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Morningstar | Fifth Third Reports Loan Growth Acceleration in Fourth Quarter; Raising Our FVE to $31

No-moat rated Fifth Third Bancorp reported a reasonable fourth quarter that was generally in line with our expectations. Diluted earnings per share was $3.06, up 6% from last year, and the return on average assets and return on average tangible equity were 1.5% and 16.4%, respectively. We think that this year's results are above normalized levels for two major reasons. First,  we anticipate deposit costs increasing, which will weigh on net interest income in the medium term.  Second, items related to  Fifth Third’s one-time sale of Worldpay accounted for 9% of net revenue.  While the tailwinds of Worldpay share sales will eventually run out, we remain positive on Fifth Third's overall profitability going forward, and we are increasing our fair value estimate for Fifth Third Bancorp to $31 per share  from $29 .

Commercial and Industrial loan growth picked up pace during the fourth quarter, which brought the 2018 full-year loan growth to about 3.2%. Management remained upbeat on the underlying economic growth it is witnessing in the economy, and we think 3% or more is closer to Fifth Third’s normalized loan growth rate. Net interest margins expanded 20 basis points in 2018 and 6 basis points in the fourth quarter alone. We agree with management that most of the NIM expansion for this cycle has happened, and we are projecting only modest NIM expansion going forward.

Ignoring Worldpay-related items, noninterest income grew modestly at 3.25% year over year. We were pleased to see that wealth and asset management fees grew in the midsingle digits as we think these non-banking businesses  generate sticky client relationships as well as asset-light incremental  revenue. This additional noninterest income was partially offset by a midsingle digit decline in mortgage banking revenue, which was expected given last year’s rising interest rate environment. Noninterest expenses were down 1.55% year over year, and we believe there are still costs available to cut from the business.

Related to cost cuts, management provided additional details on future plans, including that the new branches it is planning to roll out will be 40% smaller than legacy branches. The bank also expects to be a net closer of branches in 2019. While core, legacy expenses will be decreasing, Fifth Third is also planning additional middle-market expansions in Denver, Dallas, and Houston. This will be a key item to watch, as multiple banks are planning expansions in key markets.

Fifth Third remains on track to close the MB Financial acquisition in the first quarter of 2019. We believe that overall the acquisition will improve long-term returns on tangible equity, but there may be a long earn-back period given the 8% tangible book value dilution set to occur.

For a more detailed view of our expectations regarding interest rates and their effects on banking profitability, please see our December 2018 Observer, "The Return of the Bank: Net Interest Margins Reach a Turning Point--Funding Advantages and Net Interest Income."