Q3 2022 Fifth Third Bancorp Earnings Call
Good morning, My name is Dennis and I will be your conference operator today at.
At this time I would like to welcome everyone to the fifth third Bancorp third quarter 2022 earnings conference call.
All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.
If you would like to ask a question. During this time simply press Star then the number one odd your telephone keypad to withdraw your question. Please press star one again.
I would now like to turn the conference over to Chris Doll Director of Investor Relations. Please go ahead. Good morning, everyone and welcome to fifth third third quarter 2022 earnings call. This morning are president and CEO , Tim Spence and CFO , Jamie Leonard who will provide an overview of our third quarter results and outlook are chief credit Officer, Richard Stein.
And Treasurer, Brian Preston have also joined us for the Q&A portion of the call.
Please review the cautionary statements on our materials, which can be found in our earnings release and presentation.
These materials contain information regarding the use of non-GAAP measures and reconciliations to the GAAP results as well as forward looking statements about fifth third's performance.
These statements speak only as of October 20th 2022, and fifth third undertakes no obligation to update them.
Following prepared remarks by Tim and Jamie We will open the call up for questions.
With that let me turn it over to Tim.
Thanks, Chris and thank you all for joining us this morning.
Before we turn to our financial results I'd like to take a moment to express our sympathy for all those across the state of Florida were impacted by Hurricane Dorian.
Also like to thank our employees for answering the call to take care of our customers and communities in the state.
In the days since the Hurricane made landfall our employees have made nearly 90000 customer wellness calls reopened all of our branches and staff fifth third financial empowerment boss to enable customers, who lost power and internet access to apply for FEMA disaster relief.
Those of you listening today your resilience in the face of this natural disaster is all inspiring.
Thank you for living our core values.
Turning to the financials earlier today, we reported third quarter results that reflect our commitment to strong performance through the cycle.
We generated record adjusted revenue of $2 2 billion.
Up 10% year over year.
Credit quality remains strong reflected in charge offs at the low end of our previous guidance.
We also generated 10 points of positive operating leverage compared to the year ago quarter and achieved one of our lowest adjusted efficiency ratios over the past decade at 53%.
Most all of our core return measures have remained in the top quartile among peers, including an ROA of approximately one 3% and then Aro TCE, excluding OCI of nearly 18%.
We also produced strong organic growth during the quarter sustaining a record pace and adding new quality relationships and commercial and growing new households by 3% across our footprint in consumer.
Our two recent Fintech acquisitions dividend, then provide each achieved record quarterly origination levels.
Turning to the balance sheet loan growth was solid across our franchise, our commercial loan production remains well diversified and supported by the banks strategic investments.
Within our regions loan production in our southeast and other expansion markets roughly pulled our Midwest markets.
Our verticals new production was strongest in energy, including renewables with a 70% increase in origination volume compared to the year ago quarter.
Small business production was led by provide which doubled year over year.
Average consumer loans were up 1% led by dividend finance.
A top five national residential solar lender and a return to growth in home equity dividend.
Dividend recently announced several key national partnerships, which will continue to accelerate growth in the future.
Switching to deposits consistent with prior guidance, our third quarter end of period balances were stable with average balances down nearly $5 billion.
Due primarily to the full quarter impact of our deliberate access in the second quarter.
In consumer we grew households, 3% year over year led by our southeast markets, which grew 8% we generated consumer transaction balanced growth of 5% compared to last year and opened a $1 million momentum banking accounts in the quarter.
In commercial our deposit franchise is anchored by our peer leading Treasury management business. We ranked number two through number nine nationally and most M payment types as shown in <unk> annual cash management survey.
We have a strong deposit base, a new relationship growth engines in both our consumer and commercial business lines and we expect deposits that production momentum that we built during the third quarter to produce growth in the fourth quarter.
Turning to the income statement, the strength and diversification of our fee based businesses throughout the bank has helped to partially offset the market headwinds all banks are experiencing.
In commercial our gross Treasury management revenue increased 6% compared to the year ago quarter led by our expert and expert AP solutions.
Our capital markets revenue associated with helping clients hedge their exposure to rates commodities and foreign exchange increased 30% compared to the year ago quarter.
In consumer we generated strong mortgage revenue growth this quarter in an otherwise challenging environment. Thanks to the strength of our mortgage servicing operation.
Fifth third is a low cost high quality servicer, one of the only banks to be recognized as both a Fannie Mae star Servicer, and a hard great a servicer.
The actions, we took to grow our MSR portfolio nearly 30% since the end of 2019, we will continue to pay dividends going forward.
Finally in wealth management, excluding tax payments, we have generated positive AUM inflows in every one of the past 13 quarters and we will recognize this quarter as the best private bank for high net worth clients by the digital banker in global private banker magazine.
We continue to focus on maintaining our culture of prudent expense management across the company, while investing in organic growth and tech modernization initiatives in the third quarter, we made meaningful progress in our technology and platform modernization journey.
We successfully migrated our core platforms to our new data center and have now virtualized over 90% of our servers strengthening network resiliency, increasing speed and capacity and improving the experience for both our customers and employees in.
In the fourth quarter, we will relaunch, our mobile app and a new cloud based architecture and with several improvements to the user experience.
Credit quality remained strong throughout the bank our charge off ratio was 21 basis points for the quarter and our nonperforming asset ratio declined compared to the prior quarter.
We remain cautious with respect to the broader economy, given persistent inflation, the fed's aggressive monetary policies and global growth concerns we've continually improve the granularity and diversification of our loan portfolio with a focus on high quality relationships and companies with more diversified resilient business models.
We continue to proactively monitor our portfolios for signs of potential stress and regardless of what comes I am confident in our ability to outperform peers through the full economic cycle with respect to capital, we announced a 10% increase to the quarterly common dividend in September we continue to accrete capital with strong PNR growth and expect.
To achieve a nine 5% CET one by year end, we also expect to resume share repurchases in the first quarter of 2023 subject to economic conditions.
We continue to make decisions with the long term in mind hold ourselves accountable to what we say, we're going to do and invest in product and service innovations that generate long term sustainable value for our customers communities employees and shareholders.
With that I will now turn it over to Jamie to provide additional detail on our third quarter financial results and our current outlook.
Thank you Tim and thank all of you for joining us today we.
We are pleased with our third quarter results, we generated strong loan growth in both commercial and consumer categories and generated record adjusted revenue.
NII was positively impacted by higher market rates fee income was resilient. Despite the market related headwinds and expenses were well controlled while we continued to reinvest in our businesses. Consequently, we achieved a 53% adjusted efficiency ratio.
Also excluding net securities losses related to two legacy venture capital investments, we generated core <unk> growth of 13% compared to last quarter and 27% compared to last year.
Net interest income was approximately $1 5 billion, a record quarter and increased 12% sequentially and 26% year over year, primarily attributable to the benefit of higher market rates growth in commercial loan balances and the full quarter benefit of securities purchased in the second quarter.
Our NIM expanded 30 basis points during the quarter, while interest bearing core deposit cost increased 32 basis points to 41 basis points in total this quarter.
This equates to a cycle to date deposit beta of 16%, thus far on the first 225 basis points of rate hikes.
Total reported non interest income decreased just 1% sequentially, we generated improved mortgage banking and leasing business fee income, which was offset by softer results in market sensitive businesses, including capital markets and the impact of higher earnings credit rates in Treasury management.
Noninterest expense increased 5% compared to the prior quarter, driven by an increase in compensation and benefits expense, including the impact of the July minimum wage increase to $20 per hour higher technology and communications expense, reflecting our focus on technology.
<unk> modernization initiatives and the full quarter impact of the dividend finance acquisition.
Expenses in the quarter included a $7 million benefit related to the mark to market impact of nonqualified deferred compensation with a corresponding offset in securities losses.
This compares to a $27 million benefit in the prior quarter.
Excluding the end Q DC impacts from both periods total non interest expense increased $35 million or 3%.
Noninterest expense was flat compared to the year ago quarter. Despite the impacts of our fintech lending acquisitions of both dividend and provide.
Moving to the balance sheet.
Total average portfolio loans and leases increased 2% sequentially, including held for sale loans total average loans increased 1% compared to the prior quarter.
Average total commercial portfolio loans and leases increased 2% compared to the prior quarter.
With muted payoffs and a stable revolver utilization rate of 37%.
Period end commercial loans increased 1% sequentially and 14% compared to the year ago quarter average total consumer portfolio loans and leases increased 1% compared to the prior quarter driven by dividend Finance, which as a reminder is recorded in other <unk>.
Tumor loans.
As well as growth in residential mortgage.
This growth was partially offset by a decline in indirect secured consumer loans.
At quarter end dividend loan balances were approximately $1 4 billion.
Average core deposits decreased 3% compared to both the year ago quarter and the prior quarter impacted by the intentional run off of excess and higher cost commercial deposits in the second quarter and lower consumer interest checking balances in the third quarter.
Compared to the year ago quarter average commercial transaction deposits decreased 10%, while average consumer transaction deposits increased 5%, reflecting our continued success growing consumer households.
We grew our securities portfolio of approximately $1 billion during the third quarter compared to $6 billion in the prior quarter. We currently expect security portfolio balances to remain generally stable through the rest of the year.
We have continued to focus on maintaining structure in the investment portfolio to provide stable and predictable cash flows.
Our overall allocation to bullet and locked out structures at quarter end remained at 67% and our duration declined to five five in the current quarter compared to five eight in the prior quarter.
Moving to credit.
As Tim mentioned credit trends remain healthy and our key credit metrics remained well below normalized levels.
The NPA ratio of 46 basis points was down one basis point sequentially.
Our commercial NPA ratio has now declined for eight consecutive quarters.
The net charge off ratio was flat sequentially at 21 basis points.
The ratio of early stage loan delinquencies 30 to 89 days past due remain relatively stable sequentially in the amount of loans 90 days past due was approximately two thirds of what it was a year ago.
We continue to closely monitor central business District hotels nonprofit health care, including senior living.
The office CRE.
We are also monitoring exposures, where inflation and higher rates may cause stress, including the impact of changing consumer discretionary spending patterns as well as the ongoing monitoring of the leveraged loan portfolio.
From a balance sheet management perspective, we have continually improve the granularity and diversification of our loan portfolio with a focus on high quality commercial relationships and on homeowners, which are 85% of our consumer portfolio.
We maintain the lowest overall portfolio concentrations in both commercial real estate and in non prime borrowers among our peers.
Through the dividend and provide acquisitions, we added granular fixed rate loan origination platforms.
We are also focused on positioning our balance sheet to deliver strong stable NII through the cycle, our strong deposit franchise, our securities and cash flow hedge portfolios as well as the additions of dividend and provides lending capabilities should continue to position us to drive strong outcomes.
And the cash flow hedge portfolio, we have added an incremental $5 billion since the end of the second quarter, bringing the total cash flow hedges added this year to $15 billion.
<unk> securities and cash flow hedge positions will support NII through the end of the decade.
Moving to the ACL.
Our ACL build this quarter was $96 million <unk>.
Primarily reflecting loan growth as well as a slightly worsening economic outlook relative to June .
Dividend finance loan growth contributed $63 million to this ACL build realm.
Relative to the second quarter, the Moody's GDP growth forecasts are slightly stronger while the unemployment in home price forecast have weakened in both the baseline and downside scenarios.
<unk>.
Given our expected period end loan growth, including stronger production from dividend Finance. We currently expect a fourth quarter bill to the ACL of approximately $100 million.
Assuming no changes in the underlying economic scenarios.
The impact of the expected dividend loan originations to the ACL should be in the $80 million to $90 million range due to our improved loan growth expectations.
Our economic scenarios incorporates several key risks that could exacerbate existing inflationary pressures and further strained supply chains, including continued aggressive rate hikes and quantitative tightening in labor supply constraints, becoming more binding than originally anticipated.
Our September 30th allowance incorporates our best estimate of the economic environment.
Future baseline unemployment estimates may begin to be increasingly impacted by the fed's aggressive monetary policies.
Moving to capital our CET, one ratio ended the quarter at nine 1% compared to 9% in the quarter.
The increase in capital was primarily due to our strong earnings capacity, partially offset by <unk> growth, reflecting robust organic business opportunities.
Moving to our current outlook.
For the fourth quarter of 2022.
We expect average total loan balances to be stable to up 1% sequentially.
We expect commercial loans to grow 1%, reflecting strong pipelines in middle market and corporate banking and assuming commercial revolver utilization rates remained stable at 37%.
We expect consumer balances to be stable down, 1%, reflecting our decision to lower auto loan production to enhance our returns on capital and lower residential mortgage balances, partially offset by dividend loan originations of around $1 billion.
In the fourth quarter.
From a funding perspective, we expect average core deposits to increase 1% to 2% sequentially. However, we do expect some continued migration from DDA into interest bearing products.
Wholesale funding balances should be stable given expected core deposit growth relative to our earning asset base.
Shifting to the income statement, we expect fourth quarter adjusted revenue growth of 6% compared to the third quarter, excluding the third quarter security losses associated with legacy venture equity investments.
We expect NII to be up approximately 5% sequentially, assuming a 75 basis point hike in November and another 50 basis points in December .
We expect a cumulative deposit beta of around 30% by year end.
This should result in interest bearing core deposit costs rising from 41 basis points in the third quarter to the mid to high 90 basis point area for the fourth quarter.
We expect fourth quarter, adjusted noninterest income to be up 6% to 7% compared to the third quarter or stable, excluding the impacts of the TRA.
We have a strong M&A advisory pipeline and expect to continue generating strong financial risk management revenue, which we expect will be offset by earnings credits and softer topline mortgage banking revenue given the rate environment.
We expect total adjusted noninterest expenses to be up 3% to 4% compared to the third quarter, reflecting continued investments in talent technology and our southeast branch expansion.
Our guidance assumes we opened 17, new branches 16 of which will be in our high growth southeast markets.
Our fourth quarter guide implies stable expenses for 2022 on a full year basis compared to 2021.
And 8% adjusted revenue growth, excluding securities losses, resulting in pp and our growth in the high teens.
This will result in a mid <unk> efficiency ratio for the full year, a four point improvement from 2021, and a fourth quarter efficiency ratio in the 51% to 52% range.
We expect fourth quarter net charge offs to be in the 20% to 25 basis point range, which will result in full year net charge offs of approximately 20 basis points in.
In summary, with our pp and our growth engine disciplined credit risk management and commitment to delivering strong performance through the cycle. We believe we are well positioned to continue to generate long term sustainable value for customers communities employees and shareholders.
With that let me turn it over to Chris to open the call up for Q&A.
Thanks, Jamie before we start Q&A given the time, we have this morning, we ask that you limit yourself to one question and a follow up and then return to the queue. If you have additional questions. Operator, please open the call up for Q&A.
At this time I would like to remind everyone in order to ask a question simply press Star then the number one on your telephone keypad, we'll pause for just a moment to compile the Q&A roster.
And your first question is from the line of Scott Sievers with Piper Sandler. Please go ahead.
Good morning, guys. Thanks for taking my question good morning, Scott.
I was hoping you guys could sort of address the maybe maybe Jamie best for you.
Walk through the puts and takes with with dividend finance I think since that closed the original origination expectations have been great and continue to increase but so do the reserve build expectations. So maybe just some thoughts on.
How much longer will those related reserve builds last.
And how.
The overall accretion from that transaction trending relative to what you would've thought it announcements.
Yes, thanks for the question Scott.
<unk>.
A good one in timely because the dividend expectations on loan growth have continued to.
Go up and up their performance.
<unk> continues to be very strong from a loan origination standpoint, when we bought them they were fifth and market share and our best estimate is that they are top three in market share now today and.
Certainly a booming business.
Given the rising energy costs, so with that two year. We had originally modeled a five year earn back on the acquisition that they would be profitable in 2023 ex the <unk>.
And in 2024.
With the ACL and there is certainly tracking ahead of those expectations. Obviously the challenge during this quarter and as we look ahead, given the strong loan growth as the ACL build the ACL build and the credit performance is in line with how we modeled.
The portfolio with.
The.
Annual loss rates.
Yeah.
<unk> net 125.
Charge off rate give or take but given the long dated nature of the asset bid results in a much higher ACL build in some of our other <unk>.
Loan categories, and so we're going to be providing that a pretty healthy rate.
In dollars given their strong loan production and that could be $80 to $90 million next quarter and perhaps every quarter in.
In 2023, given that we expect $1 billion more per quarter from them. So.
I guess, that's a long answer to say, it's a good problem to have in the long term because it's a high returning asset both from NII perspective, but also a return on the capital. It's just the unfortunate cost of providing life of loan losses at origination.
Yeah. Okay. Thank you for that color and then maybe maybe.
A follow up.
As have really good common equity tier one and are anticipating resumed share repurchases early next year, but the TCE ratio continues from the OCI and maybe if you can sort of.
Just to discuss the extent to which TCE if at all ways into your capital decisions I think one of the emergency question that market is.
Investors are going to rally behind share repurchase from a low starting point a TCE. So just curious to hear your thoughts there.
Well thanks for the question because as you know I do have some opinions on this stuff again bear with me a moment, while I walk through it.
Because we run the company looking at metrics that both include and exclude <unk> and.
And we've been showing you both sets of metrics for better or worse consistently over the past decade, whether thats ROTC your tangible book value per share TCE.
When you look at the tangible book value per share excluding <unk>, we actually grew it in the quarter again for the year, even with the dividend finance acquisition.
So really when it comes down to the lower TCE ratio and the tangible book value per share.
Including the OCI it really does come down to how the OCI is moving and so when Brian and I talk about this and I've been thinking through it.
We think we're really mixing two issues into that one question.
The first question when you parse it out is really based on how do I feel about our investment portfolio positioning and performance and I would answer that is I feel very good about how we're positioned and especially how we're positioned relative to peers.
What had been great to time, the market perfectly and hit the very best entry points of course, but our two years of patients definitely paid off for us on a relative basis. We continue to have one of the highest yielding portfolios and among the lowest unrealized losses as a percent of total securities.
In the industry.
So the potential TCE and Aoc issue from this perspective ultimately comes down to whether you have a low quality or poorly structured investment portfolio that will incur losses in the future. We do not we will accrete 45 to 50 basis points or about $1 billion of TCE per year going forward and do not expect to incur.
Any losses in the portfolio.
And as we've always said.
Given the high composition of floating rate loans on our balance sheet. The investment portfolio should act as a shock absorber in a falling rate environment and we believe the nice duration and structure that we have in the portfolio will do just that.
So then the second question.
That gets mixed into this business.
Should we be putting securities in HTM, instead of FES and as we've said before as a category four bank the election to put the security in the RFS, our HCM really doesn't impact regulatory capital other than a small deferred tax asset impact.
Nor does it change the economics or the risk of an investment.
For the largest banks clearly theres value to minimizing the risk of regulatory capital volatility by using the held to maturity bucket.
For banks like us.
We believe the benefits of maintaining some flexibility to manage the portfolio through a volatile environment.
Really does create value for us through the cycle and given that there is no change in the actual value of the security simply based on the accounting classification of which the portfolio that we've put the security is in.
So it really does come down to do we think the company from a TCE or value perspective is worth less by simply fair valuing one line item in the balance sheet or is it worth less because we placed the security and <unk> and the answer to that we believe is clearly no. So our goal is always optimize the balance sheet.
To deliver long term real economic value and.
And not make decisions that optimize accounting outcomes over economic value.
So with that I apologize for what May have just been the longest answer in the history of earnings calls yet, but as you might imagine we feel strongly about that and if I can put a point on it no. It hasnt.
Not factor into the decisions that we make on a day in day out basis, and the way that we run the company or as it relates to capital return.
Perfect I appreciate that color.
Interesting issue to say the least.
Kind of wide ranging ramifications I really appreciate that.
Proper.
Your next question is from the line of John <unk> with Evercore. Please go ahead.
Good morning.
Good morning.
Moving to if you could give us a little bit more color on your thoughts on deposit growth.
I know that you indicated that you do expect growth in the fourth quarter, maybe if you can help.
Size up that.
That level of growth with how do you think about growth into 2023, particularly given that you've completed the deliberate.
Positive balance.
That you had talked about sort of how you're thinking about 2023.
Also in the perspective of the noninterest bearing.
As a percentage of the total how do you expect that shifting as well.
Yes, Brian why.
Why don't you address the first part of the question and then I'll talk a little bit about why we think we can grow deposits in 2023.
Yes, I mean, our goal our goal is always to grow deposits and take share every year.
Obviously got strong consumer household growth our investments in our southeast markets are leading TM business now we have confidence that we can take share. We obviously have some full year headwinds on average balances due to the excess commercial balances, we intentionally let runoff in <unk>, but.
But we do expect to grow from these <unk> levels.
<unk>, probably up 1% to 2% kind of range.
You, obviously have normal seasonality.
That we should expect to benefit from from a commercial perspective, as we also continue to grow households, and grow our commercial relationships.
Yes, I think I, just would add John to put a point on that.
We do feel good about our ability to grow deposits the remainder of this year and.
As Brian said about our ability to grow deposits on an ongoing basis can you just step back and look at the engines that drive deposit growth here.
The integration of the branch and the digital offering has been very powerful for fifth third right and over the course of.
The past few years the investments we've been making in the southeast.
Have really accelerated and that is evident in the rate of growth that we see in those markets like I mentioned, 8% household growth as an example.
They're the only bank that has built more branches in the last three years in the southeast and fifth third is JP Morgan Chase. Okay. So we have a very fresh branch network. We have another 20 plus branches that will be opened before the end of this year.
And are on pace to do another 35 next year all of which are in really high growth markets.
I mentioned, the millions dividend add 1 million momentum banking households.
It was opened.
In the third quarter of this year.
I don't think I can overstate the way in which.
That sort of a product offering changes the nature of the relationship with a customer like if you just assume the checking account has a $5000 average balance.
Point of interest.
On 5000 box equates to about $4 a month and when you think about how many other places you spend more than $4, a month and get less values and we're providing now and momentum as it relates to helping you to manage cash flow and achieve savings goals and move money efficiently.
And otherwise and I think that is going to be.
Powerful driver of growth. It just makes those core retail deposits stickier than they were in the past and lastly, then we've talked about the Treasury management business and new shared in some of our Investor Conference.
<unk> presentation this ratio of turnover and average balances in commercial so if you just look at AC H volumes over average balances.
And compare that across banks in our peer group fifth third has by far and away the highest turnover, which is a really good thing because what that means is that the balances that are sitting here are being used to support the cash flow velocity of the business as opposed to being treated.
And investment alternatives right.
So if you take that as the foundation of the deposit business here.
And take into account the <unk>.
Hard it is to build those sorts of capabilities over a period of years thats going to be a pretty powerful moat for the bank going forward.
And I think we'll be able to grow from there and then Jon on your DDA mix question. When we look back the last tightening cycle. Our total DDA to total core deposits dropped five points from 35% to 30%.
This cycle, we started at 38% and we model a similar 5% decline.
Or I should say, we're forecasting 5% decline and then we actually model in the rate risk disclosures in the presentation additional migration even beyond that so.
We're assuming.
A similar mix shift as last tightening cycle, but as Tim mentioned, our product lineup is certainly different and better and the Treasury management market share certainly has improved since the last cycle, but either way we feel good about how we're forecasting it and think it will be manageable.
Got it.
Okay. Thanks, Jami and then separately on credit.
If you could just give us some color on the drivers of the higher loan delinquencies in the quarter. It looks like both 90 days 30, maybe nine went up and then separately maybe just thoughts on the trajectory of the loan loss reserve ratio, excluding what you're doing with dividend.
Do you expect.
<unk> here on the underlying reserves beyond that portfolio. Thanks.
Yes, it's Richard I'll start with that with the delinquency comment and I'll, let Jamie talk about the ACL changes.
Starting from a small base we had a couple we have a couple of deals roll into delinquency you have a couple of rollout theres really no trend.
There's no there's no pattern with respect to industry or borrower type.
I think it's just a little bit of seasonality in terms of are a little bit of.
A small change in terms of borrower borrower impact as we get through through the end of the quarter.
The ACL.
Driver of the coverage ratio this quarter was certainly.
Dividend more than anything else, but the other impact been.
A little bit worsening in the Moody's scenarios so from here.
Dividend loans continue to grow and be an outsized portion of our originations in that coverage ratio just because of that loan mix shift.
We will continue to increase but otherwise you wouldn't expect the ACL coverage ratio to go up or down unless the economic scenario changes or the credit profile.
Improves or worsens more than what we've currently modeled.
Alright, okay, great. Thanks again.
Your next question is from the line of Michael Mayo with Wells Fargo. Please go ahead.
Hi can you start off the call talking about.
Virtualized <unk>, 90% of your workload or I missed some of what you had to say, but what does that mean for your efficiency efficiency ratio of 53, 3%.
Where do you think a terminal efficiency ratio is how much do you have in stranded costs and on the other hand in place and right cost that hurt your expenses. So I guess im looking for longer term expense and efficiency guidance and the implications of some of these tech Bruce.
Yeah.
I had you in mind as we were right in that paragraph Mike.
Data centers and Virtualized applications.
I think the way to think about what we are getting to at this point as we have talked for many years now about the opportunities that we had to use the cloud whether it was private.
Or public said take.
Some of the load off of legacy mainframe infrastructure and to put it into an environment that will allow us to be much more scalable and resilient over time.
We had a couple of important milestones in the quarter in that regard.
The commentary about the data centre move.
Having virtualized now, 90% a little over 90% of the servers inside the company long term.
I think we feel very good about.
The ability to drive efficiency on the maintenance and network infrastructure side of the business.
<unk>.
But we also intend to be able to continue to invest on an ongoing basis in new front end application development.
And in building new capabilities into the products and services. So I think what we said in the past is that technology spend.
It has been growing at call it 10% on an ongoing basis that you should expect that sort of growth to continue but then it would be offset by our ability to eliminate manual processes and drive automation into the company and if you look at banks in totality people expenses about half of our total expense on an annual <unk>.
So theres still a lot of opportunity in front of us in that three to five year timeframe.
Substitute technology.
For work that has to be done manually today, that's where I think the efficiency opportunities are and as it relates to the long term.
53% efficiency ratio I believe.
Is.
At least as we were looking at it. This morning, the vast of any of the commercial banks over $100 billion set of reporting so I feel really good about where we're at.
At the moment and the intent is to be able to run the company and that sort of 53% to 55% range.
On an ongoing basis.
Okay. So how many data centers do you have left and is it your goal to eventually have no data centers as well.
We will have indicated.
We'll have to we'll always have too.
There's a lot of our female redeemers, but run certain applications and then be able to store data in your own private environment, you need to have redundancy.
Okay, and so with the Moon just happened can.
Can you size those cost savings are those savings are simply going to help self fund your new tech investments can be there'll be the mechanism to fund the new tech investments.
Okay alright, thank you.
Your next question is from the line of Betsy <unk> with Morgan Stanley . Please go ahead.
Hi, good morning.
Good morning.
Just to ask a couple of questions one I heard the commentary around deposits earlier in the outlook for deposit growth from.
Effectively benefiting from the new branches et cetera that you've been.
<unk> been putting in could you just give us a sense of that branch.
Trajectory from here and what you're anticipating over the course of the next year or two and then also give us a sense as to what your deposit pricing strategies are as well for the next several.
Quarters.
Yes, sure I'll take that.
Branch trajectory Bryan you can handle it I think.
We have been running on a pace to open call it 20% to 30 new branches.
A year, we'd like to see that be and then more of the 30% to 40 range. So we'll hit mid twenties this year.
The expectation is to end up somewhere between 30% and 35 next year and to have the 30 to 48 year range would be what we run in the southeast markets.
And until we achieve that market position that we want to be able to achieve in each of the msas that we are focused on down there now on a net basis. The branch network has not been growing that fast because we have taken advantage of opportunities.
As customers have done more of the transactional activity online.
Then our core relocate branches in the legacy network.
Which has provided a basis for funding several of the investments that we're making down in the southeast Brian you want to talk about right, yes, yeah, absolutely. Thanks, Tim.
We continue to feel good about what we've been able to do on the deposit front. The pricing is obviously starting to get more competitive, especially in the commercial portfolios, but we.
We feel good about the 30% cumulative beta that we have talked about for that first 300 basis points and hikes certainly as rates move higher from here, we're going to continue to see some increase in betas. We've previously talked about maybe that next 100 125 basis points of hikes, those betas will get over 50%.
But we think we're going to be able to manage to below 40% cumulative beta from here certainly a little bit higher on commercial then on the consumer side, but we recognize as rates move higher.
To start to see more consumer beta fluctuate as well.
Yeah, No I know I noticed you.
Opt your CD offers unmatched J P, which is I know it's competitive.
Positioning that you've got a lot of your footprint so.
That's helpful color on the from her beta that Youre looking for.
Maybe you can just give us a sense on loan growth trajectory.
Just one of the things obviously, we're all thinking about is <unk>.
Loan growth in dollars deposit growth.
Any any expectation that.
You would need to lean on wholesale funding a little bit more.
Did notice in the quarter. Your average has went up but in wholesale funding, but that looks like it was.
And that you took at the end of <unk>. So maybe just give us a sense as to how you see that all trajectory. Thanks.
Yes.
Hi.
And Betsy from my standpoint on loan growth I think the guide in the fourth quarter is stable the 1% on a.
Quarter over quarter basis.
That feels like a pretty good benchmark right. If you were to start on something for where we see loan growth goal and we have really strong production coming out of dividend as we mentioned and are very pleased with the performance there and also strong production on provide on C&I more broadly I think we.
Have been deliberate about moderating production over the course of this past year, you can see that in the numbers, but the production itself is still really good it's more granular than it had been in the past, which is an important strategic priority for us.
What do you think I don't see a catalyst for is a material move from here on utilization rates right and against that strengthen that fintech platforms and.
Good core middle market production in C&I youre going to have the drag from the slowdown in auto production in mortgages.
I think we started on.
Perhaps earlier than others, and therefore will make its way into the number of SaaS or then you may see us and.
In other places against that that goal is always to grow deposits, we like to be able to grow deposits faster than loans that we is that and then there's a way that we try to grow the company that doesn't always happen in any one quarter, but we do expect fourth quarter, 1% to 2% deposit growth.
Dan.
While we're still in the early stages of the planning process, we intend to grow deposits next year.
And Betsy from an overall funding perspective, our wholesale funding portfolio as a percent of our asset base is obviously down a decent amount from where we were pre COVID-19.
It was kind of closer to 9%.
Total assets pre COVID-19 from a long term debt perspective that number is down to more like 6% right now our loan to deposit ratio. Obviously is still near those historic lows and so overtime, we do expect to have more structure in our liability base.
This as well as a little bit more long term debt. So even if we were to see some moments of loan growth faster than deposit growth, we have confidence in our ability to fund it and adding some of that structure to our balance sheet.
Some place to be as well right now I noticed your liquidity sources, it's very.
The slides that really appreciate that thank you.
Okay.
Your next question is from the line of Ken It was done with Jefferies. Please go ahead.
Hi, Thanks, good morning.
A couple of questions on the fee side.
Understanding your guidance flat to the 727 I just wanted to understand Tim.
Tim in your in your intro, you mentioned that mortgage servicing will continue to be a benefit so as the mortgage business hanging from here going forward and then the second question is just can you flush out a little bit for us since the impact of earnings credit rates on service charges and what type of impact that could have going forward as well. Thank you.
Yeah, Hey, Ken it's Jamie I'll take that one.
Since we've had long discussions over the years on the strength or lack thereof in our mortgage business.
Happy to report that the third quarter was a very nice.
Mortgage performance.
Fifth third.
I do think from a topline perspective.
Volumes will be down given the environment into the fourth quarter.
But what youre seeing in the strength of the business is really that servicing.
Revenue.
Showing through and as Tim mentioned in his prepared remarks.
One of the top Servicers.
Rated in the industry.
The improvement in that revenue stream is part of.
Why are we beat the outlook for the third quarter and will help support the mortgage.
<unk> business going forward, we were running.
The mortgage banking in the first half of the year total mortgage banking fees I think in the first six months of the year were $80 million and we're going to grow that 60% over the back half of the year.
Simply driven by the strength of that mortgage servicing business that we operate so we feel good about that that's a run rate servicing fees net of MSR decay should be around 40% to $45 million a quarter going forward and that's going to be a 10% yielding asset for us, but again, the topline will there'll be a little.
Bit.
Challenge so that net net.
No MSR valuation changes.
We expect the mortgage banking fee line to be in that $60 to $65 million range in the fourth quarter.
Okay and sorry, that's on the service charges with regards to the ECR impact there in.
Does that continue to.
How does that trend going forward.
When we look just at the fourth quarter.
Topline fee equivalent as Tim mentioned, we have a very.
Strong pipeline and good business and so top line will be growing 2% or so but to your point the earnings credit just given the rising rate environment.
We will result in total service charges being down.
2% to 3%.
We have earnings credits moving.
Similar to the deposit betas, and so they'll continue to edge higher.
The fed keeps moving on rates.
Okay, and if I can just ask one more just on your slide 24, you added.
$5 billion more swaps since the end of the second quarter and we can see how you've ladder that all out I just can.
Can you help us understand as you start to look past <unk> in terms of.
Hi.
Can you continue to show positive NII growth given yes.
Deposit beta comments, you made earlier and just the trajectory of the protection that you've that you've put onto the balance sheet. Thanks, Jamie.
Yes, Ken it's Brian Thanks for the question.
Based on where we stand today, we feel good about our exit rate NIM in <unk> 'twenty two carrying over into 2023 with some upside as our balance sheet continues to benefit from the 22 hikes. We've previously talked about that for Q, NIM and that kind of $3 35 to $3 40 range.
Assuming a $4 50 terminal fed funds rate, we think our NIM will peak in mid $3 <unk> in the first half of 2023.
We do expect to give some of that upside back as deposit repricing lag catch up.
But given the balance sheet actions, we've taken to date to monetize our asset sensitivity. We expect we can maintain a 330 plus.
330, plus NIM over the next couple of years, even if rates were to fall 200 basis points, obviously 2023 and beyond results are subject to significant uncertainty given the economic outlook and.
And we will give you additional color on 'twenty three expectations as part of our fourth quarter earnings in January .
Great. Thanks, a lot Bryan.
Yes.
If I'm just going to throw one editorial comment in here, Ken because you hit on two of the topics that we're spending a lot of time talking about internally is.
I think perhaps because we operated for 15 years and in Euro zero and near zero interest rate environment people forgot about what long term drives performance.
In the banking business and if there's anything that that current point in the cycle is reminding us of that.
Deposits matter.
In the diversified fee income business lines matter and that interest rate risk and credit risk management matter and by those measures. If you look at where.
We are right now I mean, the company has been around for 164 years and this is literally going to be its best year ever in terms of profitability and the strength of some of these fee lines.
Like mortgage servicing right like what we have been able to do on topline with Treasury management and the quality of the deposit base coupled with that.
The prudent that I think that our treasury, which has done really an outstanding job here.
And that we have in the crowded organization is going to that fifth third ought to be able to perform very well.
Regardless of what 2023 2020 for 2025.
Thanks for the color Tom.
Okay.
Your next question is from the line of Erika Najarian with UBS. Please go ahead.
Erica.
Morning, actually my questions have been asked and answered thanks, so much guys.
Thank you.
Your next question is from the line of Matt O'connor with Deutsche Bank. Please go ahead, Hey, Matt.
Good morning.
Any impact to the dividend.
Business from recent legislation I guess, let's call the inflation, we bought snack, but there's a lot of.
Climate and initiatives on their debt.
No help from broader areas, but any impact to that business in terms of volumes and reducing their credit versus what you thought it would have been before.
Yes, it will.
It will be a tailwind for the business when we underwrote the business and entered into the agreement to buy dividends. The assumption we were using in our base case was that the federal tax credits would expire.
And the actions and the inflation reduction Act.
Are only going to help support it.
Okay and then.
Do you think about how big this portfolio can get or are you willing to let it get obviously there is a lot of room to run.
But if youre originating over 4 billion in the year and it's pretty long duration balances can build pretty quickly any thoughts on that.
That's how big I know I've asked you before but how.
How big it can get and youre willing to like that.
Yes.
Obviously theres a lot that can change over the next couple of years as outlooks and things adjust and rate expectations change but.
As we look at it now and given the capacity that we have on the consumer side, because we are going to continue to let our auto portfolio rundown getting that portfolio north of $10 billion doesn't cause us any concerns and we also know that there is a pretty robust market, whether its securitizations or whole loan markets, where we're going to have the ability to manage the <unk>.
Portfolio of risks associated with these assets. So we feel good about our options associated with it.
Okay and actually just following up on my first question I'm, a little slow today as always.
Long week.
The benefit of these credits.
Does this increase the volume reduce the kind of long term expected.
Credit costs or what what's in the order.
Looking about it increases the volume.
Yes, the way to think about it is that from the homeowners perspective.
Clearly there is.
And incentive pay impact your own personal carbon footprint at these decisions ultimately get made on an economic basis. So the trade off that the homeowner is making is the cost to install the panels and then to service the debt attached to that relative to the cost.
<unk>.
<unk> pay an energy Bill for energy that you buy from a utility company on a month to month basis. So anything that reduces the installation costs on the side of solar or that increases the cost.
Buying energy off the grid is beneficial to the size of the overall market is the way to think about it Matt.
Dividend being one of the largest players anything that im positively impacts the Tam.
For residential solar positively impacts the outlook from an origination perspective so.
So that's where I expect the impact the benefit primarily to be as it relates to the vendor the extension of the federal tax credits.
That makes sense and obviously higher energy prices can also increase demand.
Yes would there be an opportunity to securitize or like figure out a way to.
The increase.
Going to originate even more with our keeping our balance sheet over Greg maybe thats more two five years now.
I think Brian mentioned that dividend has been a top five originator Jamie mentioned 80 again, we believe it's a top three originated today. The other players in the top five are all funding through whole loan transfers or securitization. So there is a very liquid market for the asset we have the ability to run at.
An origination level that is above and beyond that what we would hold in the portfolio. If we elected.
To do it but that as you said earlier, we have a long way to run between.
Where we're at today.
And where we.
We would stop <unk> add.
At very attractive yields from the standpoint of NIM enhancement and overall credit performance.
Okay. Thanks, so much.
Your next question is from the line of Gerard Cassidy with RBC. Please go ahead.
Hi, Tim Hi, Jamie.
Gerard.
Tim you talked about.
Third is one of the most active.
Branch openers in the southeast along with J P. Morgan Chase can you give us some color on the cost of opening I know each branch is different but the typical cost of opening a branch one type of deposit level, you need to reach to make it breakeven and how long does it take you to reach to get to that deposit.
If you use deposits as the measure for breakeven.
Yes, Gerard its Jamie thanks for the question.
We've really reduced the square footage in the branches so that the cost.
Lay into construction is much lower than it used to be and it can range from $3 million to $4 million.
Book value, maybe a few.
Hub branches would go higher than that but for the most part that's where were the investment cost is and as you know.
The people side, the staffing is about half of the cost of operating <unk>.
Branch and so you start to make money when you get into the.
$25 million plus deposit range, and so that usually takes us two and a half years or so.
Sometimes three sometimes two but our recent de novo's are tracking well against the model and actually Youre outperforming on a household growth basis. So thats part of the reason why we are continuing the strategy and as we look ahead.
So next year, we did 22 new branches. This year in total and we should do 35 or so next year, primarily in the southeast.
And Jamie when you get to that breakeven point.
How much longer does it take to get to a return on investment or a return on equity. However, you measure it to have it at the level that you are very satisfied with.
Yes, five years is really where.
Leading up to the five year Mark could you then become profitable flip over probably at that four and a half on accumulative basis and then.
The earnings power really starts to.
Accumulate beyond that.
Very good and then as a follow up go ahead Tim.
Are going to say, but these are investments with extremely high terminal values right. If you look at the branches that we have across the network today.
It is especially in the world, where I think we have done a very good job of being able to integrate the digital investments that we make and the access to a human being in the local market right. We've talked a lot about the ways in which we're using analytics and.
In other direct connection points to make sure that thats, a seamless experience for customers.
It just has proven to be a very strong long term recipe tiger.
To grow the franchise and the longer the fed stays up the faster that breakeven on those branches materializes in the third and more attractive that the returns look like right.
Yes, very true.
And as a follow up on credit obviously your credit quality is very strong similar to your peers.
Maybe just remind us why are the customers and when you look at all the economic outlooks you mentioned Jimmy about Moody's It was a little worse than what you had in the prior quarter in terms of building up the reserves how is it that credit just remains so strong in view of these cross currents, particularly in <unk>.
The housing market is starting to weaken and then the second as part of this can you just share with US also about the used car prices. Obviously, there's finally starting to come down you guys are in that market and how does that impact maybe.
Future charge offs delinquencies if prices continue to fall down yes.
Yes.
Now, let Richard provide more specificity the Gerard if you just step back and look at it because this is the conundrum that.
We find ourselves in as we look forward and think about how we run the business relative to the signal we've got today on.
On the consumer side of the equation if you look at.
Fifth third consumer checking deposit balances they are essentially exactly where they were about between 60% to 80% depending on the cohort youre looking at or above where they were at in February of 2020 and that ratio has stayed.
More or less perfectly constant.
That third stimulus check pay so there were was a temporary spike as tax refunds came in this past year that money dot spend down by and large over the summer, but a re stabilized and that sort of 60% to 80% range.
One two at least in our case such as significant.
Percentage of our consumer exposure is to homeowners right, it's 85% of total exposure and 75% of our credit card.
And auto AD customers are homeowners that they had an opportunity to lock in historically.
Historically, low fixed rate mortgages and to manage housing costs.
In the past couple of years that will allow them as long as they're seeing 4% to 5% wage inflation, which is kind of where we've been running the managed seven 8% headline CPI pretty well right.
And the byproduct of that is the liquidity buffers, there and they have leverage over their costs in a way.
Than others and I.
I think equivalent Lee Richard and I have been out together in several markets recently talking directly with customers and what we hear are by and large is that customers have been able demand has stayed very strong and that customers have been able to exercise pricing leverage and to push input costs through.
Add to that.
Our customers right.
I think the dynamic in fact with them and in each case that they'd all remain more concerned by us.
Although supply chain pressures have eased a little bit.
And they are still concerned about stability of global supply chains and are making investments to.
To support that and then labor is the other primary constraint right now and there again I think where there is a.
Good activity going on a lot of it is going on defined capex to drive labor productivity.
So that labor requirements can go down at a given level.
Demand now now first principles would tell you that with the fed moving as rapidly as it is and with rates having headed.
Direction they have.
That at some point here the rate cycle has to turn into a credit cycle.
And that I think is the reason why we've been maybe more cautious.
In terms of some of our actions then.
Feels like we hear other people being.
Because we just think thats prudent at this point in time, but I mean, Richard you want to talk a little bit about some of the other specifics, yes, I think the one thing to add on commercial Gerard is remember theres a loss emergence period. So it takes a little while for the stress to ultimately rolled through loss.
And I think what we see and Tim articulated a lot of it is our customers are adapting and they've had to adapt honestly for about three years outlets. If you go back to 2019.
The tariffs the new tariffs were a challenge for a lot of supply chain and manufacturing they had to adapt they've learned that in cohort <unk> had inflation and so.
We see resilient business owners do what they do and that's that's adapt to the challenges and run their business as well and I think thats part of the conversation and that's what we get from <unk>.
From our relationship and our relationship managers talking to customers or really get good insight to what's happening on the ground in and I think as Tim said, there's more strength there from a from a fundamental perspective than perhaps people would otherwise otherwise belief.
Now to your question on auto.
I think the answer the answer is auto is going to be a really classic example of a normalization.
And again, you've got a shorter generally shorter duration in terms of the <unk>.
That loss emergence period, and you have two things that are happening at the same time, one clearly you can see it with manheim used car prices are down, 10%, 12% and trending down normalizing at the same time, we're going to be rolling into originations, where we bought it where customers bought at higher car prices. So we don't run.
We see anything abnormal except for an acceleration of this intersection between between car values and the originated loan to value getting back to something that looks more normal.
It's where it's a super Prime book for the most part.
Disciplined on the underwriting.
The resilience when you look at things like delinquencies continue to be very very good in fact, they're at.
I continue to be at seasonal low. So I think it's just this intersection of prices coming down in and loan origination prices coming up.
And then just one quick follow up on that during this financial crisis with housing.
Many times houses fell below the mortgage value and people if they were unemployed and couldnt afford it walked away from the house.
Auto loans really go upside down and loan to values start to get up to 120% to 130% because of the manheim number keeping our keeps falling.
Have you guys seen any history of people literally just turning the keys over to the car because the loan is upside down or is that really not a factor in the auto market.
It's certainly not a factor today in fact, Gerard if anything.
About where auto prices have gone at Youre seeing were seeing customers and we see this across the spectrum that we don't lend into.
I don't want to have to go turn the car in and buy a new one it's too expensive. So they're doing a lot of things to keep their car and to add to to stay current or work through with the lenders. We don't see a lot of that because we don't we don't really have that situation given the.
The quality of our consumer but right now I think people. If they are if they have a job they want to keep their car. They don't want to go buy a new one.
Great. Okay. Thank you.
Thank you.
Today's final question will come from the line of Bill Karachi with Wolfe Research. Please go ahead.
Hey, Bill Hey, good morning, Thanks, Hey, good morning, Jim and Jamie I really appreciate hearing your thought process on your earlier question about TCE. What's your response to that question change at all if we had a credit cycle and the fed wasn't able to lower rates due to inflation. So the securities portfolio was unable to add as much of a shock absorber.
You described earlier and then to bring that back to the broader question is there a point where decreases in TCE would become a concern for you in that scenario in particular.
Well you see I guess first off we've been.
Accretive capital just through the strong earnings power of the company that's going to continue.
As Tim mentioned CET, one will grow in the fourth quarter. So obviously that will help the TCE ratio and then where we pick up the buybacks next year, we will run the company at that $9 25, CET one level, that's our expectation if theres, a credit cycle or credit events.
We will be very happy that we have the portfolio, we do given the.
Structure as well as the duration that we have so.
I'm not worried about the performance of the investment portfolio I would say that it's probably the best portfolio in the industry. So we feel good about that.
That's helpful. Thank you and then separately on the funding side can you speak to your ability to bring off balance sheet client funds back on balance sheet and the potential.
The potential amount.
That is available in theory.
Yeah, right now, there's about $4 billion and our client.
Liquidity portal.
Then theres also.
Opportunity within the wealth and asset management business, but again that would just come down to the well.
Willingness to pay 100% beta type of pricing them at this point in time, there is no need to do that but if we wanted to match money market rates, we could certainly.
Bring more deposits back onto the <unk>.
Very helpful. Thank you for taking my questions. Thanks, Bill. Thank you.
At this time I would like to turn the call back over to Christophe for any closing remarks.
Thanks, Dennis and thanks, everyone for your interest in fifth third please feel free to contact the Investor Relations Department. If you have any follow up questions. Dennis you can now disconnect the call.
Thank you ladies and gentlemen, this does conclude the fifth third Bancorp third quarter 2022 earnings Conference call. Thank you for your participation you may now disconnect.
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