Fifth Third Bancorp Does Not Currently Appear Attractive – Fifth Third Bancorp (NASDAQ:FITB)

Fifth Third Bancorp’s (FITB) earnings have surged in the first nine months of 2019 partly on the back of unusually high non-interest income. The returning of the non-interest based income to a more normal level next year is expected to lead to an earnings decline. A slight dip in net interest margin is also expected to contribute to pressure on the bottom-line. On the other hand, subdued organic loan growth and cost savings are expected to relieve some of the pressure on earnings.

Normalization of Non-Interest Income to Drag Earnings

Unusually high non-interest income drove earnings in the first nine months of 2019. Going forward, this record level is unlikely to be reached again, but non-interest income will still be high. As per guidance given in the third quarter investor presentation, the management expects non-interest income to be 4% down in the fourth quarter of 2019 compared to the third quarter.

Non-interest revenue is expected to be at a decent level next year due to corporate banking revenues, particularly driven by the energy mergers and acquisitions team. Fee income is also expected to buoy non-interest income following the company’s investments this year. Nevertheless, non-interest income in 2020 is likely to be below the income in 2019 as the unusually good performance of this year is unlikely to be repeated. Overall, I’m expecting non-interest income in 2020 to be at a more normal level of $2.9 billion, down 10% year over year.

Non-interest Expense Fall to Support Earnings

FITB’s earnings are expected to receive some support from an expected fall in non-interest expense next year. The decline in non-interest expense is attributable to tapering off of merger related expenses (FITB acquired MB Financial earlier this year) and cost savings. As mentioned in the third quarter conference call, the management expects to achieve $255 million in savings by the end of the first quarter of 2020.

On the other hand, some pressure is expected from an expected increase in salary expense following FITB’s plan to increase the minimum wage. The new minimum wage of $18 an hour will primarily impact employees located in branches in the operations center. Overall, I’m expecting FITB’s non-interest expense to fall by 3.8% year over year in 2020.

Organic Loan Growth Likely to Remain Low

FITB’s loan growth in the past has been mainly attributable to merger activity with very little growth coming from organic sources. The sharp jump in loans this year was almost entirely driven by the acquisition of MB Financial in the first quarter. As there are currently no new merger and acquisition plans, I’m expecting loan growth to decline sharply in 2020, as shown in the table below.

Economic and political uncertainties are also expected to contribute to a deceleration in loan book expansion. On the other hand, some support for credit demand is likely to stem from low interest rates.

Margin to be Slightly Affected by Interest Rate Movement

FITB is only very slightly asset sensitive, meaning that a decline in interest rates leads to a much smaller decline in net interest margin. The low sensitivity is attributable to a high deposit beta that results in sufficient decline in funding cost to offset a large part of the dip in yield. According to the conference call comments, the management expects deposit beta to be greater than 40% (note: beta of 40% means that a 25bps decline in interest rates will lower funding cost by 40% times 25bps, which equals 10bps).

As per the results of a simulation disclosed in the third quarter’s 10-Q filing, a 100bps downward ramp in interest rates can decrease net interest income by 3.11% over a 12 month period. I’m not expecting any further rate cut, so my estimates incorporate only the 75bps decline in federal funds rate that have already happened this year. Based on my interest rate assumption and asset sensitivity of the company, I’m expecting FITB’s net interest margin to decline by 7bps quarter over quarter in 4QFY19 and by another 7bps year over year in 2020. These estimates are shown in the following table.

Fifth Third Bancorp Net Interest Margin

My estimates are more or less inline with management’s guidance given in the third quarter conference call. The management expects full year 2020 core NIM to be in the range of approximately 3.2% to 3.25% depending on the size and timing of Federal Reserve actions. According to the management, NIM is expected to be at the upper end of the range assuming no fed rate cuts in 2020 and it’s expected to be at the lower end of the range assuming two additional 25bps rate cuts in March and September of 2020.

The dip in NIM and non-interest income (discussed previously) are expected to be the major contributors to a decline in earnings next year. Their negative impact on the bottom-line is expected to be partly offset by subdued loan growth and fall in non-interest expense. As a result, I’m expecting FITB’s net income to decline by 3.7% in 2020 to $2.88 per share. The following table presents my estimates for key income statement items.

Fifth Third Bancorp Income Forecast

FITB Considering Dividend Raise

As mentioned in the conference call, FITB is considering increasing its quarterly dividend by $0.03 per share. Assuming the raise comes in the second quarter of 2020, it will lead to a full year dividend of $1.05 per share implying dividend yield of 3.39%. Apart from the dividend, shareholders stand to also get rewarded through the ongoing share repurchase program. As of the time of the last conference call, around a maximum of $900 million worth of repurchases were remaining to be executed over the next three quarters.

The dividend and repurchases will reduce equity book value while net income will add to it. Equity will also be affected by the implementation of the Current Expected Credit Losses, CECL, accounting standard in January 2020. According to the management’s estimates, CECL can lead to an increase in reserves for the loan portfolio in the range of 40% to 55%. Based on this guidance, I’m assuming that the reserves will increase by $507 million (45%) in the first quarter of 2020 and equity book value will decrease by the same amount. I’m expecting book value per share to stand at $28.23, and tangible book value per share to stand at around $22.13 by the end of 2020.

Limited Price Upside Expected

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 1.43 in the past as shown below.

Fifth Third Bancorp Historical Price to Book

Multiplying this P/TB ratio with the forecast tangible book value per share of $22.1 gives a target price of $31.6 for December 2020. This target price implies an upside of just 2.1% from FITB’s December 19 closing price. The following table shows sensitivity of the target price to P/TB multiple.

Fifth Third Bancorp Valuation Sensitivity

Due to a low price upside I’m adopting a neutral rating on FITB. The current market price does not appear attractive; therefore, I believe it is not advisable to invest at this level. An entry point of lower than $28.8, which is 10% below the target price, seems more feasible.

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.

Additional disclosure: 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.

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