Fifth Third Bancorp (FITBO) 2006 Q1 法說會逐字稿

At this time I would like to welcome everyone to the first quarter 2006 earnings call. (OPERATOR INSTRUCTIONS). I will now turn the call over to Brad Adams, Investor Relations officer of Fifth Third Bancorp.

Good morning. Thanks for joining us. I'd like to remind everyone before we get started that this call contains certain forward-looking statements about Fifth Third Bancorp, recently completed acquisitions of 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'd like to turn the call over to George Schaefer, President and CEO of Fifth Third.

Good morning, everyone, and thanks for taking the time to listen in. I'll have a few comments, and then Kevin Kabat will review some of the other trends before we open it up for your questions.

Regarding trends this quarter, earnings per diluted share were $0.65. The $0.65 is both with and without a $3.5 million positive impact from a change in accounting principles related to stock-based compensation.

Next, loan growth trends remained consistently strong at 10% over last year. Most of the strength this quarter was on the commercial side, with average loans and leases increasing by 11% annualized, led by strong growth in C&I loans. Average consumer loans were essentially unchanged from the fourth quarter, excluding residential mortgage, but they were up 12% over the prior year.

Next, deposit growth trends were good, with core deposits increasing by 6% over last year and 4% annualized, despite the seasonal weakness in commercial. Most of the growth was in March, and we feel encouraged by the trends thus far in April. Our primary focus remains on funding loan growth with core deposit growth.

Next, net interest income declined by 17 million on a sequential basis due to a 3 basis point contraction in the net interest margin, [day comp] comparisons and relatively modest average earning asset growth. Margin performance was slightly below our mid-quarter guidance.

Compression in the first quarter resulted from the mix of deposit growth and, relative to our March projection, the increase in rates served to decrease the amount of cash flow from the portfolio, leading to less-than-expected mix improvement on the asset side. We'll talk about our expectations for margin for the rest of the year in a moment.

Next, service income trends were very good in some areas and mixed in others. Considerable strength remains in our processing business and corporate banking subcategories. We feel very good about the results and trends we see here.

Deposit revenues declined modestly from fourth-quarter levels, due to seasonal factors and overdraft related revenues. With the other noninterest income categories, trends were fairly similar to what we saw last quarter. Expenses were well controlled in the first quarter, and they were $32 million less than the fourth-quarter levels. We will remain diligent in 2006 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. The expectation this year is for low to mid single-digit expense growth. Net charge-offs were 42 basis points in the first quarter, credit trends improved substantially from the fourth quarter levels, and our outlook for the remainder of the year remains optimistic. The tangible capital ratio increased modestly and remains a strong 6.90%. We remain committed to a prudent level of leverage given the interest rate environment and the outlook for sustained flatness to the curve.

A couple of additional comments before I turn things over to Kevin. As we look forward in 2006, our earnings and balance sheet trends this quarter were in line with our expectations. A sustained flat curve is a difficult environment in this business, but we feel very good about our competitive position and the progress we've made on improving the balance sheet.

Loan growth has been funded with core deposits and securities sales and runoff for the last four quarters, leaving our tangible capital ratio unchanged. This (indiscernible) hard work over the last 12 months have improved the interest rate positioning of the balance sheet. The continuation of current balance sheet trends will leave Fifth Third very well positioned when the short end of the curve stabilizes.

More success on the deposit side, which continues to be our primary focus, will result in additional improvement. In total, we believe that the strategic actions we've taken are driving results. Deposit attrition has improved substantially and we like our competitive position. We continue to be enthused with the trajectories we're seeing on the fee income side as well, and we expect expense growth to be much more controlled this year.

I know some of you may have questions on our progress on our CFO search. I can say that we have met with a number of talented people over the last few months, and believe that we will have an announcement to make very soon. With that I will turn things over to Kevin to discuss in a little bit more detail.

Thanks, George. Let me start with some of the balance sheet trends in general, and then move through some of the lines of business results before opening it up for questions.

On the balance sheet and net interest income, on the asset side, loan growth remained good this quarter, with average balances increasing by 1.1 billion, or 7% annualized. Earning asset growth was more modest at approximately 800 million, or 3% annualized, due to continued reductions in the securities portfolio.

First-quarter margin compression resulted from 8 basis points of compression in the net interest rate spread, due to less-than-expected asset and deposit mix improvement. Overall, 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 current trends and the forward curve, at this point we would expect a few additional basis points of contraction in the second quarter from seasonally-high first-quarter levels. Margin stability is expected in the third quarter.

Within the business lines, let me talk about commercial. Commercial banking momentum remained strong in the first quarter. Average loan growth was up 11% annualized, highlighted by 12% annualized C&I growth. Deposit revenues increased modestly, despite the impact of increased earnings credit rates. Commercial deposits were down from fourth-quarter levels on seasonal weakness, and you'll notice that we provided greater fee income detail this quarter with the breakout of corporate banking revenue on our income statement. This category is comprised primarily of international fee revenues, commercial loan and lease fees, customer derivative sales and institutional bond underwriting and sales, and you'll find additional historical performance in our supplement to update models and illustrate any seasonality in these revenues.

Fifth Third Processing Solutions had a very good quarter, with revenue up 15% over the same quarter last year. Retail sales and merchant transaction volumes were a little softer than our initial expectations heading into the quarter. Merchant revenues increased by 11% over last year. Financial institution revenue increased by 18% over last year.

Mortgage -- mortgage banking revenues increased by 5 million from fourth-quarter levels on originations of 2.2 billion. That was an increase of 16% over last year. The breakdown on mortgage banking revenues is provided in the text of the release.

Investment advisers increased 1% over last year and 4 million from last quarter on improved retail brokerage and personal trust revenues. And in retail banking, retail deposit growth was consistently strong through the first quarter and on into April, overall deposit growth was 8% annualized in the first quarter, and net new deposit account growth in the first quarter represented our best quarter ever.

Interest checking balances exhibited positive growth in March, and same-store deposit growth was also 8% annualized for the quarter. New banking centers are continuing to produce very strong results as well.

We have said consistently that pricing isn't the only element in growing deposits. For us, it's been executing on our everyday great rate strategy, numerous customer service initiatives, and continued investment in our de novo and distribution channels. This combination is producing significant momentum in retail deposits for us.

On the affiliate side, the first quarter marked the one-year anniversary of our expansion in Florida. And we often receive questions regarding the performance of our investment. While we've had some ups and downs, particularly with employee turnover, the results overall have been good in some areas and very good in others. In total, I would say we are enthusiastic about recent results and the opportunity in front of us, performance has improved since we divided into three affiliates in the third quarter last year, and we still believe the shareholders will receive a very good return on the investment in Florida.

Our first-quarter average trends in Florida over the same quarter last year showed considerable strength. Transaction deposits increased by 10%. Core deposits increased by 12%. Total loans increased by 26%. Fee income increased by 32%. Net charge-offs in Florida were 567,000, or 4 basis points, on a $6 billion loan book. All of the above performance metrics exceed the Bancorp as a whole. Overall, we feel a lot of work in progress continues to be made, we feel good about our affiliate model, the strength of our sales culture and the quality of our teams.

Thank you for your attention this morning, and we would be happy to answer any questions that you now may have.

(OPERATOR INSTRUCTIONS). Michael Holton, T. Rowe Price.

I actually have two follow-up questions to a couple of things George said. You mentioned that the good deposit trends you saw in the first quarter were mostly in March and then continued in April. Can you talk a little bit about maybe what actions you took that caused things to pick up? And then the second question is on the CFO search. You said you expect an announcement very soon. What does very soon mean? Does that mean next couple of weeks, by the end of the summer? How are you thinking about that?

Let me take the second question first. On the CFO front, you know this is a very important decision for us, and that decision should be occurring within the next couple of weeks.

Okay.

Let me talk about your question on the deposit side. On the deposit side, really two fronts -- as we talked about the commercial seasonality we did expect and we did get. On the retail side, we are seeing good strength. It is building momentum in March and into April. And I would tell you that it's a myriad of initiatives that we continue to focus on. And I'll give you a little bit more in depth on that.

For example, one of the things that we've been doing now since about the second half of last year is really doing some customer service and customer satisfaction surveying for us. And that's giving us great insight in terms of customer expectations of us and the values that we can drive in terms of different behaviors. And that is starting to show an impact for us. As I mentioned, we had some improvement in terms of our attrition. A lot more work to do, but we are enthused by the trends from that standpoint.

Our great rate strategy continues to be effective from our perspective. Again, as we've talked about, we're not attracting or trying to attract hot money per se, and we're really giving a good value proposition for our customer base. And we think that is showing up in the numbers as well. So, those are some of the things that we're really focused on as well. I hope that gives you some additional insight in terms of deposits.

Patrick O'Brien, Alex Brown Investment Management.

The variance from very recent estimates of what the NIM would be for the quarter is small. It's really a rounding error. But could you explain why that went wrong? And also, with this great rate strategy, can you quantify what a great rate is? Are you guys targeting -- maybe this is proprietary, but I guess everybody knows what everybody else's rates are in a given market. How much over the average or under the aggressive guys are you?

First on the margin side, the key variable for us remains attracting low-cost deposits. Strong growth in attracting deposits enables us to improve our funding situation a lot more quickly. And based on the current trends and the forward curve, at this point we would expect a couple of additional basis points of contraction in the second quarter from where we were in the first quarter. But basically it's been a deposit mix issue out there.

Two fronts relative to the mid quarter 8-K, Patrick. One is the deposit mix. We were not demand deposit -- the growth was not driven by demand deposits; we actually had shrinkage thanks to the seasonal impact in commercial. The other piece is with the increase in rates towards the end of March, we did see some cash flow slowdown on the portfolio. That didn't give us quite as much mix improvement as we were hoping for there. In total, the disappointment relative to the mid quarter was probably not more than a few million dollars. But it does show up when you're trying to be precise with that sort of forecasting. But overall, I think we're pretty pleased with what we see there and the outlook.

In terms of the great rate strategy, you're right; there isn't a number I could give you in terms of that. We do look at our competitive positioning in each of the markets that we compete in. And if you look at that, you'll find that we are often -- we're not anywhere at the very top of the list in those markets. So, what we really are trying to do is manage the value proposition across all of our tiers and all of our clients, so they feel they're getting a good value for leaving their deposits with Fifth Third. And we think that's working. So, that's about the best strategy that we think is really making a difference in terms of the clients that we're attracting and the deposits we're gathering.

Does your affiliate manager have a lot of discretion in picking with the rate is?

We do it together. They do have discretion in terms of local pricing as they see a competitive opportunity from that standpoint, which we let them. But again, it's well communicated and well understood and well vetted within the Company.

John McDonald, Bank of America Securities.

I was wondering if you could give a little more color on the outlook for expenses. You mentioned a moderation of expense growth this year. Just wondering if that's driven by a lower level of investment spending, or do you have some cost save opportunities. Give a little color on that.

We're taking a very hard look at all expense actions given our current revenue trends, and believe that we do have a lot of opportunities there to improve expense leverage. Investing for the future -- this year we plan on opening 75 new offices, 50 net. We'll do some consolidations and a couple of closures there. And those do add to the expense ratio. Our current expectation is for expense growth to be in the low to mid single digits for the full year 2006.

And what I would say is, in terms of our ability to control those expenses, what we really have been targeting within the organization is also some redundant operations. We're doing some of the consolidation in terms of some redundancies around. And we're also then leveraging some of the efficiencies off the technology that we've been investing in. That's allowed us to be more effective in managing those expenses as we go forward as well.

It seems like you've stepped up your investment spending in the franchise over the last year or so. Would you say that you're probably going to spend the same amount going forward in what you categorize as investment spending, salespeople, branches, those kinds of things?

I think that we've given you our branch outlook there. On the sales force, you know what we've added over the past couple of years, and now we're looking for the proper productivity out of that sales force. We want to make sure that the people are performing at our standard levels there. So, the absolute number of adds probably isn't going to be as significant, but we expect the productivity from the people that we have added to improve significantly going forward.

My second question is about the margin. You mentioned in the press release, George, that hopefully in 2007 you see the margin start to normalize. What do you guys -- you mentioned the core deposit growth; you're looking for that. What else needs to happen? Is it just a case where your asset repricing needs to catch up to what'd happened on the short end? Is that what you're hoping for to normalize the margin?

Yes, basically. And let me give you a couple of things that I think are important here. As you know, the industry is experiencing a secular decline in margins since deregulation, and that continues. Fifth Third's earning asset mix is now richer and more loan-concentrated that it has been historically, but the loan to deposit ratio is also higher. Historically, Fifth Third has had a margin that averaged in the neighborhood of 3.75%. With a great deal of loan growth through the trough and rates that will continue to reprice, and with the liability repricing slowing with an expected stabilization in short rates, a margin about 3.5 appears reasonable for us to achieve in the next couple of years.

And that's assuming some continued kind of reduction of the securities portfolio that you're going under right now?

We're on the high-end of the securities portfolio there. There should be some, and we will continue that.

Again, our expectation is not to continue to leverage in the flat curve.

And without doing that, you feel like over time you should be able to get back to a 3.50 type -- in that ballpark of margin.

Exactly.

Betsy Graseck, Morgan Stanley.

Thanks. Most questions have been asked. One question just on the securities portfolio. In the past, you had indicated that you were looking to bring that down to, I don't know, something like 15 to 18% of average earning assets. Is that right, and are you still aiming towards that?

I would tell you that from our perspective, that would be correct. Again, as you know, where we are really is a function of interest rates, deposit loan growth. Our goal, again, remains to avoid increasing leveraging to a flat curve. So, we will continue to monitor that with that objective.

I think if you saw rates increase further or fairly dramatically, you would see our appetite to reinvest cash flows increase.

Just on the deposit side, you were discussing earlier some of the programs that you had in place to understand what the customer interest, desires, needs were. Were you referring to commercial or retail?

Predominantly retail.

Could you speak a little bit to what you're doing on the commercial side of the equation?

Similar. We are, across the entire organization and all lines of business, doing a lot more in-depth in terms of customer satisfaction. So, a lot of the things that were piloted or initiated in terms of retail we've really expanded to all of our lines of business. So, beginning; we're not as far along in terms of baseline information, but everywhere -- it does exist now everywhere.

One thing we have always done is every few years we do a market survey with our own pollsters to get a feel for where we are in terms of market share in the middle market segment. Those trends continue in select markets. I think they do three a year or something like that, just to get a feel for how our actions are working and what kind of progress we're making on taking share.

So, when you look at the opportunity for deposit growth, where do you see it stronger, on the commercial side or on the retail side?

Both, hopefully.

Absolutely.

Ed Najarian, Merrill Lynch.

First on the deposit side, it seems like everyone is focused on deposits here. I'm wondering, you're talking about growth potentially ramping up, and I understand it was a little bit seasonally weaker on a linked-quarter basis this quarter. But what kind of deposit growth would you be happy with this year, now that we're seeing deposit in the industry slow? It seems like a few quarters ago we were talking about the potential for double-digit deposit growth, and I'm just wondering what sort of your mindset is for deposit growth going forward.

Secondarily, I'm wondering what kind of deposit repricing sensitivity you see relative to additional Fed funds increases. It looks to me like you've been raising your deposit rates a little bit faster through this tightening cycle than the typical banks, and I'm wondering if you expect that to continue or if you think you can ease off the pedal a little. I'll leave it at that.

I think on the deposit growth side, what we would target would be in this 8 to 10% range, is kind of what we're targeting for right now on that side. I'll let Kevin go through the [betas] here on the deposit side.

What we would say, and obviously, as we were establishing the great rate strategy and our baseline, we had some core fixing to do, if you will, last year. On a go-forward basis, I would tell you that our costing would probably be in the 40 to 60% range, we think, from a competitive standpoint. Again, that would depend on the environment, but our expectation would be about there.

If I could just follow up with one quick question on the taxable securities portfolio, which is, obviously, the bulk of the securities portfolio. Your first-quarter average yield was 4.44%, which is pretty darn low relative to most of the other banks. And I'm wondering -- you said you didn't get as much repricing opportunity in that portfolio as you expected. But I'm wondering, now that rates are a little but higher, how quickly you would expect that 4.44 to reprice upwards.

The duration on the portfolio is about 3.7 years. We'll continue to see cash flow off of the portfolio in the neighborhood -- it's going to vary based on rates, but somewhere between 100 and $200 million a month. Our appetite in terms of reinvesting that portfolio is going to be a function of two things, like Kevin said -- deposit growth and interest rates out there. I don't think we're too terribly far off from where we want to be long-term. But again, it's going to be a function of those two variables as much as anything.

[Felice Thelman], Sonoma Capital.

I just wondered if we could get a little commentary on credit quality. It certainly looked good. At the same time, you can't open a newspaper without reading negative stuff about the Midwest. So, can you talk a little bit about what you're seeing in your portfolio and how you're managing it?

I think credit quality overall has been very well behaved over the last several quarters, and the trends overall continue to be pretty 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 that will ultimately follow our general outlook for the near-term credit trends based on our model, and we think that our reserve levels where they are are really pretty adequate. But in terms of the credit quality out here, it, as you know, is mixed. We are in the heart of the auto industry out here, and the domestic auto, and those suppliers are having difficulties. And so far we've been able to avoid any big issues on that side. On the other hand, the foreign manufacturers -- Toyota North America is headquartered right here in Cincinnati -- those people are doing very well. So, that's kind of a counterbalance balance to that. But we continue to look very hard at the commercial credit quality out there and feel pretty optimistic about it.

Vivek Juneja, JP Morgan.

A couple of questions. Let me -- on Felice's trend of the credit side. Can you talk a little bit about where you're getting your strong growth in commercial real estate?

I think that's coming -- some of that is coming from the Tennessee, down in Florida, but generally that's coming from all over. All of our affiliates, generally, have been adding to that, whether it's the Chicago market; our Detroit market has done particularly well out there in the Metropolitan area, some of the expansion that's going on there. But it's been generally broad-based.

George, any color on type of product, what kinds of properties (multiple speakers)

We are not in any new lines, nothing speculative out here. This is -- a lot of this in the Midwest is owner-occupied out there with -- and we're really keeping an eye on the quality of the projects here, especially in markets like certain parts of Florida.

What are you seeing in terms of competition, in terms of both terms as well as pricing for these, the areas, since the whole commercial real estate space [isn't] pretty hot?

They're out there. It's a very competitive market out there, and it varies throughout our 19 affiliates by the level of aggressive pricing out there. But we look at it, like I said, on a pretty broad spectrum out there, and make sure -- we want to make sure we're not doing anything that's -- we don't want to reach anywhere at this point in time. We've had good growth, so we don't need to reach for that next piece of credit.

John Balkind, Fox-Pitt.

Just a quick question on the tax rate. Could you give us a little guidance on what it might look like going forward?

I think for this quarter we were at 30.7, and we expect the rate in the future quarters to be fairly similar, if not a little bit higher. That 30.7 is up a little bit from the last quarter. And like I said, we'd expect it to approach the 31 range going forward.

Fred Cummings, KeyBanc Capital Markets.

Kevin, can you touch on specifically Michigan? What are you seeing there with respect to commercial loan demand and loan growth?

I would tell you that Michigan, obviously, is impacted by a heavy influence in terms of the auto sector. But again, we're being very prudent relative to the credit that we have there. There's a lot of other opportunity within the state, and we are looking at that. We're seeing good growth in terms of heavy owner-occupied projects, as George mentioned. So, nothing unusual or anything that I would tell you from our perspective that we haven't been out in front of and are watching, from our standpoint.

Up in Grand Rapids, our loan growth for the first quarter of the year has been up 6%. Over on the eastern side of the state, over in Metro Detroit and those areas, our loan growth is up 15%. That should give you a feel.

One last question, George. Should we be surprised if you were to pursue an acquisition? What's your appetite for looking at deals, and are you still biased towards looking at the Southeast if you were to pursue an acquisition?

Generally, I think we're going to be pretty consistent there. And you know that acquisitions are never something that we really plan for. Right now we're really focused on organic expansion. We like the potential returns from our organic efforts, if you will, and expect to continue along those lines. There are a few deals that we would be interested in at this point, but generally they're going to be a lot smaller in scale. And these things are always really difficult to predict. But if an opportunity came along that offered a compelling return on investment, and added a presence in a new market, whether this would be in the Southeast or in the Mid Atlantic or continuing in the Tennessee area, we would be interested in taking a look there. Our expansion over in Pittsburgh is going very well and we're starting to open offices in the St. Louis market on a de novo basis. And both of those, we feel, are going as we had planned there.

I think that's all the questions we've got this morning. Thank you for taking the time to listen in. We appreciate it very much. Thanks.

Thank you. This concludes today's first quarter 2006 earnings call. You may now disconnect.