Fifth Third Bancorp (NASDAQ:FITB) has underperformed its peers on a year-to-date basis. Considering how a bad start to the year the financials are off, the bank's performance has been even more miserable. While accepting that the current valuation offers upside potential, I do not expect that Fifth Third could emerge as an outperformer.
The bank posted moderate results in 2015. The net income reported for the full year was $1.6 billion. That corresponded to a diluted EPS $2.01, which was up 16% year over year. The remarkable growth in earnings was driven by the sale of the Vantiv (NYSE:VNTV) stake, in which Fifth Third reaped $419 million. The divesting did not just help the bank boost its earnings, but highlighted that the bank was making the right move to focus more on the core businesses from a strategic point of view. Going forward, I, however, believe that the bank still has a lot to prove to deserve to be treated as a gem within the banking sector.
It is very likely that we will see some interesting moves in the balance sheet of the bank this year. Firstly, I need to mention that the management guided for 2-3% higher net interest income, and 3-4 basis points higher net interest margin for 2016 during the 4Q earnings call. Loan growth is expected to be in line with the U.S. GDP growth, which somehow seemed to have disappointed analysts. Commercial lending will be the source of growth in loans while no signs of improvement appear in the consumer side. The bank will be even lowering auto loans with deliberate actions and look for growth in credit cards and home equity loans. Given these, the average yield for the total loan portfolio will inevitably be lower. The bank is planning to offset this with more opportunistic portfolio investments and it is able to do so considering its high liquidity coverage ratio.
Fifth Third's average loans-to-deposits ratio stood at 91% at 2015 year-end, which puts the bank in not a comfortable place regarding the funding. Despite the fact that the bank is set for fast loan growth this year, I foresee that risks related to the cost of funding have the potential to curb its earnings to some extent. The bank managed to grow its core deposits at a fast pace in 2015 (up 6% while loan balances up 2%), but this brought an increase to the costs. With rates in the credit markets rising in parallel with the Fed tightening, we might see further pressure on NIM through higher cost of funding. As a result, I am not optimistic about the improvements in NIM, but I believe that the bank may post a faster loan growth this year than it had projected, largely due to the commercial loans. According to the Federal Reserve data, banks in the U.S. saw an increase of 3% in commercial and industrial loans on a year-to-date basis.
The management expects core non-interest income to grow at a rate between 4% and 5%. Due to the relatively volatile nature of fee income, it is hard to estimate whether the bank would achieve this target. In 2015, FITB only saw 0.6% non-interest income when the "other" line was excluded despite an amazing performance in mortgage banking revenue. Note that almost all the large-cap banks in the country interestingly posted lower MBRs this year. Having said that, we will definitely see higher expenses this year due to higher regulatory-related compensation costs, technology investments and inflationary pressures. The bank has been adding new jobs in the risk management and compliance side that would result in a significant rise in total salaries this year. Overall, I believe Fifth Third should report an efficiency ratio around 62% for 2016.
On the asset quality front, FITB performed quite well as well as kept its exposure to the energy market limited. Even so, we will eventually see the bank building higher provisions for that exposure if the commodity prices continue to remain at low levels in the upcoming period. Despite the promising asset quality trends, the management will expect provisions for credit losses to exceed net charge-offs this year. I estimate that total provisioning over the next two years would amount $1.1 billion.
The recent sell-off in the financials has created opportunities, but I recommend investors to look for options in the industry other than Fifth Third. Accepting that the bank has been making progress in some areas, the earnings outlook, in my view, is still not compelling enough to build a position even at the current levels. With a 2016E EPS of $1.56 (in line with consensus) corresponding to a ROATCE of 9.6%, I am cutting my target price for the stock from $22 to $18.
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