Tayfun Tuzun - Executive Vice President and Chief Financial Officer
Jim Eglseder - Vice President, Investor Relations
Fifth Third Bancorp (FITB) Goldman Sachs Financial Services Conference December 11, 2013 11:30 AM ET
Up next we have Fifth Third Banc that has been able to navigate the mortgage slowdown better than most this year by rightsizing cost well ahead of peers. In addition it remains one of the best positioned for both, the rebound in manufacturing in its home state of Ohio as well as the housing recovery in southeast. Further, Fifth Third has almost the highest payout ratios in the regional banks, a trend that we expect to continue.
With that, it's my pleasure to turn over to Tayfun Tuzun, who is Chief Financial Officer, who is going to walk us through the Fifth Third. Joining him is Jim Eglseder from Investor Relations.
I have a few slides to share with you to address some of the exciting and fundamental changes that are undergoing at Fifth Third. And then I'm going to try to give you a majority of the time back for Q&A. So let's get right into it.
2013 clearly has been a good year for us with strong profitability. PPNR efficiency, return on assets and return on equity have continued to improve, and we believe we stand among the best-in-class. Fee income has also have reflected to many strengths across our core businesses in the wake of a changing mortgage environment.
We are actively managing the mortgage environment with a focus on increasing purchase originations, while also reducing expenses. We continue to capitalize on opportunities to gain share and build value for our shareholders in a sustainable manner.
Our profitability levels have driven substantial capital returns to shareholders in the form of dividends and buybacks. We continue to execute on our 2013 CCAR plan and have been very active lately.
Near the end of November, we issued $2.5 billion of long-term debt and last week we issued $450 million of preferred stock. We now have $1 billion of preferred in our capital stack, as we work to make it as efficient as possible.
We also submitted the notice for redemption of $750 million of outstanding TruPS, which will happen at the end of December. And finally, we announced two share repurchase agreements this quarter totaling $656 million.
Also this quarter, we've setup with the SEC and reached an agreement with Freddie Mac to resolve legacy repurchase claims. Our reserves for both of these matters are fully sufficient.
I'd note that we are reviewing the recent NPR that proposed a modified LCR requirement for bank holding companies, our size and our business composition. As we are drafting our comments for the January deadline, we are also spending a lot of time with our business leaders to set a long-term strategy to mange to these new requirements in the most efficient manner.
It is clear that our future decisions will not only focus on maintaining a liquid securities portfolio, but also on managing the liability side and our contingent commitments across all areas. We have some work to do on this front in order to adapt to the rules as written.
Overall, we are in a very good position today with positive momentum. Our solid fundamentals and our ongoing investments will continue to add incremental value going forward. I am happy to share more details about our strength and opportunities with you today.
Fifth Third's internal capital generation rate is among the highest in the industry. The ability to earn consistently higher returns on equity enabled us to return substantial amounts of capital to shareholders and execute our strategies, all while maintaining strong capital levels.
Over the last seven quarters, we have had the highest level of payouts at 65% of net income available to common shareholders compared with other CCAR commercial banks. Our goal in the annual CCAR process are to maintain a dividend payout consistent with the feds guidance, and to utilize net share repurchases to manage common equity capital ratios at relatively stable levels.
This is in line with our long-term goal to maintain strong and prudent capital levels, while working to ensure that we are not holding capital at levels greater than our expected needs in this rather muted economic environment. We are finalizing our 2014 CCAR plan right now, which we will submit by January 6, and we will share our plans in more detailed fashion with you at that time.
As I mentioned, the result of our focus on efficient capital management clearly demonstrates our long-term goal to maintain a strong balance sheet for a variety of economic environments, while returning excess capital to our shareholders. We have been one of the more aggressive banks in buying back stock over the last couple of years and that's reduced our share count quite significantly compared with others.
At the same time, we continue to maintain a level of capital that gives us room to expand and maintain a healthy base to manage our risk exposures. I'd note that in the third quarter, shares outstanding grew to the conversion of our Series G preferred stock, but we'd expect that number to fall back in line here in the fourth quarter following the share repurchase agreements that we recently announced.
Even with our dividends and buybacks, we have maintained strong levels of capital and we're able to increase tangible book value during this time. Our tangible book value is up 12% since the first quarter of 2012 and our Tier 1 common ratio at the end of the third quarter was 9.9% or 9.5% on a pro forma Basel III basis.
All-in-all, we are quite pleased with the performance that got us here and with a relative position in the industry. In the past, we've spent a lot of time talking about our corporate banking results and the success drivers there. And about mortgage business, which performed very well during the last refi cycle.
With the exception of our deposit product changes, we really haven't spent much time talking about what's happening in the retail side of the business. Clearly, regulatory changes and customer behavior shifts have had a significant impact on how that business operates, but the industry is still trying to figure out.
Today, I want to spend some time on that, to give you a better idea about how we look at and run this business. It is an area of rapid change and we are positioned well to adapt with our customer and deliver strong results for our shareholders.
Several years ago, we began to study and embark on a redesign of our entire retail platform. Our experience led us to take a measured approach in the phase of the rapidly changing technological environment and the pace of change in the customer behavior. We carefully laid out a multiyear plan and sequenced the actions to support our partnership with our customers.
Our first phase was a focus on customer satisfaction and driving deeper relationships, including a transition away from totally free checking in 2009 and the focus on bundle product offerings. We also began to utilize financial need assessments in our sales conversations to learn more about our customers' financial goals.
Customer feedback and the information we gather through our consultative sales process has been an important component of our evolution. It has given us insight needed to develop better products and streamline existing processes in order to serve our customers better.
It led to a shift in the customer value proposition away from punitive fees towards a more value-orientated model that rewards the depth of the relationship. We have been able to successfully execute this strategy, while avoiding some of the well-publicized pitfall that other banks have had to struggle with.
All along, our focus has been on offering services that customers would value and be willing to pay for either in the form of deeper relationships or directly with fees, along a fair value exchange. Late last year, we introduced streamline products that designed to simplify relationship for our customer bankers by eliminating the complexity of our account offerings.
We have reduced about 40 types of checking accounts and savings account products to five core checking products and three core savings products. The new offerings align with our strategy to provide simple and effective solutions that meet our customers' needs.
We converted the last of our 2.1 million checking households back in March, and we believe that we are ahead of our peers in repositioning our consumer bank. That brings us to today. We have many initiatives in progress that address the changing retail landscape.
We are extremely conscious of and focused on improving the profitability of our retail business by addressing both, the revenue and costs sides of the equation, while also improving customer experience. There are four key components of this strategy.
First, we will evolve our distribution network through our integrated channel strategy. We are testing some new branch formats and evaluating existing branches across our footprint to better optimize the distribution cost structure. An important component of this strategy is the integration and optimization of global capabilities.
We also look to maximize the value offered and revenue generated from every customer. Here, we are focused on executing a consistent sales process and making the full scope of Fifth Third products and services available to our customers, in order to acquire and deepen primary banking relationships.
Third, we are driving deeper penetration into high-value customer segments. We believe that delivering a more differentiated sales and service experience to these segments can drive revenue growth that will deliver very strong results.
And finally, we'll continue to focus on product optimization and innovation that provide cost synergies and revenue opportunities. I look forward to speaking more in the future about these components of our strategy, but today I am going to turn back to the integrated channel strategy, which has been a hot topic in recent conversations.
Our integrated channel strategy is about our entire distribution network, not just branches, and how the individual components can be arrayed to not just deliver better service, but to increase efficiency as well. As you can imagine, we continue to see a fairly rapid evolution in consumer behavior, and frankly the acceleration of this shift has been dramatic over the last 12 months or so.
The adoption rate of new technology, mobile apps and image ATMs has been very significant. That shift presents us opportunities to look at our branch network in a much different way. We have made investments to develop an integrated channel strategy to address the way our primary customer segments prefer to do business today.
To that end, we've enhanced our alternative delivery channels, specifically the online and mobile platforms. As you would expect, we have found that customers who use electronic delivery services, provide greater value to the bank through lower attrition rates and higher cross-sell than non-users.
Once introduced and acclimated to these new technologies, customers are also quicker to more broadly adopt them. For example, already 25% of our consumer deposit volume comes through self-service channels, a portion of that through the remote deposit capture feature on the mobile app, which we launched late last year.
That represents the fastest adoption rate we've seen on any new technology. The cost of processing self-service transactions is a very slow fraction of the cost for a teller to perform the same transaction. And we believe our costs for transaction are in line with the industry, if not slightly better in some areas.
The benefits of greater mobile usage is a compelling story and there is more room for improvement. We believe that 70% of transactions executed with a teller in our branches in 2012, were eligible for self-service.
The majority of those transactions are deposits, which can now be completed on a mobile device or ATM, but withdrawals, balance transfers and payments are also eligible. It's very simple. A higher volume of lower cost transactions presents significant opportunities for expense savings.
So I'd beg the question, how is the branch still relevant? Our banking centers are the most visible branch identifier in our communities and they will remain a key source of deposits and cross-selling. Customers have indicated that branch proximity and convenience are still top factors in selecting a bank and a vast majority of our checking account customers have utilized the branch in past six months.
We intent to be thoughtful, when contemplating the future of our branches, and we expect to strike the right balance between customer convenience and how to efficiently manage declining teller transactions. I'm not convinced that simply closing branches is the right course of actions to address this change.
Alternatively, by improving branch efficiency, we can reduce branch operating cost and redeployed those savings to optimize our branch distribution and grow our retail business. We have identified the four key areas, listed on the slide, to help us get there and they are all interdependent.
Earlier this year, we ran a pilot in 10 branches, across two different affiliates, where we installed image-enabled deposit ATMs in the branch lobby, front and center, ahead of the teller line. But we also stationed branch personnel in the lobbies to introduce and help show customers how to utilize the ATM for self-service eligible transactions. This seems the very basic, but it drove a noticeable shift in teller versus ATM transaction volumes at those branches.
You can clearly see in the graph that teller transactions are in a secular decline, even in the non-pilot branches, but our goal is to accelerate the pace of customer adoption of these self-service technologies even more. During self, we'll expand the reach of our network by making ATMs an accepted first option for our customers.
With this shift of behavior in mind, we developed a smaller branch format, which is a more cost effective alternative with two to three personnel bankers in a fully automated self-service, no cash handling branch. For comparison, a traditional branch will have between six and eight personnel. The personnel in the smaller format branch are there to assist the customers if they need it and also to sell additional services based on that customers' need.
Bottomline, we think overtime about a-third of our current branches will fit the profile for some sort of self-service format, and we have identified a portion of those for rollout in 2014. These would be primarily branches in close proximity to other full-service locations and which share a branch manager. It's something akin to a hub-and-spoke system.
We certainly know that the upgraded ATMs and self-service channels are not unique to Fifth Third, but we strongly believe that our holistic approach to address the changing customer behavior and steady and responsive shift in our operating pattern will be a key differentiating factor, and we are seeing the results.
We didn't want to shock our customers with all of the changes at once. We did want to be thoughtful and measured in how we roll this out. Our deposit simplification plan and how we executed that project is a perfect example of that.
We expect these investments to help us provide customers with a consistent multi-channel experience and lower our cost to serve through multi-channel distribution and branch efficiencies. This is how technology is expected to work. Improved service and delivery options that results in branch efficiencies and deeper and more profitable relationships.
While it is still early in the process for some of our initiatives, we have already seen important indicators heading in the right direction, an increase in our total cross-sell ratio, a decline in the number of single-service households and higher average revenue contribution for household. We have strong momentum in our results with more consumer deposit accounts and higher average balances in those accounts.
These are all things that increase our organic growth potential and ultimately will increase the profitability of our business. I look forward to speaking more in the future about other aspects of this evolution, including enhancements to our consultative sales process and our ongoing investments in research and development, product optimization and innovation.
To wrap up, Fifth Third has a strong competitive position and profitable business model. Our strategies focused on the customer in creating a differentiated experience. Offering a unique value proposition and taking a holistic approach to each customer relationship. Ultimately, we believe this allows us to build deeper and more meaningful relationships with our customers that will continue to the drive out performance in our results.
We continue to look for opportunities that position us best for growth. And we are committed to listening carefully to our customers needs and working with them to develop the right solutions. We've worked hard to build the platform that enables us to drive substantial growth. Ultimately, we have scale with our significant complexity and we believe that will continue to benefit us in the future.
We believe that Fifth Third is on clear path forward and well-positioned to drive value in the future for our customers and for our shareholders. So those are my prepared comments and we'll open it up for questions.
Couple of questions on the retail business. First, I just wanted to start just in the core business and in the entire business, and then we'll circle back to retail. As you think about 2013, it was a year that was driven by a pickup in commercial loan growth for you. A good first half of the year in mortgage, then restructuring later in the year, continued to return significant amounts of capital. As you think to 2014, what do you think will be the themes for your company? As you move into next year, what do you think will be different?
I think clearly a similar level of execution in all fronts is going to be the theme for us. And we've done a very good job in both the corporate and retail sectors, and obviously doing refi cycle, we've operated a very efficient profitable mortgage business. So we have proven to our shareholders that we are able to execute on all fronts in a very efficient manner. And clearly, as we look through the economic environment, it is difficult to expect a much different economic environment in 2014 than 2013. So I think that execution theme is going to be probably the highest priority for us.
You mentioned earlier in your prepared remarks that you guys are studying the recent NPR and LCR and obviously it's still an NPR, but just in your initial read on that, a couple of questions. So how do you think it will change the dynamic of the balance sheet in terms of, will you need to add more liquidity on the asset side of the balance sheet? And you also referenced repricing of commitments, is that something that you foresee will happen over time?
I think at those, as we've frequently talked with you guys, over the last three, four years, we've had a very small investment portfolio compared to our peers. And so we have room to grow that portfolio and LCR clearly will be a factor in the way we actually design the composition of the portfolio as you know not all investments are good LCR investments. So I think the focus will remain to maintain a liquid portfolio as it is defined in the LCR rules.
I think the other side managing the liabilities and loan commitments is going to be key for the entire sector in the long-term, because you're going to see not only the impact of the LCR rules, but the impact of the supplementary leverage ratios et cetera. Those are all sort of going to be very important for the top four or five banks.
And as they reconfigure the way they actually conduct business with their clients and choose which ones they want to maintain in this very difficult environment for them, it's going to have trickle affects on us. It's going to have trickle affects on pricing, those types of commitments, and the way we actually work with our clients deepening the relationships. I think in general the impact of that side, the loan side is going to be a much lighter than just the LCR, it's going to have I think significant profitability and return implications for all of us.
From where you sit, do you think that gives you a competitive advantage competitively-wise when you are going up against some of the larger institutions or do you think that the industry will more follow along their lead, given how revenue side of the industry is at this point?
I think it's not going to be necessarily following their lead, but really more what is going to be the impact of them changing their business model. I think despite we are at $125 billion given both the liquidity rules as well as the capital rules, we are in actually a very good position to take advantage of the repricing in lending that will almost certainly follow the capital rules and how they impact the top four or five banks.
As they step out of certain relationships there is going to be one more available business, but clearly we have to be careful in terms of choosing and funding profitable businesses, but in general one would expect a repricing of credit availability across the entire sector, and given our size, we clearly have significant amount of room before we start getting close to some of the threshold levels, where we would be impacted by the same rules. So we like where we are from a size perspective.
Just switching to the retail part of the presentation. When you think about all the revenue that was lost across the industry in terms of Durbin, Reg E and I guess to a smaller extent for you guys CARD Act. How much of the lost revenue do you think you guys were able to makeup? And when you think about all the new products that you rolled, which of these do you think have actually resonated the most, that had the best returns since you've launched them?
I think probably the most impactful change for us was the positive location, because it enabled us not only to sort of reduce the number of offered products to a much more manageable number, but it also enabled us to tell the customers, look, I mean, if you want to use our bank in a certain way, we will actually provide those services to you with not much of a change in the underlying economics for you.
But those customers who are more interested in a transaction account, which with no additional product sets, they are ending up paying fees for that fair value exchange. And that probably has had the most significant impact, not only from sort of a revenue support perspective, but from sort of an average balance perspective.
But because we have seen a very clear increase in average balances, pre and post deposits implication and we believe that actually is very important, as we ultimately, some time in the next, pick your number of years, we're going to move to a different rate cycle. And actually having definite relationship with higher average balances is going to help us to retain that customer, lower attrition rates, and then grow from there.
So it has, again, a fee component, but it also has a broader balance sheet component, which work also as deposit implication, clearly with transformation. And from a cost perspective, some of the things that we talked about today, I mean the trends if they continue the same slope, the customer behavior will have significant impact on expenses and cost.
Just to follow-up on that point. One of your peers was here yesterday and he thought we were in the first inning on the changing landscape of the entire retail franchise, the way customers interact, the way they use the branches. Would you agree with that that we're in the very early innings? And how long of a timeframe do you think the transition is going to happen over? And what kind of implications do you think it will have for the efficiency of the retail business?
I'm more of a soccer fan, so I'll say we're in the first half yet.
Are you in the first half?
Fortieth minute. I don't think that it's necessary. All is it going to be a function of technology. I mean if technology doesn't change, which is clearly not going to happen today and if everything stays constant, I think we all have adopted the technology. So we're probably not necessarily at the beginning stages, but the technology is going to improve. We're going to see a better and more cost effective opportunities. And I think there is still a lot of room for just to play out, I would agree with that.
But what we cannot do is we cannot stay on the sidelines and watch this develop because as we have seen the last 10 years, you can't wait for the next version to come out before you upgrade your system. You have to, I mean because the pace of change is so fast that you need to keep up, and our goal is on a consistent basis to adopt a technology, to offer the client what he or she wants, because if they're not getting what they want from the bank, it's very easy to walk away these days.
I guess just switching to the current environment for momentum. Sure you'll give us more of an update on the fourth quarter earnings call, but one of the themes that we've heard today, is there are signs of optimism of potential for a pickup in parts of the market in terms of loan growth, and while you guys were early, particularly in the large corporate space, in some of the verticals was having really good growth. Can you just give us a sense of maybe not just over the near-term, but your expectations for loan growth over the next nine to 12 months? Do you see it staying in the similar pace to what we've seen? Are you expecting deceleration? And are you expecting to see become broader base?
Well, I think obviously, we would hope that in 2014 that there is not going to be a significant deceleration in economic activity. From our perspective, clearly we've had great success with a number of these specialized verticals. We had great success with our renewed focused or actually focus on mid-corporate space, where we were underrepresented, which gave us a lot of room to grow. And we are working on sort of other, what we would call, vertical areas to continue to support the success that we've had over the last couple of years in other specialized areas.
The other piece for us is commercial real estate. Clearly, in the last post crises, our commercial real estate portfolio shined quite a bit, and we're at $8.3 billion as of the end of the third quarter. There is a lot of room for us there. We're hoping that in 2014 that portfolio will see the reversal, but again, I want to remind everyone that we're still as a sector, as a bank, leveraged to the economy and ultimately we do need to see nominal GDP growth for a meaningful pickup in sort of loan activity, but borrowing that sort of macro comment, we're still very focused on growing the corporate loans.
We're in every CFOs favorite time of the year in terms of submitting the CCAR application. And you guys have one of the highest dividend yields, it's around 2.5%. You're paying out closer to a 100%. Any changes to your priorities in terms of distribution as you look towards this year CCAR given the stocks had a good run, and then maybe just talk more towards dividend in terms of the improvement?
Our priorities are just same. I mean we want to maintain our capital in a safe and sound manner and to support long growth. And then after that we basically look what additional opportunities we have with our excess capital, which is quite a bit. And right now, we think that our stock is still the best buy, the return to capital to shareholders is still the best option, and we've demonstrated that not only with our sort of regular capital growth, but we've seen out some converts to our advantage sales into share buybacks as well.
So not necessarily commenting on the 2014 CCAR plans, given where our capital ratios are, which are still quite a bit higher than our long-term capital targets, I would expect us to maintain the same focus in 2014. From a share price perspective, we don't necessarily focus what the share price is, day and day out, months and months out, when we make these share repurchase decisions, it's more of a long-term shareholder capital return play for us.
And clearly, we are cognizant of where we are, but at the same time our focus is more long-term, making sure that at every moment when we do make capital distribution decisions, that we do the best for our shareholders. And so far returning back capital to our shareholders has worked pretty well for us.
We'll open up to the audience for a question or two.
We've seen a lot of banks exit the wholesale, the broker mortgage business. And I think you guys are still pretty active in this, I guess. What do you see or what opportunities do you still see in that space that the other banks don't? And then when we think about the overall mortgage business, when do you think we could see a bottom end origination revenues?
Well, first of all I think the retail versus wholesale percentage composition changes a little bit when you move out of a very high refi cycle to a more normalized level. From our perspective, I mean the wholesale business in general has lower margins compared to retail channels. And I think in a normalized refi environment, where the focus is on purchase money, I think you will see a natural shift more to retail business.
But in general, if you uncomfortable with your underlying processes, underwriting, our business plan is a predominantly originate and sell business plan on the mortgages. So if you're comfortable with the underlying processes, then you have to look at the relative profitability and whether or not you're willing to channel resources into the correspondent or wholesale business.
We don't have a sort of predetermined percentage allocated to wholesale. That decision truly is a very periodic, looking to the profitability. We will maintain our presence there, but there will be ups and downs depending on what the overall environment looks like. It also has some seasonality concept, because as you move into Q2 and Q3 clearly the retail business will weigh more heavily.
I'll try one more. I'll start with the revenue environment. It's obviously challenging, given the big follow-up we've had in mortgage. You guys have been out ahead of us taking our cost, but if we don't see a big pickup in GDP growth and hence big fall off in loan growth. As you focused on execution, can you continue to deliver positive operating leverage in 2014?
Yes, absolutely, and we have. I mean we have actually delivered very good cost control and you can look at our efficiency ratios, and we will maintain that focus. I mean some of the discussion that we had today in the medium and long-term, these numbers are large enough to make an impact on cost efficiencies, but we do, I mean every quarter, we take a look at our cost base in all of our businesses, not just mortgage. And you'll see that, we're not necessarily a flashy, the flavor of the day cost saving package-type bank, we're more on the steady basis. Cost efficiency is clearly very high on our priority list all the time.
Great. Well, please join me in thanking Tayfun for his presentation. Thank you.