Fifth Third Bancorp: Earnings Likely To Have Bottomed Out
Summary
- Exposure to high-impact industries and worsening of economic outlook since the end of the first quarter will likely drive provision expense in the remainder of the year.
- Non-interest income will likely continue to decline in the year ahead due to fee waivers and an overall slowdown in business activity amid the lockdown.
- Earnings for the remainder of 2020 will likely improve compared to the first quarter but remain below the 2019 level.
- Uncertainties related to COVID-19 have increased the riskiness of the stock.
Fifth Third Bancorp’s (NASDAQ:FITB) earnings plunged to $0.04 per share in the first quarter from $0.96 in the fourth quarter. The earnings decline was mostly attributable to a surge in provision expense and a drop in non-interest income. I’m expecting earnings to have bottomed out in the first quarter, but the return to a normal level of earnings will likely be slow. I’m expecting non-interest income to decline further due to fee waivers and a slowdown in business transactions. Further, provision expense in the remainder of 2020 will likely be higher compared to 2019 due to the worsening of the economic outlook since the end of the first quarter. Meanwhile, strong loan growth will likely cancel out the effect of further net interest margin compression. Overall, I’m expecting earnings to decline by 59% year over year to $1.37 per share in 2020. The December 2020 target price suggests a high upside from the current market price, showing that FITB is offering a high return. However, the stock is quite risky due to the COVID-19 related uncertainties; consequently, I’m adopting a neutral rating on FITB.
Exposure to High-Impact Industries to Drive Provision Expense in the Remainder of the Year
FITB’s provision expense surged to $640 million in the first quarter from $162 million in the fourth quarter due to the impact of COVID-19 under CECL, the new accounting standard for credit losses. The provision expense will likely improve after the first quarter as a majority of the impact of COVID-19 on asset quality is already reflected in allowances. However, the provision expense will likely be higher than last year's due to the worsening of the economic outlook since the end of the first quarter. Additionally, loan growth, excluding Paycheck Protection Program loans, will drive provision expense in the remainder of the year.
FITB has some exposure to high impact industries that will drive provision expense this year. As mentioned in the first quarter’s investor presentation, 11.7% of total loans were to high impact industries like leisure and recreation, non-essential retail, and travel. Moreover, FITB has some exposure to the oil and gas industry, which will drive provision expense in the remainder of the year. As of the end of March 2020, around 2.8% of total loans were to the oil and gas sector. Hedges on the oil and gas portfolio will mitigate the risk from the sector, as mentioned in the first quarter’s conference call. Additionally, the management estimates the portfolio to have an average production breakeven point of $18/barrel. Considering these factors, I’m expecting provision expense to increase to $1.7 billion in 2020 from $471 million in 2019. Further, I’m expecting the provision-expense-to-net-loans ratio to increase to 139bps in 2020 from 43bps in 2020.
High Demand for Relief Loans to Buoy Net Interest Income
FITB’s net interest margin, NIM, declined by 13bps in the first quarter of 2020. I’m expecting NIM to decline further in the second quarter due to the full quarter impact of the Federal Funds rate cuts in March. The management estimates that a 25bps rate cut can reduce NIM by 4-5bps, as mentioned in the conference call. Moreover, the management intends to maintain higher-than-normal liquidity in the near term, which will further pressurize NIM in the second quarter. Furthermore, the relatively low fee under the Paycheck Protection Program, PPP, will pressurize NIM. On the other hand, balance sheet hedges will protect NIM through 2024, as mentioned in the conference call. Overall, I’m expecting NIM to decline by 25bps in the second quarter, and by 33bps in the full year 2020. The following table shows my estimates for yield, cost, and NIM.
Loan growth will likely counter NIM compression in the remainder of the year. Net loans increased by 6.8% quarter over quarter in the first quarter of the year due to the high demand for relief loans. The management expects loans and leases to grow at a high-single to low-double-digit rate in the second quarter, as mentioned in the investor presentation. I’m expecting loan growth to return to a normal level in the second half of the year as the economy reopens. Overall, I’m expecting loans to increase by 15.8% year over year in 2020, as shown below.
The expected loan growth will likely counter the NIM compression, resulting in a slight increase in net interest income. I’m expecting net interest income to increase by 2.5% year over year in 2020.
Non-interest Income to Slip Further on the Back of COVID-19
FITB’s non-interest income declined by 35% quarter over quarter in the first quarter of the year. The management expects it to decline further by a high-single to low-double-digit rate in the second quarter, as mentioned in the investor presentation. In order to provide relief to its customers so that FITB can retain them, the management is offering fee waivers, which will curtail non-interest income in the second quarter. Additionally, the slowdown in business activity during the lockdown will also constrain non-interest income. Overall, I’m expecting non-interest income to decline by 27% year over year in 2020.
Expecting Earnings to Decline to $1.37 per Share
The surge in provision expense, contraction in NIM, and drop in non-interest income will likely pressurize earnings this year. Meanwhile, strong loan growth will support the bottom-line. Overall, I’m expecting FITB’s earnings to decline by 59% year over year to $1.37 per share. The following table shows my earnings estimates.
The impact of COVID-19 on provision expense is uncertain and could lead to negative surprises in the year ahead. Additionally, the repayment period of PPP loans is uncertain, which could lead to surprises in NIM and loan balances. These uncertainties make FITB quite risky to invest in.
I’m expecting FITB to maintain its quarterly dividend at the current level of $0.27 per share. Despite the earnings decline, I’m not expecting a dividend cut because the earnings and dividend estimates suggest a payout ratio of 79%, which is manageable. Moreover, the management mentioned in the conference call that they expect to maintain dividends at this time. The dividend estimate suggests a dividend yield of 6.2%.
FITB Offering a High Return, But with a High Level of Risk
I'm using the historical price-to-tangible-book multiple, P/TB, to value FITB. The stock has traded at an average P/TB multiple of 1.44 in the past, as shown below.
Multiplying this P/TB ratio with the forecast tangible book value per share of $22.3 gives a target price of $32.1 for December 2020. This target price implies an upside of 84.5% from FITB's May 5 closing price. The following table shows the sensitivity of the target price to the P/TB multiple.
The significant upside shows that FITB has the potential for a high return. However, the stock also carries a high level of risk, as discussed above. Consequently, I’m adopting a neutral rating on FITB.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.