Fifth Third CEO Forecasts Loan Growth, Sluggish M&A in 2012

Kevin Kabat has lived a lifetime in his four-plus years as chief executive of Fifth Third Bancorp — and he is prepped for more.

Kabat has the Cincinnati company chasing acquisitions and loan growth after navigating it through the financial crisis and out of the Troubled Asset Relief Program.

During a recent stop in Durham, N.C., where he spoke at a North Carolina Bankers Association's annual Economic Forecast Forum, Kabat shared his outlook for banking, including the environment for M&A and the role of regional banks, during a wide-ranging interview with American Banker.

Here is an excerpt:

What are your expectations for the industry in 2012?
KABAT: We're in a different place than we were a year ago. To fast forward to today, we're cautiously optimistic about our outlook. While we don't think it's going to be a great recovery or great bounce back, we think steady, continued growth and increasing loan demand will carry us along in 2012. We think GDP will be, plus or minus, 2%, and it could surprise to the upside. We're not in the camp that a double dip [recession] is imminent. There is always a slight chance of something coming along to derail the economy, but that's all we have. As is, we don't see that happening.

What are the challenges?
Most of the headwinds out there are the ones we've already been talking about and they're already known. The investors know about them. The communities at large know about them. The challenge remains, first and foremost, jobs. We don't expect a lot of change [there] in terms of 2012. As far as other challenges, it's an election year, and that's always a challenge from our perspective. At the least, advertising costs are going up this year. And we still have in our industry a lot of unresolved legislation.

How should banks measure success this year?
You already have the [Federal Reserve] saying they're going to keep interest rates low into 2013, and the rumor now is that some of the Fed governors want to keep it low until 2014. That's going to stress margins. The issue is can you get the loan growth in 2012. We think it will be there. That momentum helps. So while margins come down, net interest income can potentially hold up. That will feel better to most people. We'll get additional clarity, in terms of the election and hopefully some of the fulfillment of [the] Dodd-Frank [Act]. That would put the industry on much stronger ground. If you look at balance sheets [and] capital ratios you see a much stronger industry today than you did 12 months ago.

Last year was a slow year for M&A. What about 2012?
We think that M&A will continue to be slow through 2012 for a couple of reasons. The industry hasn't fully let provision flow through the P&L so there's a great deal of expectation by bank managements that valuations are too low. We think there will be more positioning and more improvement in the course of 2012 and you could see M&A pick up in the latter part of the year and certainly in 2013. We think it will be rather challenging. Still some opportunity for challenged institutions, but we don't think it is going to be a robust M&A year at all.

There's still a gap between buyers and sellers, right?
There has always been a gap, but I think the gap is potentially a lot wider than what people have seen historically. That needs to get a little bit closer, or reality needs to set in about our industry and some of the challenges.

What would make a good M&A fit for Fifth Third?
If you look at our franchise, we're very happy with our geography. We look to see where we fall one, two or three in a given marketplace. The Southeast, Chicago and some other markets in the Midwest all are fit for us to bring density to our marketplace. We don't feel like we need to expand outside the footprint. It is really about creating greater density. Obviously, when you look at the bell curve of the industry, in terms of where the players are, there are very few middle or large institutions that would [be available to acquire]. So you're really talking about smaller institutions that fit specifically within the geographies that can help fill our density.

Where are banks finding growth?
Our footprint goes from the heartland to the Midwest to the South, and the recovery has been led by a few significant [areas]. Health care obviously never really left. Secondly, our bread and butter has been manufacturing, and that is coming back very strong. …We've seen some very strong performers come out of that, predominantly in the upper Midwest. There's a rebounding auto business that is not just Detroit or the Midwest, but also the international domestics and tier-two and tier-three suppliers.

Home pricing is rebounding in the Southeast, particularly the closer you get to the coasts. It is still challenging in the central part of the states but there's some stabilization. So that is giving us some balance. We're seeing tremendous deposit growth in the Southeast. Some people will question if deposit growth is a good thing right now, but we look at it very positively as long it is households and household relationships. That is what feeds future earnings. …We've been very prudent to make sure we continue to grow our households but we've been disciplined in terms of our pricing.

What about the regulatory environment?
I've been in this business for 30 years, and I've gone through cycles in the past. This is certainly the most challenging time period for me personally, for my company and for the industry as a whole for a lot of reasons. A lot of the regulatory burden is being placed, from a legislative orientation, on the regulators to make sure that 2008 never, ever happens again. That's a high standard. From a regulatory standpoint, to try and ensure that it doesn't happen with this mammoth regulatory legislation of 848 pages that is only 24% completed, there is lot to play out in this environment. It puts a lot of pressure on our regulators to get it right.

The good news out of all that … is to look where U.S. financial institutions are compared to European financial institutions. I think the regulators helped and our institutions were very aggressive and very early in addressing our issues. Looking at today's balance sheets and capital ratios, you see the U.S. financial institutions in a much stronger place in 2012 than a lot of other places. We're faster. We reacted quicker. A lot of us did the right things early and that helped to cut the tail off and put us in a position to move forward.

What role will large regional banks play in the industry?
I'm very bullish and optimistic about the role of regionals. …From the regional standpoint, we're coming into a very attractive time period. You have some of those trillionaires [banks with $1 trillion or more in assets] that can no longer play in the consolidation game. That helps us and our strategy. … I have always believed that the regionals, and Fifth Third specifically, have an operating model that allows us to compete on both ends of the spectrum. We can compete against the trillionaires. We have the balance sheet and size to be able to handle the commercial brand awareness and product and technology enhancements that are necessary. … There's a whole lot of runway from where we are to the 'too big to fail' bank of the future.

Do economies of scale and scope still exist for regionals?
To an extent. We've always believed there are economies of scale, but only to a point. And we've felt like we have exceeded that point. The new play is the regulatory impact. We're just beginning to see what that will look like. That can create a new economic step where size matters going forward. You have a layer of embedded costs that will go much broader and much deeper in the industry than some of the other economies that we've already taken care of. Technology is cheaper over time and it is scalable. The regulatory burden, not so much.

That's going to be a challenge across the industry and particularly as you move lower into the industry. We're already seeing that in the 2012 stress tests. Originally it was the top 19 of us. Now it is for banks with $50 billion [or more] in assets. Trust me, [the regulators] like it. It gives them insight and that will spread back to anybody over 10 [billion dollars in assets] and maybe even 5 [billions of dollars]. There may be different layers of discipline, but at the end of the day the entire industry will be affected.