Fifth Third Bancorp

Good day and thank you for standing by. Welcome to the Q1 2021 Fifth Third Bank Corp Earnings Conference Call. At this time, all participants are in a listen-only mode. After the secret presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone keypad. If you require any further assistance, I would now like to hand the conference over to your speaker today, Christal, Director of Investor Relations.

Thank you. Good morning, and thank you, everyone, for joining us. Today, we'll be discussing Fifth Third's financial results for the first quarter of 2021. Please review the cautionary statements in our materials, which can be found in our earnings release and presentation. These materials contain reconciliations to non-GAAP measures, along with information pertaining to the use of non-GAAP measures, as well as forward-looking statements about Fifth Third's performance. We undertake no obligation to, and would not expect to, update any such forward-looking statements after the date of this call. This morning, I'm joined by our CEO, Greg Carmichael, CFO, Jamie Leonard, President Tim Spence, and Chief Credit Officer, Richard Stein. Following prepared remarks by Greg and Jamie, we'll open the call for questions. Let me turn the call over to Greg now for his comments.

Thanks, Chris, and thank all of you for joining us this morning. Hope you are all well and staying healthy. Earlier today, we reported first quarter net income of $694 million for 93 cents per share. We continued our positive momentum from the past several quarters and once again delivered strong financial results in the first quarter. These strong results reflect record commercial banking fee revenue, continued success generating consumer and household growth, and a strong underlying net interest margin. Our performance reflects focused execution on our key strategic priorities. We continue to benefit from the diversification and resilience of our fee-based businesses in retail, mortgage, commercial, and wealth and asset management, which are generating strong results and helping to cushion the impact of lower short-term rates. We have maintained our disciplined client selection and conservative underwriting, which are evident in our credit metrics. Over the quarter, we recorded a benefit in our provision for credit losses, reflecting a stronger economic outlook, as well as historically low net charge-offs, which included improvements in both our commercial and consumer loan portfolios. In addition to muted credit losses, our criticized assets and MPLs also improved sequentially. Non-performing loans decreased 11% from the prior quarter, with NPL inflows at the lowest level since the third quarter of 2019. Our balance sheet earnings power remained very strong. As a result, our robust CET1 ratio further improved to 10.5% this quarter. Our CET1 target remains at 9.5%. As we have stated many times before, we are focused on deploying capital for organic growth opportunities evaluating non-bank opportunities where it fits our strategy, and share repurchases. Based on our current dividend trailing four quarters of net income, we have the capacity to repurchase shares up to $347 million in the second quarter. After that, we have more flexibility in terms of how and when we return capital to shareholders under the SCB framework. Jamie will provide more details on our capital plan. The improved macroeconomic data and outlook are aligned with our strongest overall commercial loan production since before the pandemic. Furthermore, we have seen our pipeline strengthen considerably over the past 90 days with significant strength in manufacturing, renewables, healthcare, and technology, partially offset by immune demand and leisure and hospitality and CRE. Production was offset by elevated payoffs and paydowns, combined with another 1% decline in and line utilization. We are retaining the customer and their core banking relationship as virtually none of our commercial payoffs during the quarter were the result of client attrition. Additionally, paydowns in our corporate bank largely reflected clients tapping the capital markets, where we benefited significantly from additional capital market fees. Given the strong production trends, firming pipeline, and retention of the client relationship, We remain well positioned to take advantage of a more favorable economic backdrop should clients execute their growth plans in the second half of 2021. We will continue to assess the implications of client supply chain constraints as we progress through the year. Consumer employment, savings, and spending trends also remain favorable given the fiscal stimulus, temp demand, and a gradual reopening of the economy throughout our footprint. Despite the overall economic recovery over the past several quarters, I recognize that not everyone in our society has benefited equally. This is why I'm very proud that, in addition to producing strong financial results, we have also continued to take deliberate actions to improve the lives of our customers and the well-being of our communities. I am particularly pleased that we exceeded our five-year, $32 billion commitment to invest in low- and moderate-income communities by more than $9 billion. We also recently announced a $2.8 billion commitment in support of racial equality focused on lending, investing, and financial accessibility. We also announced a new banking product this quarter called Momentum Banking, which competes with the FinTechs and is now our flagship mass market banking offering. Momentum Banking provides customers with equity solutions in our newly enhanced mobile app to help them avoid unnecessary fees including immediate access to funds from digital deposits, short-term on-demand borrowing options, simple goal-based savings targets, free customer access to their paycheck up to two days earlier with a qualifying direct deposit starting in June, and no monthly service fees. In addition, we were honored to once again be named one of the world's most ethical companies by Ethisphere, also reflecting our strong corporate culture and compliance program, and ESG actions. We were one of just five banks globally to receive this accolade this year. We believe our balancing strength, diversified revenues, and continued focus on disciplined expense management will serve us well in 2021 and beyond. We remain committed to generating sustainable long-term value for shareholders and anticipate that we will continue improving our relative performance as a top regional bank. I would like to once again thank our employees. I am very proud of the way you have continually risen to the occasion to support our customers and each other over the past year. You have enabled Fifth Third to continue to be a source of strength for our customers and our communities. With that, I'll turn it over to Jamie to discuss our first quarter results and our current outlook.

Thank you, Greg, and thank all of you for joining us today. We generated strong returns this quarter, reflecting our solid operating performance and continued improvement in credit quality. We produced an adjusted ROA of 1.4% and an ROTCE excluding AOCI of 19.8%. PPNR results were also strong, driven by strength in both NII and fees. Consequently, expenses were elevated relative to our previous guidance due to performance, and market-linked compensation expenses. We recorded a $244 million release to our credit reserve this quarter, which lowered our ACL ratio from 2.41% to 2.19%. Our historically low charge-offs, which came in better than expected, combined with an improving economic outlook versus previous expectations, resulted in a $173 million net benefit to the provision for credit losses. Continuing with the income statement performance, net interest income declined just 1% sequentially due to the lower day count and a reduction in prepayment penalties received in the securities portfolio compared to the fourth quarter. This was partially offset by the impact of $2.1 billion in government-guaranteed residential mortgage forbearance loans purchased from a third-party servicer in December and another $600 million in March. We have continued to take action to prudently deploy excess liquidity in order to improve our NII trajectory for 2021, and these loans provided a more attractive risk-adjusted return relative to other alternatives. Our first quarter NII results also included approximately $12 million in incremental PPP fees reflecting loan forgiveness compared to the fourth quarter. Additionally, as we discussed previously, our prior quarter NII results included prepayment penalty income for our investment portfolio, which declined $10 million sequentially. From a liability management perspective, we reduced our interest-bearing core deposit costs another two basis points this quarter, resulting in a cost of only six basis points. Reported NIM increased four basis points sequentially, reflecting a decline in excess cash, incremental PPP forgiveness fees, and day count, partially offset by the aforementioned securities prepayment penalty income decline. Underlying NIM excluding PPP and excess cash decreased just four basis points to 310 basis points. With a top quartile margin relative to peers, an asset-sensitive balance sheet and over $30 billion in excess liquidity, we believe that we remain well positioned for a higher rate environment while also benefiting from structural protection against lower rates given our securities and hedge portfolios. Additionally, we have updated our interest rate risk disclosures to reflect a 38% deposit beta to better align with our future expectations based on the last rate hike cycle experience. In a plus 100 basis point scenario where we invest about one-third of our excess liquidity over a 12-month period, we would expect annual NII to be about 15% higher compared to a static rate environment. Total reported non-interest income decreased 5%. Adjusted non-interest income, excluding the TRA impact, increased 3% compared to the prior quarter. Our fee performance reflected strength throughout our lines of business, including record commercial banking fees led by robust debt capital markets revenue, mortgage banking revenue driven by strong production, and strong leasing business revenue. Top-line mortgage banking revenue increased $42 million sequentially, reflecting improved execution and strong production in both retail and correspondent, which was partially offset by incremental margin pressure. Also, as we discussed in January, our fourth quarter results included a $12 million headwind from our decision to retain a portion of our retail production. Mortgage servicing fees of $59 million and MSR net valuation gains of $18 million were more than offset by asset decay of $81 million. If primary mortgage rates were to move higher, we would expect to see some servicing revenue improvement, which would likely be more than offset by production and margin pressures in that environment. As a result, we currently expect full-year mortgage revenue to decline low to mid-single digits given our rate outlook. Reported non-interest expenses decreased 2% relative to the fourth quarter. Adjusted expenses were up 3%. driven by seasonal items in the first quarter, in addition to elevated compensation-related expenses linked to strong fee performance, as well as the mark-to-market impact on non-qualified deferred comp plans. Current quarter expenses included $10 million in servicing expenses from our purchase loan portfolios. For the full year, we expect to incur $50 to $55 million in servicing expenses for purchase loans, including the impact of an additional $1 billion in forbearance pool purchases in April. Moving to the balance sheet, total average loans and leases were flat sequentially. CNI results continued to reflect stronger production levels offset by paydowns. Additionally, revolver utilization rates decreased another 1% this quarter to a record low 31% due to the extraordinary levels of market liquidity and robust capital markets. The sequential decline in utilization came primarily from COVID high-impact industries and our energy vertical. Also, our leveraged loan outstandings declined more than 10% sequentially. As Greg mentioned, we are encouraged by the fact that we are retaining customer relationships throughout this environment and are benefiting from the fee opportunities. Average CRE loans were flat sequentially with end-of-period balances up 2% reflecting drawdowns on prior commitments which were paused during the pandemic. Average total consumer loans were flat sequentially as continued strength in the auto portfolio was offset by declines in home equity, credit card, and residential mortgage balances. Auto production in the quarter was strong at $2.2 billion with an average FICO score around 780% with lower advance rates, higher internal credit scores, and better spreads compared to last year. Our securities portfolio increased approximately 1% this quarter as we opportunistically pre-invested expected second quarter cash flows of approximately $1 billion during March. With respect to broader securities portfolio positioning, we remain patient, but we will continue to be opportunistic as the environment evolves. Assuming no meaningful changes to our economic outlook, we would expect to increase our cash deployment when investment yields move north of the 200 basis point range. We are optimistic that strong economic growth in the second half of 2021 will present more attractive risk return opportunities. We continue to feel very good about our investment portfolio positioning, with 57% of the investment portfolio invested in bullet and locked out cash flows at quarter end. Our securities portfolio had $2 million of net discount accretion in the first quarter, and our unrealized securities and cash flow hedge gains at the end of the quarter remained strong at $2.4 billion refax. Average other short-term investments, which includes interest-bearing cash, decreased $2 billion sequentially and increased $30 billion compared to the year-ago quarter. The unprecedented excess cash levels are the result of record deposit growth over the past year. Core deposits were flat compared to the fourth quarter as growth in consumer transaction deposits impacted by the fiscal stimulus was offset by seasonal declines in commercial transaction deposits and a reduction in consumer CD balances. We are experiencing strong deposit growth so far in April and expect low single-digit growth in the second quarter from both consumer and commercial customers. Moving to credit. Our overall credit quality continues to reflect our disciplined approach to client selection and underwriting, prudent management of our balance sheet exposures, and the continued improvement of the macroeconomic environment. The first quarter net charge-off ratio of 27 basis points improved 16 basis points sequentially. Non-performing assets declined $81 million, or 9%, with the resulting NPA ratio of 72 basis points declining seven basis points sequentially. Also, our criticized assets declined 8% with considerable improvements in casinos, restaurants, and leisure travel, as well as in our energy and leverage loan portfolios, partially offset by continued pressure in commercial, real estate, particularly central business district hotels. Our base case macroeconomic scenario assumes the labor market continues to improve, with unemployment reaching 5% by the middle of next year and ending our three-year R&S period in the low 4% range. As a result, this scenario assumes most of the labor market disruption created by the pandemic and resulting government programs is resolved by 2024, but still leaves a persistent employment gap of a few million jobs compared to pre-COVID expectations. Additionally, our base estimate incorporates favorable impacts from the administration's recent fiscal stimulus and assumes an infrastructure package over a trillion dollars has passed this year. We did not change our scenario weights of 60% to the base and 20% to the upside and downside scenarios. Applying a 100% probability weighting to the base scenario would result in a $169 million release to our reserve and Conversely, applying 100% to the downside scenario would result in a $788 million bill. Inclusive of the impact of approximately $109 million in remaining discount associated with the MB loan portfolio, our ACL ratio was 2.29%. Additionally, excluding the $5 billion in PPP loans with virtually no associated credit reserve, the ACL ratio would be approximately 2.4%. With the recent economic recovery and our base case expectations point to further improvement, there are several key risks factored into our downside scenario, which could play out given the uncertain environment. Like all of you, we continue to closely watch COVID case and vaccination trends, which could impact the timing of reopening of local economies and reverse the strengthening consumer confidence trends. Our March 31st allowance incorporates our best estimate of the impact of improving economic growth, lower unemployment, and improving credit quality, including the expected benefits of government programs. Moving to capital. Our capital remained strong during the quarter. Our CET1 ratio grew during the quarter, ending at 10.5% above our stated target of 9.5%, which amounts to approximately $1.4 billion of excess capital. Our tangible book value per share, excluding AOCI, is up 8% since the year-ago quarter. During the quarter, we completed $180 million in buybacks, which reduced our share count by approximately 5 million shares compared to the first quarter. As Greg mentioned, we have the capacity to repurchase up to $347 million in the second quarter based on our current dividend and the Federal Reserve's average trailing four quarters of net income framework. As a Category 4 bank, we expect to have additional flexibility with respect to capital distribution starting in the third quarter. As prudent stewards of capital, we expect to get closer to our CET1 target by mid-2022. While we did not participate in CCAR 2021, we are required to submit our board-approved capital plan to the Fed. Those plans support the potential to raise our dividend in the third quarter and repurchase over $800 million in the second half of 2021. Moving to our current outlook. For the full year, we expect average total loan balances to be stable to up a bit compared to last year, reflecting relative stability in commercial combined with low single-digit growth in consumer, which includes the additional $1 billion in Ginnie Mae forbearance loan purchases in April. We continue to expect CRE to remain stable in this environment. Our loan outlook assumes commercial revolver utilization rates migrate closer to 33% by year-end. It also includes the impact of $2 billion in loan balances we expect to add from the latest round of PPP, including the $1.7 billion we've generated to date, which will continue to be offset by forgiveness throughout the year. We expect our underlying NIM to be in the 305 area for the full year. Combined with our loan outlook, we expect NII to decline just 1% this year, assuming stable securities balances. On a sequential basis, we expect NII to be stable to up 1%. Within our NII guidance, we assume we generate approximately $150 million in PPP-related interest income in 2021 and of which $53 million was realized in the first quarter, compared to $100 million in the full year of 2020. We expect full-year fees to increase 4 to 5 percent compared to 2020, or 5 to 6 percent, excluding the impact of the TRA. Improvement from our previous guide reflects a more robust economic rebound, as well as our continued success taking market share as a result of our investments in talent and capabilities resulting in stronger processing revenue, capital markets fees, and wealth and asset management revenue, which will be partially offset by mortgage. We expect second quarter fees to decline 3% to 5%, reflecting lower mortgage and leasing revenues, partially offset by low single-digit growth in card and processing and treasury management revenue. We expect relatively stable commercial banking revenues sequentially. Given both our stronger fee and NII outlook, combined with the servicing costs from the loan portfolio purchases, we expect full-year expenses to be up 1%, driven by volume-based compensation and other expenses. On a sequential basis, we expect expenses to decline 5% to 7%. We expect to generate positive operating leverage in the second half of 2021, reflecting our expense actions, our continued success growing our fee-based businesses, and our proactive balance sheet management. We expect total net charge-offs in 2021 to be in the 30 to 40 basis point range, given the strong first quarter performance and assuming our base case scenario continues to play out. Second quarter losses are likely to be in the 25 to 35 basis point range. In summary, our first quarter results were strong and continue to demonstrate the progress we have made over the past few years toward achieving our goal of outperformance through the cycle. We will continue to rely on the same principles of disciplined client selection, conservative underwriting, and a focus on a long-term performance horizon, which has served us very well during this environment. With that, let me turn it over to Chris to open the call up for Q&A.

Before we start Q&A, as a courtesy to others, we ask that you limit yourself to one question and a follow-up, and then return to the queue if you have additional questions. We will do our best to answer as many questions as possible in the time we have this morning. Operator, please open the call for questions.

Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Your first response is from Bill Karkachi with Wolf Research. Please go ahead.

Thank you. Good morning. I wanted to ask about your investments. specifically in the Southeast. You're obviously managing expenses for the revenue environment, but can you talk about the priorities with the investment dollars that you are allocating to the Southeast? Where are those investments being made? And have we started to see the returns when those investments come through already in the loan growth NII and the trends that we saw this quarter? Just a little bit more color on the return timeline would be helpful.

Fantastic. This is Greg. First of all, thanks for the question. You know, listen, we continue to be bullish on our investments and our strength in our Southeast markets. To remind you, these are markets we're already in, that we have a presence. It's really about being a better provider of products and services in those markets and really taking advantage of the opportunities those markets create for us. We couldn't be more pleased to date with the progress we've seen in that market, especially if you look at household growth, new customer acquisition, strength of our commercial businesses in the Southeast markets. So the progress we've made to date, we're going to continue to invest in those markets as it makes sense. From an other investment perspective, obviously, we balance our investments for the greatest return for our shareholders. But right now, we think the Southeast is still a good place for us to continue to invest until we get to the scale and take advantage of the opportunities that are out there. And Tim, you may want to add a few things on progress.

Yeah. So, good question. Just to add to what Greg said. When we announced the build out of the de novo strategy in the markets in the Southeast, we announced that we were going to build about 120 branches. Only about 30 of those have come online, but those 30 branches collectively are contributing almost 10% of our new household production this year. So we're seeing some benefit there, but a lot still to come as we add another 30 plus branches in the Southeast this year and another 35 next year. On the commercial banking and wealth management side of the equation, I think we've talked in the past about the additions we have made in the southeast on the fee income side of the business. Both Coker Capital and H2C are headquartered down there and have strong southeast presences. But we also talked about adding 30 additional middle market bankers to the southeast. And only about seven of those positions were filled in the first quarter with another 10 offers outstanding. So very clearly those benefits are not yet in the run rate, but we've been very pleased with the quality of talent that we are able to attract. And we expect that to continue to further accelerate the shift in the business mix between the Midwest and the Southeast markets.

That's very helpful. Thank you. As a follow-up question, Can you speak to your asset sensitivity and any plans to alter it from here and then maybe just discuss how you're thinking about the potential for layering and any swaps from where we are currently?

Yeah, it's Jamie. Thanks for the question. We did, as I said in our prepared remarks, update our asset sensitivity disclosures to, I think, be a little more – transparent and give you our views of how we see the next rate hike cycle playing out. So we did change our deposit betas from 70 down to 38%. So with that in mind, obviously, that reflects a very asset-sensitive balance sheet, as you can see in the disclosures. How we look at it right now is that given our view on the economy, we believe there's still momentum and a bias for higher rates as 2021 plays out and even 2022. So for us, you know, we can afford to be patient. And fortunately, you know, our investment portfolio is running off at a pretty slow pace. The hedges aren't running off at all. We still have two and a half more years before we have that headwind. So we're really not forced into trades today that would sacrifice future NII levels just to make income now. So I think we'll continue to be patient. We'll be opportunistic, but we would certainly like to see entry points a little bit better. And our focus would be more on, you know, just extension of protection as opposed to laying on, you know, net new notional amounts to where we are today.

Got it. Thanks, Jamie. Thank you all for taking my questions.

Thank you. Your next response is from Gerard Cassidy of RBC. Please go ahead.

Thank you. Good morning. How are you guys? Good morning, Gerard. Good morning. Jamie, can you share with us, and maybe Greg too, we all have seen in the banking industry, and you guys certainly are showing it as well, this incredible deposit growth year over year. And clearly the quantitative easing from the Fed is a major contributor to the industry's deposit growth, as well as the deficit spending by the U.S. government. Obviously, you're not a wholesale bank like some of our money center banks that might be gathering some of these deposits from this quantitative easing program. Can you share with us where is the – or kind of give us a timeline or a trail of where is this deposit growth coming from in terms of your customer base and what's going to eventually bring it down so that your short-term investments will eventually be utilized by your customers basically drawing down those deposits?

Thanks, Gerard. Great question and a difficult answer, but I'll start with the easy parts. In terms of where our deposit growth has come from, we're up 27% year over year, $30-plus billion. Seventy percent of that has come from our commercial customer base, and 30% has come out of the consumer book. In terms of the consumer book, the growth is really driven, as we've talked about, the 3% household growth, but also just the consumer's deleveraging. And when you, you know, slice the consumer deposit book, just March over March, average DDA and IVTs per account are up about 30%. Savings are up 15%. So we're seeing that consumer behavior being a little more conservative, plus the additional stimulus and all the other liquidity programs available are just adding significant balances to these consumer accounts. I think that will come down as consumer spending picks up, and we should expect that excess liquidity of about $2,000 per account, you know, start to wane in the back half of this year. But for the second quarter, we do expect consumer deposit growth to continue. We've seen that with the stimulus payments, with tax refunds, And so we see a portion of that excess liquidity being applied to paying down unsecured loans, but for the most part sticking. From a commercial perspective, I think clients are just being more conservative, and I expect the commercial deposit balances perhaps stick down a little bit slower and over a period of years as folks, while we continue see strong pipelines and encouragement for loan growth, I think corporations will hold a little bit extra liquidity given what we've just been through. And so I think you might see the ability to grow loans without really seeing a lot of runoff in the commercial deposits, but I think consumer spending will drive a decline in the consumer book, perhaps sooner than commercial.

Very good. I know you gave us some good color, Jamie, on the loan loss reserves relative to loans. And credit quality for you and your peers has been extraordinarily good through a cycle that was pretty dramatic, as we all know. What do you think, and I know it's a moving target with CECL, but What do you think about getting the reserves down to that day one CISO level in January of 2020? What would it take and how long would it take, do you think, for you guys to bring it down to that level?

So our day one reserve was 182 basis points on an apples-to-apples basis. Today, if you exclude PPP, let's call it a 230 level. So when you look at Our process at the end of each quarter, we have a robust process that estimates the allowance based on the credit risk in the portfolio, and that's driven by the economic forecasts over the three-year reasonable and supportable horizon that we use. So while we feel very positive about our credit performance today through the pandemic, there's still segments of the economy and our loan book that have not returned to those pre-pandemic levels of health. So we do think full normalization will take time and will not occur over a period of just a few quarters. And I guess to answer the heart of your question, to get back to those adoption level reserve rates, we would need to see a sustained strengthening in the credit characteristics of those borrowers that are most at risk for the longer term negative impacts from the pandemic in concert with improving economic forecasts. And most importantly, those forecasts need to improve above our current expectations. So I think it will take some time.

Very good. Thank you for the answer.

Your next response is from Mike Mayo with Wells Fargo Securities. Please go ahead. Hi.

Can you size the level of your investments? You know, you expect positive operating leverage in the second half of the year. This must be taking some sort of a toll. And I guess we've heard a lot of investments. You have the Southeast expansion where you're opening 70 branches. That's one category. A second category would be other expansion markets like Texas and California. And the third category would be the loan process automation. So when you add it all up, what sort of impact does this have? When do these investments peak? If you think of a J curve as investing and hurting your business, your profits then improving later? When do you get to that inflection point?

Yeah, Mike, it's Jamie. Thanks for the question. Really, when you look at our expense outlook for the year, yes, as you mentioned, we do expect the positive operating leverage second half of the year. The second quarter of 2021 is probably going to be the highest year-over-year growth rate on expenses. And The IT investments will be, you know, year over year up double digits. We expect marketing to accelerate in the second quarter. And then we have the investments from the loan servicing costs for some of the loan pool purchases. So, really, when we look out at the expense guide, each quarter should be better and better in terms of expenses, whereas NII grows. You know, we're at the trough now. NII should grow every quarter. And then as we talked about before, you know, fees from the second quarter trough should then build throughout the rest of the year. So that's how we see the year playing out. Obviously, we've got some flexibility to change that expense progression should it not play out and deliver that extra revenue. But that's really how we see the year playing out.

And just a separate question. For the southeast expansion strategy, what is the end game? in terms of where do you want to be in terms of market share, where you are today, or other metrics that you're monitoring?

Mike, this is Greg. I mean, listen, as we've said many times before, we like the southeast markets for all the reasons you would expect. It's also been one of our strongest performing – the strongest performing sector of our business, both on the retail side and on the commercial side and on the wealth side. So it's really been a strong – performance for us. So end game, we want to be, let's call it top five banks in the market from a deposit perspective will be the objective of ours. That's pretty much what we search for. We think that makes us relevant, allows us to serve the community the best. So top five retail deposits, how we're thinking about it. And then from a banker perspective on the commercial side, just making sure we have the talent in the market to take advantage of the opportunities down there that are presented to us. So that's kind of what we're focused on. Tim, anything you want to add to that?

No, I think that's right. We're a little bit unique if you look at the southeast footprint and most of the growth in the southeast is happening on the Atlantic coast side in the mid-Atlantic and then on both sides in Florida. And we really have a metro market strategy down there. So the focus is on places like Charlotte, Raleigh-Durham, Chapel Hill, Nashville, Naples, Tampa, The high-growth, mid-sized markets, and as Greg said, top five in those markets would get you to call it 8% to 10% market share in those stated metro areas as opposed to including the micropolitan markets elsewhere in the state.

All right. Thank you.

The next response is from Ken Usden of Jefferies. Please go ahead.

Thanks. Good morning. Just a follow-up on the Ginnie Mae and the mortgage banking businesses. Do you still see room to find and repurchase more of those Ginnie Mae buyouts? And you mentioned on the mortgage side that you're retaining a little bit more of your production. Can you give us an understanding of how much of that production you're now planning to retain and how much that's changed over time? Thanks.

Yeah, thanks, Ken. In terms of the Ginnie Mae pool, they're becoming more and more difficult to locate, I think, as everybody's been executing on that play for their own portfolio. And as we talked about, we bought back our $750 million in the third quarter of 2020. So that combined with the fact that we're over $3 billion of product now, I think that's a healthy and appropriate allocation for our balance sheet. So I'm not looking to add more there. In terms of the mortgage retention, we did retain in the fourth quarter a quarter billion or so of our retail production. This quarter, we did not elect to retain anything that was saleable. So we're currently selling everything that is saleable and then retaining jumbo nonconforming and other items. So I think that for now would be our intention for the rest of this year.

Okay. And Jamie, one follow-up on mortgage. You guys had been taking a little bit longer to get kind of the pipeline through, and we saw the originations up. Can you just give us an update there on just your outlook for origination volumes, and have you kind of gotten to the right spot in terms of being able to get the production through in terms of that opportunity set? Thanks.

Yes. For as disappointing as the fourth quarter was in mortgage, the first quarter was just as exciting. So we feel very good about how the team performed. The first quarter was very strong and we've got the trains running on time and everything is in a good spot, as you can tell from the first quarter results. So in terms of the outlook for the year, we expect the mortgage originations to be up a bit, call it mid-single digits, second quarter volumes, mid-single digits. But the headwind is going to be you know, margin compression. So while we, you know, transition to more of a purchase environment here over the summer months, volumes should be strong, margins will compress, and then as those, you know, prepayments, refis slow down, we expect to see a little bit of a lift in the servicing portfolio. So it's, you know, less of a headwind and perhaps even a positive in the back half of the year. But net-net, I think on a year-over-year basis, we're looking at a slight decline in both top line and bottom line mortgage fees.

Okay. Thank you, Jamie.

The next response is from Ken Zerbe of Morgan Stanley. Please go ahead. Ken, your line is open.

I apologize. I was on mute. In terms of getting to the 9.5% CE Tier 1 target, how much of that comes from being at the very high end of your allowable stock buybacks, like the $800 million in the back half of the year versus balance sheet growth later in the year?

The balance sheet growth is fairly stable in terms, I guess, of the year-over-year. We do have, I guess, the dynamic of CNI growth, but PPP paydowns. But I don't see the balance sheet, at least in 2021, being that big of a driver. I guess there's the nine basis points of erosion with the CECL transition that kicks in in the first quarter of 2022. But overall, you know, our income levels are more than sufficient to cover the balance sheet growth. So, you know, the real benefit for us is just buying back the $347 million in the second quarter and then $800 million or more in the back half of the year to try to bring that down to 9.5% by mid-year 2022. That's our goal. And then I also have a dividend increase here in the third quarter.

Got it. Okay, perfect. And then just as a follow-up, in terms of your net charge-off guidance, I think you're at 27 basis points this quarter. Your guidance for next quarter is sort of call it maybe 30 basis points at the midpoint, but your full year guidance is the 30 to 40 basis points. Are you implying that second half should see noticeably higher charge-offs, or is that just being more conservative?

Yeah, I think it's an element of conservatism given the uncertainty in the environment. We certainly... could experience charge-offs, you know, at the very low end of that range. But, you know, at this point in time, I feel like it's prudent to guide to a 30 to 40 basis point range.

Got it. Okay, thank you.

Your next response is from Matt O'Connor with Deutsche Bank. Please go ahead.

Good morning. Hi, Matt. So just to ask a liquidity question a little bit different, you actually had a more modest increase in both deposits and the cash this quarter than what we're seeing for the overall industry. And just wondering, you know, how you'd reconcile that difference.

Yeah, it's really driven by our commercial clients and, in particular, Our focus on retailers, where you typically have seasonal runoff in the first quarter of every year from elevated fourth quarter balances. I think on a year-over-year basis, our growth is certainly at the high end, and I think we've done a very nice job of capturing more than our fair share of the excess liquidity in the commercial book, and then obviously the household growth on the consumer side has contributed. So I feel good about how we're positioned from a deposit gathering perspective, but it's just more about you know, when is the right time to start putting the money to work.

Okay, and then just separately, the incremental costs related to the mortgage servicing for the loans that you purchase, there's obviously a lot more revenue that you're getting than the $50 million of additional costs, but I guess I was a little surprised that there's that much incremental costs that it's just not more scalable, or is it a a bit of a kind of more intensive product to service given the nature of the Ginnie Maze?

No, very good question. The answer is actually far simpler, which is we don't service the loans, and therefore we pay a servicing fee, and that servicing fee is certainly on the high side given the yield on the securities, and so it ends up being almost a 2% servicing fee. fee paid to the servicer, but the flip side is you get more than that benefit, but it does show up in NII. So when you look at our expense guide, as diligent as we are and as focused as we are on expenses, at the end of the day, we did raise the expense guide two points. Half of that is from the volume-related compensation expense and fee growth, and then half is from these additional loan servicing costs that are more than offset by the improvement in NII.

And what's the related pickup in revenue that you get for those loans or the yield if you want to put in percent?

Yeah, high 3% yield.

Okay.

And then there's additional fee income that comes as the loans are resold. So all in, it's an ROA of roughly 2%, which is very attractive in this environment and certainly better than just buying MBS in the portfolio.

Yep, agreed. Thank you.

Your next response is from Scott Seifers of Piper Sandler. Please go ahead.

Morning, guys. Thanks for taking the question. I guess when we talk about the line utilization improving potentially from 31% up to 33% by the end of the year, maybe just a reminder of what you would consider sort of a typical number for you guys. And then just as the follow-up, I'm not sure anyone has a great answer for it, but maybe just best guesses or thoughts on why utilization isn't already improving kind of broadly for the industry, given that we all have what seems like pretty good visibility into the likely trajectory of the economy, vaccination rates, et cetera. Just would be curious to hear your thoughts there.

Yeah, Scott, good question. This is Greg. I'll start it and maybe throw it back over to Tim for some more color. And first off, normalized line utilization for us going into the pandemic would have been 36%, 37% on average. So obviously with the pandemic, we saw a spike up to 40-plus percent. But think about a normalized range, 36%, 37%. We're running about 31% right now. So hopefully the second half of the year is a little stronger as we anticipate as we look at our bottoms-up forecast. We can pick up another 2% lift. That's a stretch out there, but we think that's doable given what we're seeing in our pipelines. Get us back up to 33%, which is still not the normalized level. You think about each 1%, it's about $750 million of the standings for us. So the impact of a 2% uplift by year-end is less than 1% on total loan growth for 2021, given the ramp-up throughout the year. So it's possible, but once again, I think there's a lot of variables out there we're watching. But we are encouraged by the pipeline strength that we're seeing right now. Our production levels in commercial in the first quarter were at pre-pandemic levels, so we're encouraged by that. If you look at the pipelines going forward, you know, the forecast right now will be about 30% up in production over 2020, but slightly below pre-pandemic levels. And we're seeing good strength in manufacturing, healthcare, TMT, and renewables right now. If you look at our markets, we're seeing some good progress. Indiana, Michigan, California, and the Carolinas would jump out as a source of strength from an asset perspective. So production is strong. Pipelines look good. You know, we're hopeful we'll see in the back half of this year an improvement in line utilization. But once again, there's a lot of liquidity out there, so it's something we're watching.

I think just to add to what Greg said, I mean, Scott, we're asking the same question to ourselves, right, in terms of what the visibility we have into the economy. And some of the signals we're seeing about a pickup in inflation and input costs, I've had the chance since the beginning of the year to be out in 12 of our 15 different regions and to spend time with clients there. So we've been asking that question. And what we're hearing from them primarily are either supply chain disruptions. Some of that obviously is some of the global dynamics that we have talked about, whether it was stuff stuck in the canal or shortages in semiconductors. But it also is just access to materials. And then on the other side of the equation, labor shortages, in particular as it relates to the skilled trades. And the byproduct of that is we're not seeing the inventory building that you might otherwise expect to see yet. So we're watching inventory levels closely. We're watching the ISM index closely as leading indicators to when we may see a pickup in utilization. I think one positive note, which is reflected in the results in the first quarter, is we are seeing increased demand on the equipment side of the business. And that is encouraging because that obviously would be the other free condition to an expansion.

Yep. All right. That's perfect. Thank you guys very much for the thoughts. Sure.

Thank you. And your last question is from Erica Naharian of Bank of America. Please go ahead.

Hey, good morning.

Good morning, Erica.

Hi, Erica. First question is for Jamie. Jamie, thank you so much for slide five. I love it. You know, most investors have started to talk about normalized ROTCs, you know, as they think about valuing banks with a two- to three-year forward look. You know, and even though you deployed some excess liquidity, you know, what's stunning is how significant it still is relative to 4Q19. And as investors contemplate what normalized returns are for fifth-third returns, Where do short-term investments normalize to?

So your question, are you from a total return perspective, Ratsi, or are you just asking on, you know, what do we – how much excess cash do we end up holding?

Yeah, so do you ever go back to $3 billion, or have we redefined what excess liquidity is for you guys?

Yeah.

Yeah, because obviously we debate daily when is the right time to put the money to work and how do we see the environment playing out. Right now, I think the easiest way to consider the excess liquidity would be a third of it runs off, a third of it we'd love to invest in organic loan growth, and a third of it ultimately gets invested in the investment portfolio. And so in terms of, you know, what that return profile looks like with regard to the investment portfolio, you know, we want to wait for the right time to put the money to work. But when we do put it to work, you know, we're at 18% right now. Securities is a percent of total assets. You know, we're comfortable running that number at 23% or so. So that means about $10 billion. or so of that additional liquidity we would deploy into the investment portfolio over a period of time.

Got it. And just one last question on momentum banking. How should we think about how momentum banking can potentially impact long-term consumer deposit growth versus whether or not that renormalizes service charges on deposits lower?

Sure, Erica. It's Tim. Good question. So I think we are very focused. Our strategy, as I think we've discussed quite frequently, is a primary relationship strategy. It's a focus on primary banking. It's a focus on being the place where you get paid on where you pay your bills and how you build up liquidity. And the byproduct of that, obviously, as Jamie mentioned earlier, is we did see really positive trends on the consumer side of the business because The liquidity that consumers have built up really is in the transaction accounts as opposed to somewhere else. So our deposit growth on the consumer side has been underpinned by call it two to 3% household growth over a period of several years now. We would like to continue to bump that number up. And we think that the momentum banking products coupled with the expansion in the Southeast gives us a path to doing that in terms of the overall household growth rates that we experienced. which will support non-interest bearing deposit growth. I think on the other side of the equation, yes, when somebody elects to use a short-term liquidity product, take our early access product, the deposit advanced product that we've had in the market for several years now, that is a lower cost way to cover a cash flow shortfall than an overdraft fee, but it's also a very sustainable way And owing to the fact that we have had those products in our product set for several years now, our overdraft charges as a percentage of total consumer deposits are lower than all but one of the large US banks already. So I think from our perspective, we're giving the consumer the widest possible range of options to avoid fees. We're getting the benefit of that in the form of household growth and of primacy, which is the entry point for us to the broadest range of products and services that we offer. And because of our position on the overdraft side of the equation and the low reliance on that fee line, we have left to give up there and are going to be able to outgrow any sort of an impact on the fees per household measure.

Got it. That was clear. Thank you.

Thank you. There are no further responses at this time. I'll turn the call back over to Crystal.

Thank you all for your interest in Fifth Third. If you have any follow-up questions, please contact the IR department, and we will be happy to assist you.

This concludes today's conference call. Thank you for participating. You may now disconnect.