the 2006? What are you going to do to ensure customers that security breaches will not be a necessary problem and you will make sure your customers are well secured?

Again, like I said, we're trying and through the tremendous efforts of our data processing and our Fifth Third processing group. We're staying on the leading edge in this area because of its concern. And we're staying very close to the regulators. Our risk people are staying extremely close here in this area.

Do you pretty I much have a team that's always monitoring that?

Totally. Totally. We're constantly monitoring this.

With that, I think we need to move on to the next question. And we'll continue to stay diligent on obviously customer related fraud issues. It is extremely vital to our customers and we will be on the forefront and the cutting edge of handling that. Thank you for your question.

Your next question come from the line of David George with A.G. Edwards.

A couple quick questions. First, can you update us and I apologize if I missed it. Can you update us with respect to your CFO search? And then as it relates it your forward looking commentary, on NII then, do you expect just the balance sheet to be relatively flat as you continue to shrink the securities book? And then on the credit quality side, I thought, George, you said that charge-offs were 15 million above normalized levels. I'm just trying to get a sense as to what kind of normalized charge-off rate we should be thinking about as you move through '06. Thanks.

Okay. Let me try to get all three of these in here. On the CFO search front, we have interviewed a number of candidates and as of today we have not found the perfect fit. This is an extremely important decision and while we would prefer to make an announcement sooner than later, this is not a decision that we're going to rush into. We look forward to making an announcement as soon as we possibly can. I think you know Mark Graf continues to serve as our acting CFO. And we announced this morning that Mark has agreed to a short term extension to his originally scheduled January 31 resignation date. So, this is where we stand on the CFO search front.

I think your next question was the interest rate environment; what's our for net interest margin and net interest income? The key variable here really remains attracting low cost deposits. Strong deposit growth in this area will enable us to improve our funding situations more quickly. Based on the forward curve today and with the core deposit growth similar to fourth quarter trends, we would expect to see flat to modest margin compression over the next two quarters.

I think your next question was regarding credit quality. What's our outlook for overall charge-offs? Credit overall has been extremely well behaved over the last several quarters. And the trends overall continue to be very benign. We currently expect net charge-offs in 2006 to be below our long term historical average of 50 basis points. In terms of the level of provision, that is something will ultimately follow our general outlook for near term credit trends based on our model. We feel that our reserve levels are adequate based on our current expectations. But I do think that we have had good credit quality here. But we might be at the bottom here as the economy tightens up a little bit.

Okay. Thanks, guys.

Thank you.

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

You highlight that you're looking at expenses more but you're already one of the more efficient shops. So, I was wondering what your target is for the expense to revenue ratio and a little detail on how you might get some of these savings?

We're taking a hard look at expense actions given our current revenue trends and believe that we have some really good opportunities to improve our expense leverage. We have significant Six Sigma processes that we're working on throughout the organization. But investing for the future remains important to us. And we'll continue that de novo banking center expansion. Like Kevin said, we're going to build a net 50 offices. That probably means we will open about 75 and consolidate about 25. And these are going to be in markets like Chicago and Florida where they're our most cost effective avenue for growth. Our current expectations for expense growth is to be in the low to mid-single digits for the full year. But these are the basic kind of expense items that we've traditionally done here. And it is becoming more efficient. Making sure the productivity of our sales force continues to increase, like I mentioned. That we get everybody up to those Fifth Third standards on the selling side also, Mike.

So, why do you think that revenues can grow faster than expenses again? I am guessing you're saying the second half of the year?

Yes, I think that would be pretty accurate again there.

Obviously, Mike, as we continue to really self fund our core loans, that's our key objective. The quicker we can do that, the better we can do that, the quicker we can move through this period and see a revenue lift in the second half.

Okay. And just an unrelated question. There has been a lot of press reports that Fifth Third is a takeover target and all of that. I am sure you're tired of hearing all of that. But what is the official Company response when someone asks you or me; is Fifth Third for sale? What's your attitude?

You won't find many people around here, Michael, who think the intrinsic value of Fifth Third is in the $40 range. At this point we believe that most of the pain to fix the problems here as already been felt. And it would be not - - it wouldn't be fair to our shareholders to deliver that value to another company's shareholders. So, I think we're pretty optimistic looking forward here.

Have you sold any of your stock?

Please?

Have you sold any of your stock.

No. I continue to have interest in almost 4 million shares, Michael. Now, when I exercise an option, there is some exchange there. But no, I haven't sold any shares.

Thanks a lot.

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

Good morning gentlemen. Questions have been asked and well answered. Thank you.

Thanks, Gary.

Your next question come from the lane of Kevin St. Pierre with Bernstein.

I was just wondering if you - - Kevin, I'm sorry if you touched on this. But if you can you give me a little more insight into the sequential increase in other noninterest increase, as well as the trends throughout the year? We started out -- we've had quite a run-up in other noninterest expense during the year.

We chat a little bit about your question in terms of the other noninterest expense. I am going to keep that response brief because I know you're going to want more on the core business trends. We did have a fairly complex scheme perpetuated on the mortgage side that led to approximately about a $9 million fraud loss recognized in the fourth quarter. I would say that there are no further expenses incurred in that matter. And additionally, we did have certain incremental tax expenses recognized in Q4 that was really sales and use tax based. Those were really kind of the main items, about 10 million in that number. Those were really the main items, Kevin, that I think that we'd kind of give you better clarity on.

And unrelated, George, you mentioned that no one around there thinks the intrinsic value is in the $40 range. Could you comment on current period share repurchases -- or fourth quarter share repurchases and why with the stock where it is why we didn't see a bit more?

We did no share repurchase during the fourth quarter. And some of the that period we were -- some of that time we were in a blackout period. But during that quarter we didn't do any repurchasing. We have -- we're always conscious of the margin impact on share repurchase. We are comfortable at the current levels of our capital between 6.5% and 7% on a tangible basis when you exclude the mark to market impacts. We would not expect to increase leverage into a difficult rate environment. So funding loan growth with core deposits still remains our first priority. Share repurchases will continue, though, to be viewed opportunistically. I believe we have about 17 million shares left in our current authorization there.

Thank you.

Your next question comes from the line of John Balkind with Fox-Pitt.

Just a quick question on the tax right. It has been running lower the last several quarters and I know you had some adjustments in prior quarters related to audits and the like. Would we expect to continue to run at this low and effective tax rate through '06 or should it --?

No, no, we wouldn't. The answer to that is definitely no. We don't expect an effective tax rate below 30% to continue. The rate for the fourth quarter was positively impacted by tax credits and the expiration of certain statutes of limitations, which gave us a little kick there. We expect our tax rate to return to the mid-31% range for 2006. That's the mid-31% range for 2006. That's a more realistic level.

Great. Thanks, George.

Your next question is from the line of Betsy Graseck with Morgan Stanley.

Hi, thanks. I just wanted to touch base on one of the comments that you made regarding the securities portfolio. Did I hear you correctly saying that you were anticipating reducing that to somewhere between 15% to 20% of total assets?

Correct.

Yes, I think that's the target that we would shoot for.

And over what kind of time frame would you be anticipating that?

We continue to reduce this. Of course in the last fifteen months it's come down pretty significantly. Currently we're at about 22% there. The natural cash flows I think run off at something like $3 million -- I am sorry, $3 billion per year, so that would be the anticipated rate.

Okay. And then does that factor into your NIM outlook? You mentioned that you NIM was going to be fairly stable.

Yes, that's totally factored in there.

So, in other words your loan yields should be improving quite nicely.

Yes, as the rates continue to move up they should move up commensurately.

And then on the corporate other, in the other fee line where you had some relatively strong corporate activity this quarter, should we be anticipating that that is sustainable going forward? Or is there anything in there that relates to year end for the corporate clients that you have?

Betsy, the other fee income category, the strength was in the commercial banking segments as well as some broad based smaller increases across other line items. Commercial banking would probably tell you that they don't want to be held to maybe 5 million less than the number they posted in the fourth quarter. But overall we're not too far off, from a run rate perspective, in the other fee income side.

And then just lastly on the new branches that you have been opening over the past 1.5 year or so, two years, could you give us an indication on how the revenue growth run rate has been the kind of revenue growth run rate you have been experiencing?

Betsy, we've said, as you know and as we talked about on these calls before, very aggressive targets in terms of our new banking center performance. We monitor that weekly, monthly. And our banking centers -- our new centers are performing to our standards. So, they're on track. They're doing very well from that standpoint. And we're pleased with their overall performance.

Has the break even -- the years to break even changed at all?

No. It is the same as we talked about in the 10 to 13 month time period.

Okay. Thank you.

You bet.

Your next question comes from the line of Mike Holton with T. Rowe Price.

Actually, I have two questions, which are basically followups on stuff people have asked already. Number one, on the I guess the finance function, the CFO search, given that probably until last week Mark Graf was thinking more about the Bangles than Fifth Third, can you talk a little about how other members of management are helping out in finance? Have you added other people in the finance department to help out?

Yes, I think you have to recognize that we run a decentralized structure here. So, each one of our 19 affiliate banks has financial people in those areas. Each ones of our lines business has financial people in those areas. And management team coupled with Mark and his staff have all been working very cooperatively here as we go forward. And I don't think we're skipping a beat right now going forward here.

And then just the second question, is on expense growth. You say numerous times. you're remaining diligent on it. You're focused on the expense categories. But then you talk about I guess kind of low to mid-single digit expense growth in '06, which is frankly higher than banks that are actually growing their revenues. What is the disconnect, George? Where in the expense structure are you guys having a hard time either bringing stuff down or just investments need to be a lot higher than people think? Basically, why is an expense growth likely to be lower in a tough revenue growth environment?

I think that we continue to open de novo branch offices. A lot of people -- I think if you look for the year 2005 we've got 108 more offices that were running and operating. And like we mentioned, we have 1,400 more sales people. Now, we could have chosen not to do any of these things. And that would have brought that expense level down much more similar to what the other people are doing. And we would have looked much better on the operating leverage side there. But I think overall for the long term we have to continue to invest both in the people and these offices. And we've also made a significant investment in the IT area. And this is needed -- these IT investments are needed for future efficiencies. But those have been big investments over the last three -- two years or so.

Right. And then just the last one on the CFO, will you make a commitment in terms of; you were going to have a new CFO at Fifth Third by X date, or does it continue to be open ended?

No, we want to get an extremely well qualified person in that slot. Just to put somebody in there for the sake of hitting a time target, we're not going to do that. And our management team isn't going to do that and our Board doesn't want to do that. We wanted to get an excellent person in there in that position.

I would assume though, that you've probably interviewed the highest quality highest qualified people first, right?

We continue to look at the whole landscape there.

There is a lot of good conversation, Mike, going on. It is very active right now. So we feel very good about the activity that we have there. But to George's pointed, we're not going to make a decision for the sake of making a decision. We're going to find the right person for the job.

Okay, Kevin. Thanks.

You bet.

Your next question comes from the line of Ed Najarian with Merrill Lynch.

My questions were all basically answered, so thanks for your time.

Your next question comes from the line of Vivek Juneja with J.P. Morgan.

Commercial loan losses, you had a little bit of an increase. You're up to about a 53 basis point run rate. Can you talk a little bit about that, what the outlook is? And also give us more color on this bankruptcy related loss modest increase that you're talking about, what's driving that? And is it first quarter you see that ending or is anything firm?

I think that's probably first quarter. But again, as you know and as other banks have reported, the backlog in the bankruptcy courts is really pretty significant here. And for us to get the paperwork, we're getting some of it in. But we don't know how backed up they are. And so what we want to do is be conservative in our estimates there, Vivek. On the commercial side I think our 8-K did indicate and our release that we did take those airline charge-offs at $27 million. That was pretty significant. The other charge-off we had one $5 million communication related charge-off here in Cincinnati. But the rest of it has been granular. Some of it has been in the small business area where we've had some small ones in different areas. But the charge-offs for this quarter are higher obviously. We expect those to get back under that 50 basis point range going forward.

Great. And a question for Kevin. On the deposit pricing side, you're following this every day good rate. What kind of response are you seeing from your competitors? Are you seeing anybody coming close to matching you or where do things stand at this point given where we are in the cycle?

Vivek, that's every day great rate, not good rate. We are still seeing that while we're not price leaders in our competitive markets, that they are still using teaser strategies; that really we feel very good about our positioning from an every day great rate level. So, we think in terms of the fourth quarter results that's a pretty good indication of the success. That it is working and that quite frankly, that's continuing into the first part of this year. So, we feel good about it.

Thanks.

Thank you, Vivek.

At this time there are no further questions. Gentlemen, are there any closing remarks?

Thank everybody for their attention this morning. And if you have any follow up questions, we're obviously around to answer them. Thank you.

Thank you.

This concludes today's Fifth Third fourth quarter 2005 earnings conference call. You may now disconnect.