Fifth Third Bancorp looks unattractive as competition eats deposits (NASDAQ:FITB)


Fifth Third Bancorp Shares (NASDAQ:FITB) fell more than 4% in response to third-quarter results that fell short of expectations. The bank is experiencing cost pressures and its deposit performance has been particularly disappointing, which threatens to dampen net interest margin (NIM) growth forward. With stocks trading at around 1.5 times adjusted tangible book value, I see better value elsewhere in the regional space and do not expect stocks to significantly recoup their 2022 losses.

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In the third quarter, the company achieved adjusted EPS of $0.93. This missed expectations by around $0.05. The company generated a return on equity of 15.3%, so like virtually all banks that reported earnings, on an absolute basis, the company is doing well. After years of living under low interest rates, banks are finally taking advantage of rising rates with significant gains in net interest income. Fifth Third was no exception to this rule.

During the quarter, it gained an NIM of 3.22%, up 30 basis points sequentially and 63 basis points from a year ago. Combined with modest asset growth, this resulted in net interest income growing 12% sequentially to $1.5 billion. Of NIM’s change contributions, its assets gained 0.32% while funding costs were a drag of 0.06%.

Loans rose 2% to $119.6 billion with strength on the business side, although that growth was a bit slower than its peers. On the secured consumer side, the company actually saw its loans drop by $200 million to $16.8 billion. Although this is only a small portion of the portfolio, it was also surprising to see the credit card balance at the end of the period holding steady at $1.8 billion. Credit card balances have risen sharply nationally, so I expected to see some growth here. On the bright side, Fifth Third’s loan portfolio rate rose 58 basis points, given that most of its loans are floating rate.

Non-interest revenue decreased 1% to $727 million due to lower custody fees. In April, it announced the end of minimum balance fees, and that headwind is now fully felt in financials. At the same time, non-interest expenses rose 5% due to 4% wage inflation as the FITB raised its minimum wage to $20 an hour.

Fifth Third’s fee reduction on its deposit business is of particular interest as we look at how the bank tries to compete to hold on to funds. With consumer savings declining and the Fed’s balance sheet shrinking, deposits are facing headwinds. As they offer the cheapest and most stable type of funding, it is important to keep the bulk of deposits to maintain strong NIM margins. Here, Fifth Third’s performance was underwhelming. Its deposit base fell 3% to $157.2 billion. Now, some banks that think they have excess deposits, like Comerica (CMA), have essentially let deposits go by being particularly stingy about how much of the higher Fed rates they pass on to depositors. I don’t particularly value this strategy as I would prefer deposits to be held to ensure medium-term funding stability, but it is an active choice. Unfortunately, it doesn’t look like the FITB is making that choice as it has dramatically increased its deposit from 0.09% to 0.41% (Comerica for comparison has risen to 0.20%).

FITB is passing on more Fed rate hikes than most peers, yet its deposits are falling more steeply. This suggests that it is losing market share against its peers and facing a competitive environment for deposits. If this was a management choice, it could be quickly remedied by increasing deposit rates, but it looks like other things are going on here. Combined with weak loan growth, FITB appears to be facing a particularly competitive environment for its business. This creates a risk to its ability to maintain its margins and grow its assets.

Due to lower deposits, its securities portfolio shrunk by $700 million to $63.5 billion. This decline was driven by a significant drop in cash and cash equivalents. The yield on his portfolio edged up 13 bps to 2.86%. Unlike its loan portfolio, its securities portfolio is largely fixed rate, so it only benefits from higher rates gradually as it reinvests maturities into higher yielding securities. The portfolio has a duration of 5.5 years, so this will be an extended period of slowly rising interest rates.

On the credit side, the FITB is managing the slowdown in economic activity well. Provisions for credit losses decreased $147 million from $168 million last quarter. Over the past three months, non-performing loans have declined by 1bp to 0.46% of all loans. The Company’s allowance for credit losses is 1.91% of loans. This provides a sufficient buffer for more loans to become delinquent. Unless there is a significant recession, its quarterly provisioning rate of $150 million to $200 million seems sufficient.

During the quarter, FITB also raised capital. Its CET1 ratio is now 9.1% compared to 8.95% in Q2, and it is aiming for 9.25% at the end of the year. The company offers a safe 4% dividend yield, but I wouldn’t expect significant redemptions until the capital grows further, likely in 2023, depending on economic conditions. When reviewing the valuation, it is important to remember to exclude unrealized gains or losses in its held-to-maturity investment portfolio, which resulted in -$5.3 billion in accumulated other comprehensive income. The tangible book value excluding AOCI is $21.60.

In the fourth quarter, the bank expects loans to grow 1%, another sequential decline in the growth rate. The competitive pressures that weighed on the results of the third quarter do not seem to be weakening. Thanks to higher rates, net interest income should increase by around 5%, although this also represents a significant slowdown compared to the third quarter, probably because banks are feeling a little more pressure on the funding side.

With some pressure on margins and questions about its deposit trajectory, the company may show less upside earnings than peers who have built up deposits like Citizens Financial (CFG) or at least hold more deposits more easily, as Truist (TFC). With credit provisions likely at a more sustainable rate now, I would expect EPS to stay in the $0.90-$0.95 area. This leave shares 9 times earnings. I see the risk is skewed a little downside if deposit performance deteriorates further. With most regional banks trading at a single digit P/E at 1.5x the tangible pound and facing more competitive pressures, FITB is relatively unattractive, and I would prefer to own banks more clearly ready to benefit from higher rates like CFG. I would expect FITB to stay in the $30-$35 zone until there is evidence of improved trading performance.

Martin E. Berry