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Banking: Strategy for a ‘Divergent’ Economy

Fifth Third Bank says shifting U.S. financial trends create opportunity in Kentucky.

By Mark Green

Fifth Third Bank’s $9.03 billion in Kentucky deposits rank it third in state market share at 7.6%, according to the FDIC’s annual deposit market share report at midyear 2022.

PNC Bank has 10.6% of the Kentucky market and JP Morgan Chase has 9.4%, but the commonwealth is a smaller portion of those banks’ business. Kentucky is 5.4% of Fifth Third’s deposit base, but only 2.8% of PNC’s deposits and a scant 0.5% for Chase, which is the nation’s largest bank.

The Lane Report talked recently with Tim Spence, CEO of Cincinnati-based Fifth Third, and Kimberly Halbauer, Kentucky market president. [Editor’s note: The interviews occurred prior to both the Federal Reserve Open Market Committee’s Nov. 2 vote to increase benchmark interest rates by 0.75 percentage points and the release of the third-quarter gross domestic product numbers showing 2.6% growth.]

Mark Green: The Fed raised benchmark interest rates another 0.75 percentage points to the highest level in 15 years and more hikes are coming. What adjustments is Fifth Third making as a result?
Tim Spence: Most adjustments we make are less driven by specific rate hikes and more by what the rate hikes indicate, which is an environment that has a lot of uncertainty. Clearly, there are dynamics directly associated with interest-rate increases in terms of debt service and liquidity. But when you look at the global backdrop and the dynamics around the world—whether it’s the (September) run on currencies in the United Kingdom or the dynamics associated with geopolitical instability—we have elected not just to take care of clients but to make sure that we’re proceeding with caution and have a pretty balanced posture.

We’re big believers in the markets where we operate and in their vitality. I think of Kentucky as a gateway between the Midwest and the South, very well positioned to benefit from areas of the economy that are going to see good long-term growth prospects, including a resurgence of domestic manufacturing and onshore supply chains. We need to pursue those opportunities and at the same time make sure we’re doing the things we need to do to run a company that performs well, even if the Fed has to tip the economy into a recession in an effort to get inflation under control.

MG: How does Fifth Third view the Kentucky market? is it different from elsewhere?
Tim Spence: Kentucky is very important for Fifth Third. Our headquarters literally sit on the border. It’s a large market for the bank. It’s a strategic market for us because of our focus on U.S. manufacturing and the investments we are making in helping rebuild U.S. supply chains and transitioning the economy toward electronic vehicles and renewable energy sources as a complement to fossil fuels. When you look at the markets that are big for you, that have positive long-term growth prospects and that are home to the industries that are points of focus for your company, it becomes an important market.

Kimberly Halbauer: Fifth Third would be missing a big part of our footprint if we didn’t have a presence in Kentucky. This market and the commonwealth are important to our overall strategy. We’re specifically very excited about the expansion of our team in Kentucky. Most notable is hiring the only investment banker in the state of Kentucky.

We hired Matt Ward, who came to us most recently from Truist. He was the market president for Truist and had a background at JP Morgan in the investment banking world. We have made a commitment unlike anyone else by hiring somebody focused on capital markets and investment banking for businesses in the state of Kentucky and Tennessee and southern Indiana. That’s a huge differentiator for us in the market.

Having grown up in this market, he’s earned the trust of business owners throughout the commonwealth to help guide them through transitions—growing and acquiring new business, passing assets to the next generation, selling to a strategic partner or facilitating growth in mergers and acquisitions. He understands some of the unique dynamics that happen in Kentucky rather than some of the other folks that fly in from San Francisco, Chicago and New York.

On the wealth management front we’ve gained some influential talent from PNC, JP Morgan and U.S. Bank in the past year. We are incorporating opportunities for our existing pipeline of talent to continue to be promoted and brought up through the organization.

MG: Over the next couple of years, do you foresee economic conditions improving, staying about the same or worsening?
Tim Spence: “Divergent” is the word I would use. In general, the U.S. economy is a consumer economy, and consumers are actually in good health. Wage inflation has kept up with inflation overall. A big segment of the U.S. population was able to lock in very low mortgage rates, which means their housing costs are in good shape. And there is something like two times as many jobs as there are job seekers. The health of the consumer as a function of their earning power is keeping up with the cost of living.

That said, segments of the population are much more exposed. Folks who are renting as opposed to owning homes and who make less than $50,000 a year are the segment getting squeezed the hardest right now. Rents have continued to rise in most markets, and they spend a larger share of their incomes on food and energy and gas than other segments of the population. We worry a little about that segment.

On the commercial side of the equation, businesses in general have recovered nicely and been able to pass on increases in input costs in the form of price increases, which is in part why you see the price inflation that we have. But there are segments of the market—including some segments of commercial real estate—that are more exposed to interest rate increases because they have high amounts of leverage and floating interest-rate structures. I expect a little bit of squeeze in that sector of the economy.

MG: Does Fifth Third take a position on whether you expect a recession?
Tim Spence: Economic cycles and Father Time are undefeated (in creating a recession) when you look at this over a long enough time frame. We’re in a technical recession if you look at it as measured by two consecutive quarters of GDP contraction. Our crystal ball is not better than the Fed’s and (Fed Chairman Jerome) Powell has been fairly clear in his comments since (the Fed’s August annual symposium at) Jackson Hole that he believes it’s very unlikely there’s going to be a painless way of taming inflation. I would say in the next 24 months, a recession is more likely than not.

MG: Trend reports say that the largest banks—of which Fifth Third is one—are incorporating artificial intelligence to improve operations. Are you and if so, how?
Tim Spence: Yes, but there’s a broader dynamic for the U.S. economy over the next 10 years that has been a little underreported. There are going to be more people to retire every year over the next decade than graduate from high school and college combined. The byproduct is we’re going to be short on labor in general. When I talk to business owners, that’s still the No. 1 concern. It’s not the macro economy; it’s actually the shortage of labor. Everybody is going need to find ways to invest in technology that improves productivity because we just are not going to have enough workers in the U.S. to do all the work that needs to be done.

So absolutely we’re using artificial intelligence. We’re using digital tools. (But) we don’t believe in running unsupervised AI in our environment. We use techniques like machine learning for model development. But you don’t allow those models, when they’re employed, to adapt in real time in your environment. You use the development models and then reground the models.

MG: Banks are traditional and conservative but in a position of needing to adopt cutting-edge technology—AI, Internet of Things, data analytics—into operations. It sounds like Fifth Third has a careful approach to adopting something that sounds dramatic.
Tim Spence: Three-fourths of all transactions our customers do are electronic today. Technology is actually the primary way we interact with our customers, but it’s still not the most important mode. Even in a world where we provide excellent digital channels and enable people to do simple things on their own, when it comes to resolving the issue or making a complex decision, there’s value in having access to somebody who can work with you and help you make the right decision, get your problem resolved or provide advice.

We have embraced technology, but we start from what the customer needs to accomplish and go back from there. The starting point is the things you worry about doing on a day-in, day-out basis. You need to get paid, you need to pay for things, you need to manage liquidity. We have been very deliberate in leveraging software and analytics to build solutions for customers that help them to do those things better.

MG: Do you anticipate an increased level of merger and acquisition in Kentucky?
Kimberly Halbauer: The economic cycle dictates that, but we’ve seen significant activity. We continue to see activity around mergers and acquisitions on both sides. As you look at the aging population of business owners, they’re always thinking about the exit strategy. That might be transitioning to the next generation, selling to employees, selling to a strategic partner, selling to private equity. There are a lot of options that business owner has. Our objective is: How can we be part of the team that’s helping evaluate the pros and cons of the opportunities that might be presented to them?

MG: What type of a business-loan customer is Fifth Third prioritizing?
Kimberly Halbauer: I like to say we have an opportunity at Fifth Third to be all things to most all people—not all people, but most all people. We have the opportunity to serve very small businesses through our branch network, and we’re doing that today throughout Kentucky. We have a business banking segment that’s focused on businesses with revenues of $10 to $50 million in sales revenue. We then have a middle-market segment focused on businesses that are usually privately held, from $50 million to $1 billion in sales revenue. And when you get into the $1 billion-plus space, there are a lot of different places we could take that.

For example, Valvoline is a Kentucky-based company in that billion dollar-plus range, publicly traded. We have a vertical tied to chemicals specifically—we’ll bring expertise into the market to help assist a Valvoline or an Ashland in their overall trajectory, maybe in the spirit of talking about renewable versus nonrenewable energy.

We’ve been working internally to focus on ideas around the bourbon industry. It becomes interesting when you think about business lending because very few times do we find an underlying asset that is an appreciating asset. The way we have to look at that is very different because most things when you bottle them, package them, try to contain them, they start to depreciate in value. But in the spirits industry, specifically with bourbon, it appreciates. So, we’re looking at how we can be creative to help the bourbon industry—not just the bourbon manufacturers but also the suppliers, whether it’s the cooperages, glass makers or others. This is similar to what we’ll do long term as we look at opportunities around what the battery plants both in Hardin County and Bowling Green will produce for us.

MG: Kentucky is in the midst of a wave of manufacturing industry transformation. As vehicle makers pivot to electric, how does Fifth Third get involved in the EV sector?
Kimberly Halbauer: We are looking at all components around it. We’re working on a business plan right now and trying to understand everything from the impact this will have on consumer growth. You have a need for employees and housing that will happen in those areas. How do we capitalize on that from a consumer level as it relates to employees who will be moving to the area? From the executives who will move to the area? In our wealth management space? With startup businesses and the relocation of businesses that will come around the electric vehicle manufacturing facilities?

We’ll look at the opportunities that exist as these partnerships are formed. We believe there will be significant opportunity for existing businesses as well as new businesses that are going to focus on Tier 1 and Tier 2 supplier engagement. We are well positioned to service the overall market and the opportunities that present themselves. We’ll continue to build business strategy. Our hope is to continue to attract really positive, good talent as well as good customers while we take care of our consistent customers.