Fifth Third’s Significant Underperformance Strikes Me As Odd (NASDAQ:FITB)

If you need things to make sense, the stock market may not be the place for you. While stocks don’t typically stay too cheap or too long for extended periods of time, in the short term there can be some odd moves.

That brings me to Fifth Third (NASDAQ:FITB) and the significant underperformance of these shares since my last update. Down about 25%, Fifth Third isn’t alone in its underperformance (peers like Comerica (CMA) and KeyCorp (KEY) have had similarly poor runs), but it strikes me as odd given relatively decent financial performance in 2022 and exposures/risks in 2023 that aren’t substantially different than its peers.

I don’t love Fifth Third, but the valuation is much more interesting to me now, and I think the bank has a credible plan to drive growth in core expansion markets like California and the Southeast without compromising opportunities in its traditional footprint. Sentiment is an issue for the entire sector, but this name may be worth a closer look today.

On-Target Results Give Fodder To Both Bulls And Bears

Fifth Third’s fourth quarter results and guidance for 2023 aren’t going to resolve any of the questions around the stock. The results were OK, but not great. Likewise, guidance for 2023 looked pretty constructive to me, but not particularly so for the next quarter.

Revenue rose 16% year over year and almost 6% quarter over quarter, beating by about 1% (or $0.03/share). Net interest income rose 32% yoy and more than 5% qoq, beating by about a penny, with net interest margin expanding 80bp yoy and 13bp to 3.35% (1bp below expectations) and earning assets growing 1% qoq.

Core fee-based income fell 6% yoy and rose 7% qoq, beating expectations by about $0.02/share. Mortgage banking remains weak (down 9% qoq), but commercial banking was stronger (up 18%) and wealth management (down 1% qoq) wasn’t too bad. Results from the card business (down 2%) were a little weaker than I expected.

Operating expenses rose 2% yoy and 4% qoq on a core basis, with the bank seeing decent operating leverage (efficiency ratio improved by 80bp qoq to 51.6%), though missing by about $0.01/share. Pre-provisions profits rose 37% yoy and more than 7% qoq, beating expectations by more than 1% or about $0.02/share.

Guidance for 2023 had most analysts bringing down estimates (myself included), but not any more so than for peer banks. First quarter guidance was softer, though, with revenue down around 3% to 4% and expenses up 6% to 7% (down about 2% ex-seasonal items).

Spread Income Slowing, Provisioning Accelerating

Given where we are in the rate cycle, it’s pretty much inevitable that Fifth Third is going to start seeing net interest income growth slow, with slowing loan growth and more expensive funding pressuring results, while credit costs will rise. Again, this is not a Fifth Third-specific issue, and I think this bank’s net interest margin could hold up better than average.

Loans rose a little more than 1% sequentially, which is not a particularly strong performance, and both C&I and CRE lending growth were so-so. In line with management’s intentions to improve full-cycle credit performance, I would expect CRE lending to lag other categories.

At the same time, I think the Street is still nervous about Dividend Finance – the point-of-sale consumer lender focused on renewable energy and sustainability-oriented remodeling that the bank acquired early in 2022. Management has been boosting reserves here (85% of the net increase in the bank’s allowance for credit losses), and I think the Street is concerned not only by the extent to which this business has been contributing to growth (loans were up 19% qoq, driving about half of the bank’s loan growth), but how it will fare during this housing downturn.

How well Dividend Finance fares through this next phase of the credit cycle is certainly important, particularly in the context of messaging from management that they want to reduce risk – reducing exposure to CRE, reducing leveraged lending, and reducing consumer lending to low-FICO borrowers. That said, Fifth Third’s credit metrics still aren’t bad, including stable non-performing asset ratios and charge-offs, though consumer charge-offs did tick up 10bp (from 0.28% to 0.38%) this quarter.

The Outlook

On the whole I like management’s plan to grow the business in large part by continuing to focus on its key markets – Cincinnati, Chicago, California, and the Carolinas – and continuing to grow the business in the Southeast. Management is targeting 100 organic branch openings over the next three years (primarily in the Carolinas), and while these are increasingly competitive markets, they’re also outgrowing national averages for population and household income.

My estimates for FY’23 and FY’24 are a little below the Street (about 3% and 2%, respectively), but I do still expect Fifth Third to generate two-year pre-provision CAGR of around 8%, which is about in line with its peer group.

Between discounted long-term core earnings, ROTCE-driven P/TBV, and P/E, Fifth Third shares look undervalued today, with a fair value around $41 (and a range of $37 to $44 depending upon methodology).

The Bottom Line

I feel like there’s something I must be missing here, beyond just weak overall sentiment for bank stocks. I can understand concerns and skepticism about Dividend Finance heading into this downturn, as well as larger worries about the bank’s credit position and concerns about its ability to profitably gain share in attractive Southeast markets, but the impact on the share price seems a little outsized to me.

As I said in the beginning, this isn’t a bank I’m particularly fond of, and there are banks I like better that offer similar or better upside (including M&T Bank (MTB) and Truist (TFC)). But at today’s price, I think investors looking for relative bargains may want to take a closer look here.