Fifth Third Bancorp (FITBP) 2003 Q3 法說會逐字稿

Good morning. My name is Leslie and I will be your conference facilitator today. At this time I would like to welcome everyone to the Fifth Third Bancorp third quarter 2003 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. If you would like to ask a question during this time, simply press star then the number 1 on your telephone key pad. If you would like to withdraw your question, press star then the number 2. I would now like to introduce Mr. Brad Adams, Investor Relations Officer. Mr. Adams, you may begin.

This conference call may contain certain forward-looking statements about Fifth Third Bancorp pertaining to the financial condition, 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 introduce George Schaefer, President and Chief Executive Officer of Fifth Third Bancorp.

Good morning everyone and thank you for taking the time to listen in. Neal and I will review, what we feel are the highlights of the quarter and we will quickly open it up for your questions. I hope that most of you have had a chance to take a look at our results that were released earlier this morning. Our loan growth was very strong, revenue demand remains strong despite the low rate environment. Our operating expenses improved in the quarter, our deposit growth remains good and the credit quality continues to be manageable despite the lack of a meaningful recovery. In all there were some moving parts with recent accounting changes but I think the release does a pretty good job in detailing the impacts.

From my perspective the highlights of the quarter were about five things. Number one, loan growth. Overall, loan growth was very strong out there with average loans and leases increasing by 20% annualized from last quarter and 18% over last year. Installment lending remained very strong with balances increasing by 33% annualized over the last quarter. Commercial lending remained positive with period-end balances up $332 million from last quarter, and the balances are up 12% over last year. I think our sales effort and our calling effort and our upselling effort on the loan side really showed this quarter.

Number two, operating expenses. On a core basis they decreased by over $20 million from last quarter as we saw some benefit from the lessened third party expenses. We are also seeing the benefit of some automation and some process improvements which are improving quality and improving controls at the same time they are decreasing expenses. Number three, we are seeing a continuation of strong deposit growth trends. Our average demand deposits increased by 20% and average interest checking balances increased 9% over last year. Sequentially, average demand deposit balances increased by 32%, on an annualized basis. We recently concluded a checking account campaign from the third quarter, and realized our goal of $1.2 billion in new balances. Over the course of this campaign, we opened up over 116,000 new checking accounts. At Fifth Third we've always focused on deposit account gathering and this quarter was no exception.

Number 4, strong revenue and service income growth. Our net service income was up 7% over last year despite a $1 billion dollar decrease in the securities portfolio. Fee income was up 12% over last year, showing some of the benefits of Fifth Third's diversified mix of key businesses. Neal will go over the trends we're seeing here in greater detail in a little bit. And timely credit trends continue to be manageable with some improvement in the metrics showing improvement modestly in the quarter. And again Neal will go through this in a little bit of detail later on.

Overall we're still seeing some mixed signals here in the Midwest but small business still looks very healthy to us and consumer activity certainly picked up in the quarter. With that in mind we're going to continue to approach the business the same way that we always have here at Fifth Third. Number one, we're going to focus on building market share within each of our 17 metropolitan markets. Number two, we're going to improve our cross-selling of both loan and fee-based products and taking advantage of the large retail and commercial customer bases that we have here. We think we have about 5.5 million retail customers and about 300,000 commercial accounts that we still have a lot of room to cross-sell our many products and services to. And then finally we're going to continue to maintain the low-risk profile of our balance sheet. If you look at our capital levels and our liquidity, our earning asset mix and our asset quality I think all of these are indicative of our low-risk motto which we plan to continue to continue going forward. Now I'd like to turn it over to Neal for additional review on our business and trends for the future quarters. Neal.

Thank you George. Thank you everyone. Couple things I'm going to highlight, spend a little time on. First of all on line of business trends that we've seen through the first nine months of the year. And specifically within the quarter. Fifth Third Processing Solutions is up 6% year over year, 9% if you exclude the $5 million impact of the Visa MasterCard settlement. This is obviously a little slower than we'd hoped but I think there are a couple of items I'll spend a moment on underneath that total. On the merchant side we had a 13% increase in merchant revenue as a result of new customer transactions and signups. Their volume on existing customers is up only 2% over third quarter last year. So we feel very good about the sales effort on the merchant side, and I think that will be positive there as we continue to head into the fourth quarter, typically a strong quarter for us. On the EFT side it was down 3%. As I said earlier, really driven by the MasterCard Visa settlement. Here the pipeline on the customer side feels very good. We certainly recognize there's a great deal of opportunity in the market. But we still have a lot of work to do there. But we're pretty positive over the next couple of quarters that we have seen a low point on the impacts of merchant -- or the MasterCard Visa settlement. So we hope to reverse some of this slow down in revenue in the next couple of quarters.

On the investment advisor side, increased 6% year over year. This quarter predominantly driven by institutional asset management, services area in the funds group, they are a smaller piece of the total but we're starting to see better trends out of that side. I would also see -- say we see better sales effort coming out of our newer markets where we've been hiring salespeople in the asset management area. On the commercial side, commercial banking revenues up 26% over last year, and I'd say commercial continues to have a very, very strong year. We're very pleased across the board here. First of all, on the deposit side, as George said, they are the predominant driver of the DDE growth that we’ve seen, very strong growth there. On the loan side we see very strong loan growth continuing and they continue to have very strong fee-based growth in the quarter, with several new categories driving this.

On the retail side, as George said, loan deposit growth continues to be very strong. For the quarter, we had a record number of consumer loan origination with balances increasing by 20% over last year and 33% on an annualized basis. In fact, as we looked at our loan balances, we're up to about $53 billion average loan portfolio. $17 billion of which we think is branch originated, so better than 20% of our balances today are coming out of the branch, and we think that's a positive both for us on the yield side and for credit quality. We feel very good about what retail's done on the loan side. On the deposit side, as George said, we continue to focus very much on the deposit side. We'll have another strong fourth quarter campaign. We certainly have made deposits an emphasis as we see the yield curve steepen in here.

Mortgage banking, a better quarter than expected. You can see the revenue breakdown I think in the text of the earnings release, approximately $120 million in revenue, two mark-to-markets on our hedging, $16 million reduction and a $29 million reduction to get to our $75 million worth of net revenue in the quarter. We expect that we will see slower in refinance activity certainly over the next couple of quarters but again, we feel good about where we are. OMSR at $275 million, we are predominantly retail, better than 95% of our originations are driven off the retail side. So we feel good about mortgage banking side for the quarter. Certainly their operating environment has gotten a lot tougher. We have seen an improvement on the expense side on the quarter as those revenue numbers slowed down. Shifting to operating expenses, as George said some of the noise in trying to compare year over year, but if you look at versus a year ago, we see net of the adjustments, operating expenses up about 3% so pretty well behaved. Link quarter, a reduction as George said of about $20 million. Driven by third party kind of expenses predominantly, but also driven by a slow down in mortgage banking. We think that will continue in the next couple of quarters as well. Shifting to a moment on the balance sheet and net interest income, certainly we all feel challenged on continuing to derive quality net interest income in this kind of environment. Net interest income up 7% quarter over quarter, that's with a reclassification of the minority interest. And that had about $10 million pretax impact to us in the quarter, but I think net interest income trends adjusted for that still feel like that 8.5% kind of run rate area.

Net interest margin was down 17 basis points from last quarter, spread, and I would say if you look at page 17 of the tables, we provided you can see the earning asset yields are down to 4.75 earning asset yield, far and away the lowest earning asset yields we've seen in a long time. Cost of funds at a 1.53, again I think things I would point you to going forward, is that this is certainly not an easy interest rate environment. The steeper curve will help balance sheets such as ours, and we think that with the loan volumes that we have, and that steeper curve, you've seen the low point on net interest margin. We think it will improve over the next two quarters as well. But I think, again, not an easy operating environment with a 4.75 earning asset yield environment. As you saw in the quarter, we brought down the investment portfolio, and I think that's a function of the kind of loan growth that we've seen and the ability to change the posture of the balance sheet.

Shifting now to credit quality, as George mentioned earlier, we felt like credit trends started to moderate in the quarter. Net charge-offs were 59 basis points this quarter versus 64 last quarter. Certainly moving in the right direction, not a meaningful improvement yet in dollars, but we feel pretty good. A moment on color on the charge-off side. We had only ten charge-offs above a million dollars in charge-offs in the quarter. On the commercial side, largest of which was $4.7 million of charge-off coming out of the Indiana affiliates. But I'd say that's pretty well -- the rest of them were quite manageable and we feel pretty good about the charge-off levels as to where we're at. If you look at where we're at on coverage, and you look at provision, we've provided $37 million more than charge-offs in the quarter on the provision side, and for the year, $111 million better than charge-off. So again, we think the quality of our accounting around the credit quality side still continues to be very strong. Non-performers over the last three quarters have been essentially flat. There's some change in geography, but nothing that jumps out at us. At this point I'll open it up for any questions you might have. George and I will be happy to answer any questions.

At this time I would like to remind everyone if you would like to ask a question please press star then the number 1 on your telephone key pad. We'll pause for just a moment to compile the Q&A roster. And again, we're pausing to queue the Q&A roster. Your first question comes from Betsy Graseck, Morgan Stanley.

Good morning.

Good morning.

I had one question on the release on page 4, you were discussing some expectations for near term improvement in the expense line items, related to efficiency initiatives, and some volume-related expense line items. Can you could you give us a little bit of color on what you're thinking about there, what you expect to occur over the next couple of quarters and the degree of operating leverage you're anticipating?

Yeah, let me take a shot at that first Betsy. Surely as mortgage banking revenues slowed down, you see that on the expense side as well, that was a positive in the quarter. And certainly it's not easy to get all the costs out in the short term given the volatility in mortgage banking but we feel good about where we are. I would say beyond that on the efficiency side, as George said, we've really spent a lot of time on the non-risk management categories in the company to really look hard as any areas where automation continues to take us. We spent a lot of time looking at all of the technology initiatives and did a lot around the risk management area. Early in 2003, we continue to do that really around the process areas, to look at areas where we can save money. I think service industries in general are really having to look at much as manufacturing did over the last five years, at those areas that we can do, you know, more, cheaper than anyone else out there. So whether that's outsourcing or whether that's automation, I think you'll see that continue.

Improvements some of our processing, we've just installed three new Z900, the new IBM mainframe computers which run faster, quicker, cheaper, those were installed the last month here getting us ready for the end of the quarter but improving a lot of the through-put there. One of the processes we did too Betsy is we eliminated a million and a half or two million manual tickets that we used to do here where either our tellers or people answering the phone would fill these out. We have totally automated these debit and credit processes here which are really starting to save us not just in the processing time but in the quality improvement time. The error rates for automated go to less than, you know, 1%, significantly less than 1, where they'd run about 10%, 15% on a manual basis out there. But it's those kinds of things I think you're going to see us continue to improve. We've got a whole new automation project which we call ACE here which is helping us significantly on the control side but is also looking at the ease of access, lookup, retrieval, handling customer questions a lot better here that we are rolling out throughout the bank so it is those kinds of things we are implementing.

Are you planning on continuing to hiring as you had done in the first part of the year as well.

If you look at our hiring and look at our statistics, we have got a thousand more employees, FTEs, full time employees, than we had a year ago. We are always hiring qualified salespeople and we're looking for some real aggressive capitalists and we continue to hire those out there.

Lastly do you think that the efficiencies are going to drive a lower expense ratio going forward or are you going to be reinvesting that in the business.

No, I think you'll see a lower efficiency ratio. Keep in mind you have operating leases now into the overhead ratio.

Sure.

And that's had, how do you recalibrate that? But as George said we are looking at every process, all the paper, that's, you know, in the service business that's really where you want to tackle it.

Great, thanks.

Thank you.

Next question comes from Fred Cummings, McDonald Investment.

George and Neal, couple of quick questions. Neal first, can you reconcile this two cent charge, adjustment going from 76 to 77 and not to 78?

Gosh, I wish I was that good in math Fred. Only in accounting can you have this kind of clarity be confusing. What you have is rounding, when you take a $10 million buyer share base and you decouple the 77, 2 cents and 76, that's how it works out. I wish I could tell you there was an elegant answer.

Okay.

But it's a function of dividing all three numbers by different -- you know by the share count and how the rounding works.

All right. And secondly, now when we look at your loan sale for sale, this $1.5 billion at the end of the quarter, what's the mix between, say, your residential mortgages and other consumer loans, and then obviously this quarter you sold some equity loans. And is that likely to occur in future quarters?

Yeah. The reconciliation, Fred, is obviously is if you look over the last couple of quarters we were averaging in 3 billion held for sale. The slow down in mortgage banking is the biggest change, all residential mortgage in nature.

Okay.

And we had the home equity assets in held for sale last quarter, they are driven in this securitization. And quite honestly, we always look at lower coupon assets. They obviously float with prime. We've looked at a lot of the, you know, the lower coupon assets historically, be they consumer leases, and the like, Fred.

Okay. All right, thank you.

Your next question comes from John Coughie with CitiGroup.

Yeah, I’m curious about Fifth Third Processing Solutions, and it seems like there was a fairly substantial difference between your 8-K guidance and what actually occurred during the quarter. I wondered if you could elaborate a bit on what had changed between the issuance of the 8-K and the end of the quarter?

John, this is Neal. A couple of things, I think we saw two months in the quarter that were on the merchant side softer for our large retailers than we expected. How much of that's seasonal and how mach of that is retail trends, you know, we certainly see the external numbers and believe that retailers are going to have a better second half of the year than they had first half of the year. But we had two weaker months than we expected in the -- in the third quarter.

So that relates to the -- your comment about the volumes being up just 2%?

Yes.

And that is exclusive of new customers? That's including the 13%?

Yes, including the 13% as new customers.

Okay.

And volumes obviously in a business that have, you know, pennies per transaction, volume is certainly a big piece of the driver.

Okay. And what would have been the typical volume increases over, say, the last several quarters?

It was probably in the range of 3 to 5%.

Okay. That's a fixed cost business so that really impacts?

Correct.

Okay, thank you.

For the large merchant guys.

Thank you.

Yep.

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

Good morning.

Good morning.

Could you elaborate on whatever actions you took for balance sheet repositioning, and what it is you were trying to achieve, and therefore how’s your position now going forward?

Yes, Katherine, I'll take a shot at it. Two things very high-level. Obviously, we've had loan growth in excess of deposit growth all year, some of that certainly driven by improvement in the equity markets. But I would say the dollar amount of loan growth is something that we look very closely at. And as our short-term borrowed funds has increased we've looked for other avenues to fund the balance sheet. We've not securitized home equity loans. We've done that for the first time this quarter. I would say that's an overriding one that always happens, regardless of interest rates, is sort of the mix of funding going on in the balance sheet. But I would say and certainly we done a lot to try to have a bigger impact on deposit campaigns into the fourth quarter. I would say the other piece of it on rate sensitivity, when you have a 4.75 earning asset yield, there is not a great deal you can do. We can change the composition of the asset side by shrinking more of the bond portfolio. As we see more and more repricing benefit of a steeper curve.

Okay. So Neal, is it fair to say, given the low asset yields, your strategy is to keep those securities really short at this point to minimize the pain?

Yeah, I would tell you that our loan assets, we've seen a lot of growth in what I'll describe as three to five-year kinds of assets out of the consumer side. You've seen a lot of prepayment on the securities portfolio. And in general, we'd rather, obviously, put on assets out the curve on the loan side and keep the bond portfolio shorter.

Okay, great. And then on a separate topic, I know you've been tracking some aircraft leases pretty carefully on the NPA side. Could you give us an update on that, did some of those go NPA this quarter, et cetera?

Yes, the -- we have charged off two of the three that we had. We have another that we're in the throes of resolution on. It would be too early for me to comment, but I would tell you as I think we said earlier in the year, we had three of them that we were focused on in the year.

Okay. Can I ask, well, I'll ask. I don't know if you can respond. But the one that you're still trying to resolve is it on NPA or not?

A piece of it is on NPA I believe Katherine but I have to verify that.

Okay, thank you.

Your next question comes from Scott Steifer (ph), Fenmore O'Neill.

Good morning just a quick question on process business, actually couple of questions. First can you refresh my memory on how much more we should expect the Visa MasterCard settlement to impact revenues in fourth quarter, and then separately, can you discuss some of the I guess competitive dynamics in the process business, so maybe asked another way, what comfort can you give that you know, we are kind of in a low point for the growth trends in the processing business, outside just slower volumes and just basically if you could address the competitive pressures there?

Yes, Scott, this is Neal and I'll take a shot at it and then George may jump in. Couple of things, the Visa MasterCard settlement happened August 1st. So essentially add two months in the quarter. I think I’ve given people direction that was $5-8 million depending how volume shook out, I think that's a full quarter's impact. When you look at the fourth quarter, I think that's what you'll sort of be dealing with. None of us know with great certainty how it will change the mix of transactions going forward but I think most everyone is trying to impact strategies to improve the economics of the debit part of that business. The -- probably the biggest thing that we see out there on the landscape is that there have been an awful lot of merger and acquisition activity in this space. And all retailers are looking hard at their processors. I think there's a lot of competition for that new business. And so I think there's a lot of disruption among all competitors. And we will continue to aggressively pursue new customers there.

I think on the EFT side, where we're selling to other banks, there we've consolidated some of our sales efforts there and have -- we've seen some early improvement there. We've made a couple of nice sales and a couple of those larger accounts are going to be coming on line here fully converted in the next quarter or the following quarter here. So --

Names we can't release, incidentally.

We feel positive on that side. But this year transaction counts are going to be -- we're going to do almost 10 billion different electronic transactions and maybe 9.8, 9.7 billion different transactions. And that's up pretty good when you look at both of them combined out there. But as Neal said there is competitive pressure out there.

It is the retailing business Scott, so I think you're going to have more and more impact on that. I think margins have behaved pretty darn well given the pressures going on in the business. And so I think if you have usable capacity, and you have strong reliability, I think we think you're going to have an advantage over the next year.

Okay.

It's gotten tougher for everyone.

Yeah, okay, thank you very much.

Yeah.

Your next question comes from Jason Goldberg, Lehman Brothers.

Thank you. A lot of them have been addressed. Sorry if I missed this though. Did you buy back any stock during the quarter?

No.

Any particular reason? I guess after your heavy buy back activity last quarter?

I think we've said we'll be opportunistic. Obviously we look at our equity capital ratio. We've had a lot of balance sheet growth, Jason, so we're certainly cognizant of that. Obviously the securities portfolio has gone from a big positive to slight drag on that, so you know, we look at the overall balance sheet.

And then secondly, any chance you can give us an update with respect to where you stand with your written agreement?

I think there, Jason, we continue to work very well with the regulators when compared to the quarter a year ago. We have submitted all of our third party reviews to the regulators. They are reviewing them and we do feel more positive about where we stand there and we're just waiting for their reviews.

Okay, thanks.

Your next question comes from Joe Dewan (ph) with [Inaudible].

Yes, good morning. I'm covering for John here. Couple of questions on FIN 46 for you Neal I think. You did disclose the lease revenues of $66 million, depreciation of $50 million, any other line items on the income statement?

No.

Above the line? No.

There's an equity adjustment of a small amount.

Okay. And should we expect a similar impact in the fourth quarter and are there any other assets coming back on the balance sheet?

No, you shouldn't expect any more and we implemented July 1. So you saw a full quarter.

Okay.

Welcome back.

Thank you.

Your next question comes from Joe Stieven, Stifel Nicolaus.

Good morning guys.

Good morning.

Couple questions. First of all, your loan growth was excellent this quarter, beat our numbers again. Can you sort of comment George or Neal, do you have any geographic regions leading that area, and was it better than your expectation, that's question number one. Question number two, just an update on the regulatory front. Thanks, guys, good quarter.

Very good. I think our loan demand is coming out of all 17 markets out there. We've had obviously in the newer bigger markets, places like Chicago, Detroit, even up in Cleveland, we're seeing some good growth in those markets as we beef up our commercial middle market commercial lending and our staffs up in those markets, those volumes have been particularly good. But throughout the whole organization, this is pretty broad, this is coming out of the Cincinnati’s and Indianapolis’ and Columbus, Ohio’s, as well as those new markets. And it's coming from both the middle market commercial side as well as the consumer side. Our 940, 950 banking center people, our branch managers and their staffs, are really hustling on the loan side out there. We're doing a lot of upselling. When somebody is coming in for the home equity, we're wrapping the credit card, car loan and student loan in there and explain the tax advantages that occur there on the home equity side. And I think we've got that message out to all of our people in the banking centers which is really helping the balance sheet growth on that side. That's been very positive out there. And I think just a little bit earlier we answered the question about, you know, where we stand. And I think, you know, with the regulators. And like I said we've completed those third party reviews. And we continue to improve all of our internal controls and our operations area and our risk management area and continue to beef up those staffs. If you look at the kind of audit coverage that we have now it's probably three times what it was a year ago out there. So we're putting a lot of effort into those controls, and procedures.

Okay. Thanks, George.

You have a question from Chris Marinac, FIG Partners.

Hi good morning. George I just want to follow-up on the acquisition question going forward, I guess A is if you were in a position to do acquisitions what makes sense from the standpoint of pricing, are things at all getting too expensive for you to look at in the future?

I think on the acquisition side, the pricing numbers still seem pretty high, the prices that are being paid out there. And I think we're using maybe a Home Depot or Wal-Mart strategy where we're just building stores on our own. I think in the last, since probably the first of October, we would have opened ten new offices. The offices we've opened up in the Chicago market for example, have been -- have been very rewarding there. We're heading profitability at these new offices much quicker than we've done, you know, ten, 15 years ago it took us about three years to get profitability. In the new offices we're opening now those are occurring in the three to six-month time frame, just due to our increased marketing efforts there, how we're going about the markets due to the fact that we're really getting much better in our siting of these new offices. So you know, we've said before when we open a new office we pay only one times book. And we haven't been able to find a lot of good properties at one times book out there. The markets are a little bit higher than that. So just hiring our own good-quality people and then putting them in nice, new, good locations out there seems to be a strategy that I think you're going to see us continue to follow, as we fill out the market. And again, I don't think most people realize that we only have 7% of the business in Ohio, Kentucky, Indiana, Illinois and Michigan, the five main states that we operate in, we have plenty of room to grow. Especially in Chicago, 3% of the business. Detroit may be 4%, Cleveland where we've been for ten years now, just 5%. There is tremendous upside in those big, big markets, there is a lot of meat on those bones up there.

I just think you're in a market right now with all the volatility that people have been probably stepping back and trying to assess where they're at.

That's very helpful. Just as a follow-up, would [denovos] make sense to you in 2004 and in new markets as you've said in past calls?

Yes. We like metropolitan markets, we like them where there's big deposit bases and George has been pretty straightforward in the past that the next rim of cities at some point would be ones that we look at.

Yes, we would have 10, 15 people both in, as Neal said that next rim maybe the Pittsburgh’s or the St. Louis’s, those are just natural markets extension for us out there, we have been calling on those markets for years over there and we're starting to put some bodies in those markets. And we'll continue to move that concentric circle out a little bit further.

Great guys, thanks very much.

Thank you everyone. I know it's a busy morning. We appreciate your time and attention getting through all the numbers and all the accounting changes. Thanks, bye.

Thank you for participating in the Fifth Third Bancorp third quarter 2003 earnings conference call. You may now disconnect.