Fifth Third Bancorp: Attractive positioning for higher rates (FITB)

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The deteriorating economic outlook has pushed investors away from the banking sector, as inflationary risks and rising borrowing costs dampen earnings growth. But if these concerns are real, investors should do not underestimate the impact of the rise in the Fed funds rate on the interest income that banks derive from the loans they grant.

Earnings growth across the sector is expected to be uneven, however, as not all financial institutions will benefit equally from rising interest rates. At the same time, other factors must also be taken into account, such as differences in the composition of their balance sheets, trade exposures and credit risk characteristics.

Considering the above, a bank that seems to be particularly well positioned is Fifth Third Bancorp (NASDAQ:FITB).

Interest rate tailwinds

The regional bank’s asset-sensitive balance sheet is one reason why interest rate tailwinds could have a bigger impact on its earnings compared to its competitors.

Fifth Third, like many regional banks, derives most of its income from money lent at higher rates than those paid on deposits – the difference known as net interest income. NII accounted for more than 60% of the bank’s revenue, even as lending spreads hit new lows in 2021. And while variable rate loans make up just under half of its loan portfolio, the lender has a loan to deposit ratio of only 69%, indicating an excess deposit position.

Its low reliance on wholesale funding, along with the ability to sacrifice market share for deposits, should mean that Fifth Third would be under less pressure to push higher rates to its depositors as the rate Fed chief climbs. As such, its interest charges should remain relatively low compared to industry peers in the current tightening cycle.

Meanwhile, on the asset side, interest income would increase not only due to higher lending rates, but also the ability to increase lending to customers and intentionally add duration to its securities portfolio, which should further boost NIMs.

“We expect deposit betas of around 15% on the first 125 basis points of Fed rate hikes…[and] around 25% over the first 200 basis points of this cycle compared to the last cycle in the 1930s. The ultimate impact on the NII of further rate hikes will depend on the timing and magnitude of interest rate moves, balance sheet management strategies, including stock growth and hedging transactions, and realized deposit betas. »

“For the second quarter, we expect the NII to be up 11% to 13% sequentially.”

Chief Financial Officer James Leonard, First quarter 2022 results call

Headwinds for fee income

The rise in net interest income will, however, be partially offset by headwinds on the non-interest side of the business. Fee-based revenue, which has been a strong boost to bank revenues following the pandemic, is expected to come under pressure in the near term.

First, the outlook for mortgage income is expected to decline by around 10% in 2022 compared to 2021, as rising rates dampen refinancing activity and slow the housing market. And to compound its woes, commercial banking fees and private equity earnings could also come under pressure from the Fed’s tightening cycle, slowing capital markets activity and a tougher investment environment. hard.

Management has revised its expectations for fee income down – its latest forecast puts adjusted non-interest income at stable at 1% lower in 2022 from the previous year’s benchmark of $3.15 billion, down from growth of between 3% and 5% as indicated in its January forecast.

Net interest income, on the other hand, is expected to be 13-14% higher for the full year, a sharp increase from the 4-5% growth in its January forecast. The current forecast for April assumes that the federal funds rate will rise to 2.50% by the end of this year, from 1.00% previously. But with market expectations pointing to an even higher year-end rate of between 2.75%-3.00%net interest income could still significantly exceed management’s revised forecasts.

Conservative Provisioning

Looking ahead, the big uncertainty is the impact of the deteriorating economic outlook on the bank’s credit quality. In particular, aggressive monetary tightening risks plunging the US economy into a recession.

The reversal of loan loss provisions in 2021 has been the main contributor to the recovery in banking sector profits, and so a potential sharp increase in credit costs could quickly erode projected profit growth from rising banking revenues. net interest.

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On the other hand, it’s important to realize that Fifth Third hasn’t been as aggressive in releasing reserves during the pandemic as some of its rivals had been.

As such, its loan loss reserves remain significantly high relative to pre-pandemic levels and relative to industry peers. Its total provision for credit losses covered 411% of its non-performing loans at the end of the first quarter of 2022, a much higher ratio than many of its peers. This suggests that the credit risks of the loan portfolio are managed in a prudent manner, which should mitigate the increases in provisions in the medium term.

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Earnings revisions

Fifth Third Bancorp Earnings Revisions

Chasing alpha gains for Fifth Third Bancorp

Wall Street analysts braced for the Fifth Third earnings outlook. The stock has an A+ review rating from Seeking Alpha’s Quant Ratings, reflecting 14 upward earnings revisions in the past 90 days and no downward revisions.

Over the past three months, the current year EPS consensus estimate has risen 6.12%, while the forecast for the same in 2023 is 7.99% higher.

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Valuations don’t look too steep either, with the stock trading at 10.2 times its expected 2022 earnings, a 3.8% discount to its sector and an 11.6% discount to its peers. its 5-year average.

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