Q1 2023 Fifth Third Bancorp Earnings Call
Ladies and gentlemen, thank you for standing by and welcome to the fifth third Bancorp first quarter 2023 earnings Conference call I would now like to turn the call over to Christophe <unk> head of Investor Relations. Please go ahead.
Good morning, everyone. Welcome to fifth third is first quarter 2023 earnings call. This morning are president and CEO , Tim Spence and CFO , Jamie Leonard who will provide an overview of our first quarter results and outlook our treasurer, Brian Preston has also joined for the Q&A portion of the call.
Please review the cautionary statements in our materials, which can be found in our earnings release and presentation.
These statements speak only as of April 22023, and fifth third undertakes no obligation to update them.
Following prepared remarks by Jim and Jamie We will open the call up for questions.
With that let me turn it over to Tim.
Thanks, Chris and good morning, everyone. Thank you for joining us today.
The past six weeks have seen a great deal of volatility in the banking sector.
Markets have been trading our narratives over fundamentals and the term regional bank has been used to describe such a broad cross section of business models that it has lost any real descriptive value.
Well, we at fifth third taking any instability in our sector very seriously there was no price us inside our four walls.
We've been running the company with the expectation for a higher for longer rate environment for many quarters now as we've consistently communicated in these calls and at Investor conferences.
As our first quarter results demonstrate our balance sheet remains well fortified and our capacity to generate strong profitability through the cycle is strong.
Excluding items noted in the release, we reported earnings per share of <unk> 83.
A 20% increase compared to the year ago quarter we.
We generated nine points of year over year positive operating leverage driven by an 18% increase in revenue.
During the quarter, we held average and period end deposits flat sequentially. Despite the industry wide impact of quantitative tightening and normal seasonal pressures.
Our key credit metrics remain near historical lows with net charge offs of 26 basis points coming in at the low end of our guidance range.
N P as mpls and early stage delinquency ratios remained below normalized levels and criticized assets decreased modestly during the quarter.
Moreover, we accomplished all this while also being recognized by Ethisphere as one of only two U S banks on their world's most ethical companies list. We were named by Fortune as one of America's most innovative companies and we saw our Fintech platform provide named by fast company as one of the world's most innovative businesses.
Our strong outcomes achieved this quarter and in particular in the month of March highlight the strength granularity and well balanced nature of our deposit franchise.
On the weekend following the failure of Silicon Valley Bank alone, we opened more new commercial deposit accounts than we would in a typical month Sim.
Similarly, our consumer household growth accelerated after the March turmoil.
Our commercial deposit franchises led by our peer leading Treasury management business, where we rank in the top 10 nationally in most major commercial payment types.
88% of our commercial deposit balances are attached to relationships that utilize <unk> services today and the average age of our commercial deposit relationships is 24 years.
These characteristics contribute strongly to stability regardless of balance size.
Our consumer deposit base is granular with nearly 90% of total consumer deposits FDIC insured and is anchored by our flagship mass market momentum banking offering and strong branch presence in the markets we serve.
Annual consumer household growth finished the quarter above 3% led by our southeast markets above 7%.
During the quarter, we opened five branches in our southeast markets on top of the 70 added in the past three years and we expect to open an additional 30 branches by the end of 2023.
All said end of period total deposit balances ended the quarter above the level on March eight.
Looking forward, while we face the same headwinds that all banks do from increased deposit competition economic uncertainty and the potential for regulatory change I am confident in fifth third's ability to achieve top quartile returns through the cycle with a focus on stability profitability and growth our long term disciplined managing interest rate and.
Liquidity risks positions us well to generate differentiated outcomes in a range of economic environments.
From a credit risk perspective, or low CRE concentration in commercial and in particular in office CRE, along with our focus on homeowners in consumer should prove to be significant advantages.
Jamie will provide more information on our forward guidance, but the implied profitability and return metrics for our full year 2023 expectations are well ahead of our core 2019 results considering the uncertain environment, we have elected to pause share repurchases for the second quarter, and we will evaluate resuming them in the second half of the year.
Last but certainly not least I want to thank our 20000 employees for their hard work and dedication in supporting our customers communities and shareholders.
Your commitment to living our purpose and making sure. We do the right thing every day as evidenced with that I'll now hand, it over to Jamie to provide more details on our financial results and outlook.
Thank you Tim and thank all of you for joining US today, our first quarter results were strong despite the market volatility during the quarter average and period end total deposit balances were flat compared to the prior quarter average core deposits declined in line with our guidance of down 1%.
Yes.
We grew loans modestly during the quarter, while adding new quality relationships in both commercial and net new households in consumer.
We achieved an adjusted efficiency ratio of 59% and a seasonally challenged quarter, which was a six point improvement compared to the year ago quarter.
Our first quarter core <unk> grew nearly 40% compared to last year, reflecting the diversification and growth of our revenue streams combined with disciplined expense management.
Net interest income of approximately $152 billion increased 27% year over year, but declined 4% sequentially.
Our sequential NII performance was impacted by our shift to a more defensive balance sheet position given the volatile environment the impact of lower day, count and seasonally strong investment portfolio income in the prior quarter.
Fee income exceeded our expectations, despite the market related headwinds.
We remain disciplined on expenses, while continuing to invest in our businesses.
<unk> was impacted by the expenses associated with higher than expected fee income.
Our NIM declined six basis points for the quarter, while interest bearing deposit cost increased 64 basis points to 176 basis points, reflecting a cycle to date interest bearing deposit beta of 36% through the first quarter, which includes the impact of.
Cds.
Total adjusted non interest income increased 2% compared to the year ago quarter, driven by strength in commercial banking and mortgage fee income, which more than offset a decline in deposit service charges due to the elimination of consumer NSF fees last year and the impact of higher earnings.
Credits from higher market rates this year.
Growth in commercial banking fee income was primarily driven by increased loan syndication fixed income sales and trading and M&A advisory revenue, partially offset by a decline in corporate bond fees.
The improvement in mortgage revenue was driven by increased servicing fees and lower asset decay.
Adjusted noninterest expense increased 6% compared to the year ago quarter, excluding the impact of nonqualified deferred compensation expenses from both periods.
Expense growth was elevated due to the dividend finance acquisition in the second quarter of 2022 and growth in the provide franchise, excluding the fintech growth impacts and the FDIC assessment total expenses increased approximately 3% compared to the year ago quarter as did.
<unk> throughout the bank combined with automation initiatives were offset by compensation associated with our minimum wage hike higher fee income and higher technology and communications expense, reflecting our focus on platform modernization initiatives.
Moving to the balance sheet total average portfolio loans and leases increased 1% sequentially, reflecting growth in both commercial and consumer portfolios.
Commercial was led by C&I, where payoffs were muted and production was stable and our regional middle market banking business, but down in our corporate bank.
The subdued production in the corporate bank reflects our focus on optimizing returns on capital in this environment combined with less robust demand.
Impaired to a year ago quarter, C&I loans, excluding PPP have increased 13%.
The period end commercial revolver utilization rate remained stable compared to last quarter at 37%.
Average total consumer portfolio loans and leases increased 2% compared with the prior quarter led by dividend finance, while balances from the rest of our consumer captions remained relatively stable.
Average total deposits were flat compared to the prior quarter as increases in Cds and interest checking balances were offset by a decline in demand deposits.
By segment wealth and asset management average balances increased sequentially consumer was stable and commercial modestly decline consistent with normal first quarter seasonality.
Period end total deposits were also flat compared to the prior quarter.
Notably we have grown deposits, 1% since the end of last June compared to a 4% decline for the top 25 banks as shown in the Fed's H eight data we.
We have included additional materials and our earnings presentation to highlight some of the key attributes of our high quality deposit franchise that may be relevant in this environment.
Moving to credit as Tim mentioned credit trends remained healthy and our key credit metrics remained well below normalized levels. The ratio of early stage loan delinquencies 30 to 89 days past due decreased four basis points sequentially to 26 basis points remains bill.
<unk> 2019 levels.
The net charge off ratio of 26 basis points increased four basis points sequentially and was at the low end of our guidance range.
The NPA ratio was 51 basis points was up two basis points compared to a year ago.
From a credit management perspective, we are continually improve the granularity and diversification of our loan portfolios through a focus on high quality relationships.
In consumer we are focused on lending to homeowners, which are 85% of our consumer portfolio.
We are also maintaining the lowest overall portfolio concentration and non prime consumer borrowers among our peers.
In commercial we have maintained the lowest overall portfolio concentration in CRE at 14% of total loans.
Across all commercial portfolios, we continue to closely monitor exposures, where inflation and higher rates may cause stress and continue to closely watch the leverage loan portfolio and office CRE.
Office loans of $1 $6 billion represented just one 3% of total loans with a criticized ratio of eight 2% and only one basis point of delinquencies.
While the leveraged loan portfolio has declined 65% since 2016 and is now less than $3 billion outstanding today.
We are focused on positioning our balance sheet to deliver strong stable results through the cycle.
Moving to the ACL.
Our reserve change this quarter was a net increase of $37 million.
Or a build of $86 million, excluding the onetime impact of adopting the accounting standard eliminating TD are accounting, which reduced the reserve by $49 million.
Our build primarily reflected loan growth, notably from dividend finance loans, which contributed $88 million of the increase.
The ACL ratio increased one basis point sequentially or five basis points, excluding the accounting change.
As you know, we incorporate moody's macroeconomic scenarios when evaluating our allowance.
The base economic scenario from Moodys assumes the unemployment rate reaches 4%, while the downside scenario underlying our allowance coverage incorporates a peak unemployment rate of seven 8%.
We maintained our scenario weightings of 80% to the base and 10% to each the upside and downside scenarios.
Moving to capital.
Our CET one ratio remained relatively stable compared to last quarter, ending the first quarter at $9 two 5%.
Our capital position reflects our strong earnings generation offset by the impacts of returning capital in the form of dividends and repurchases risk weighted asset growth, primarily in consumer loans and a seven basis point decline from the seasonal phase.
Our tangible book value per share increased 11% sequentially, partially impacted by our Aoc I position, which improved 17%.
Tangible book value grew 7%, excluding <unk> compared to the year ago quarter.
Moving to our current outlook.
We expect full year average total loan growth between 2% and 3%, which reflects our cautious outlook on the economic environment.
We expect total commercial loans to increase in the low to mid single digits area compared to 2022, which implies modest incremental growth from the first quarter through year end, given our outlook for a temporary lending environment in the second half of the year.
We expect line utilization rates to remain stable.
We expect total consumer loan growth to also be modest as a strong increase from dividend finance will be mostly offset by a decline in auto and mortgage.
We continue to expect approximately $4 5 billion and dividend loan production for the year, given the secular tailwind and our investments in the business combined with market share gains.
We expect deposits to be stable or grow from the first quarter average level as we progress throughout 2023, consistent with our strong customer acquisition trends.
Within that we expect continued migration from DDA into interest bearing products throughout the remainder of 2023 with the mix of demand deposits to total core deposits declining from 32% today to 30% by year end.
For the second quarter of 2023, we expect average total loan balances to be stable to up 1% sequentially with growth fairly balanced between commercial and consumer portfolios.
We expect average deposits to also be stable to up 1% on a sequential basis.
Shifting to the income statement, we expect full year, NII will increase 7% to 10%.
As other banks have noted industry wide deposit pricing pressures intensified in the wake of the Silicon Valley and signature bank failures. Therefore as shown in our presentation materials, we are providing NII guidance under a range of deposit betas, given potential diverging levels of intensity.
With respect to deposit competition going forward.
The upper end of our NII guidance assumes an approximate terminal beta of 43% and the lower end assumes approximately a 49% terminal beta compared to our January expectation of 42%.
The midpoint of our NII outlook translates to a 47% beta with total interest bearing deposit costs, increasing 45 basis points or so in the second quarter and another 25 basis points in the second half of the year.
Our outlook also considers the lag effects from previous rate hikes and continued DDA migration and assumes the fed hikes 25 basis points in May and then holds short term rates at 525 basis points for the remainder of the year.
Our guidance assumes that our securities portfolio balances declined a couple billion dollars between now and year end and that we hold closer to $10 billion in excess cash for most of the year.
Assuming we continue to defensively position the balance sheet for the remainder of the year by maintaining an elevated excess cash position combined with continued intense deposit competition.
We are assuming NIM will be in the $3 20 to $3 25 range for the year.
We expect second quarter NII to be down approximately 1% sequentially, reflecting the deposit loan and cash dynamics I mentioned.
We expect adjusted non interest income to be stable to up 1% in 2023, reflecting continued success taking market share due to our investments in talent and capabilities, resulting in stronger gross treasury management revenue capital markets fees wealth and asset management revenue.
<unk> and mortgage servicing to be partially offset by higher earnings credit rates on TM.
Dude lease remarketing revenue and a reduction in other fees, reflecting lower TRA and private equity income this year.
We expect our fourth quarter TRA revenue to decline from $46 million in 2000 $22 million to $22 million in 2023.
We expect second quarter, adjusted non interest income to be 2% to 3% compared to the first quarter.
We expect to continue generating strong revenue across most fee captions.
And that will be partially offset by a slowdown in debt capital markets revenue.
We continue to expect full year adjusted non interest expenses to be up 4% to 5% compared to 2022.
Our expense outlook incorporates the FDIC insurance assessment rate change that went into effect on January one.
The mark to market impact on nonqualified deferred compensation plans, which was a reduction in 2022 expenses.
And the full year impact of investments to grow the dividend finance and provide businesses.
Excluding the dividend acquisition FDA.
The FDIC assessment and MQ DC impacts, we would expect our full year 2023 core expenses to be up less than 3%.
Our guidance reflects continued investment in our digital transformation, which should result in technology expense growth in the low double digits for the year.
We also expect marketing expenses to increase in the mid to high single digits area.
Our guidance also factors the run rate benefits from the severance expense recognized in the first quarter, which reflected proactive actions taken to reduce ongoing expenses given the operating environment.
We expect second quarter, adjusted noninterest expenses to decrease 8% to 9% compared to the first quarter.
In total our guide implies full year adjusted revenue growth of 6% to 8%, resulting in <unk> growth in the 9% to 10% range.
This would result in an efficiency ratio below 55% for the full year.
We expect second quarter, pp NR to increase 10% to 11% compared to the first quarter and for second quarter efficiency ratio to be around 54%.
We continue to expect second quarter and full year 2023, net charge offs to be in the 25% to 35 basis points range.
Given our expected period end loan growth, including continued strong production from dividend finance.
We continue to expect a quarterly build to the ACL of approximately $100 million.
Assuming no changes in the underlying economic scenarios.
In summary, with our strong <unk> growth engine disciplined credit risk management and.
And commitment to delivering strong performance through the cycle. We believe we are well positioned to continue to generate long term sustainable value for our 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 end. This morning, we ask that you limit yourself to one question and one follow up and then return to the queue. If you have additional questions. Operator, please open the call up for Q&A.
The floor is now open for your questions to ask a question at this time. Please press star one on your telephone keypad. If at any point you would like to withdraw from the queue. Please press star one again, we will now take a moment to render our roster.
Our first question comes from the line of Scott Cyphers from Piper Sandler. Please proceed.
Good morning, guys. Thank you for taking the question.
Let's see Tim you talked about the much higher than typical commercial account openings. During all the turmoil can you talk about sort of early read on what has happened with those and sort of generally speaking how you would expect commercial customers to behave going forward, whether they will keep the same amount with their primary institution diversify sort of permanently.
<unk>, how would that all work in your mind, yes. So good morning, Scott. Thanks for the question just a note for everybody.
No you have a busy day here so with the exception of the soliloquy that jamie's prepared on regulation going forward, we're going to try to keep our answers.
Chris we were delighted to see the activity, obviously and to see that continue to carry forward through the end of the quarter.
All but literally it's single digits you can count on.
I think one hand, and two fingers the number of the accounts that we open.
That didn't fund up.
Prominent bifurcation in behavior between operational accounts and non operational accounts right.
In fact on that corporate treasurer side cash as an investment versus cash as a tool in terms of the way that you manage the business and that is reflected in the operational account behavior that we saw during the period I think probably contributed very significantly to the stability and the fit.
Third experienced in terms of commercial account balances, but Jamie give anything you want to add yes, and Scott what we also.
Saw in the first quarter was that.
Our clients, we're focused on getting money to.
To the best vehicle possible so for us during the quarter, we moved almost $1 billion more into the money market portal.
We manage for them and even with that incur.
Incremental movement, we were only down about $1 billion in commercial and a seasonally challenged quarter. When last year, we were down $2 billion in the quarter seasonally in the year before that we were down 3 billion so to Tim's point.
Money has been moving to the optimal investment vehicles, but the good news for US as we were able to overcome that headwind and actually posted a very solid commercial deposit quarter.
Perfect. Thank you and then Jimmy maybe.
Additional color on <unk>.
Give the thoughts on noninterest bearing to total deposits and sort of that go forward mixer and of your mix what.
And you're thinking it makes that the right number why not why not lower on a higher what was sort of the the inside baseball on that yes. The last tightening cycle, we moved down.
Down five points. This time were forecasting to go down eight.
To finish the year at a 30% DDA to core deposit level.
Given that our rate outlook now has the 525.
Longer hold with no cut.
We think we will see continued migration and higher earnings credit rates that will result in more DDA migration and then the.
The challenge over time as can you sell enough Treasury management services to rebuild that DDA.
Balance and given our strong Treasury management business, we feel confident in our ability to do it. So hopefully we do bottom out at 30.
But for every 1% more than that it translates to <unk> <unk>.
<unk> million dollars of NII erosion.
So.
While.
Not tremendous impact we would still want to ensure that we get that 30% higher as we head into 2020 for 2021.
Perfect Alright, thank you erinn.
Thanks.
Our next question comes from the line of Jared <unk>.
<unk> from RBC capital markets. Please proceed.
Thank you Jamie good morning, good morning.
Jamie.
You touched on the credit and how strong it is.
Particularly in the commercial real estate office I think when you guys look at the C&I portfolio is there anything on the horizon, whether it's I know that your leverage loan balances as you pointed out are down dramatically from 2016, what are you guys seeing or sensing on the scene in the C&I portfolio non CRE.
Yeah on C&I that was the driver of the NPA increase this quarter. So on the surface npa's were up seven basis points the sector.
That drove it the most within C&I would be restaurants entertainment as well as professional services.
With that said the delinquency levels.
In commercial and certainly in C&I continue to be benign.
Benign and Tim and I were.
Looking back at where we were on <unk>.
In the fourth quarter of 19, we were at 62 basis points versus the 51 that we're at today and if you look at the 10 year average for US we're at a 69 basis point average so while we're up that seven basis points sequentially, its really more of a normalization.
And we're still 25% or so below our normal run rate when it comes to commercial.
NPA, so it's really a normalization within some of these sectors and for us at least right now.
Yes.
Entertainment and professional services and high if I just add one.
Staying on that.
Scale is going to matter.
In the in terms of the clients that you bank in C&I, because if you think about the dynamics that are creating headwinds.
For the economy.
They are related to your ability to manage input costs.
Ore production.
And ultimately the higher.
Higher cost of carrying inventory to offset concerns around supply chain.
Our resiliency on an ongoing basis. So when you the sense you get IV when amount talking with clients is.
The manufacturing businesses and the businesses attached to the resurgence of manufacturing in the U S are doing really really well.
That businesses.
Our attached to more discretionary spending.
The larger clients have been able to pass.
Input cost increases higher cost of labor through.
The smaller ones are having a more difficult time and I think that arm wrestling, we're seeing going on right now as an example between the not for profit hospitals and the health.
<unk> healthcare.
Insurance companies is a really good example.
Where the larger not for profits are having easier ago.
Extracting concessions to cover increases in nursing costs, and otherwise and the smaller ones.
It's us it's been more of a standoff.
Very good and then as a follow up question Jamie in the outlook earned net interest revenue.
Obviously, you guys got it down a little bit but.
You bet to paint two scenarios one is the bullish scenario what would rates have to do where you could actually see maybe deposit beta news stall out faster or net interest revenue picks up and then what's the more cautionary view is at higher rates.
Frozen and five in a quarter, but we get the six five or something like that on fed funds rates in the first quarter of 2004 can you give us those two variables.
Yes, I would say that.
On the.
Positive side of.
Net interest income.
Yes.
The industry and the competitive dynamics settled down.
Over the next couple of months couple of quarters then.
We would expect that we would operate in that low to mid Forty's beta and that would deliver the higher end of our NII guide.
We're a little cautious, though and what we're seeing from a competitive standpoint as banks are clearly focused on driving.
More insured retail deposit growth and therefore, the retail beta is the wildcard in our guide and why we show the range of.
Deposit betas that could play out and therefore the range of the NII guide is a little wider than what we normally would do just given the uncertainty with how competition will react so in the near term.
That is the wildcard that perhaps retail deposit betas, which had been very well behaved actually double by the end of the year and that would take us to the low end.
Of the guide I think longer term when it comes to rates progressing beyond five in a quarter.
It really comes down to what are the credit implications as the fed reaches an even higher level. We think the magnitude of the rate increases have certainly created some shock.
Across the country and you saw that obviously in what we're calling the March madness.
But I think from an NII perspective, those higher rates could continue to be productive as long as the deposit beta dynamics stay in the 40% range, but if competition heats up in.
We get into a 60% plus.
Ada environment that would be unproductive to NII.
Very good thank you.
Our next question comes from the line of Ken <unk> from Jefferies. Please proceed.
Hey, guys good morning.
As you think further out I know, Jamie you had talked about that that trying to channel that downside NIM.
Obviously the rate environment has changed and all the points about the mix and the deposit growth.
As well, but just in terms of just how the how you expect the balance sheet mix to change over time, given that you are running down the securities book.
Your points about the DDA mix.
How do you just think about that NIM protection angle and does it make sense. Thank you does it make you think any differently about your the way you built the swaps portfolio and protecting that thanks.
Yes, we feel very good about how the balance sheet is positioned especially for a down rate environment.
Obviously, the swaps were very pleased with the entry points. There we've talked at length about in 2025, there'll be a nice increase to NII as the new swaps kick in in terms of the investment portfolio positioning.
We'll have a bit of a decline in the second quarter as we.
Adult reinvest cash flows but from there should be relatively stable. We may continue to reposition non <unk> and the level ones, but ultimately that'll be regulatory dependent.
But overall feel good about.
The bullet locked out nature of the structure that we have.
So I think for us it's going to be more of operating in a high seventy's loan to deposit ratio.
And continuing to maintain that while being very disciplined on credit which is why the loan growth.
<unk> was trimmed a bit.
That up up 2% to 3% level.
Got it and then on the same point about deposit repricing.
If and when the fed does cut and obviously a lot of banks are guiding with with the curve right now.
How does your models work in terms of.
Timing of fed cuts versus your ability then changed the direction of deposit pricing.
Yes, I mean in general it's going to be it's a balance of that nature of when the cuts actually occur.
And our foreign liquidity environment, where things still are relatively tight the fed has gotten inflation under control, but there is not a big credit event, obviously the measured cuts.
Would be one where youre going to have a little bit more challenging time.
Reversing all the beta youre still going to get some of the data out.
But in the scenario, where the fed is that having to loosen liquidity conditions pretty rapidly you're going to have an opportunity to get a little bit more aggressive on your rate cuts from there and get some more of that data out. So it really is going to be a little bit of a balance of how things play out. We've spent a lot of time positioning the commercial book in particular.
<unk> to make sure that we stay with the appropriate amount of price sensitivity. There. So that we can reprice down as necessary, we're up to about $20 billion of index deposits.
So we're taking a lot of actions to make sure that we're well positioned whether they stay high or if they cut that we've got the flexibility to navigate through those different environments.
Understood. Thank you.
Yes.
Our next question comes from the line of Erika and generation from UBS. Please proceed.
Hi, good morning good.
Good morning Erika.
My first question is on that.
Potential coming regulatory environment, and Jamie you probably need something so congrats on coffee for the question.
Okay.
The first is on.
CET one.
We generated 30 basis points of capital organically this quarter.
And I'm wondering as there is no NPR, yet, but the market is anticipating tighter capital and liquidity standards, Tim How do you think about the endpoint of capital for an institution like fifth third from this line in the quarter.
And how should we think about.
With that sort of endpoint is over the medium term.
Role as share repurchases.
Potentially more our Wi optimization sure I'm going to let Jamie start on that one Eric and then I'll follow so.
From a short term perspective, obviously pausing the buybacks and given the second quarter Guide we would expect.
To your point that we would continue to generate call it 25 basis points of capital.
Even.
With some <unk> growth in the second quarter.
I do believe that it will be dependent on what the regulations ultimately come out with in order to then answer the medium term part of your question because if I were king for a day I would not change.
<unk> opt out rules because this was not a capital.
Crisis, I think the capital regime works.
As stated but should they decide.
Either to eliminate.
Held to maturity enforce everybody in the <unk> and then force.
<unk> Mark for US the core earnings capacity of the company along with for the year. We included in the deck additional cash.
Capital accretion measures that we would.
Prove the OCI levels by 45% by the end of next year that it would be a manageable item for US. We just don't believe it's necessary, we have a balance sheet that.
Our target capital level is 9% all stress testing so as 9% is great but.
In this environment, we're going to.
Accrete capital here in the short term and we will get to 950, and hopefully have a little more clarity.
For everybody next quarter.
I think just did.
Add two thoughts our capital stress testing indicates you can run the bank and below 9%, which is the reason that hasnt been the binding constraint for US we just elect to do it at the level, we do because we like stability right.
And I think we were clear with everybody when we reset the capital target last year, we did it because we were concerned about.
Uncertainty in the outlook and we felt that it was prudent to start building capital early as opposed to having to do it later so.
Im pleased that our positioning I think more broadly.
One caution I would give everybody is I think some will take the discussion about.
The change in regulation on capital liquidity, and just bake it into models.
Without assuming that there is any sort of evolution in the business model.
The FDIC has been publishing quarterly data on the sector I think since $19 34 at least the dataset goes back that far.
And there has been more than one regulatory regime change during that period, and if you adjust for tax.
The tax policy at a given point in time the return levels in the sector have been remarkably consistent.
So to the extent that more banks are required to hold more capital or more liquidity or to change the structure of funding I think it's reasonable to expect that the business model is going to evolve.
As well.
Got it.
Raising Brazilian banks can be when there is some level targets right.
And just a follow up question to that fifth third manage this management team is sort of well known for being more forward thinking.
Whether it's your balance sheet resilience to what's been happening in the rate environment or that ACL ratio and.
As we think about like you mentioned, Tim sort of the market trying to force to regional banks in Q.
A tighter regime in terms of how they're valuing the stock versus what we know to be.
What tends to be a very slow regulatory process in terms of NPR comment period phase and how do you balance that sort of market demand for higher capital.
<unk> eligible debt greater cash liquidity.
Versus the.
The regulatory timeline and that we don't know nothing.
Okay.
Dan.
I mean I think the answer is you the way that you manage that proactively as you would've started doing something on each of those topics last year right. So we were in the market. After every earnings call last year four times.
And as a result have the lowest incremental need in the event that T. Lack had no phase in period right as an example.
You were deliberate about the way that you manage the ACL to reflect uncertainty.
And the forward outlook, and therefore year Kerry and good coverage today, right, which we certainly feel we are and you would have.
Allowed that yourself to accrete capital.
During a period when.
The market was certainly more robust for regional banks.
Which I think of course, we did as well I think lastly, what we're going to see here coming out of this even if there is no change in regulation as we all will flow.
Empirical data from March madness through our models and it's going to get paid a very different value for non operational money and operational money right and the byproduct of that is that the banks that have good core retail deposit franchises and who have.
Good commercial operational commercial franchises, so linked at payment activity Treasury management services and otherwise.
That is going to be the place that you want to be because while we think the fed obviously astral and at some point rates are going to stay higher than zero on an absolute basis, and our ability to make money on both sides of the balance sheet is going to be a big driver of HUD as well as there is more capital.
Acquired mineral liquidity requirements are higher.
Thank you.
Our next question comes from the line of Mike Mayo from Wells Fargo Securities. Please proceed.
Hi.
So you said you expect deposits to be stable or increase from here, but for NII to go down.
The second quarter.
Did I get that correctly, yes, sir.
So the driver on NII is really two fold one is the DDA mix.
Into interest bearing and then the second element of the guide is that.
The movement up in rates in March.
To have a full quarter effect of that.
Rate increase.
We'll bleed through into the second.
<unk> and then that'll be offset by some benefits from day count as well as some of the consumer loan growth.
And how are you.
Or are you, becoming more cautious firm wide and why.
Joe you trimmed your loan growth guidance down by 1%.
Yes.
In terms of maybe Extensile ratcheting that back are you preparing for tougher times or are you preserving the infrastructure for the potential for growth, but may be understanding.
Yes.
So I mean, you know ask Mike we like to try to tell the line, where we're at and company more than we are an oil company.
There's no question.
I think we all feel more cautious about the prospects for loan growth part of that is the fed's been abundantly clear theyre going to tamp down demand right no matter what it takes.
But I would note that the 1% decline for US comes on top of what I think was already in the lowest full year loan growth guidance. So we have been pretty cautious as it related to.
Loan growth and in terms.
<unk> expenses I think you noted the actions we took during the quarter, we continue to be surgical about pruning the branch network, which creates the capacity to invest in the southeast we had.
Little north of $12 million box and severance that rolled through attached to expense actions that were designed to take capacity out of businesses that we just don't believe we're going to need it given.
The outlook.
And I think the discipline that we have had which is we believe in self funding investments because it drives good discipline around capital allocation.
And effort.
It is going to be the same here. So we do not intend to pause the strategic investments, we're making in the southeast or the investments we're making in the technology platform those are going to be too valuable for the franchise.
In the long term, but we are not going to be spending money on a discretionary basis that we don't think is going to generate a near term return outside of our strategic investments.
And then last one I just it was interesting as you talked about you said you could go ahead and recognize your securities losses May impact has been manageable.
I guess, you could sell those or do all sorts of things with that do you have the capacity.
Yes.
How much more in key like would you need you said you've been in the market for the last four quarters.
And if you had to go ahead and do that and be the only bank that did that was that set you apart would that just be an economic.
Yes, just to clarify on the <unk> My comment was about the OCI should it be a capital requirement that we would have significant improvement based on the implied forward curve through the end of 2020 for about 45% of that would roll down the curve given the bullet structure of the portfolio not.
Necessarily selling at all so we do like the portfolio, but in terms of the T. Lac challenge at the at the end of the year.
Our gap to the 6% <unk> bank level would be about $4 billion.
<unk>.
For a bank our size that are certainly manageable and then the question then becomes.
What would the regulations change with what you would do with the proceeds so right now we're sitting on $10 billion of excess cash, which is frankly, the biggest driver of the NIM.
Erosion as we look forward on a full year basis, because of that $10 billion of excess cash.
Cost about 16 basis points of NIM and so if we were to issue 4 billion more than that.
Obviously, we would prefer to lend it to customers, but if the liquidity rules tighten and we have to hold a higher.
Greg YY liquidity buffer then we would be forced many of them just holding it in cash or buying more level ones and so it starts to become.
A challenge with the distribution of the proceeds when you say what would it set you apart and what your earnings profile improve.
Ed.
I think it would just be a gross up of the balance sheet and really not productive and so that's why we haven't done it.
No Thats clear lastly, $4 billion gap for key lag how much have you issued or <unk>.
We havent issued any this year, but total long term debt is $13 billion right now.
Yes, Mike. Thanks, Mike. This is Brian that's about six 6% of assets pre Covid, we were at 9% of total assets and that gap is about $5 billion. So we're just getting back to levels, where we were before COVID-19. So that T lab requirements. There is not a big deal for us relative to our historic balance sheet structure.
Great Alright, thank you.
Our next question comes from the line of Jam from Carey from Evercore. Please proceed.
Good morning, Good morning, John .
Just a question on the Securities book I. Appreciate the detail you gave on slide 25 on the commercial mortgage backed securities I know there are 52% of your Securities book.
Could you maybe give us an update there are you seeing any stress there in terms of the performance of those securities.
Commercial real estate stress and then what type of.
Yes.
<unk>.
Other than temporary impairment in that portfolio.
Absolutely Bryan again, so you need to break the C. MBS portfolio into two components the agency portfolio, which is effectively and as Fannie Freddie and Ginnie guaranteed so that portfolio looks just like our MBS than many people are invested in so from a credit perspective, no issues on $29 billion of that.
Portfolio.
Its GSE guaranteed the non agency portfolio, which is only $5 billion. It is all Super senior AAA rated and we perform very significant analysis from a stress perspective and from an underwriting perspective every time that we buy in and as well as when we monitor the portfolio.
To give you some color on our recent stress test that we performed we assume a 50% decrease in property values across all of the underlying properties within these structures.
And even in that scenario, we would record we would realize no losses on that portfolio and still have 23% hard enhancement.
The office loans within that portfolio or about 30% of the underlying loans. If we assume that from a weighted average perspective that dose office loans that the underlying properties would experience a 90% decrease.
That's when we would get to our first dollar of credit loss on that portfolio. So we feel very confident and there would be significant loan losses across the entire industry before we'd even recognize our first dollar loss on this on the structure associated in this portfolio.
Got it. Thank you that's very helpful.
And then separately.
Just wanted to see if you can update us on the status of your core systems conversion.
The March madness at all impact.
Progression of the conversion of the timing of the expected conversion and then lastly can you maybe help us with.
The sizing up of the cost of the conversion and how much is expected to be capitalized.
Yes, John its Jamie Thanks for the question.
As you saw in the expense numbers. This quarter. We did have continued ramp up in technology costs that ultimately is a good thing because it means.
We're getting things accomplished and we continue to track on all of our deadlines for this year, we have new ledger going in in the third quarter, followed by CD platform as well as continued rollout of the <unk> platform across the commercial business and then.
We're really at this point about halfway through the game because 2024 2025 has additional deadlines.
Associated with it on ATM and TM billing as well as the core checking conversion, but so far so good.
We do capitalize and follow the appropriate accounting standards on the total spend here.
I think the spend over a multiyear period.
Reach as much as $100 million of which.
Sure.
Well less than half would be capitalized.
Got it thank you Jamie very helpful.
Our next question comes from the line of.
<unk> <unk> from Morgan Stanley . Please proceed.
Hey, good morning.
I was wondering if you could give us some more color on.
Why you expect deposits to grow as we get into the remainder of the R.
What do you see in your online account openings and conversations with clients.
That gives you the confidence in that outcome.
I guess my.
My question is why shouldn't some of these new deposits just go back to the banks.
They have longer relationships, so what the volatility in the system settles out yes.
Yes. Good question. So I don't think we took a lot of deposit share from banks.
That were non operational in nature of the new accounts that we opened Manhattan or linked to Treasury management sales.
And inclusive of our embedded banking business and where it had been on the sales pipeline in some cases for as long as 18 months and there had been technology work that ended up getting accelerated.
In a handful of other places like we do a very good business with payroll processors.
We were a net beneficiary of folks who need it.
Payments infrastructure that fifth third provides and those relationships, which were not on the sales pipeline previously moved.
And because they're embedded in the day to day operations of the business they tend to be very sticky.
<unk>.
I mean look the EAP.
Kind of have to go back to first principles for us on the deposits to say why do we believe that we can continue to be stable or to generate a little bit of growth. So a big part of the growth that we're generating on the retail side is coming out of that.
It's sort of sustained primary household growth that we've been able to generate.
We've run in the 2% to 3% range for several years now we breached 3% in the first quarter.
We're running faster than that and that is led by the southeast markets, where I think the year over year growth rate was like seven 3%.
So very significant there in addition to that the branches. We've added in the southeast are driving really really strong growth. So if you look at the southeast overall same store sales and deposits were.
We're plus 5% a.
Year over year for the quarter. If you include the de Novo's, the markets like North and South Carolina, Georgia, and Florida in totality grew at.
10% year over year, and if you just annualize the first quarter.
In the fourth quarter they grew 20%.
In terms of deposits, so really strong production come in from those investments.
And then I think we've talked a lot about the treasury management business, but that on the commercial side of the equation continues to be the thing that is the driver we have a disclosure in one of the slides here on.
The percentage of commercial relationships that are linked to treasury management, it's about 88%.
If memory serves maybe slide nine.
And then the length of that balanced weighted average relationship 10 year and commercial is 24 years. So we're not talking about people who were parked money here because we were a ratepayer I think we have only about a half a billion dollars in total in all deposits in the bank that are priced ahead of fed funds and its reasons.
To assume that whether it's because of the fed raises or because we take other actions that that number is going to be zero by the end of June . So we just have a very stable deposit base. The growth is coming from investments that are multiyear in nature and that are proven in terms of their ability.
To support the company and very little.
Deposit gathering activity.
That would've been an economic relative to alternative funding sources less than that $5 billion I believe in total.
Got it very helpful and then maybe as a follow up.
The response to this is the same but as I.
Looking at the deposit beta assumptions on slide 11.
They look pretty conservative relative to the rest of the street, but if I look at the slope of that line is flattening as we look into the forecast period. So why shouldn't we expect the same rate of change that we've seen more recently.
Our base view as I said in our prepared remarks or the midpoint of our guide is a 47% beta.
And that is really driven by.
Our assumption that the battle for retail deposits continues to be very competitive and that that retail beta actually doubles over the course of the year.
If that were to not happen then we would be at the low end so.
On the commercial and wealth and asset management side, the betas have been running.
65% to 70% in those betas will flatten out as the fed stops hiking, so part of what's assumed in the slide.
Is that the fed gets to $5 25, and stops and so that would have a flattening effect.
And the reality here is that there is a lot of uncertainty as to how competition is going to behave over the next several quarters and you can see on the slide thus far we've done well versus the industry from a deposit beta standpoint, but.
We definitely want to.
Defend our book as well as continue to have strong new customer acquisition.
Got it thank you.
Our next question comes from the line of Ebrahim Quinoa from Bank of America. Please proceed.
Hey, good morning.
Good morning, Brandon.
Just two quick follow ups one.
Okay.
I think Jamie you mentioned.
About 80%, 80% <unk> unemployment, 12% give us a sense of just sensitivity net 12% were to be five what does that mean for you.
So the consumer allowance, yes, the ACL would go up $250 million for every 1% assuming all other assumptions stay as is.
Okay helpful and.
A quick follow up going back to Tim's comments on capital and Matt given just the uncertainty around regulations Mac macro economy, the nine and a quarter CD one leg deal.
Should we anticipate that <unk> hired at least for the next few quarters until there's more visibility or do you expect to be more proactive and to turn back to sort of buybacks in the back half of the year, Yes, I think.
Just given the guidance that we provided if you assume no buybacks in the second quarter, which is right. It would imply we get to 95% by June 30.
Hey, Brian .
Jamie and I, both feel confident we can run the business at nine and a quarter. It just feels prudent at this point in time.
Make sure that the environment does fully settle out before we resume repurchases.
And just on the environment I think last quarter, you talked about things are worsening maybe back half of this year into 24 do you have any better visibility in terms of just the shape of the credit cycle.
How deep it could be and just when do you begin to actually see the first sort of deterioration show up in the numbers and credit metrics.
We continue to think the back half of this year to the beginning of next is probably the right period I think we.
Have been operating under the belief that some of the Rosa year data that came out in the winter was a little bit of a head fake because you had unseasonably good weather and the byproduct of that.
Was your AD spending.
And a variety of under other indicators.
Flash more positive than I think people had anticipated and in part that's why.
You saw the fed ramp up rhetoric again.
The ISS indices are from my point of view the best thing to watch here. They certainly are.
And our footprint and they all are signaling a slowdown.
And the fed is not going to be able to rollout and get inflation under control just based on what we hear from clients without sticking at five plus level for some extended period of time and when that happens that's very restrictive right things are going to break.
Sure.
My own view is that this is light we are likely to return to a period that.
Where theres more regional divergence than <unk> seen.
In the.
Most recent two cycles.
I am very happy to be Midwest, and southeast bank as a moment like the data that's come out of the census Bureau.
Spending on factories right, we had 108 billion in spending in factories last year, which was an all time record.
Financial times did nice work on commitments that have been made there is more than $200 billion in capital commitments. This is all stuff that's tied to the two trillion dollars.
That the government intends to invest in rebuilding supply chains here in the U S and.
If you just look at the manufacturing jobs that were added last year like there were 348000 manufacturing jobs added in the U S.
Compared to I think 6000 in 2010 as an example in 60% of those were in our footprint. So.
The markets that are going to benefit from the government investment in infrastructure and domestic supply chain.
And that sort of broader trend and re shoring are going to do better than markets that were more reliant on technology.
And professional services or does that have more profound challenges as it relates to state budget deficits.
Add challenged city centers, there just is going to be a divergence that materializes there.
So I at least think you should be more focused on regional economic data.
Then on the economy overall, as you think about where losses may materialize.
That's great color. Thanks Kim.
Our final question comes from the line of Christopher Merrimack from Janney Montgomery Scott. Please proceed.
Thanks for taking my question, Tim just wanted to ask about dividend finance kind of skewing the loan growth. This year, maybe in a positive way to where the loan growth ex dividend is very conservative is that a fair way of thinking it through.
Yes.
Yes.
The two areas of the portfolio, where there is any material loan growth. This year, Chris sorry, the dividend finance that portfolio as we see the benefit of the balances rolling on because we our portfolio and their production. They were originated sell before we bought them.
And then in C&I, which is really the AG good core steady production in the middle market, where I am a part because of the dynamics around manufacturing youre seeing really solid production out of our legacy markets in the Midwest.
And the continued growth and provide right, which is of course linked to healthcare and primarily <unk>.
Non elective dental.
And then.
Got it and then the rest is just rolling off and not.
<unk> enable are in modest decline.
Got it very well thank you Tim I appreciate it.
I would now like to turn the call over to Chris <unk> for closing remarks.
Thanks, Marty and thanks, everyone for your interest in fifth third please contact the IR Department. If you have any follow up questions. You can now disconnect the call.
Thank you ladies and gentlemen, this does conclude today's call. Thank you for your participation you may now disconnect.
Okay.
Yes.
[music].