Q2 2021 Fifth Third Bancorp Earnings Call
Yeah.
Ladies and gentlemen, thank you for standing by and welcome to the fifth third Bancorp second part of 'twenty 'twenty 1 conference call. At this time all participants are in a listen only mode. After the speaker's presentation. There will be a question and answer session. So I'd say a question during the session you will need to press star 1 on your telephone.
If you have kind of any further assistance. Please press star zero I would now like to hand, the conference over to your Speaker today, Chris Doll director of Investor Relations. Thank you. Please go ahead Sir.
Thank you operator, good morning, and thank you for joining US today, we'll be discussing our financial results for the second quarter of 2021. Please.
Please review of the cautionary statements in our materials, which can be found in our earnings release and presentation.
These materials contain reconciliations to non-GAAP measures as well as information pertaining to the use of non-GAAP measures as well as forward looking statements about fifth third's performance, we undertake no obligation to update any such forward looking statements. After the date of this call.
This morning, I'm joined by our CEO, Greg Carmichael, CFO, Jamie Leonard President, Tim Spence, and Chief Credit Officer, Richard Stein.
Following prepared remarks by Greg and Jamie We will open the call for questions.
Turn the call over to Greg now for his comments.
Thanks, Chris and thank all of you for joining us this morning.
Earlier today, we reported second quarter net income of $709 million or <unk> 94 per share.
The adjusted basis, we earned <unk> 98 per share once again, our financial results were very strong.
The pause of momentum from the past several quarters.
1 of the quarter, we generated sequential <unk> growth of 15% on an adjusted basis, the growth of 6% compared to the year ago quarter.
<unk> loan production increased 10% from last quarter with strength in the middle market across our footprint as well as in corporate banking.
We generated strong consumer household growth of 4 per cent compared to last year.
And we also experienced historically low net charge offs of 16 basis points, reflecting improvement in both our commercial and consumer portfolios.
We generated an adjusted auto TCE of nearly 20% for the second consecutive quarter reflect the strong business incurred results across the franchise.
Our results were supported by our continued improvement in our diversified businesses.
In fact, the achieved record results in several of our fee based businesses, including commercial banking and wealth and asset management.
Despite continued pressure from low interest rates net interest income increased 3% sequentially and the underlying NIM increased 2 basis points.
We believe that our disciplined approach to manage the balance sheet.
Including in our securities and hedge portfolios will continue to generate differentiated performance relative to peers.
We also continue to maintain our expense discipline, while still investing for long term outperformance of.
The result of our strong revenue growth combined with our expense management, we generated positive operating leverage on a year over year basis with the adjusted efficiency ratio of 58%.
We are prioritizing investments that drive further operational efficiencies to improve our resiliency.
Generally the household growth and improve the customer experience.
To that end, we recently announced.
Expanded partnership with <unk> to modernize our core deposit and wealth systems to the cloud, which will enable us to further our digital transformation of.
This will significantly improve the flexibility of the scalability of our technology infrastructure and accelerate our speed the market.
Combined disagreement with the renegotiation of our existing payment processing relationship allows us to modernize our platforms, while maintaining an efficient overall cost structure from a commercial standpoint loan production. This quarter was the highest since before the pandemic with significant sequential improvements in technology.
<unk> renewable energy and manufacturing.
However.
Our strong production was once again offset by elevated paydowns and PPP forgiveness.
Continue to retain the customer and the core banking relationship loan growth remains muted due to the environment.
Our commercial lending production trends pipelines and the retention of the client relationship all continue to support the potential for improved loan growth once supply and labor constraints normalize.
We currently expect of 31% commercial revolver utilization rates of increase 1% by year end.
On the consumer side as I mentioned, we once again generated robust household growth the strong.
The performance reflects our ability to acquire new customers combined with low attrition both of which were supported by our branch of digital investments are.
Our recent southeast de Novo branches of helped contribute toward household growth.
On the digital side, we continue to leverage technology and data analytics to deliver solutions that improve the customer experience increase revenue and drive efficiencies.
We recently launched fifth third momentum banking across our footprint.
Banking value proposition unparalleled in our industry momentum combines the best of the traditional bank offering with several leading fintech capabilities.
The <unk> early pay which gives the customers free access to their paycheck up to 2 days early.
The time, which allows the customer secured over Jeff until midnight, the following business day without a fee.
My advance, which gives customers short term on demand liquidity advances.
Smart savings and other features all provided with no monthly fee.
Our strategy to keep the cost for the center has significantly reduced our reliance on purion of consumer deposit fees, including Overdress and ATM fees for fifth third has been among the lowest compared to peers for several years.
Fifth third momentum banking the salaries of our efforts to help customers avoid unnecessary fees.
As I mentioned during the quarter, we recorded a net benefit of credit losses, reflecting the historically low net charge offs combined with a stronger economic outlook.
The strong credit performance reflects disciplined client selection and conservative underwriting and continue support from fiscal and monetary government stimulus programs.
In addition to historical low credit losses, our criticized assets in Npa's once again improved this quarter.
Criticized assets declined another 16% and our NPA ratio declined 11 basis points sequentially.
Our balance sheet and earnings power remained very strong.
Our CET 1 ratio of 10, 4% was relatively stable compared to last quarter, despite share repurchases of $347 million.
In the second quarter.
As we have said before.
Main focus on deploying capital into organic growth opportunities evaluate strategic non bank opportunities dividend increases and share repurchases.
Additionally, our capital position and earnings capacity supported an increase in our common dividend starting in the third quarter. We currently expect to request a <unk> <unk> increase to our quarterly dividend of September subject to board approval and economic conditions.
We also expect to execute share repurchases totaling approximately $850 million in the second half of 2021 and continue to target a 9.5% CET 1 of June 2022.
We recently announced the strategic acquisition of provide the Fintech healthcare practice finance firm.
Provide focuses on the dental veterinarian envisions segments and delivers digital capabilities, which support a best in class experience and speed to close.
Provide previously utilized an originate to sell model as a result, the closing of the acquisition will not include a transfer of loan balances. However.
However, post close fifth third will retain all loan originations.
Currently hold around for $1 million in loans generated by provide and have non credit relationships with over 70% of these borrowers through deposits and our Treasury management products. The acquisition is expected to close in early August and will utilize approximately 20 basis points of capital.
In summary, we believe our balance sheet strength diversify revenues and continued focus on disciplined throughout the company will serve us well this year and beyond we remain committed to generating sustainable long term value and consistently producing top quartile results.
Once again like to thank our employees I'm very proud of the way you have continually risen to the occasion to support our customers are.
Our commitment to generate sustainable value for stakeholders is evident in our second annual ESG report published in June. This expanse of last year's report with the increased transparency, including enhanced disclosures on priority topics, such as inclusion and diversity, our climate strategy and our commitment to fair and responsible.
Banking.
We remain guided by our purpose vision and core values and expect to continue delivering strong results over the long term with that I will turn over to Jamie to discuss our second quarter results and our current outlook.
Thank you Greg and thank all of you for joining US today, we're very pleased with the financial results this quarter, reflecting focused execution throughout the bank.
Our quarterly results included solid revenue growth and continued discipline on both expenses and credit the Ric.
Ported results for the quarter included a $37 million reduction in fee income for the negative mark related to the visa total return swap.
Our improved business performance throughout the bank resulted in strong return metrics, we produced an adjusted ROA of 143% and adjusted our OTC, excluding Aoc EI of 19, 7% our.
Our adjusted earnings per share were a record for the Bancorp.
We generated healthy pp in our results the strongest since before the pandemic with net interest income growing 3% sequentially continued success growing and diversifying noninterest income and diligent expense management.
Improvements in credit quality of this quarter resulted in a $159 million release to our credit reserves, resulting in an ACL ratio of 206 basis points compared to 219 basis points last quarter.
With historically low charge offs of just 16 basis points this quarter and an improved economic outlook, we recorded a $115 million net benefit to the provision for credit losses.
Moving to the income statement net interest income increased $32 million sequentially, reflecting our ability to effectively manage the balance sheet. Despite the environmental headwinds from low interest rates and elevated pay downs given capital market conditions are.
Our NII growth was driven by average loan growth of 1% on the $11 million of incremental prepayment penalty benefits from our bullet and locked out cash flow strategy, and our investment portfolio, which that position remains of 58% at quarter end, our loan balances benefited from the additional $1 billion of Ginnie Mae forbearance.
Loan buyout purchases in early April, bringing the total third party purchases to $3.7 billion.
The other NII benefits for from a higher day, count and not replacing long term debt maturities, partially offset by the impact of declining average commercial loan balances and lower loan yields.
PPP related interest income was $53 million this quarter unchanged relative to the prior quarter.
On the liability side, we reduced our interest bearing core deposit costs by another basis point this quarter to 5 basis points and also had maturities of approximately $2.3 billion of long term debt.
With most of the profit products at or near their assumed floors. The remaining liability management benefits going forward will likely be limited to Cds and reductions in long term debt balances due to maturities.
Reported NIM increased 1 basis point compared to the prior quarter as the aforementioned divestment portfolio long term debt and Ginnie Mae loans buyout impacts were partially offset by the decline in commercial loan balances and lower loan yields.
Underlying NIM, excluding PPP and excess cash increased 2 basis points to 312 basis points.
With the highly asset sensitive balance sheet and over $30 billion in excess liquidity, we continue to be well positioned to benefit when interest rates rise. While also remaining well hedged if rates remained low given our securities portfolio and derivatives.
Total reported non interest income decreased just 1% sequentially.
Adjusted noninterest income increased 1% driven by record commercial banking revenue with strength and loan syndications and financial risk management products.
Solid card and processing revenue from higher credit and debit interchange revenue, reflecting the robust economic rebound and an increase in both commercial and consumer deposit fees.
These increases were partially offset by sequential declines in mortgage and lease syndications.
Topline mortgage banking revenue decreased $8 million sequentially, reflecting incremental margin pressure production was strong during the quarter in both the retail and correspondent channels with second quarter originations of $5 billion up 7% sequentially.
Compared to the year ago quarter, adjusted non interest income increased 15% with strength in deposit service charges commercial banking revenue wealth and asset management and card and processing revenue, reflecting both the underlying strength in our lines of business and the robust economic rebound over the past year the.
<unk> the resilience of our fee income levels over the past several quarters highlight the benefit of the revenue diversification that we have achieved.
Noninterest expense decreased 5% compared to the first quarter, reflecting declines in compensation and benefits expenses lower card and processing expense due to contract renegotiations and disciplined expense management throughout the bank.
This was partially offset by expenses linked to strong business performance as well as servicing expenses associated with loan purchases and a $12 million mark to market impact from our nonqualified deferred compensation plans, which had a corresponding offset in the security gains.
For the full year, we expect to incur around $50 million in third party servicing expense for purchase loans.
Our compensation related expense growth. This year continues to be proportionate to the success, we are seeing in our fee based businesses on.
On a year over year basis total adjusted fees of increased 15% compared to 4% expense growth. Additionally, compared to the pre pandemic levels of the second quarter of 2019.
Total adjusted fees of increased 14% compared to expense growth of just 3%.
Moving to the balance sheet total average loans and leases were up 1% sequentially as consumer loan growth was partially offset by a decline in commercial loans. Additionally period end loans were up 1% excluding PPP.
Average total consumer loans increased 4% as ongoing strength in the auto portfolio and the impact of Ginnie Mae loans purchased were partially offset by declines in home equity and credit card balances, reflecting the continued impacts of government stimulus.
Average commercial loans declined 1% compared to the prior quarter, largely driven by PPP forgiveness, and elevated payoffs, which were partially offset by strong production across most of our verticals and throughout our middle market footprint.
Production was up 10% compared to the prior quarter and up over 20% compared to the pre pandemic levels of the second quarter of 2019.
Excluding the impact of PPP, our end of period C&I loans were up slightly sequentially as client sentiment and business activities in several industries are showing signs of stabilization.
Of all of our utilization of 31% was flat compared to the prior quarter, reflecting the market liquidity and capital markets conditions.
We are encouraged by the fact that we have successfully retained virtually all clients throughout the pandemic, which will enable us to further deepen and grow these relationships going forward.
Average CRE loans were flat sequentially with end of period balances declining 3%.
Our securities portfolio increased 1% this quarter, we continued to reinvest portfolio cash flows, but we'll remain patient on deploying the excess cash we will continue to be opportunistic as the economic environment evolves, assuming no meaningful changes to our economic outlook, we would expect to increase our cash deployment when investment.
Yields moving north of the 200 basis point level.
We remain optimistic that strong economic growth in the second half of 2021, and an eventual fed tapering of bond purchases will present more attractive risk return opportunities in the future.
Average short term investments, which includes interest bearing cash remained elevated due to continued strength of core deposit balances, which have grown 10% year over year, we are seeing strength in both consumer and commercial deposits compared to the prior quarter average core deposits increased 3%.
About 2 thirds of the balanced growth on a sequential and year over year basis has come from consumer reflecting continued fiscal and monetary stimulus and strong household growth.
Moving to credit or.
Our strong credit performance once again this quarter reflects our disciplined client selection conservative underwriting and prudent balance sheet management, while also benefiting from continued fiscal and monetary stimulus and improvement in the broader economy.
The second quarter net charge off ratio of 16 basis points was historically low and improved 11 basis points sequentially non.
Nonperforming assets declined 16% or $126 million.
The NPA ratio declined 11 basis points sequentially to 61 basis points, which is comparable to the fourth quarter of 2019.
Also our criticized assets declined 16% with significant improvements in retail non essential leisure and the health care as well as in our energy and leveraged loan portfolios.
However, we continue to focus on non owner occupied commercial real estate, particularly central business District hotels.
Moving to the ACL.
Our base case macroeconomic scenario assumes the labor market continues to improve and job growth continues to strengthen with unemployment, reaching 4% by the first quarter of 2022 and ending our 3 year reasonable and supportable period at around 3.5%.
We did not change our scenario weights of 60% of the base and 20% to the upside and downside scenarios.
Applying a 100% probability weighting to the base scenario would result in a $169 million reserve release, Conversely, applying 100% to the downside scenario would result in a $763 million Bill.
Inclusive of the impact of approximately of $108 million and remaining discount associated with the MB loan portfolio, our ACL ratio was 215%. Additionally.
Additionally, excluding the $3.7 billion in PPP loans with virtually no associated credit reserve the ACL ratio would be approximately 2.2%.
While the favorable economic backdrop in our base case expectations point to further improvement in the economy. There are several key risks factored into our downside scenario, which could play out given the uncertain environment.
We continue to monitor the COVID-19 situation, which could still impact many businesses, particularly those we have identified as being in highly impacted industries or reverse the rising consumer confidence trends.
Our June 30 at the allowance incorporates our best estimate of the economic environment with lower unemployment and continued improving credit quality move.
Moving to capital.
Our capital levels remained strong in the second quarter, our CET 1 ratio ended the quarter at 10, 4%, which was $1.3 billion above our stated target of 9.5%.
Our tangible book value per share, excluding <unk> increased 3% during the quarter.
As the category for institution fifth third was not subject to the latest federal reserve stress test and we did not opt in.
At the end of June the fed notified us that our SCB would be 2.5% effective July 1 which is the floor under the regulatory capital rules without the floor of our buffer would have been approximately 2.1%.
During the quarter, we completed $347 million in share repurchases, which reduced our share count by approximately 9 million shares compared to the first quarter.
As Greg mentioned, we expect to repurchase approximately $850 million of shares in the second half of 2021, while also increasing our common dividend in September.
We also announced our acquisition of provide this quarter.
We will utilize approximately 20 basis points of CET 1 upon closing the.
Financially compelling acquisition of an asset generation engine dovetails perfectly with our existing strategic focus on digital enablement and generating profitable growth on our balance sheet.
We believe <unk> provides strong growth prospects from an origination standpoint, they have produced $300 million from the first half of 2021 of which fifth third purchased approximately 80%.
We expect second half originations to be around $400 million and given the expected early August closing virtually all of that will go on our balance sheet.
We expect over $1 billion in originations in 2022.
And could grow to over $2 billion annually within a few years.
Moving to our current outlook.
For the full year, we expect average total loan balances to be stable compared to last year, reflecting continued pressure from PPP forgiveness and pay downs in commercial combined with low double digit growth in consumer.
We continue to expect CRE balances to remain stable in this environment.
We continue to expect our underlying NIM to be in the 305 basis point area for the full year combined with our loan outlook, we expect NII to be down 1%. This year, assuming stable security balances in incorporating all PPP impacts.
On a sequential basis, we expect NII to decline around 2% given the impacts of the securities portfolio prepayment income we experienced in the second quarter that we do not assume we will repeat in our outlook as well as an assumed decline in PPP income.
Within our NII guidance, we expect approximately $165 million in PPP related interest income for 2021 of which of $106 million was realized in the first half of the year compared to $100 million in 2020, and approximately $50 million expected in 2022.
For the third quarter of 2021, we expect approximately $40 million in PPP income.
Therefore, excluding PPP impacts, we would expect third quarter NII to decline around 1% compared to the second quarter are up over 2% from the third quarter of 2020.
Given the continued strength throughout our businesses, we expect full year fees to increase 7% to 8% compared to 2020 or 8% to 9% excluding the impact of the TRA.
Our outlook assumes a continued healthy economy as well as our ongoing success, taking market share as a result of our investments in talent and capabilities, resulting in stronger processing revenue capital markets fees, and wealth and asset management revenue, which will be partially offset by mortgage declines.
Additionally, as we discussed in January we expect to generate private equity gains from several of our direct investments in venture capital funds throughout 2021 potentially exceeding the 2020 level of $75 million we have recognized.
Nice around $30 million in gains through the first half of 2021, which we expect to double in the second half of 2021.
We expect third quarter total fees to be relatively stable from the second quarter and would be up mid to high single digits year over year in the mortgage business. We expect revenue throughout the second half of the year to benefit from lower asset the K and higher servicing fees. The topline revenue is expected to decline high single digits year.
Over year due to continued headwinds from margin compression of.
Our fee outlook does not incorporate a pretax gain of approximately $60 million associated with the sale of our HSA business that is expected to close in the third quarter.
We do plan to redeploy half of that gain in the third quarter split evenly between the $15 million donation to the fifth third foundation that will complete our previously announced philanthropy commitment to accelerating ratio of the quality and inclusion in our communities and a $15 million additional marketing program.
<unk> momentum given the upside potential we see in that product.
We expect full year expenses to be up 2% to 3% given our strong revenue outlook and the continued servicing costs from the loan portfolio purchases as well as the incremental expenses associated with the provide acquisition.
On a sequential basis, we expect expenses to be down 1%, excluding the redeployment of half of the HSA gain.
As we recently discussed we expect to consolidate 42 branches, primarily in our legacy Midwest footprint, which we expect to complete in early 2022. Additionally.
Additionally, we've opened 5 branches so far this year and plan to add approximately 25 more southeast in market de Novo branches in the second half of 2021 of.
All run rate branch impacts are included in our outlook, we generated year over year positive operating leverage this quarter and we expect to continue to generate positive operating leverage for the second half of 2021, reflecting our expense actions. Our continued success growing our fee based businesses and our proactive balance sheet management.
We expect total net charge offs in 2021 to be 20% to 25 basis points given the strong first half performance and assuming our base case scenario continues to play out third.
Third quarter losses are likely to be in the 15% to 20 basis point range.
In summary, our second quarter results were strong and continue to demonstrate the progress we've made over the past few years toward achieving our goal of outperformance through the cycle. We will continue to rely on the same principles of disciplined client selection conservative underwriting and a focus on a long term performance of <unk>.
Ryzen, which has served us well during this environment with that let me turn it over to Chris to open the call up for Q&A.
Thanks, Jamie before we start Q&A as a courtesy to others. We ask that you limit yourself to 1 question and a follow up and then return to the queue. If you have additional questions.
We will do our best to answer as many questions as possible in the time, we have this morning.
Operator, please open the call up for questions.
As a reminder to ask the question you will need to press star 1 on your telephone to withdraw your question press the pound key.
Please standby, while we compile the Q&A roster.
Our first question comes from the line of Ken Zerbe with Morgan Stanley.
Hi, Thanks, good morning, good morning.
Now you guys are doing a lot to make fifth third more consumer friendly like early pay an extra time, if we expect that trend to continue what's the total amount of fees revenue that might be of risk because as the broader industry. You really continues to wean itself office of consumer fees.
Yes, Ken it's Jamie Thanks for the question. The 1 thing we are proud of at.
At fifth third is how much we've reduced our exposure on the consumer side from a punitive punitive fee standpoint, and how we are.
I would say of very consumer focused and consumer friendly bank I think 3% or so of our revenue is in consumer overdrafts and our peers are significantly higher than those levels.
We expect to continue.
To improve upon that with the momentum of bank offering in some of the features of that Greg talked about in his prepared remarks. So I think you can continue to expect that from us in the.
We were to have any future changes on.
Overdraft policies or or fees it would only be to the positive and that we would more than make up for it with the incremental volume from momentum I don't know, Tim if theres anything else you want to add yeah. No I just want to emphasize that I mean whenever you launch a new product of the trade off you have to evaluate as what you think you can produce as it relates to total franchise growth relative to any sort of.
Cannibalization right. So the fact that we have been deliberate about driving revenue growth through value added services as opposed to maintenance and punitive fees. It means that for us we're going to get the benefit of that.
Net franchise growth in more households from momentum.
With comparatively substantially less impact in any of our large competitors would have to the extent that they were attempt to follow us here.
Got it Okay, and then just maybe.
Second question in terms of the Ginnie Mae buyouts I think some of the other banks this quarter of mentioned they just didn't see the opportunity or they didn't have the kind of find the opportunity whenever to.
Do a lot of the Ginnie Mae buyouts, but it feels like you guys got it fairly decent benefit from that this quarter was that are you seeing the same trends or do you still see opportunity to continue that going forward.
Very good question actually because what we've seen is that good.
Even we were a first mover in this product.
It is for.
<unk> is the third quarter of 2020, when we bought our own pools, and then help structure.
These additional purchases that we've done totaling $3.7 billion, thus far to date I would say that the.
The economics were certainly more attractive if you were in the first mover stage and the economics of really waned to the point that we would not be.
Pursuing additional purchases at these levels.
Got it okay. Thank you very much.
Our next question comes from the line of Scott <unk> with Piper Sandler.
Good morning, guys. Thanks for taking the question.
I just wanted to ask sort of a top level on sort of the eventuality of a commercial recovery.
Best guess as to what that will look like for <unk>.
The larger regional like yourself sort of.
The unclear.
To the degree the degree to which capital markets competition will abate.
The questions regarding the sustainability of the sort of the sugar high that consumers are on right now meaning demand.
The decrease further we go and then you've got all of this excess liquidity thats getting worked through so just curious to hear your top level thoughts on what.
What that recovery will ultimately look like in your eyes.
Let me start and all of those.
Maybe for Tim for additional color first of all.
It's right now there's just a lot of.
Certainty out there right now as we're dealing with the labor shortages of supply chain disruptions, which are extremely real and you see the across the board in all conversations of our customers.
But with that said are we back.
Back to pretty much prepaid debit global production of numbers.
<unk> continues to be stout, and obviously, you've got some of the him with the PPP. So when you think about the environment.
Front of US I think low growth as we continue to be a challenge as we go through the rest of the year.
I think we offset that by our strength of our fee businesses as we talked about in the prepared remarks, the compensate for some of those challenges, but I don't think this changes over time.
Utilization of third world.
The run.
For the 7% every 1% $750 million, there's a lot of upside opportunity there at some point the labor shortage.
So interest rates start to abate as we pick up the benefit of debt. We also added about $2.4 billion of new commitments since the beginning of the year.
Choose to acquire new households, and commercial relationships. So we're very very positive as what the future might hold but we got some economic.
And some environmental challenges in front of US we have to continue to deal with.
Yes.
<unk>.
When we announced the North Star and we talked about pivoting the return profile of the bank to be good through the cycle portion of the focus there was on business mix right. It was about constructing of business portfolio that had balanced so in an environment, where utilization is down like that now and where rates are low we have fee businesses that are firing.
The providing nice support and some counter cyclical business is of particular on the consumer side like autos and mortgages.
Which are doing very very well I think as.
Some of the tailwind from those businesses of base. What you would expect to see is the benefit both as Greg mentioned as it relates to line utilization.
And ultimately some benefit from rates, which provides a lot of support for the through the cycle focus.
Perfect. Okay. Thank you for the those thoughts and then.
Just a thought on overall reserving levels near you guys do you guys still maintain a very.
Hi, and conservative 1.
All of the reserves.
Sort of thinking about the steady state is it back to where we were of seasonal day, 1 or just given the backdrop and what we've already gone through can we.
And of blow through that a little bit on meaning the lower than that how do you think about those dynamics.
It's Jamie I'll take that 1 when you look at the quarter with the ACL release of $159 million.
We had that split fairly evenly between the consumer portfolio in the commercial portfolio.
And the decline was essentially driven by improvements in the macroeconomic outlook.
Versus the prior quarter.
When you look ahead, we continue to overweight the non.
On baseline scenarios of 'twenty.
Percentage, so that the upside of 20% the base of 60 and the downside is 20%.
And that's really driven by the uncertainty in the environment, including the vaccine efficacy and frankly this week's concerns highlight that risk.
So when you look at the asymmetrical nature of the upside and downside scenarios that weighting versus the $82.10 on.
Seasonal day 1.
<unk> generates about a $90 million higher reserves. So I guess the first part to your.
Fairly complicated question is that the scenario weightings do matter.
We expect to maintain the 62020.
While this period of uncertainty.
<unk> to exist and then relative to day 1 it really is a tale of 2 portfolios. So when you look at the commercial side.
To get back to those day.
The 1 adoption reserve rates, you really do need to see a sustained strength on even in the credit characteristics of the borrowers that are most at risk to the longer term negative impacts from the pandemic.
So that would have to occur in conjunction with improving economic forecast above our current expectations, but then when you look at the consumer side, we're actually already.
Below the seasonal day 1 level.
199 at the end of the.
The second quarter versus the $2.46 on the seasonal day, 1 and Thats driven by the combination of the loan mix as.
As well as improvements in real estate and auto collateral values experienced since the adoption of seasonal.
As well as the economic forecast.
At the end of the second quarter, and then we've had improvement in credit quality in auto and card as well as in the delinquency rate so consumers already already there but commercial.
Then we'd have to the half things play out differently than what we are better than what we currently expect.
Alright, Thank you guys very much for those thoughts.
Your next question comes from the line of Abraham of Wawa with Banc of America Securities.
Good morning.
Good morning.
Just wanted to go back Greg.
The announcement.
Yes.
On the more than core and on the wealth management side.
If you could give us some visibility on 3 things 1 what does that mean for near term expense impact.
What it means for longer term efficiency as you kind of.
Go to that question is if you could tell us what the timeline would be.
And then finally, we are hearing from other banks talking about moving to a modern core and that being a competitive advantage do you see the debt is a competitive advantage for fifth third when you get to that point or is it the boutiques.
Given the the industrial is moving.
That's a lot there so let me try and try and dissect a little bit for you first of all of the.
<unk> announced that we just made is the continuation of the relationship.
Thats been in place for quite some time this replacement of our third.
Core deposit platforms, but we've been on this journey.
To reengineer, our technical infrastructure focusing on the <unk>.
Actual resiliency of the skill of Bolivar businesses replace the HR platform with Workday, we completed our enterprise via the strategy, we would completely re platform of our mortgage of Lewis environment. So the US is the natural extension of the continuation of the monetization of those of those activities and we also reengineered and restructured the pricing agreement of our <unk>.
Legacy relationship with fifth that's going to help make debt the costs associated with debt.
The limitation of the new Fas components, a lot more reasonable digestible for us and will manage our costs going forward. So we're pretty pleased with the way that came out for.
Or is the competitive advantage listed in the tick at the end of the day. This is of this is the long game. We have to continue to refresh our platforms are going to continue to modernize our platforms of the cloud I think every bank is trying to get this right. So whether it comes the competitive advantage of I think it's the requirement.
Basically the table stakes to be the business to be of digital bank, our customers expect the big anywhere anytime we have the platforms that are always on so thats just the re transformation.
All of our business with the repurpose our expense dollars from the legacy brick and mortar infrastructure. When we got to continue to reinvest in technology. So we're going to continue to do that.
I think the base of adult do that it could be the competitive disadvantage, but many banks as you've already heard of will continue to focus loans.
Core modernization of we're going to be the towards the same thing we do we have a great strategy.
For the monetization if we're bringing in new technologies, we have a <unk> partner build strategy.
The strategy that we've worked on very hard.
The technology is already out there revised we can't buy them we partner.
And if we can't partner, we built and the momentum is example of debt partnerships like <unk> out of the exchange data systems common bond getting out of the list is our recent acquisition of provide.
I think we've got a good strategy for moving quickly, but it is going to take time to give us all of the legacy stuff free platform.
But net net what's the going I think it may not be of competitive advantage at the end of the day, but the depth of there'll be the requirement to be in this business for the future.
That would be created and just as a follow up on debt to debt.
When you think about acquisition of provide healthcare is obviously of any hot sector do you see more.
The thing do you like debt.
In terms of verticals, where you might be we should expect similar kind of deals which becomes tools for client acquisitions.
Yes sure Ed This is Tim I'm happy to take that 1 so health care was the right starting point for us its the first industry vertical that we launched share over a decade ago, and we have a vertically integrated strategy on that front across our corporate banking group, our middle market banking group out in the regions.
Now also business banking.
I think for.
<unk> was an important next step for us in the strategy because it gave us the opportunity to provide a differentiated value proposition to independent medical practices like Greg mentioned with the big focus on dentists that.
And otherwise.
<unk> provided us a little bit unique in net it had as of Fintech company actually already grown into 1 of the largest lenders into that market driven primarily by their technology and their expertise.
And just as a point of example, there of the digital experience that they offer enables them to get loans approved and closed about 70% faster than the typical lending process.
Within that market and in addition, because of the sector focus they have a growing digital marketplace that actually allows existing practice owners who.
Who would like to transition into retirement to post the practices for sale and to get to net debt at with folks who are interested in buying an established practice until functions I guess, a little bit like the craigslist or the ebay of dental practices today.
And are there opportunities in other verticals yeah, we do think there are.
And we have been pretty active as Greg mentioned in partnering with many of those firms whether those.
Relationships evolved from our partnership into an outright acquisition I think it depends a lot on the circumstances business at a given point in time, but in the case of provide their next leg of the growth journey was going to be about the delivery of the broad the full set of products and services and it absolutely made sense.
For them to the part of the bank as opposed to of Standalone entity on the journey.
That's helpful. Thanks for taking my questions.
Your next question comes from the line of Gerard Cassidy with RBC.
Good morning, Greg the morning Jami.
Good morning Gerard.
Hi, Jamie those questions for you on the securities portfolio can you share with us.
The yield as you presented in your deck increase.
Sequentially.
Just wondering how you cheap debt in this rate environment. It was due to the.
Derivatives and the hedges you have on the book and then second I think you said.
Net obviously youre going to keep you keep the liquidity in the portfolio until rates start to rise and I think you may have mentioned the 2% rate would you lean into it as rates were to go to 2% if they do or would you wait until we actually got to 2% where you're really moving.
The yes, I think if you look back at.
Our actions in the first quarter.
To answer the second part of your question. If you look back at our first quarter actions, we did lag into a little bit of additional investment portfolio.
Buildup at that point in time, we pre invested $1 billion of our second quarter cash flows and then given the entry points.
And the of rally in the bond market decided to.
Maintain that additional leverage throughout the quarter. So we did grow the book of little bit in the second quarter. Our guide assumes we hope hold it fairly stable as the year progresses, because we don't expect to get.
So those 2% or better entry points, but.
Should the market get there we would like.
Leg into the trade.
And not do.
Everything all at once but when you look at our additional $30 billion of excess liquidity that we're sitting on we've earmarked about a third of that to go into the investment portfolio so to get to.
The $10 billion of purchases done would certainly take some time and we've ramped that up over time.
Our goal here is.
We sift through peer results and actions versus ours, and we certainly are an outlier in terms of being more prudent and more cautious of deploying at these low rates for our goal is let's maximize our NII over the next 5 years not over the next 12 months and we think ultimately this is the better.
Come and the.
The fed will eventually taper not sure when that will be but when the largest bond buyer in the world is price of indiscriminate in their purchases every month, but certainly distorts the market sort of eventually the distortion is going to end and we think we'll get better entry points of what we see today.
And then in terms of the first part of your question the grow.
In the yield.
Quarter in the investment portfolio is really the benefit of what we did 5 years ago with structuring of the portfolio to be more weighted the bullet and locked out cash flow so that to the extent there are prepayments in the portfolio.
The make whole provisions provide a nice pickup in investment yield and as we we never include those in our outlook so that.
The guide on NII might look soft on the surface, but if things continue to be the same then obviously NII will outperform the guide should those prepayment penalties continue to occur.
Sitting on almost $2 billion of gains in the in the investment portfolio.
Very good. Thank you for the color and then Greg I've asked this question in the past.
I'll ask it again.
Which is when you sit down with you of senior management team and you guys look out over the the risks that you foresee on the horizon and if we think the the.
Delta <unk> and the Covid risk off the table.
It's an obvious 1 what are some of the risks that you guys wrestle with Asia looked out over the next 12 months that we just have to keep our eye on and looking around the corner. So that we're not surprised a year from now.
Yes, it's a good question obviously all of it.
Responded immediately with the very end of the Covid and with that community the slowing of the economy and not getting the robust recovery role of hoping for credit risk, but right now as I mentioned earlier, Gerard and think about every.
Every customer as I sit down with <unk>, with whom we have a conversation.
You're seeing it in various ways labor shortage supply strength supply chain strength.
Significant issues out there right now youre seeing net backlogs order delays on the restaurant is not being able to be open small business is not open full time.
Good labor so what's the big challenge right now when does that sort of the when the when does that start to the correct itself and I'm not sure where that is I believe it will happen, obviously, but to what does the asset later this year as of next year. So I think that's going to pull a lot of pressure inventory levels were extremely low.
Compared to what the demand is out there we're not seeing net tick up right now line utilization just kind of the kind of flat right now, but we're not seeing net tick up that we were hoping to see so those are all kind of concerns that I have right now obviously inflation and the other concern out there as you watch the Ed.
The fifth managers through that complexity.
More to come on that but net net I think overall of the economy is fairly healthy we discussed some challenges for all of us that havent havent been understood yet.
And on the <unk>.
I'm sorry go ahead Tim.
No I just was going to say if you just add.
Little bit of color Greg in the.
Together, we're out we spent a full day in 12 of our 13 regions.
This quarter, which made for a busy travel schedule, but a lot of good input in terms of what we're actually hearing from clients on the ground and I mean, some of the stories that you hear about how people are dealing with the labor shortages or inventory supply issues.
While we have of client fuels market are who's had to open their own driving school. So that they can get people enough folks with qualified commercial driver's licenses to do fuel deliveries you have hospitals, who are operating at 50% capacity on the elective portions of their business, which.
The really important driver right. When you think about the revenue and income.
Yes.
Who can't get enough skilled nursing staff on hand to be able to operate at levels above that and we had.
Folks who had been sending employees out to a local cvs or walgreens and buying out all of the gorilla glue because of the adhesives that are used to seal together their cardboard packaging of our backlog only into the hard freeze in Texas. This last 1.
Really these are not theoretical concepts, we need when you get out and you talk to our middle market clients. They are really hard realities that they are grappling with.
I think as Greg said, we all hope debt, especially as the enhanced unemployment benefits wane and as we worked through some of the supply chain challenges that our clients are able to invest in their business, but if you can't get the people who can't get the materials you can't invest of ground here.
Is there any risk just to follow up quickly net.
Is it a permanent change in the way these companies will manage themselves, which would lead to a lesser need for borrowing from banks like yours because of what they're going through and you heard that at all of the new customers.
No not yet I think we hear them exploring opportunities to be less reliant on manual labor and to drive automation, but that drives capex right. So that helps us.
Here them exploring opportunities Ted secured more captive supply and otherwise through M&A, but that also drives borrowing in terms of the way the operator and ironically actually we here at many of them say hey.
We have been pushing for decades now to run more asset light, which meant less liquidity on hand, and maybe we don't want to do that going forward and we're willing to absorb slightly higher debt service costs and.
In favor of being a little bit more liquid and that would be helpful to us in terms of the way drives long. So I don't think so Gerard it just.
We got to see our way through to the other side of this.
Because the.
You can't get Labor you can't get inventory.
Its hard debt, it's hard to grow.
Thank you for all of the color I appreciate it.
Your next question comes from the line of Bill <unk>.
<unk> with Wolfe research.
Thanks, Good morning can you.
Fee income strength.
All of this quarter to the growth Youre seeing in the South East region are you leading in the southeast with your fee based products like Treasury management rather than credit.
As you grow into that region, and if you could discuss the longer term growth outlook across your other fee based products in the southeast.
Yes, sure Bill, it's Tim I'll take that.
I think the growth if you look at new client relationships and otherwise the is very strong in the commercial business in the southeast. So they are contributing disproportionately to the incremental fee income, but I wouldn't tell you that it is focused exclusively on the southeast if you look at our new commercial relationships.
About 30% of them this year, our lead with Treasury management, and then Theres another percentage, which I don't have off the top of my head, but which has come to us primarily through the capital markets business. So we are having good success using those products as well opportunity.
<unk> to drive new relationships. If you look forward I think we're trying to build what is a really nicely diversified capital markets business with flow activities like rates and commodities hedging and otherwise to.
To complement the M&A advisory business and what we do in equities with what we do on the bond market I think what we continue to anticipate is at some point here of the capital markets will be a little bit less accommodative, we will get the benefit of that in loan balances, but youll see.
Some lightening.
On the bond fees, but the other side of it as we're sitting on an M&A pipeline now which is almost double what it was in January 1 of this year. So we do have a nice M&A advisory pipeline that should come behind debt on the Treasury management side, we've pretty consistently grown at the rate of the industry plus 2% to 3 percentage points.
I'm of the belief that we can do better than that but it's definitely better to be taking share. There over time, then the hits to have the alternative situations. So we feel good about both of those of the lines.
Over the near to medium term.
That's very helpful. Thank you and Greg you mentioned Green Sky when talking about your partnerships earlier can you give us an update on how youre thinking about.
Indirect lending partnerships more broadly and the opportunity to leverage these partnerships to continue to grow nationally beyond your footprint critics of that model argue that you really need to own the relationship and are at a disadvantage when all youre doing is putting up your balance sheet and somebody else has the relationship with the customer, but we'd love to hear your thoughts.
Youll first off Theres not a lot of these opportunities out there we got the economics of the <unk> relationship as we want it as an investor made a lot of sense for US. This is not how we grow our business over time, we're much more of a relationship business. That's why the provide acquisition was extremely important you think about provide.
That was the partnership originally we had about $4 million in assets for 70% of those relationships. We had additional relationship outside of the credit facility will be tier.
Our deposit relationship sales of importance of relationship type of opportunity for us. So that's what we're looking for the continued enhance our business and grow our business grew sky.
Credit another channel for us, but yes, thats a non relationship business for us.
Those opportunities.
That makes sense to us or very few out there, but the <unk> will it does for the economics of the transaction was put in place.
Got it that's super helpful. Thank you.
Our next question comes from Ken <unk> with Jefferies.
Thanks, and good morning.
Couple of quick ones first of all of the.
So the.
Third quarter of momentum marketing program that you mentioned.
Use part of that benefit.
Is that just kind of kick started and then would you have ongoing expenses related to marketing built into your forward outlook past 3 Q.
Yes, it's Jamie the yes, the $15 million incremental spend over the second quarter marketing spend level of $20 million. So we expect to spend $35 million of marketing in the third quarter that should abate.
Abate going forward. However, if it is successful then we will continue the program at that elevated level.
Until we've really captured as much of the first mover advantage with the product as we can.
Okay got it understood and then do you of any plans to or thoughts on re securitizing those Ginnie Mae loans that you get the $3.7 that you mentioned I know some of them are newer so they might not quite got to that seasoning point, yet but is that at all in your outlook in terms of whether they stay in loans or move to mortgage banking over time.
So for the $3.7 billion of loans that we purchased from other third party Servicers, we have there's a nominal amounts.
Fees assumed in the outlook related to that as they get re sold to the servicer the bigger economic opportunity is on the $750 million of forbearance loans that we bought directly back from Ginnie Mae on our own production.
As well as within our rest of the mortgage portfolio to the extent that there are any on non accrual or delinquent debt that sure we do have.
We have had.
The sales this year the generate.
Several million dollars in fees and we expect to do that over the next 6.7 quarters as well. So I think it's more of a run rate normal course of business than it is any 1 time pop.
That makes sense last 1 just you redeemed a bunch of debt at the most of the at the bank some at the <unk>.
Parents is there any more room to do that.
The obviously still the highest cost of funding, but then you have all of the excess deposits. What's the balancing act in terms of where you want that long term debt footprint to settle over time. Thanks guys.
Given the excess liquidity that we have there is clearly not a need to maintain the higher.
Unsecured debt levels that we have we have an additional maturity.
In the third quarter will most likely not replace that's about $850 million almost a 3% rate so there's a little bit.
The left to go in terms of improvement along with running down the wholesale CD book, but those benefits are all baked into our outlook. So I would not expect it to get better than what we've guided to from the right hand side of the sheet I think the opportunity for us from an NII.
Improvement standpoint will be on the left hand side of the sheet.
Understood. Thank you Jamie.
Our next question comes from Jamba card with Evercore ISI.
Good morning.
Hi.
On the loan growth side on the utilization I know you expected the improve by about 1% through the year and can you just.
How about with what does your pre pandemic utilization level and maybe enough.
The timing.
You can get back to that level on that front as of <unk>.
Great question I wish I knew the answer to that.
First of all of that we would typically run around 36, 37% as I mentioned every 1% of about 750 million of the asset. So we're running at 31 kind of flatline right there.
Can't really we're hopeful but like I tell my team hope is not the strategy. We're hopeful we start to see that tick up a little of it based on the production levels that we're seeing out there right now hopefully get some of these challenges in front of most of the supply chain and labor for.
Maybe of bidding.
Later this year.
But once you get us the tough thing to say when do we get back to a normalized run rate.
It's going to be alone is going to be in quarters not the.
The.
And then maybe maybe a year plus before we get there I believe.
No that's helpful and all of that same topic on the loan growth guidance.
Of the indicators of double digit consumer growth stable CRE and <unk>.
<unk> impact from commercial what would the your growth expectation for commercial.
With PPP and ex PPP on that for your guide.
Relatively stable.
On commercial.
I would say John I would say.
Full year commercial average loans.
Would be down mid single digits.
<unk> BP of little bit more than that but.
But ending the year.
With a little bit of a.
A little closer to stable.
And then.
The.
PPP is.
We've been running steadily down.
As the year has progressed, where on an end of period basis. We finished the first quarter at 5.4.
<unk> 4 billion, we finished the second quarter of $3.7.
Of that will continue to drift down to $2.1 billion at the end of the third and then of $1.7 at year end is our current projection on PPP.
Got it okay. Thanks, and then lastly on the <unk>.
M&A front as you look at incremental opportunities there Gregg just wanted to get your thoughts on potential incremental bank and non bank and more importantly curious what you think of president of Finance executive order and the implied added scrutiny around bank deals.
Do you believe that could impact the bank of your size looking at.
From a whole bank deal.
I would respond.
Respond by saying all of our focus is on non bank true.
Transactions that enhance our product and service capabilities like provide would be great example of debt. So we'll stay focused there for the most part it is.
If the right opportunity presents itself in the market thats attractive to us the kind of.
<unk> would then be financial sole source of Chicago, obviously, we'd always consider those type of opportunities, but the point of view between the not the focus of the organization supported by his executive order.
There's a lot of work to be done the agents use of <unk>.
OCC fed FDIC and the Doj are trying to figure out what that means so more to come on net but you could.
We believe as I do the transactions the economics of transactions could be more challenging going forward based on the executive order in the timeline of the get those transactions approved may take a little bit longer for good transactions will get done.
Got it thanks for taking my questions.
Our next question comes from Matt O'connor with Deutsche Bank.
Good morning, guys.
Let's talk a bit more about the path of the 9.5% CET 1 target obviously, you talked about the dividend increase the buyback back half of this year of the 20 basis point drag.
But if you put all that together.
Still got of the.
It seems like kind of treading water on the capital just given the good earnings generation and probably not of lot of balance sheet growth. The next few quarters or so.
Do you think you'll get that target of or you got a hold back for the loan growth.
Many of the question a little bit of I think about the first half next year, yes.
Our goal is certainly to get to the 95% by June of 2022, and yes. It is.
Certainly a large amount of repurchases I think the 2 factors to bake into it would be there is 20 basis points of CET 1 erosion.
From the provide acquisition in the third quarter, and then 9 basis points of seasonal transition.
In the first quarter of 2022 so.
A little bit of capital gets spent there, but yes to your point, we have a lot of capital deployment.
The opportunity ahead of us to get to the 95% and certainly if loan growth doesn't materialize then.
We will look to continue hit for the 9.5% and then we do feel that showed loan growth accelerates.
Certainly have a buffer from where we think we need to run the company from a capital perspective, clearly from the credit outcomes Youre seeing.
We could run the balance sheet at.
At 9% or so if loan growth were to accelerate but for now our focus is just getting of the 95% by midyear next year.
Okay. That's helpful. Thank you.
Yeah.
Our next question comes from Peter Winter with Wedbush.
Hi, good morning.
I wanted to I wanted to ask.
Just on the middle market and small business.
Are you seeing any willingness of them maybe.
So the top of the lines of credit, while maintaining higher levels of cash on hand or is it just.
And the issue of.
The supply and labor shortages, that's holding and all of that.
At <unk>.
Hey, Peter it's Tim.
I would tell you, it's primarily issues with supply chain and labor like Greg said of not liquidity, if youre looking for green shoots I think that borrowers who are either smaller or who rely on structures that look more like asset based lending structures are starting to tap. The airlines. So we are seeing modest.
Improvements in utilization.
And that sector now in aggregate, that's not a large segment of our balance sheet, which is the reason that you see utilization.
Overall, the fifth third being stable, but.
Generally as these things happen they happen at the lower end of the book first and they migrate upward end of the larger borrowers.
I at least when I feel like finding of positive signal of that's where I'm going these days.
Okay.
And then Jamie can I, just ask about the outlook for the margin and the <unk>.
Second half of the year some.
Some of the puts and takes share.
Sure the.
The second quarter was obviously very strong from a margin perspective.
We're pleased with how the balance sheet has been performing but given the high levels of PPP as well as the investment.
<unk> prepayment penalties that we don't expect to recur or at least don't forecast of recur.
We would expect to see the NIM.
The decline a bit to a more normalized level, which is the 305 basis point areas. What we've talked about for I think pretty much all year in terms of what we think this balance sheet should stabilize that certainly for the foreseeable future. So.
The.
NIM should come down.
Call it 5 bps or so in.
In the third quarter.
I'd say the.
The big drivers there.
Certainly the PPP, the prepayment penalties of little bit of day count.
And other.
Otherwise still maintain that floor of 3 of 5 or better.
Got it.
Thanks for taking my questions.
Our next question comes from the line of David Conrad for K B W.
Hey, good morning, a quick follow up on the Securities portfolio, maybe Jamie can you remind us.
What the remaining duration is for the the bullet structured product.
So the total portfolio as of.
For 9 duration and so the bullets.
We quote of the 58% number we're saying that the bullet or locked out for at least for the next 2 years, but the duration of that portfolio.
Not that different from the portfolio in total.
Okay. So the the lockout is 2 additional years correct, but there's not a step down.
For a while we had quoted of 12 months and then we got the question sort of expanded 24, but theres not a cliff here. It's just.
Lower erosion overtime.
Great. Thank you.
Our next question is from Christopher <unk> with J P J Montgomery Scott.
Well. This is obviously with the <unk> changing right now and there is still the process.
On the CFPB front.
From the nomination perspective.
Has it changed.
This has been it's I don't believe it's changed to be honest with you.
I think it the other day these agencies.
Job of doing a role to play in.
And I think the focus of the CFPB of the OCC and the FDIC.
We're going to be making sure that there is the safety and soundness, but also.
The way that the way the banks heal themselves and operate we're going to be extremely important so.
I haven't since the big shift.
With the new administration of on requirements of demands.
Of the bank and the totality so to speak from the top as to what they expect from us so.
It's not something that keeps me up at the night, let's put that way.
Okay, Greg Thank you for that and thanks for all of the background. This morning. Thank you.
Those are all of the questions. We have at this time are there any closing remarks.
Yes, Thank you Christy and thank you all for your interest in fifth third if you of any follow up questions. Please contact the Investor Relations Department, and we will be happy to assist you. Thank you.
Yeah.
Ladies and gentlemen, thank you for your participation you may now disconnect.
Okay.
Sure.
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Moving forward.
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