2023-05-12 08:05:52 ET
Summary
- Banks are facing challenges due to economic growth slowdown, inflation, and deposit outflows.
- Small banks are now the main concern, unlike in 2008 when it was the big banks.
- Ohio-based Fifth Third Bancorp is a good investment opportunity due to its strong deposits, healthy loan quality, and investment portfolio, but investors should be cautious of potential volatility.
Introduction
Banks are in turmoil. Year-to-date, financials are performing poorly. As the overview below shows, financial stocks have underperformed the S&P 500 by roughly 14 points in the first five months of this year. Banks are down 28%. Regional banks are down 38%, as they have quickly become the epicenter of this crisis.
As much as I dislike seeing my regional bank investment in Huntington Bancshares ( HBAN ) suffer, these sell-offs come with opportunities. After all, I sometimes say that buying regional banks is like picking up pennies in front of a steamroller. While regional banks do well over time, they are prone to steep, regular sell-offs triggered by recession fears.
The problem is finding good regional banks. In the past few weeks, I have discussed a number of them, including Huntington Bancshares and Truist Financial Corp ( TFC ).
One bank that absolutely deserves coverage is Ohio-based Fifth Third Bancorp ( FITB ) , one of the largest regional banks in the nation. The company has a juicy dividend yield, a stellar business with high-quality deposits and loans, and the ability to consistently outperform its peers.
In this article, we'll dive into this bank and reasons to consider buying the FITB ticker when looking for regional banking exposure.
So, let's get to it!
The Banking Crisis Is A Trust Crisis
While there is certainly a difference between the quality of banks - otherwise, I wouldn't be writing this article - it needs to be said that the banking business model isn't the best long-term investment, at least not for people trying to avoid volatility.
Everything is built on trust, banks are fueled by it. After all, they are just institutions that manage deposits and loans. I'm obviously painting with a broad brush here, but essentially it's all based on the trust of depositors - even more than the quality of loans.
Going back to the first trading day of the 1990s, FITB shares have returned more than 1,000%. Excluding dividends, that number drops below 400%. Also note that without dividends, the share price is still below pre-Great Financial Crisis levels.
Over the past ten years, FITB shares have returned 82%. This performance is way better than the performance of the regional bank ETF ( KRE ). The company even beat the S&P 500 until the current banking crisis. The chart below perfectly shows how FITB keeps up with the market or even outperforms it until a macro event causes the stock price to implode. After that, it often rallies, beating the market again.
With that said, and going back to the current problem, trust is gone, and policymakers have a hard time restoring it.
The other day, Bloomberg wrote that the problem may have to do with bank sizes. While some are too big to fail, some might be too small to succeed.
Essentially, many smaller banks are stuck in a cycle of doubt and guarded optimism, where stock prices dive, speculation abounds, and anxiety picks up every few weeks.
Hence, some experts suggest that raising the $250,000 cap on deposit insurance could help alleviate some pressure, as many businesses maintain bigger balances for their operational expenses. However, others argue that getting rid of deposit caps could encourage riskier bank behavior and that regulations to keep banks out of trouble in the first place should be the focus. After all, trying to prevent a crisis shouldn't provide fertile ground for another crisis down the road.
Increasing capital buffers is another potential solution, but it is not a quick fix and can be perceived as a distress flare. There is a debate about whether the bank mess is the result of the Fed's policies or the reality of monetary tightening. Experts warn that banks under stress may break in unpredictable ways. This would be bad for the dividend of many smaller banks with barely sufficient capital buffers.
In general, I would argue that the biggest risk for well-capitalized banks is regulatory changes that interfere with their ability to distribute cash or changes that spark more fear.
While some decide to buy some severely beaten down banks, I stick to high-quality banks and decide to buy these on weakness. As a long-term dividend (growth) investor, I believe that's the best way to build both income and wealth.
Fifth Third Is A Fantastic Bank
Fifth Third Bank is a great bank. It's one of the oldest banks and one of the largest regional banks.
Headquartered in Cincinnati, Ohio, 5/3 Bank operates close to 1,100 full-service branches in 11 states.
With a market cap of $15 billion, the bank is the sixth-largest regional bank in the United States.
Not only does the bank have a history going back to 1858, surviving any crisis the US economy has faced since then, but it also enjoys a high credit rating. The company is rated A- by Fitch, BBB+ by S&P, and Baa1 (comparable to BBB+) by Moody's. This puts the company in the top 6 among its peers.
Moreover, with regard to my aforementioned capitalization comments, FITB has high capital ratios, which are well-above regulatory standards.
FITB's CET1 ratio remained relatively stable in the first quarter compared to the fourth quarter of 2022 and was at 9.25% in 1Q23.
The capital position reflects FITB's strong earnings generation offset by the impacts of returning capital in the form of dividends and repurchases, risk-weighted asset growth primarily in consumer loans, and a seven basis point decline from the CECL phase-in .
The company also enjoys the trust of its depositors and clients.
In 1Q23, FITB saw a 2% sequential increase in average total consumer portfolio loans and leases compared to the prior quarter, driven by dividend finance, while the rest of the consumer captions remained stable.
Total average deposits were flat compared to the prior quarter, with an increase in CDs and interest checking balances offset by a decline in demand deposits. Wealth and asset management average balances increased sequentially, while consumer was stable, and commercial modestly declined, consistent with normal first-quarter seasonality.
This performance is remarkable, especially in light of the turmoil caused by the failure of banks like Silicon Valley Bank.
According to FITB (emphasis added):
In the weekend, following the failure of Silicon Valley Bank alone, we open more new commercial deposit accounts than we would in a typical month . Similarly, our consumer household growth accelerated after the March turmoil. Our commercial deposit franchises led by our peer leading treasury management business where we rank in the top 10 nationally and most major commercial payment types, 88% of our commercial deposit balances are attached to relationships that utilize TM services today, and the average age of our commercial deposit relationships is 24 years. These characteristics contribute strongly to stability regardless of balance size .
Based on that context, Fifth Third Bank's consumer deposit base is mostly made up of FDIC-insured accounts, with nearly 90% of total consumer deposits.
According to the company, the bank's flagship mass market momentum banking offering and strong branch presence in the markets they serve have helped drive annual consumer household growth, which finished the quarter above 3%, with southeast markets leading at above 7%. The bank opened five branches in southeast markets during the quarter, with plans to open an additional 30 branches by the end of 2023.
Despite facing increased deposit competition, economic uncertainty, and potential regulatory changes, Fifth Third Bank is confident in its ability to achieve top-quartile returns through the cycle by focusing on stability, profitability, and growth. The bank's long-term discipline in managing interest rates and liquidity risks positions it well to generate differentiated outcomes in a range of economic environments.
With that said, the company continues to benefit from healthy credit trends.
Our key credit metrics remain near historical lows with net charge-offs of 26 basis points coming in at the low end of our guidance range. NPAs NPLs and early stage delinquency ratios remained below normalized levels, and criticized assets decrease modestly during the quarter.
The ACL ratio increased one basis point sequentially, or five basis points, excluding a one-time accounting change. FITB incorporates Moody's macroeconomic scenarios when evaluating its allowance, and the base economic scenario from Moody's assumes the unemployment rate reaches 4%.
Furthermore, the company has low exposure to high-risk segments like commercial real estate.
In commercial, FITB maintains the lowest overall portfolio concentration in commercial real estate at 14% of total loans.
Office loans accounted for only 1.3% of total loans, totaling $1.6 billion. The criticized ratio of office loans was 8.2%, and only one basis point of total delinquencies.
The leveraged loan portfolio has decreased by 65% since 2016 and is now less than $3 billion outstanding. The focus has been on positioning the balance sheet to deliver stable and strong results through the economic cycle.
With that in mind, the company's massive $56 billion securities portfolio consists of 61% Commercial Mortgage-Backed Securities.
The CMBS portfolio can be divided into two parts: the agency portfolio and the non-agency portfolio. The agency portfolio, which is guaranteed by Fannie, Freddie, and Ginnie, is worth $29 billion and poses no credit issues. The non-agency portfolio is worth $5 billion and consists entirely of super senior AAA-rated loans. The company conducts rigorous stress tests and underwriting analyses on a consistent basis. While this won't protect the company in a situation where a domino effect hits debt quality, it has one of the best investment portfolios in its industry.
Based on that context, the recent stress tests assumed a 50% decrease in property values across all underlying properties. In that scenario, the portfolio would still realize no losses.
The office loans in the portfolio make up about 30% of the underlying loans, and assuming a 90% decrease in property values, the portfolio would see its first dollar of credit loss.
Valuation & Dividend
FITB's price-to-book value is below 1x. The valuation is now slightly below the 10-year median. The same goes for the tangible book value, although that valuation has been prone to outliers to both the upside and downside.
What's interesting is that analysts expect FITB to generate a book value of $26.2 per share in 2023, followed by an increase to $28.5 in 2024.
Ignoring everything after 2023, the company's conservative fair value per share would be $34 (currently $23.70), implying a 43% upside and a price-to-book value of 1.3x.
Needless to say, it's not that easy. Estimates could come down a lot, which is what the market is currently pricing in. Also, I believe the Fed will be forced to maintain high rates to combat sticky inflation, regardless of a broad deterioration in economic fundamentals.
Hence, the pressure on deposits in the industry is set to remain high, while credit quality may come down in the quarters ahead.
However, the risk/return seems to be highly favorable. I've recently added to my banking exposure.
The same goes for its dividend. The company's stock currently yields 5.6%. This dividend comes with a very healthy payout ratio and 12 consecutive annual hikes. The five-year average annual dividend growth rate is 15.7%. While I expect that number to come down, the company is one of the best dividend stocks in its industry.
This is what the long-term dividend history looks like:
From a long-term perspective, FITB looks highly attractive. We're either going to recover from this banking crisis, resulting in a renewed uptrend in FITb shares - especially once economic demand bottoms. Or we are about to enter a new full-blown financial crisis. In that case, panic selling could send shares much lower.
So, while risks remain elevated, I like the long-term risk/reward at these levels.
Takeaway
Banks are not in a great place right now. Economic growth is slowing, inflation is sticky, and high rates continue to cause deposit outflows.
In 2008, the economy suffered from too big-to-fail banks. Now, fears are mainly concerning small banks.
While I cannot make the case that the crisis will soon be over, we're now dealing with attractive long-term investment opportunities.
One of them is Ohio-based Fifth Third Bancorp. This regional bank has survived every crisis since the 19th century. It has strong deposits, healthy loan quality, and a strong investment portfolio of mortgage-backed securities.
I consider FITB to be one of the best regional banks, worthy of investment for investors seeking regional banking exposure.
However, investors need to be careful. While the risk/reward may seem highly favorable, we could be in for more volatility before a rebound in economic growth expectations is likely to trigger the next upswing in banking stocks.
For further details see:
Fifth Third: Banking Crisis Bargain With A 5.6% Dividend Yield