Q2 2023 Fifth Third Bancorp Earnings Call

Good morning. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the 5th, 3rd, Vancorp 2nd Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session.

If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press the star one. Thank you. Chris Dahl, Head of Investor Relations, you may begin your conference.

Good morning, everyone. Welcome to fifth, third, second quarter, 2023, earnings call. This morning, our president and CEO Tim Spence and CFO Jamie Leonard will provide an overview of our second quarter result and outlook. Our Treasurer Brian Preston and Chief Credit Officer Greg Shrek have also joined the Q&A portion of the call.

Please review the cautionary statements in our materials which can be found in the earnings release and presentation.

These materials contain information regarding the use of non-GAAP measures, reconciliation to the GAAP results, and forward-looking statements about fifth-thirds performance.

These statements speak only as of July 20th, 2023, and fifth third undertakes no obligation to update them.

Following prepared remarks by Tim and Jamie, we will open the call for questions. With that, let me turn it over to Tim.

Thanks, Chris, and good morning, everyone. Before we get to the quarter, I'd like to welcome our new Chief Credit Officer, Greg Schreck, to the call. Greg has been a part of Fifth Third for 35 years, and during that time, you've seen more than a few credit cycles.

He previously held leadership roles in both credit risk and the line of business, including serving as our Chief Commercial Credit Officer for several years and as our head of leasing, asset-based lending and structured finance.

We're fortunate to have them as part of the Fifth Third Executive Team.

Despite heightened market volatility over the past four months, Fifth Third has delivered consistent top quartile financial results while investing strategically to position the bank for the long term.

Our operating priorities have been and continue to be stability, profitability and growth in that order.

Earlier today we reported second quarter earnings per share of 87 cents, excluding items noted in the release.

A 10% increase compared to the year ago quarter.

Adjusted revenue increased 9%, reflecting our diverse fee sources and resilient balance sheet.

Expenses increased 4% excluding items noted in the release. And credit quality was strong with net charge offs and early stage delinquencies remaining below normalized levels. And credit quality was strong with net charge offs and early stage delinquencies remaining below normalized levels.

Our key return metrics improve even as we increased our capital levels and credit reserves.

We generated an adjusted return on assets of over 1.2%, and adjusted return on tangible common equity, excluding AOCI of 15.4%, and an efficiency ratio below 55% for the quarter.

These will be important bell-weather metrics for all banks as we adapt to impending regulatory changes.

Deposits continue to be in focus for the entire sector in the second quarter.

Fifth third total period end deposits increased, 1% sequentially, and increased 2% year over year, has compared to a 5% decline for the H8 over the same period.

Our Consumer Banking and Commercial Banking Business segments both generated period end deposit growth.

Given the year-over year decline in deposit system wide, it's reasonable to ask how fifth-third has continued to outperform.

The answers are deliberate multi-year strategies to expand distribution in our Southeast markets, to launch innovative operational deposit oriented solutions, like momentum banking and our Treasury Management offerings.

We have added over 70 de novo branches in our southeast footprint since 2019, more than any other bank except JP Morgan. As a portfolio, these branches are outperforming their original business cases on deposit production with several producing at a rate of 200 to 300 percent of plans. In consumer, we generated year-over-year net household growth of 3 percent once again this quarter, continuing a strong multiyear trend and punctuated by 7 percent year-on-year growth in the southeast.

and continued success in our momentum banking product. In commercial, we have added a record number of new quality middle market relationships this year, up 30% from 2022. We have added a record number of new quality middle market relationships this year.

Our embedded payments business, New Line, has also been a strong catalyst for deposit growth.

We expect the environment in the back half of the year to remain highly competitive for deposits.

While we will continue to protect our house relationships and manage to a strong and stable liquidity profile, we will not manage a rational price and competition in a way that prioritizes head-line growth over profitability.

Turning depending regulation, we are taking steps to adapt our balance sheet and anticipation of higher capital and liquidity requirements across the industry.

We finished the second quarter with a CET1 ratio of 9.5%, having accreted around 90 basis points of capital from retained earnings over the course of the past year.

We are balancing three capital priorities.

Continuing to build capital on accelerated pace.

supporting a dividend increase in the third quarter subject to board approval, and supporting clients to drive organic growth.

including reducing our indirect auto lending origination volumes by approximately 15% through the exit of non-core states.

trimming outside lines, and closely evaluating select areas of our corporate banking business.

While we acknowledge the market's more optimistic outlook, we remain vigilant on the potential for a recession in 2024.

Our commercial clients continue to perform well, but they are being cautious by slowing their growth plans. Many are closely watching the impact that regulation may have on credit availability and pricing.

Consumers have held up well in aggregate, but there has been a divergence between homeowners, who were able to lock in historically low mortgage rates, and renters, who have had to face persistent inflation in their largest monthly expense.

Compared to three years ago, homeowners in our deposit base have maintained strong deposit balances, whereas renters deposit balances are down meaningfully.

I want to thank our nearly 20,000 employees for their unwavering commitment to serving clients in our communities.

Last year you volunteered more than 117,000 hours to community organizations and you provided leadership to roughly 1,200 not-for-profit boards.

Didier Hardwork, we have already delivered nearly $30 billion of our 10-year, $100 billion commitment to provide affordable housing, access to essential services, and renewable energy. In June , we celebrated Fifth Thirds 165th anniversary, given the current pace of technological and regulatory change.

and the logical questions about market structure and competitive models that follow. It was an interesting time to reflect on our history and what it could tell us about this moment.

Since 5th-thirds founding in 1858, the company is withstood a civil war, two world wars, two global health pandemics, and 33 recessions.

The company adapted its business model to take advantage of technological innovations, including the telephone, electric light bulbs, the automobile, and the internet.

We were an early adopter of the wire and ACH windows, anchored the rollout of the credit card networks in the Midwest, invented the networked ATM, and were one of the 15 initial launch banks for Zelle.

We witnessed the creation of the OCC, the Federal Reserve, and the FDIC, and have continued to thrive through many different regulatory regimes.

I believe that companies that stand the test of time develop a character of their own that extends beyond the people who work there.

Fifth Third's character is rooted in hard work, ingenuity, an insistence on excellence, and a sense of responsibility for the communities we serve.

I'm as confident as ever in fifth-thirds positioning our ability to outperform through the cycle and to deliver innovations that improve lives for all our stakeholders. And frankly, I'm just thankful to be part of the team that will steward the bank into the future.

With that, I'll now hand it over to Jayme to provide more details on our financial results in Outlook.

Thank you, Tim, and thank all of you for joining us today. Our second quarter results were once again strong, despite the market headwind.

We achieved an adjusted efficiency ratio of just below 55%, which is a four point improvement compared to the prior quarter.

Our second quarter adjusted PPR grew more than 8% compared to both the prior quarter and year ago quarter driven by the continued diversification and growth of our fee revenue streams combined with disciplined expense management throughout the bank.

That interest income of approximately $1.46 billion increased 9% year-over-year.

but did decline 4% sequentially.

Our sequential NII performance was the result of our deliberate actions to grow on balance sheet liquidity, to support a defensive balance sheet position given the uncertain macroeconomic outlook and tightening liquidity conditions.

Interest-bearing deposit costs increased 54 basis points to 2.3%, which represents a cycle-to-date beta of 45% on interest-bearing deposits, which includes the impact of CDs.

Adjusted non-interest income increased 2% compared to the year ago quarter, with increases in mortgage fee income and commercial banking revenue, partially offset by a decline in deposit service charges due to the impact of earnings credits from higher market rates and the elimination of our consumer NSF fees in July of last year.

Adjusted non-interest expense increased 10% compared to the year ago quarter. As elevated compensation and benefits expense was driven by non-qualified deferred compensation costs, the minimum wage increase that went into effect in July of 2022, and continued investment in dividend finance.

Additionally, expenses increase from higher technology and communications expense and the impact of the increased FDIC assessment that began in January .

Excluding the impacts of non-qualified deferred compensation, which are offset by a gross up in securities gains, the FDIC assessment increase and incremental expense growth from dividend finance.

Total underlying expenses increased approximately 4% compared to the year ago quarter.

Moving to the balance sheet, total average portfolio loans and leases were stable sequentially in both commercial and consumer portfolios due to our continued discipline with respect to client selection and optimizing returns and also reflecting softening demand.

The Period N Commercial Revolver Utilization Rate of 35% decreased 2% compared to last quarter.

C&I balances were flat compared to the prior quarter. The strong middle market loan production and muted payoffs were offset by the lower revolver utilization.

Corvall banking production was also tempered due to our focus on optimizing returns on capital in this environment and lower customer demand. Average total consumer portfolio loan and lease balances reflected growth from dividend finance offset by decline in indirect auto and residential mortgage.

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, consumer deposits increased 1% and commercial deposits decreased 1%.

while wealth and asset management deposits decline 12%, reflecting the impact of tax payments, as well as clients' alternative investment options.

June activity reflected continued momentum, such that period and total deposits were up 1% compared to the prior quarter.

Notably, we have grown deposits 2% since the end of last June , compared to a 5% decline for the top 25 banks, as shown in the Fed's H-8 data.

Moving to credit.

As Tim mentioned, credit trends work stable with our key credit metrics remaining below normalized levels.

The net charge-off ratio of 29 basis points increased three basis points compared to the prior quarter.

The MPA ratio of 54 basis points was up three basis points compared to the prior quarter.

In consumer, we have focused on lending to homeowners, which represents 85% of our consumer portfolio.

We have also maintained one of the lowest overall portfolio concentrations in non-prime consumer borrowers among our peers.

In commercial, we have maintained the lowest overall CRE concentration as a percent of total loans relative to peers for many years.

Within CRE, we have limited office exposure with a low and improving criticized asset ratio and almost no delinquencies. We continue to watch office closely and believe the overall impact on Fifth Third will be limited.

We had de-emphasized office even before the pandemic, and we are not currently pursuing new office CRE originations.

From an overall credit management perspective, we have continually improved the granularity and diversification of our loan portfolios through a focus on generating and maintaining high quality relationships.

As many of you know, we have been and remain cautious in our economic outlook.

We tightened underwriting standards during COVID, including stressing credits to an up 200 basis point scenario off the forward curve, which limited our growth, but improved the stability of our balance sheet.

Since we began tightening underwriting standards, roughly 90% of our commercial portfolio has been re-underwritten.

Our criticized assets have been stable over the past several quarters. Across all loan categories, we continue to closely monitor exposures where inflation and higher rates may cause stress. Moving to the ACL, our reserves increased $87 million, reflecting the impacts of dividend finance, which candle such mosquitensoley

and Moody's macroeconomic forecast, which eroded slightly. The ACL ratio increased nine basis points sequentially.

As you know, we incorporate Moody's macroeconomic scenarios when evaluating our allowance. The base economic scenario from Moody's assumes the unemployment rate reaches 4.3%, while the downside scenario incorporates a peak unemployment rate of 7.8%. We maintained our scenario weightings of 80% to the base and

earnings generation. Our tangible book value per share excluding AOCI increased 11% compared to the year ago quarter.

We continue to expect a meaningful improvement in our unrealized loss position assuming the forward curve plays out. Resulting in approximately 36% of our current loss position accreting back into equity by the end of 2024. And approximately 50% by the end of 2025.

Looking forward, we expect to build capital at an accelerated pace given our RWA optimization initiatives and by extending our share buyback pause. As Tim mentioned, we will postpone repurchases until we have more clarity on the regulatory environment in order to determine the new level of required capital dollars.

Assuming we do not buy back shares through year end, we would anticipate a creating capital such that our CET1 ratio ends this year at or above 10%.

Moving to our current outlook.

We expect full year average total loan growth between 1 and 2%, which reflects our cautious outlook on the economic environment and our decision to proactively adapt our balance sheet to the new regulatory regime.

We expect total commercial loans to increase in the low single digits area compared to 2022, which implies a decline in the second half of the year relative to the first half.

This outlook assumes the revolver utilization rate of 35% in the second quarter remains stable throughout the remainder of 2023.

Our commercial loan outlook also assumes that we meaningfully reduce originations in certain areas of the commercial franchise, predominantly in the corporate bank, to meet our higher risk adjusted return thresholds.

while continuing to increase originations in our core middle market business.

We expect total consumer loans to be stable to down slightly from reduced originations of the lower yielding, out-of-footprint auto and specialty lending channels combined with portfolio residential mortgages partially offset by growth from dividend finance.

We currently expect to originate approximately 4 billion dollars in dividend loans for this year, which is a modest decrease from our previous expectations. We continue to expect to grow deposits in the back half of 2023, assuming stable or even slightly tighter market liquidity conditions.

consistent with our track record over the past year of taking market share and maintaining high levels of core operating relationships in both consumer and commercial.

Within that, we continue to expect migration from DDA into interest-bearing products throughout the remainder of 2023, with the mix of demand deposits to total core deposits declining from 30% in the second quarter to 27% by year-end, as we discussed last month.

For the third quarter of 2023, we expect average total loan balances to decline one to two percent sequentially, with commercial down in the low single digits area and consumer stable to slightly down. We expect average deposits to be up one percent on a sequential basis impacted by our strong finish to the second quarter.

some seasonal uplift, and the benefits of our multi-year investments in the franchise that Tim discussed earlier.

Shifting to the income statement, we estimate full year NII will increase 3 to 5 percent, consistent with our comments from the mid-June investor conference.

Our NII guidance assumes a cumulative beta of 53% by the fourth quarter, assuming an additional 25 basis point rate hike in July , and no further rate movements in 2023.

Our outlook translates to total interest-bearing deposit costs increasing around 40 basis points in the third quarter and another 15 basis points or so in the fourth quarter.

Our guidance assumes that our securities portfolio balances remain relatively stable between now and year end.

As a byproduct of our strong deposit growth combined with lower loan growth and stable securities balances, we expect to hold closer to $15 billion in cash and cash equivalents by year-end.

We expect our loan to core deposit ratio to end the year in the mid-70s area, which will keep Fifth Third in a strong liquidity position in anticipation of more stringent regulatory requirements.

We expect third quarter NII to be down approximately 2 to 3 percent sequentially due to the continued impacts of the balance sheet dynamics I mentioned.

We expect adjusted non-interest income to be stable in 2023, resulting from continued success increasing market share due to our investments in talent and capabilities.

with stronger gross treasury management, capital markets, wealth and asset management, and mortgage servicing revenue to be offset by higher earnings credit rates on treasury management, subdued leasing remarketing revenue, and a reduction in other fees due to lower TRA and private equity income this year.

We expect our fourth quarter TRA revenue to decline from 46 million in 2022 to 22 million in 2023. We expect third quarter adjusted non-interest income to be down 3 to 4 percent compared to the second quarter.

We expect to continue generating strong revenue across most fee captions.

which we conservatively assume will be more than offset by a slight erosion in debt capital markets and mortgage revenue.

reflecting the environmental headwinds as well as lower other non-interest income. We continue to expect full year adjusted non-interest expenses to be up four to five percent compared to 2022.

If capital markets fees improve relative to our current expectations, we will likely land at the upper end of the range.

Our expense outlook incorporates the FDIC insurance assessment rate change that went into effect on January 1st, the mark to market impact on non-qualified deferred compensation plans, which was a reduction in 2022 expenses but an increase in 2023 in the full year impact of investments to grow the dividend finance and provide businesses.

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 in the run rate benefits from the severance expense recognized in the first half of the year, which reflected proactive actions taken to reduce ongoing expenses given the operating environment.

We expect third quarter adjusted non-interest expenses to decrease one to two percent compared to the second quarter.

In total, our guide implies full year adjusted revenue growth of 3 to 4 percent. This would result in an efficiency ratio around 56 percent for the full year.

We expect full year total net charge offs to continue to be in our previously stated 25 to 35 basis point range.

However, as you would expect with normalizing credit costs in this environment from record low levels, there may be a little lumpiness in C&I in the second half, such that total bank or third quarter losses are expected to be 35 to 45 basis points.

and then fourth quarter losses improving relative to the third quarter. Given our reduced loan growth outlook, we expect a lower quarterly build to the ACL in the $25 to $75 million range, assuming no significant changes in the underlying Moody's economic scenarios.

This considers strong production from dividend finance of around $750 million in the third quarter which as you know carries a higher reserve level.

In summary, with our proactive balance sheet management, disciplined credit risk management, and commitment to delivering strong performance through the cycle, we believe we are well positioned to continue generating 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 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 press star then the number one on your telephone keypad. And your first question comes from a line of Scott Cyphers from Piper Sandler. Your line is open.

Morning, everyone. Thanks for taking the question.

for taking the question. Morning, Scott.

Good morning. Jamie, the first question I wanted to ask is, and I think if I've done the math correctly, the fourth quarter NII could kind of level out, even at the low end of the range, could kind of level out or at least really slow the rate of decline. I guess in your view, what would allow NII to find a bottom at that point? I guess I asked…

environment with the Fed in our forecast, the assumption being that the Fed reaches five and a half percent and holds and therefore by the end of the fourth quarter we've gotten through all of the repricing lag that would occur so that, you know, right now the third quarter guide is down two to three percent and then the full year guide implies...

And I guess coming out of listening to some of the other earnings calls, the one comment we would have is that our June , like everyone else's, was quite strong and could, and I think to the point you're headed, could result in better NII outcomes than what our guide reflects.

but from our standpoint, spotting one robin doesn't make it spring, and therefore, we're going to continue to be cautious in the outlook and play defense in this environment. We've got a long way to go from the liquidity conditions tightening with QT at 80 billion a month, trillion five or more of Treasury issuance, the student loan.

as it relates to the reserving needs, which look less in the second half in aggregate than in the first half. No change to the reserving needs for dividend, right? I think you mentioned that's just due to the slower anticipated commercial growth.

The correct in that the dividend reserve coverage ratio we're assuming remains in that 9% area. The reduction in the guide for the ACL build is driven by all of the loan production.

changes that we are forecasting with the RWA diet and reducing the balance sheet for the new capital regimes that will be forthcoming.

Perfect. Okay, good. Thank you very much. I appreciate it.

And your next question comes from a line of Erica Najarian from UBS. Your line is open. Morning Erica. Hey, good morning. My first question is for Jamie. You know, according to your first quarter queue, we're down 100 basis points parallel, I believe.

your NII would be up 44 basis points over a full year. A lot of investors are now thinking about the potential for a Fed rate cut in one through 24. So I'm wondering if we think about that four through 23 exit rate in NII, all else equal, do you expect relative stability in NII if in the scenario that...

that. Well now you've just given me publicity that I'm gonna have to live up to. I've given you a 2024 NII guide. I'm trying. I'm trying.

There's no question that Brian and I have positioned the balance sheet to be. Currently neutral to benefiting for the rate cuts when the rate cuts ultimately occur.

The down rate scenarios continue to be the most difficult for a bank earnings profile to manage as credit costs would ramp up and recession kicks in so For us, I believe that the deposit cost pressures will mitigate as the Fed begins a cutting cycle We just don't see that happening this year, which is why the guide on NI-

2024 so I don't think there's necessarily a gap at this point in time, but 2024 is a very long way from July 20th Understood and my second question maybe is For Tim, you know, it took a lot of years of hard work, but you know sister has put itself in a position where

You're not talking about taking expenses down next year. You're not talking about RWA mitigation. And while I'm sure there's something on LCR and long-term debt as those requirements come in that you're working on, that doesn't seem to be something that would change strategy. The question really here is, as you think about what the third is positioned.

And there seems to be now appreciable differences on how peers are positioned for this sort of new world order. How are you going to take advantage of it from a market share perspective?

Yeah, that's a good question, Erica, and I appreciate it. I will say, I think all of the things that you described, the RWA diet, a continuous focus on expenses, thinking about liquidity profile, and in particular the value of different sorts of deposits in the new world are all things we're doing here today. But we have the benefit of having made.

you know, multi-year investments in either asset classes or in particular on the operational deposit side of the equation that are benefiting us in this environment and they're gonna continue to be very valuable going forward. I think narrowly the hardest thing on an organization if you're trying to deliver predictable long-term results is to have to move into a bend.

in the door and the byproduct of that is your cuts end up being concentrated in the areas you are investing for future growth, one. Two, your people actually become more reticent to stretch and to try to achieve better outcomes because they don't want to get outsized and have to work backwards. So I think... circle over walking forward and...

What the advantage we're gonna have next year and the year after that and the year forward is our ability to be consistent about investing in the franchise. And that'll mean that we stay on the pace that we've been on the last several years in building branches. It will mean that we continue to add to the middle market teams because I think the economics of these middle market banking relationships are gonna continue to be excellent regardless of what happens, capital and liquidity.

And we're going to continue to focus on having the best retail deposit franchise and best treasury management franchise in our peer group.

and we're gonna continue to focus on having the best retail deposit franchise and best treasury management franchise in our peer group. Got it. Thank you.

And your next question comes from a line of John Pankari from Evercore. Your line is open. Morning. Morning, John .

On the back to the low loss reserve, just to clarify, the 25 to 75 million bills in your per quarter in the back half for dividends in the end, that again is is for growth expected and dividends in it, but it's no change in the reserve ratio that you're assigning to that business.

Yeah, and let me clarify one thing from what you said that just to make sure we're on the same page. Our guide for the ACL is for the total bank or balance sheet. However, the primary driver of that ACL build is dividend. Dividend we expect to do 750 million a quarter of production, that reserve rate.

shrinking other parts of the balance sheet, inclusive of auto where we exited the states west of the Mississippi, but for Texas, combined with our efforts in shrinking the corporate banking block will result in a lower ACL bill than what we've been running at this year because those other businesses.

Okay, no, that helps a lot. And then separately on the credit front, can you just talk a little bit about your C&I portfolio and how that's been performing just as we've started to see some larger bankruptcies develop. I'm curious how the book is performing on the C&I side. And I know you mentioned that

90% of your commercial book has been re-underwritten. How does that typically work with shared national credits? I know they're about 30% of your book. So how does the re-underwriting work for that portfolio? Yeah, let me start, and then I'll turn it over to Greg Schreck to add a little bit more color. But in terms of, you know, as we discussed in the...

Outlook, we continue to have a total bank or charge off guide in the 25 to 35 basis point range within Commercial over the past couple of years. It's obviously bounced around from 36 bits in 2020 down to 10 bits and 21 then 13 bits last year and this year on commercial

we continue to be in that 20 to 30 basis point range. And then within total commercial, CNI is expected to be at the high end of that range given some of the lumpiness that we're seeing, a few credits that resulted in a little bit of that uptick.

in the NPA ratio at the end of the quarter. But with that, turn it over to Greg for thoughts on CNI underwriting and other views. Yeah, I agree with Jamie. First of all, the portfolio monitoring really doesn't change whether it's a SNCC, a CNI loan, regardless. We have a robot.

I still feel really good about the middle market. As Jamie said, we're gonna have some lumpiness. You've probably seen our guidance into the third quarter from a charge-off perspective. The headline there, I think, is twofold. A, we're starting from a very low base, and so because of that low base, one or two loans can move the needle, and that's exactly what happened. We've got to make someculation in that chart there.

Very helpful, thank you so much. Your next question comes from the line of Ken Houston from Jefferies. Your line is open. Hey Ken.

Hey, thanks. Good morning guys. I just wanted to ask on the securities book, I know you guys do daily LCR calcs and you got still the two-thirds portfolio in the locked out and bulleted, as you contemplate what the LCR requirements might look like, and I know we're going to learn that soon, do you think are you comfortable with the structure of the portfolio and meeting any push down requirements to category four?

Yeah, Ken, great question and embedded in all of our comments and outlook today, we should have outlined the strategy that our approach here for our company is that we fully expect TLAC to get pushed down.

We expect the more draconian capital rules on ops risk to get pushed down, but not any of the benefits from the credit rating, credit risk weightings. And we expect to have to be compliant with the full LCR. So that is the underpinning of all of our strategies for managing the balance sheet, and we want to do that expeditiously.

therefore we are going to be holding higher levels of cash. We will be rotating more into level one securities, but we love the bullet locked out structure because that provides the shock absorber to a potential low-rate environment.

AFS inclusion, HTM exclusion, and so we may have to pivot a bit on the HTM classifications given that we've not done anything to date, but that might be an outcome from the brave new world that we will have to adapt to.

Right, and I guess in the near term with rates high, the move to cash is actually helpful, right, because you're now earning five and change versus the average yield of the book, which seems like it's kind of just held in. So, it's fair to say that that's kind of what we expect to see as the securities book for now just continues to shrink back down. And as to your point, would you see that cash build continue? Yeah, what we did in the second quarter was we let the portfolio cash flows of 600 million.

cash or treasuries.

Okay, and if I can ask one quick one, in terms of your deposit growth outlook and the higher beta assumptions, I know you talked about 3% year over year household growth. I guess?

Can you parse out deposit growth just coming from the franchise as opposed to pricing up to get it?

Yes, it's just that.

there is several factors impacting that. So in terms of consumer, on the household side, we do have very strong and consistent growth of 3%, but offsetting that tailwind is the headwind from the consumer spending and the declines in the average deposit balance. So when you look at the consumer, the average consumer is $1,000,000, $3,000,000, $3,000,000, $3,000,000, $3,000,000.

deposit is still 20% higher than pre-COVID levels, but it is down 10% from the COVID average balance peaks. And so we're modeling that that erosion does continue and therefore creates a little bit of a headwind. So for us...

The majority of the growth is obviously coming from the southeast de novo markets and they're growing at the 7% rate but the Midwest whether it's a source sales or the total Midwest networks growing households at 2% so we like what we've been able to do and I would say it's more about you know core new customers.

Hey, good morning, how are you?

I guess this first question around reserves and less to do with the mechanics of dividend finance and what you the ACL but when we think about the 80% base case Jamie that you mentioned I think if I heard you correctly you said that had an unemployment rate of 4.3.

I guess this first question around reserves and less to do with the mechanics of dividend finance and what you the ACL but when we think about the 80% base case Jamie that you mentioned I think if I heard you correctly you said that had an unemployment rate of 4.3. I guess. For that I mean maybe you know what I'm telling you. His is all.

Philosophically, I guess Tim, like in the past you've talked about 2024 could be worse in terms of credit. Maybe we do get a delayed recession. Just give us a mark to market around your operating outlook over the next, I guess, 12 to 24 months. Are you expecting a recession? If that's the case.

Shouldn't you be weighted a lot more to the downside than just the 80 10 10 split that you have? Yeah so let me let me answer the question about the outlook Eran and then I think we'll go to Jamie talk about the dynamics around the specific ACL so I look our I think our outlook

is that it's hard to know. Like I watch, we watch the same equity market indicators that you do, we see the trends on unemployment, we see that signal around inflation moderating, and I hear a lot from folks about the increased probability for a soft landing.

We just don't get paid to manage to a Goldilocks scenario outcome here, right? Because for every positive indicator, you still have like a yield curve that's more inverted than it has been in decades. You have data coming out of the Red Book that suggests that same-store sales in retail across the US has been negative.

Since the beginning of the year, the consumer spending on a real basis, so take the impact of inflation out, like flat or down in five of the last seven periods.

You know, you have a negative ISM in terms of what we're seeing there, freight levels, whether it's exports and imports or the over the road stuff here in the US, continuing to be depressed. Those are not positive signs. And if you buy the thesis that what we're experiencing today is the interest rate environment...

that's characterized by high unemployment levels, that we still are going to end up in a recessionary environment. The last thing I just want to make sure that I flag, because I think sometimes words matter, is when we talk about an RWA diet or other people talk about balance sheet optimization, what we're really saying is tightening credit supply and higher risk spreads.

Right and and those things have an impact on M2 that compounds whatever gets done on M1 That are the other factor that's sort of lingering out there that I think that we need to take into account as we're looking at the outcome so That's probably a long way of saying I don't know any more than you do and in terms of where we settle but we're going to always plan around a more conservative outcome

Because if we're wrong, everybody does well, and if we're right, we're better positioned to deliver stable earnings for you.

And in terms of the scenario weightings, we anchor to the 80-10-10 distribution because that is the probability assignment by Moody's for each of those scenarios occurring. So that as you saw in this quarter, the scenarios eroded, unemployment ticked up about 30 basis points or so on a peak basis in their baseline.

Understood. And thanks for the detailed response Tim. Just as a follow up to that means I guess

spreads widening tightening credit is one thing. Are you also seeing demand fall off like as you look through your commercial customer base both in Midwest and Southeast.

We've heard from some other banks where things are really cooled off in the last month or two. Are you actually seeing that from your customers where they are pulling back around investment spend an activity.

Yeah, we are seeing some softening in demand. There's no question about that. I think in general, part of it's conservatism on the part of the clients, I think, and the lack of visibility that they have into what the...

what the economy is going to look like 18 months from now. I think the other dynamic that we hear from clients is they are saying they're a little bit nervous about credit availability. So there's an interaction effect here that you have to take into account. You know, what I was on the phone with two large clients, one in the...

that they were hearing back and or real constraints on you know they in the way that they have to spread ancillary so I think

There is a dynamic that will materialize here where demand will be lower for credit because the cost of credit will be higher. And that's the interaction effect that I think as we roll forward here we're going to continue to see in addition to just general caution.

Thanks for taking my questions. Your next question comes from a line of Michael Mail from Wells Fargo. Your line is open. Hi. I'm not sure if Jamie was quoting Aristotle earlier, One Robin Does Not Make a Spring.

But we'll stick to the Aristotle quote, so excellence is never an accident. So in terms of operating leverage or positive operating leverage, I mean, you did guide revenues lower by 350 basis points, taking the midpoint and you didn't change expenses. And that's consistent with the industry. It looks like you could still have a shot at positive.

growth. Yeah, Mike, it's Tim. I'm going to take that one.

I mean we are working on expenses. The severance item that we called out as part of an exercise that we ran just to try to right size the resource base here for demand given the outlook and the environment. And as you know, the primary outcome of all of this investment we're making in the core platforms is to bring more automation.

and straight through processing to the business, which we think is gonna provide a lot of intermediate term, you know, expense, positive expense outcomes. What we're trying to do is to manage the expense base and the focus on positive operating leverage around.

sort of three year increments. So if you look back over the course of the past three years, we have the lowest expense growth. It's something like half of what our peer group average is in terms of non-interest expense, annual compound annual growth. And we will grow in revenue at a little more than 2X the rate we were growing expenses during that period.

I think we have every intention to do exactly the same thing over the course of the next three years. What we want to make sure that we're doing though is that when we make an investment, we finish the play, we get the outcomes of the investment, and we move on. And if you try to correct at the midpoint, you run the risk of having started a lot of things.

And then you don't get the excellence that you mentioned at the beginning. It's the binge purge cycle I referenced when I talked to Erica. And I'm sorry, the start of the three year period now is when? The last three years we will have grown expenses less than.

June was better, but you're not extrapolating that. Your guidance may be conservative, may not be, but, Jamie, what is it that you saw in June and why?

Yeah, there were two things Mike that happened in June that are certainly opportunities for the back half of the year to be better than what we're guiding to. But, you know, like most things, I'll give you another quote, the beauty's in the eye of the beholder. So some folks look at.

the credit spread widening and the CNI coupon expansion that occurred in the market, and we experienced that as well in June . Spreads were up a bit. We're not guiding to continued spread expansion in the back half of the year in CNI. And then on deposits June was a

a new customer acquisition perspective. So what we're saying from here is we actually are forecasting on an average basis some deposit growth in the third quarter but frankly if you look at the guide on an average basis it's about a point lower than our EOP.

balances. So maybe we do better, maybe not, maybe it gives us a little bit of pricing power to do better on the beta, but with all that being said, we just still are cautious about the liquidity environment in the back half of the year and we want to make sure that we prioritize stability until...

These challenges are behind us and we start to enter into at least a Fed pause cycle, let alone a Fed cut cycle. And then last follow up, just how comfortable are you that your NII guide kind of captures it and is that the entry point for thinking about 2024?

Mike, it's Brian . We certainly feel comfortable with our guide. As Jamie talked earlier and as we've talked consistently, when the Fed hiking cycle ends, we expect a quarter or two of impact as the deposit re-pricing lags play out. We still feel like we're going to see stability then, both from an NII and NIM perspective, and growth.

what we see right now we feel very good about our guide and what it's going to allow us to grow into 2024.

Thank you. Thank you. And your final question comes from the line of Gerard Cassidy from RBC. Your line is open. Hi Tim, hi Jamie. Hello Gerard. I'd like to come back to Jamie and Greg on credit for a moment.

Can you share with us what is that robust structure? And what do you mean by it keeps you ahead of those trends when you say something like that? Yeah, I think it's the ongoing review of the portfolio. For example, in the second quarter, our team completed a complete review of our office portfolio. And so as we go through the process, we're going to be looking at the portfolio

in that portfolio, in the real estate portfolio. You know, that's how we stay ahead of it. We're not waiting for covenant defaults. We're not waiting for borrowers to come to us. We're active, proactive in, again, stressing the portfolio across the board, not just in commercial real estate. So we see what's coming. I think it's one of the lessons learned, and a lot of us have the battle scars from the last crisis of being much more proactive, staying out ahead.

perspective, keeping an eye on real-time liquidity metrics out of the book that you know we've learned.

whether it's through some of the ABL monitoring that MB was doing that we've adapted as a best practice inside Fifth Third, as well as then what other banks do, always with regard to covenant monitoring and other vulnerability assessments. Real-time liquidity metrics is kind of.

And second, how big were the individual loans? And are you still making sure national credit loans today?

So, second question, yes. On a select basis, we are still making shared national credit decisions. One of the credits that I was referring to that could impact is a shared national credit. The second one is not.

And we have reached the end of our question and answer session. I will now turn the call back over to Chris Dahl for some closing remarks. Thank you, Rob, and thanks to everyone for your interest in Fifth Third. Please contact the IR department if you have any follow-up questions. Rob, you may now disconnect the call. This concludes today's conference call. Thank you for your participation. You may now disconnect the call.