Earnings of Fifth Third Bancorp (NASDAQ: FITB) will likely dip next year mostly because the provisioning for loan losses will move towards a more normal level. On the other hand, a rising interest-rate environment will support the bottom line. Further, after a tough couple of years, the loan portfolio will likely increase this year on the back of economic recovery and investments in the team and the product line. Overall, I’m expecting the company to report earnings of $3.23 per share in 2022, down from expected earnings of $3.70 per share for 2021. The year-end target price is below the current market price. Further, Fifth Third Bancorp is offering a modest dividend yield. Based on the total expected return, I’m adopting a neutral rating on Fifth Third Bancorp.
Internal and External Factors to Turn Around the Declining Loan Trend
Fifth Third Bancorp’s loan portfolio declined by 1.9% in 2020 and 0.3% in the first nine months of 2021. The loan decline was partly attributable to the forgiveness of Paycheck Protection Program (“PPP”) loans. PPP loans outstanding dropped to $2.3 billion by the end of September 2021 from $5.4 billion at the end of March 2021, as mentioned in the earnings presentation. PPP loans outstanding still made up around 2.1% of total loans at the end of September 2021; therefore, their upcoming forgiveness will have a material impact on the total loan portfolio size.
Nevertheless, the total loan portfolio will likely increase in size this year because of the ongoing economic recovery. Further, the management mentioned in the conference call that it is seeing a robust pipeline, which should elevate loan growth in the near term. Moreover, Fifth Third has recently added product capabilities and made key talent hires which will support loan growth this year.
The loan trend could have benefited from merger and acquisition activity. Unfortunately, bank acquisitions are not a top priority for Fifth Third, as mentioned in the presentation. Considering the factors mentioned above and the pre-pandemic loan trend, I’m expecting the loan portfolio to increase by only 1% in 2022. Meanwhile, I’m expecting deposits to grow mostly in line with loans. The following table shows my balance sheet estimates.
Higher Rates to Affect the Margin with a Lag
The Federal Reserve projects a 75 basis points hike in the Federal Funds rate in 2022. Moreover, the Fed’s plans to reduce the pace of bond purchases should further improve the yield this year. However, the impact of higher interest rates will get somewhat dampened by the elevated competition in the market. Peer banks are sitting on a lot of excess liquidity and all banks want to return to a better loan-to-deposit ratio, which is partly why the competition has increased.
Moreover, Fifth Third Bancorp has slightly more fixed than variable-rate loans, as shown below.
Due to the loan mix, Fifth Third’s net interest margin is more sensitive to rate changes in the second year of the rate change than the first year. According to the management’s interest-rate sensitivity analysis, a 100-basis points increase in interest rates can increase the net interest income by 5.7% over twelve months, and then by 12.3% in the second year of the rate cut, as mentioned in the investor presentation and shown below.
Considering these factors, I’m expecting the net interest margin to increase by four basis points only in 2022.
Loan Growth to Drive Provision Normalization After 1Q 2022
Allowances represented a whopping 409% of non-performing loans at the end of September 2021, as mentioned in the investor presentation. As a result, further provision reversals cannot be ruled out in the near term. However, after the first quarter of this year, the provisioning will most probably move closer to a normal level once the excess reserves have been released. Further, the additions to the loan portfolio will require higher provisioning for expected loan losses.
However, the overall provisioning will likely remain below normal because of the economic recovery. The management also mentioned in the conference call that it expects charge-offs to be better than the through-the-cycle average due to the economic outlook.
Overall, I’m expecting provisions to represent 0.15% of total loans in 2022. In comparison, the provision expense averaged 0.34% of total loans from 2016 to 2019.
Expecting 2022 Earnings of $3.23 per Share
Earnings will likely dip next year mostly because of the higher provision expense. On the other hand, subdued loan growth and slight margin expansion will limit the earnings decline. Overall, I’m expecting Fifth Third Bancorp to report earnings of $3.23 per share in 2022. For the last quarter of 2021, I’m expecting the company to report earnings of $0.82 per share, which will take-full year earnings to $3.70 per share. The following table shows my income statement estimates.
Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic, especially the Omicron Variant.
Small Negative Total Expected Return Calls for a Neutral Rating
Fifth Third Bancorp is offering a dividend yield of 2.5% at the current quarterly dividend rate of $0.30 per share. The earnings and dividend estimates suggest a payout ratio of 37% for 2022, which is easily sustainable. Therefore, I don’t think there is any threat of a dividend cut despite the outlook of an earnings dip.
I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Fifth Third Bancorp. The P/TB ratio has tended towards around 1.60x in the past, as can be seen below.
Multiplying the central P/TB multiple with the forecast tangible book value per share of $24.8 gives a target price of $39.7 for the end of 2022. This price target implies a 17.9% downside from the January 6 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
The stock has tended towards a P/E ratio of around 13.0x in the past, as shown below.
Multiplying the central P/E multiple with the forecast earnings per share of $3.23 gives a target price of $41.9 for the end of 2022. This price target implies a 13.3% downside from the January 6 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
Equally weighting the target prices from the two valuation methods gives a combined target price of $40.8, which implies a 15.6% downside from the current market price. Adding the forward dividend yield gives a total expected return of negative 13.1%. Hence, I’m adopting a neutral rating on Fifth Third Bancorp. I’m going to stay away from this stock unless its market price corrected substantially by over 20% from the current level.
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