Fifth Third Bancorp

Ladies and gentlemen, thank you for standing by. And welcome to the fifth, third, bank court, second quarter 2021 conference call. At this time, all participants are on a listen-only mode. After this speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Chris Dahl, Director of Investor Relations. Thank you. Please go ahead, sir.

Thank you, operator. Good morning and thank you for joining us. Today, we'll be discussing our financial results for the second quarter of 2021. Please 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, as well as information pertaining to the use of non-GAAP measures, as well as forward-looking statements about Fifth Thirds performance. We undertake no obligation to update any such forward-looking statements after the date of this call. This morning, I'm joined by our CEO, Greg Carmichael, CFO Jamie Leonard, President Tim Spence, and Chief Credit Officer Richard Stein. Following prepared remarks by Greg and Jamie, we will open the call for questions. Let me turn the call over to Greg now for his comments.

Thanks, Chris, and thank all of you for joining us this morning. Earlier today, we reported second quarter net income of $709 million, or $0.94 per share. On an adjusted basis, we are at $0.98 per share. Once again, our financial results were very strong. Continuing to pause momentum from the past several quarters. During the quarter, we generated sequential PPNR, growth of 15% on an adjusted basis, and growth of 6% compared to the year-ago quarter. Commercial loan production increased 10% from last quarter, which strengthened middle market across our footprint, as well as in corporate banking. We generated strong consumer household growth of 4% compared to last year. And we also experienced historically low net charge-offs of 16 basis points, reflecting improvement in both our commercial and consumer portfolios. We generated an adjusted ROTCE of nearly 20% for the second consecutive quarter, reflecting strong business and credit results across the franchise. Our results were supported by our continued improvement in our diversified businesses. In fact, we achieved record results in several of our fee-based businesses, including commercial banking and wealth and asset management. Despite continued pressure from low interest rates, net interest and income increased 3% sequentially, and the underlying NIM increased two basis points. We believe that our disciplined approach to managing the balance sheet, including in our securities and hedge portfolios, will continue to generate differentiated performance relative to peers. We also continue to maintain our expense discipline while still investing for long-term outperformance. As a result of our strong revenue growth combined with our expense management, we've generated positive operating leverage on a year-over-year basis with an adjusted efficiency ratio of 58%. We are prioritizing investments that drive further operational efficiencies to improve our resiliency, generate household growth, and improve the customer experience. To that end, we recently announced an expanded partnership with FIS to modernize our core deposit and wealth systems to the cloud, which will enable us to further our digital transformation. This will significantly improve the flexibility and scalability of our technology infrastructure and accelerate our speed to market. Combine this agreement with the renegotiation of our existing payment processing relationship allows us to modernize our platforms while maintaining an efficient overall cost structure. From a commercial standpoint, loan production this quarter was the highest since before the pandemic, with significant sequential improvements in technology, renewable energy, and manufacturing. However, our strong production was once again offset by elevated paydowns and PPP forgiveness. While we continue to retain the customer in their core banking relationship, loan growth remains muted due to the environment. Our commercial lending production trends, pipelines, and retention of the client relationship all continue to support the potential for improved loan growth once supply and labor constraints normalize. We currently expect our 31% commercial revolver utilization rate to increase 1% by year end. On the consumer side, As I mentioned, we once again generated robust household growth. This strong performance reflects our ability to acquire new customers, combined with low attrition, both of which were supported by our branch and digital investments. Our recent southeast de novo branches have helped contribute to our household growth. On the digital side, we continue to leverage technology and data analytics to deliver solutions that improve the customer experience, increase revenue, and drive efficiencies. We recently launched fifth-row momentum banking across our footprint, a banking value proposition unparalleled in our industry. Momentum combines the best of a traditional bank offering with several leading fintech capabilities, including early pay, which gives customers free access to their paycheck up to two days early, extra time, which allows customers to cure an overdraft until midnight the following business day without a fee, My Advance, which gives customers short-term on-demand liquidity advances, smart savings, and other features, all provided with no monthly fee. Our strategy to keep the customer at the center has significantly reduced our reliance on punitive consumer deposit fees, including overdrafts and ATM fees, where Fifth Third has been among the lowest compared to peers for several years. Fifth Third Momentum Banking accelerates our efforts to help customers avoid unnecessary fees. As I mentioned, during the quarter, we recorded a net benefit to credit losses, reflecting historically low net charge-offs combined with a stronger economic outlook. Our strong credit performance reflects disciplined client selection, conservative underwriting, and continued support from fiscal and monetary government stimulus programs. In addition to historically low credit losses, our criticized assets and MPAs once again improved this quarter. Criticized assets declined another 16%, and our MPA ratio declined 11 basis points sequentially. Our balance sheet and earnings power remained very strong. Our CET1 ratio of 10.4% was relatively stable compared to last quarter, despite sharing purchases of $347 million in the second quarter. As we have said before, we remain focused on deploying capital into organic growth opportunities evaluating strategic non-bank opportunities, dividend increases, and share repurchases. Additionally, our capital position and earnings capacity support an increase in our common dividend starting in the third quarter. We currently expect to request a $0.03 increase to our quarterly dividend in September, subject to board approval and economic conditions. We also expect to execute share repurchases totaling approximately $850 million in the second half of 2021 and continue to target a 9.5% CET1 by June 2022. We recently announced the strategic acquisition of Provide, a fintech healthcare practice finance firm. Provide focuses on the dental, veterinarian, and vision segments and delivers digital capabilities which support a best-in-class experience and speed to close. PROVIDE previously utilized and originated the SELL model. As a result, the closing of the acquisition will not include a transfer of loan balances. However, post-close, FITTHOR will retain all loan originations. We currently hold around $400 million in loans generated by PROVIDE and have non-credit relationships with over 70% of these borrowers through deposit and or treasury management products. The acquisition is expected to close in early August and will utilize approximately 20 basis points of capital. In summary, we believe our balance sheet strength, diversified revenues, and continued focus on discipline throughout the company will serve us well this year and beyond. We remain committed to generating sustainable long-term value and consistently producing top quartile results. I would once again like to thank our employees. I am very proud of the way you have continually risen to the occasion to support our customers. Our commitment to generate sustainable value for stakeholders is evident in our second annual ESG report published in June. This expands on last year's report with increased transparency, including enhanced disclosures on priority topics such as inclusion and diversity, our climate strategy, and our commitment to fair and responsible banking. We remain guided by our purpose, vision, and core values and expect to continue delivering strong results over the long term. With that, I'll turn it over to Jamie to discuss our second quarter results and our current outlook.

Thank you, Greg, and thank all of you for joining us today. We are very pleased with the financial results this quarter, reflecting focused execution throughout the bank. Our quarterly results included solid revenue growth and continued discipline on both expenses and credits. The reported results for the quarter included a $37 million reduction in fee income for the negative mark related to the Visa total return swap. Our improved business performance throughout the bank resulted in strong return metrics. We produced an adjusted ROA of 1.43% and an adjusted ROTCE, excluding AOCI, of 19.7%. Our adjusted earnings per share were a record for the Bancorp. We generated healthy PP&R results, the strongest since before the pandemic, with net interest income growing 3% sequentially, continued success growing and diversifying non-interest income, and diligent expense management. Improvements in credit quality this quarter resulted in a $159 million release to our credit reserves, resulting in an ACL ratio of 206 basis points compared to 219 basis points last quarter. With historically low charge-offs of just 16 basis points this quarter and an improved economic outlook, we recorded a $115 million net benefit to the provision for credit losses. Moving to the income statement. Net interest income increased $32 million sequentially, reflecting our ability to effectively manage the balance sheet despite the environmental headwinds from low interest rates and elevated paydowns given capital market conditions. Our NII growth was driven by average loan growth of 1% and $11 million of incremental prepayment penalty benefits from our bullet and locked-out cash flow strategy in our investment portfolio, which that position remains of 58% at quarter end. Our loan balances benefited from the additional $1 billion of Ginnie Mae forbearance loan buyout purchases in early April, bringing the total third-party purchases to $3.7 billion. The other NII benefits were from a higher day count and not replacing long-term debt maturities, partially offset by the impact of declining average commercial loan balances and lower loan yields. PPP related interest income was $53 million this quarter, unchanged relative to the prior quarter. On the liability side, we reduced our interest bearing core deposit costs by another basis point this quarter to five basis points. and also had maturities of approximately $2.3 billion of long-term debt. With most deposit products at or near their assumed floors, the remaining liability management benefits going forward will likely be limited to CDs and reductions in long-term debt balances due to maturities. Reported NIM increased one basis point compared to the prior quarter, as the aforementioned investment portfolio, long-term debt, and Ginnie Mae loan buyout impacts were partially offset by the decline in commercial loan balances and lower loan yields. Underlying NIM, excluding PPP and excess cash, increased two basis points to 312 basis points. With a highly asset-sensitive balance sheet and over $30 billion in excess liquidity, we continue to be well-positioned to benefit when interest rates rise, while also remaining well-hedged if rates remain low, given our securities portfolio and derivatives. Total reported non-interest income decreased just 1% sequentially. Adjusted non-interest income increased 1%, driven by record commercial banking revenue with strength in loan syndications and financial risk management products, solid card and processing revenue from higher credit and debit interchange revenue reflecting the robust economic rebound, and an increase in both commercial and consumer deposit fees. These increases were partially offset by sequential declines in mortgage and lease syndications. Top-line mortgage banking revenue decreased $8 million sequentially, reflecting incremental margin pressure. Production was strong during the quarter in both the retail and correspondent channels, with second-quarter originations of $5 billion up 7% sequentially. Compared to the year-ago quarter, adjusted non-interest income increased 15% with strength in deposit service charges, commercial banking revenue, wealth and asset management, and card and processing revenue reflecting both the underlying strength in our lines of business and the robust economic rebound over the past year. The performance and resilience of our fee income levels over the past several quarters highlight the benefit of the revenue diversification that we have achieved. Non-interest expense decreased 5% compared to the first quarter, reflecting declines in compensation and benefits expenses, lower card and processing expense due to contract renegotiations, and disciplined expense management throughout the bank. This was partially offset by expenses linked to strong business performance, as well as servicing expenses associated with loan purchases and and a $12 million mark-to-market impact from our non-qualified deferred compensation plans, which had a corresponding offset in security gains. For the full year, we expect to incur around $50 million in third-party servicing expense for purchase loans. Our compensation-related expense growth this year continues to be proportionate to the success we are seeing in our fee-based businesses. On a year-over-year basis, total adjusted fees have increased 15% compared to to 4% expense growth. Additionally, compared to the pre-pandemic levels of the second quarter of 2019, total adjusted fees have increased 14% compared to expense growth of just 3%. Moving to the balance sheet, total average loans and leases were up 1% sequentially as consumer loan growth was partially offset by a decline in commercial loans. Additionally, period end loans were up 1%, excluding PPP. Average total consumer loans increased 4% as ongoing strength in the auto portfolio and the impact of Ginnie Mae loans purchased were partially offset by declines in home equity and credit card balances, reflecting the continued impacts of government stimulus. Average commercial loans declined 1% compared to the prior quarter, largely driven by PPP forgiveness and elevated payoffs, which were partially offset by strong production across most of our verticals and throughout our middle market footprint. Production was up 10% compared to the prior quarter and up over 20% compared to the pre-pandemic levels of the second quarter of 2019. Excluding the impact of PPP, our end-of-period C&I loans were up slightly sequentially as client sentiment and business activities in several industries are showing signs of stabilization. Revolver utilization of 31% was flat compared to the prior quarter, reflecting the market liquidity and capital markets conditions. We are encouraged by the fact that we have successfully retained virtually all clients throughout the pandemic, which will enable us to further deepen and grow these relationships going forward. Average CRE loans were flat sequentially with end-of-period balances declining 3%. Our securities portfolio increased 1% this quarter. We continue to reinvest portfolio cash flows, but will remain patient on deploying the excess cash. We will continue to be opportunistic as the economic environment evolves. Assuming no meaningful changes to our economic outlook, we would expect to increase our cash deployment when investment yields move north of the 200 basis point level. We remain optimistic that strong economic growth in the second half of 2021 and an eventual Fed tapering of bond purchases will present more attractive risk return opportunities in the future. Average short-term investments, which includes interest-bearing cash, remain elevated due to continued strength in core deposit balances, which have grown 10% year-over-year. We have seen strength in both consumer and commercial deposits. Compared to the prior quarter, average core deposits increased 3%. About two-thirds of the balance growth on a sequential and year-over-year basis has come from consumer, reflecting continued fiscal and monetary stimulus and strong household growth. Moving to credit. Our strong credit performance once again this quarter reflects our disciplined client selection, conservative underwriting, and prudent balance sheet management, while also benefiting from continued fiscal and monetary stimulus and improvement in the broader economy. The second quarter net charge-off ratio of 16 basis points was historically low and improved 11 basis points sequentially. Non-performing assets declined 16% or $126 million. The MPA ratio declined 11 basis points sequentially to 61 basis points, which is comparable to the fourth quarter of 2019. Also, our criticized assets declined 16%, with significant improvements in retail nonessential, leisure, and healthcare, as well as in our energy and leverage loan portfolios. However, we continue to focus on non-owner-occupied commercial real estate, particularly central business district hotels. Moving to the ACL, our base case macroeconomic scenario assumes the labor market continues to improve and job growth continues to strengthen, with unemployment reaching 4% by the first quarter of 2022 and ending our three-year reasonable and supportable period at around 3.5%. 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 reserve release. Conversely, applying 100% to the downside scenario would result in a $763 million bill. Inclusive of the impact of approximately $108 million in remaining discount associated with the MB loan portfolio, our ACL ratio was 2.15%. Additionally, excluding the $3.7 billion in PPP loans with virtually no associated credit reserve, the ACL ratio would be approximately 2.22%. While the favorable economic backdrop and our base case expectations point to further improvement in the economy, there are several key risks factored into our downside scenario which could play out given the uncertain environment. We continue to monitor the COVID situation, which could still impact many businesses, particularly those we have identified as being in highly impacted industries, or reverse the rising consumer confidence trends. Our June 30th allowance incorporates our best estimate of the economic environment with lower unemployment and continued improving credit quality. Moving to capital. Our capital levels remain strong in the second quarter. Our CET1 ratio ended the quarter at 10.4%, which is $1.3 billion above our stated target of 9.5%. Our tangible book value per share, excluding AOCI, increased 3% during the quarter. As a Category 4 institution, Fit Third was not subject to the latest Federal Reserve stress test, and we did not opt in. At the end of June, the Fed notified us that our SCB would be 2.5% effective July 1st, which is the floor under the regulatory capital rules. Without the floor, our buffer would have been approximately 2.1%. During the quarter, we completed $347 million in share repurchases, which reduced our share count by approximately 9 million shares compared to the first quarter. As Greg mentioned, we expect to repurchase approximately $850 million of shares in the second half of 2021, while also increasing our common dividend in September. We also announced our acquisition of Provide this quarter. We will utilize approximately 20 basis points of CET1 upon closing, This financially compelling acquisition of an asset generation engine dovetails perfectly with our existing strategic focus on digital enablement and generating profitable growth on our balance sheet. We believe and provide strong growth prospects. From an origination standpoint, they've produced $300 million in the first half of 2021, of which fifth-third purchased approximately 80%. We expect second half originations to be around $400 million and given the expected early August closing, virtually all of that will go on our balance sheet. We expect over $1 billion in originations in 2022 and could grow to over $2 billion annually within a few years. Moving to our current outlook. For the full year, we expect average total loan balances to be stable compared to last year. reflecting continued pressure from PPP forgiveness and paydowns in commercial, combined with low double-digit growth in consumer. We continue to expect CRE balances to remain stable in this environment. We continue to expect our underlying NIM to be in the 305 basis point area for the full year. Combined with our loan outlook, we expect NII to be down 1% this year. assuming stable security balances and incorporating all PPP impacts. On a sequential basis, we expect NII to decline around 2%, given the impacts of the securities portfolio prepayment income we experience in the second quarter that we do not assume will repeat in our outlook, as well as an assumed decline in PPP income. Within our NII guidance, we expect approximately $165 million in PPP-related interest income for 2021, of which $106 million was realized in the first half of the year, compared to $100 million in 2020 and approximately $50 million expected in 2022. For the third quarter of 2021, we expect approximately $40 million in PPP income. Therefore, excluding PPP impacts, We would expect third quarter NII to decline around 1% compared to the second quarter or up over 2% from the third quarter of 2020. Given the continued strength throughout our businesses, we expect full year fees to increase 7% to 8% compared to 2020 or 8% to 9% excluding the impact of the TRA. Our outlook assumes a continued healthy economy as well as our ongoing success taking market share as a result of our investments in talent and capabilities, resulting in stronger processing revenue, capital markets fees, and wealth and asset management revenue, which will be partially offset by mortgage declines. Additionally, as we discussed in January, we expect to generate private equity gains from several of our direct investments and venture capital funds throughout 2021, potentially exceeding the 2020 level of $75 million. We have recognized around $30 million in gains through the first half of 2021, which we expect to double in the second half of 2021. We expect third quarter total fees to be relatively stable from the second quarter and would be up mid to high single digits year over year. In the mortgage business, we expect revenue throughout the second half of the year to benefit from lower asset decay and higher servicing fees. The top line revenue is expected to decline high single digits year over year due to continued headwinds from margin compression. Our fee outlook does not incorporate a pre-tax gain of approximately $60 million associated with the sale of our HSA business that is expected to close in the third quarter. We do plan to redeploy half of that gain in the third quarter, split evenly between a $15 million donation to the Fifth Third Foundation that will complete our previously announced philanthropy commitment to accelerating racial equality and inclusion in our communities, and a $15 million additional marketing program supporting momentum given the upside potential we see in that product. We expect full-year expenses to be up 2% to 3% given our strong revenue outlook and the continued servicing costs from the loan portfolio purchases, as well as the incremental expenses associated with the provide acquisition. On a sequential basis, we expect expenses to be down 1%, excluding the redeployment of half of the HSA gain. As we recently discussed, we expect to consolidate 42 branches primarily in our legacy Midwest footprint, which we expect to complete in early 2022. Additionally, we've opened five branches so far this year and plan to add approximately 25 more Southeast in-market de novo branches in the second half of 2021. All run rate branch impacts are included in our outlook. We generated year-over-year positive operating leverage this quarter, and we expect to continue to generate positive operating leverage for the second half of 2021, reflecting our expense actions, our continued success growing our fee-based businesses, and our proactive balance sheet management. We expect total net charge-offs in 2021 to be 20 to 25 basis points given the strong first-half performance and assuming our base case scenario continues to play out. Third quarter losses are likely to be in the 15 to 20 basis point range. In summary, our second quarter results were strong and continue to demonstrate the progress we 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 well during this environment. With that, let me turn it over to Chris to open the call up for Q&A.

Thanks, Jamie. Before we start Q&A, as a courtesy to others, we ask that you limit yourself to 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 up for questions.

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. Our first question comes from the line of Ken Zerbe with Morgan Stanley.

Hi, thanks. Good morning. Good morning. Now, you guys are doing a lot to make Fifth Third more consumer-friendly, you know, like early pay and extra time. If we expect that trend to continue, what's the total amount of fees or revenue that might be at risk? Is the broader industry really continues to wean itself off of consumer fees?

Ken, it's Jamie. Thanks for the question. The one thing we are proud of at Fifth Third is how much we've reduced our exposure on the consumer side from a punitive fee standpoint and how we are I would say a very consumer-focused and consumer-friendly bank. I think 3% or so of our revenue is in consumer overdrafts, and our peers are significantly higher than those levels. We expect to continue to improve upon that with the momentum bank offering and some of the features that Greg talked about in his prepared remarks. So I think you can continue to expect that from us in that if we were to have any future changes on revenue overdraft policies or fees would only be to the positive and that we would more than make up for it with the incremental volume per momentum.

I don't know, Tim, if there's anything else you want to add. Yeah, no, I just want to emphasize that. I mean, whenever you launch a new product, the tradeoff you have to evaluate is what you think you can produce as it relates to total franchise growth relative to any sort of cannibalization, right? So the fact that we have been deliberate about driving revenue growth through value-added services as opposed to maintenance and punitive fees, means that for us we're going to get the benefit of the franchise growth and more households from Momentum with comparatively substantially less impact than any of our large competitors would have to the extent that they were attempting to follow us here.

Got it. Okay. And then just maybe a second question. In terms of the genuine buyouts, I think some of the other banks this quarter have mentioned they just didn't see the opportunity or they didn't have – or they couldn't find the opportunity, whatever, to do a lot of the Ginnie Mae buyouts. But it feels like you guys got a fairly decent benefit from that this quarter. Are you seeing the same trends, or do you still see opportunities to continue that going forward?

Very good question, actually, because what we've seen is that, you know, given we were a first mover in this product and, you know, as far back as the third quarter of 2020 when we bought our own pools and then helped structure these additional purchases that we've done, totaling $3.7 billion thus far to date. I would say that the economics were certainly more attractive if you were in the first mover stage, and the economics have really waned to the point that we would not be pursuing additional purchases at these levels.

Got it. Okay. Thank you very much.

Our next question comes from Scott Severs with Piper Sandler.

Good morning, guys. Thanks for taking the question. I just wanted to ask at sort of a top level on sort of the eventuality of a commercial recovery, what's your best guess as to what that will look like for, you know, larger regionals like yourself? You know, it's sort of unclear exactly. to the degree to which capital markets competition will abate. I guess there are questions regarding the sustainability of the sort of the sugar high that consumers are on right now, meaning demand can decrease the further we go, and then you've got all this excess liquidity that's getting worked through. So just curious to hear your top-level thoughts on what that recovery will ultimately look like in your eyes.

Let me start, then I'll quote David or Tim for additional thoughts. First off, You know, it's right now, there's just a lot of uncertainty out there right now. We're dealing with the labor shortages and supply chain disruptions, which are extremely real. You see it across the board in all conversations with our customers. But with that said, we're back to pretty much pre-pandemic level production numbers. The payoffs continue to be stout, and obviously you've got something to do with PPP. So when you think about the environment in front of us, I think loan growth is going to continue to be a challenge as we go through the rest of the year. I think we offset that by our strength in our fee businesses, as we talked about in our prepared remarks, to compensate for some of those challenges. But I do think this changes over time. If you look at our line utilization at 31%, we run at 37%. Every 1% is $750 million. So there's a lot of upside opportunity there. At some point, you know, labor shortages. and supply chain constraints start to abate if we pick up the benefit of that. We also added about $2.4 million in new commitments since the beginning of the year and continue to acquire new households in commercial relationships. So we're very, very positive as to what the future might hold when we've got some economic and some environmental challenges in front of us that we have to continue to deal with.

Yeah, I think... When we announced Northstar, we talked about pivoting the return profile of the bank to be good through the cycle. A portion of the focus there was on business mix, right? It was about constructing a business portfolio that had ballast. So in an environment where utilization is down like that now and where rates are low, we have fee businesses that are firing and providing nice support and some counter-cyclical businesses in particular on the consumer side, like autos and mortgages, which are doing very, very well. some of the tailwind from those businesses abates, what you would expect to see is a benefit, both as Greg mentioned, so it relates to line utilization and ultimately some benefit from rates, which provides a lot of support for the through-the-cycle focus.

Perfect. Okay, good. Thank you for those thoughts. And then maybe just a thought on overall reserving levels. You guys still maintain a very high-end conservative overall reserve. How are you sort of thinking about the steady state? Is it back to where we were seasonal day one, or just given the backdrop and what we've already gone through, can we kind of blow through that a little bit? I mean, go lower than that. How do you think about those dynamics?

It's Jamie. I'll take that one. When you look at the quarter, you know, with the ACL release of $159 million, we had that split fairly evenly between the consumer portfolio and the commercial portfolio, and the decline was essentially driven by improvements in the macroeconomic outlook versus the prior quarter. When you look ahead, you know, we continue to overweight non-baseline scenarios at $20 percent so that, you know, the upside is 20 percent, the base is 60, and the downside is 20 percent. And that's really driven by the uncertainty in the environment, including the vaccine efficacy. And frankly, this week's concerns highlight that risk. So when you look at the asymmetrical nature of the upside and downside scenarios, that weighting versus the 80-10-10 on Cecil day one is generates about a $90 million higher reserve. So I guess the first part to your fairly complicated question is that the scenario weightings do matter. And we expect to maintain the 60-20-20 while this period of uncertainty continues to exist. And then relative to day one, it really is a tale of two portfolios. So when you look at the commercial side, to get back to those day one adoption reserve rates, you really do need to see a sustained strengthening in the credit characteristics of the borrowers that are most at risk to the longer term negative impacts from the pandemic. And so that would have to occur in conjunction with improving economic forecasts above our current expectations. But then when you look at the consumer side, we're actually already below the CECL day one level. We're at 199 at the end of the second quarter versus the 246 on CECL day one. And that's driven by the combination of the loan mix. as well as improvements in real estate and auto collateral values experienced since the adoption of CECL, as well as the economic forecasts at the end of the second quarter. And then we've had improvement in credit quality in auto and card, as well as in the delinquency rate. So consumer is already there, but commercial, again, we'd have to have things play out differently than what we – better than what we currently expect.

Okay. All right, thank you guys very much for those thoughts.

Your next question comes from the line of Abraham Vanawala with Bank of America Securities.

Good morning. Good morning. I just wanted to go back, Greg, on your announcement partnering with FIS on the modern core and on the wealth management side. If you could give us some visibility on three things. One, what that means for near-term expense impact. what it means for longer-term efficiency as you kind of go through that process, if you could tell us what the timeline would be. And then finally, we are hearing from other banks talking about moving to a modern core and that being a competitive advantage. Do you see that as a competitive advantage for Fifth Third when you get to that point, or is it table stakes given where the industry is moving?

Okay, that's a lot there, so let me try and dissect a little bit for you. First off, the FIS announcement we just made is a continuation of a relationship that's been in place for quite some time, just a replacement of our WAM, our core deposit platforms. But we've been on this journey to re-engineer our technical infrastructure, focusing on and the scalability of our businesses, replaced our HR platform with Workday. We completed our enterprise data strategy. We completely re-platformed our mortgage LOS environment. So the FIS is the national extension of the continuation of the modernization of those activities. We also re-engineered and restructured the pricing agreement of our legacy relationship with the FIS. That's going to help make the cost associated with that implementation of the new FIS components a lot more reasonable, digestible for us. It'll manage our costs going forward. So we're pretty pleased with the way that came out. As far as the competitive advantage, listen, I think at the end of the day, this is a long game. We have to continue to refresh our platforms. We've got to continue to modernize our platforms to the cloud. I think every bank is trying to get this right. So whether it becomes a competitive advantage or not, I think it's a requirement. And it's basically a table stakes to be in a business, to be a digital business. Our customers expect the bank anywhere, anytime. We have to have platforms that are always on. So that's just a re-transformation of our business. We have to repurpose our expense dollars from the legacy brick-and-mortar infrastructure, and we've got to continue to reinvest in technology. So we're going to continue to do that. And I think the banks that don't do that are going to be at a competitive disadvantage. But many banks, as you've already heard, will continue to focus on core modernization, and we're going to be doing the same thing. We think we have a great strategy for that modernization and for bringing in new technologies. We have a buy, partner, build strategy that we've worked on very hard. If the technology's already out there, we buy it. If we can't buy it, we partner. And if we can't partner, we build it. And the momentum's an example of that. Partnerships like Green Sky Avenue Exchange, Dane Systems, Common Bond, getting out of the list, and our recent acquisition of Provide. So I think we've got it. Good strategy for moving quickly, but it is going to take time to get all the legacy stuff replatformed. But net-net, once again, I think it may not be a competitive advantage at the end of the day, but it definitely will be a requirement to be in this business in the future.

That's good, Connor. Appreciate it. And just as a follow-up to that, when you think about acquisition of ProWide, health care is obviously a very hot sector now. Do you see more opportunities like that across different verticals where we should expect similar kind of deals which become tools for client acquisitions?

Yeah, sure. This is Tim. I'm happy to take that one. So healthcare was the right starting point for us. It's the first industry vertical that we launched here over a decade ago, and we have a vertically integrated strategy on that front across our corporate banking group, our middle market banking group out in the regions, and now also business banking. You know, I think provide was an important next step for us in the strategy because it gave us the opportunity to provide a differentiated value proposition to independent medical practices, like Greg mentioned, with a big focus on dentists, vets, and otherwise. And provide was a little bit unique in that it had, as a FinTech company, actually already grown into one of the largest lenders into that market, driven primarily by their technology and their expertise. And just as a point of example there, the digital experience that they offer enables them to get loans approved and closed about 70% faster than a typical lending process would in that market. And in addition, because of the sector focus, they have a growing digital marketplace that actually allows existing practice owners who would like to transition into retirement to post their practices for sale and to get connected with folks who are interested in buying an established practice. So it functions, I guess, a little bit like the Craigslist or the eBay of dental practices today. Are there opportunities in other verticals? Yeah, we do think there are. And we have been pretty active, as Greg mentioned, in partnering with many of those firms. Whether those relationships... evolve from a partnership into an outright acquisition. I think it depends a lot on the circumstances of the business at a given point in time. But in the case of Provide, their next leg of the growth journey was going to be about the delivery of the broad, the full set of products and services, and it absolutely makes sense for them to be part of the bank as opposed to a standalone entity on that journey.

That's healthy. Thanks for taking my questions. Yes.

Our next question comes from Gerard Cassidy with RBC.

Good morning, Greg. Good morning, Jamie.

Good morning, Gerard.

Jamie, this question is for you. On the securities portfolio, can you share with us, I saw the yield, as you presented in your deck, increase sequentially, and I was Wondering how you achieved that in this rate environment. Was it due to the derivatives and hedges you have on the books? And then second, I think it said that obviously you're going to keep the liquidity in the portfolio until rates start to rise. I think you may have mentioned the 2% rate. Would you lean into it as rates were to go to 2% if they do, or would you wait until we actually got to 2% before you really move?

Yeah, I think if you look back at our actions in the first quarter, to answer the second part of your question, if you look back at our first quarter actions, we did leg into a little bit of additional investment portfolio buildup at that point in time. We pre-invested $1 billion of our second quarter cash flows, and then given the entry points and the rally in the bond market, decided to maintain that additional leverage throughout the quarter. So we did grow the buck a little bit in the second quarter. Our guide assumes we hold it fairly stable as the year progresses because we don't expect to get to those 2% or better entry points. But should the market get there, we would lag into the trade and not do anything. everything all at once. But when you look at our additional, you know, $30 billion of excess liquidity that we're sitting on, we've earmarked about a third of that to go into the investment portfolio. So to get, you know, $10 billion of purchases done would certainly take some time, and we've ramped that up over time. And, you know, our goal here is, We sit through peer results and actions versus ours, and we certainly are an outlier in terms of being, I think, more prudent and more cautious at deploying at these low rates. Our goal is, you know, let's maximize our NII over the next five years, not over the next 12 months, and we think ultimately that this is the better outcome. And, you know, the Fed will eventually taper. I'm not sure when that will be, but you know enough. largest bond buyer in the world is price indiscriminate in their purchases every month, it certainly distorts the market. So eventually that distortion is going to end, and we think we'll get better entry points than what we see today. And then in terms of the first part of your question, the growth in the yield this quarter in the investment portfolio is really the benefit of what we did five years ago with structuring the portfolio to be more weighted to bullet and locked-out cash flows so that to the extent there are prepayments in the portfolio, the make-hole provisions provide a nice pickup in investment yield. And, you know, we never include those in our outlook so that – the guide on NII might look soft on the surface, but if things continue to be the same, then obviously NII will outperform the guide should those prepayment penalties continue to occur. We're sitting on almost $2 billion in gains in the investment portfolio.

Very good. Thank you for the color. And then, Greg, I've asked this question in the past, but I'll ask it again, which is, When you sit down with your senior management team and you guys look out over the risks that you foresee on the horizon, and if we take the Delta variant and the COVID risk off the table, since that's an obvious one, what are some of the risks that you guys wrestle with as you look out over the next 12 months that we just have to keep our eye on and looking around the corner so that we're not surprised a year from now?

Yeah, that's a good question. Obviously, I would respond immediately with the variant of COVID and with that community is slowing down the economy and not getting the robust recovery we're all hoping for and creating risk. I think right now, as I mentioned earlier, Gerard, think about every customer I sit down with, we have a conversation, and you're seeing it in various ways. Labor shortage, supply chain constraints, significant issues out there right now. You're seeing that in backlogs, order delays, restaurants not being able to be open, small businesses not open full-time, can't get labor. So it's a big... But what is that, later this year? Is it next year? So I think that's going to pull a lot of pressure. Inventory levels are extremely low compared to what the demand is out there. We're not seeing that tick up right now. Line utilization is kind of flattened right now, but we're not seeing that tick up that we were hoping to see. So those are all kind of concerns that I have right now. Obviously, inflation is another concern out there as we watch that and how the Fed manages through that complexity and more to come on that. But, you know, Ned, I think overall the economy is fairly healthy. We just got some challenges still in front of us that haven't been understood yet.

I'm sorry, go ahead.

No, I just was going to say, if you just add... A little bit of color. Greg and I together were out. We spent a full day in 12 of our 13 regions this quarter, which made for a busy travel schedule, but a lot of good input in terms of what we're actually hearing from clients on the ground. And I mean, some of the stories that you hear about how people are dealing with the labor shortages or inventory supply issues are or wild. I mean, we have a client, a fuels marketer, who's had to open their own driving school so that they can get people, enough folks with qualified commercial driver's licenses to do fuel deliveries. You have hospitals who are operating at 50% capacity on who can't get enough skilled nursing staff on hand to be able to operate at levels above that. And we had folks who had been sending employees out to a local CVS or a Walgreens and buying out all of the Gorilla Glue because the adhesives that are used to seal together their cardboard packaging are backlogged owing to the hard freeze in Texas this last winter. I mean, And really, they're not theoretical concepts. When you get out and you talk to our middle market clients, they are really hard realities that they are grappling with. And I think, as Greg said, we all hope that, especially as the enhanced unemployment benefits wane and as we work through some of these supply chain challenges, that our clients are able to invest in their business. But if you can't get the people, you can't get the materials, you can't invest to grow them.

Is there any risk, just to follow up quickly, that there's a permanent change in the way these companies will manage themselves, which would lead to a lesser need for borrowing from banks like yours because of what they're going through? Have you heard that at all from your customers?

No, no, not yet. I think we hear them exploring opportunities to be less reliant on manual labor and to drive automation, but that drives CapEx, right? So that helps us. We hear them exploring opportunities to secure more captive supply and otherwise through M&A. But that also drives borrowing in terms of the way that we operate. And ironically, actually, we hear many of them say, hey. You know, we have been pushing for decades now to run more asset light, which meant less liquidity on hand. And maybe we don't want to do that going forward. And we're willing to absorb slightly higher debt service costs in favor of being a little bit more liquid. And that would be helpful to us in terms of the way it drives borrowing. So I don't think so, Gerard. It just doesn't. We've got to see our way through to the other side of this because, you know, you can't get labor, you can't get inventory. It's hard to grow.

Thank you for all the color. Appreciate it.

Very nice. Next question comes from the line of Bill Kahachi with Wolf Research.

Thanks. Good morning. Can you relate the income strength that you saw this quarter to the growth you're seeing in the Southeast region? Are you leading in the Southeast with your fee-based products like treasury management rather than credit as you grow into that region? And if you could discuss the longer-term growth outlook across your other fee-based products in the Southeast.

Yeah, sure. Bill, it's Tim. I'll take that. I think the growth, if you look at new client relationships and otherwise, is very strong in the commercial business in the Southeast. So they are contributing disproportionately to the incremental fee income. But I wouldn't tell you that it is focused exclusively on the Southeast. If you look at our new commercial relationships, About 30% of them this year are lead with treasury management. And then there's another percentage, which I don't have off the top of my head, but which has come to us primarily through the capital markets business. So we are having good success using those products as wedge opportunities to drive new relationships. If you look forward, I think we're trying to build what is a really nicely diversified capital markets business with low activities like rates and commodities hedging and otherwise to complement the M&A advisory business and what we do in equities with what we do on the bond market. I mean, what we continue to anticipate is at some point here, the capital markets will be a little bit less accommodative. We'll get the benefit of that in loan balances, but you'll see some lightening on bond fees. But the other side of it is we're sitting on an M&A pipeline now, which is almost double what it was in January 1 of this year. So we do have a nice M&A advisory pipeline that should come behind it. On the treasury management side, we've pretty consistently grown at the rate of the industry plus two to three percentage points. I am of the belief that we can do better than that, but it's definitely better to be taking share there over time than it is to have the alternative management. So we feel good about both of those felines over the near to medium term.

That's very helpful. Thank you. And, Greg, you mentioned Green Sky when talking about your partnerships earlier. Can you give us an update on how you're thinking about indirect lending partnerships more broadly and the opportunity to leverage these partnerships to continue to grow nationally beyond your footprint? Critics of that model say, argue that you really need to own the relationship and are at a disadvantage when all you're doing is putting up your balance sheet and somebody else has a relationship with the customer. But we'd love to hear your thoughts.

First off, there's not a lot of these opportunities out there. We have the economics of the Green Sky relationship. And as we wanted as an investor, it made a lot of sense for us. This is not how we grow our business over time. We're much more of a relationship business. That's why the provide acquisition was extremely important. You think about provide acquisition. That was a partnership originally. We had about $400 million in assets. But 70% of those relationships, we had additional relationship outside the credit facility, where it would be TM or deposit relationship. So that was important. It's a relationship type of opportunity for us. And that's what we're looking for to continue to enhance our business and grow our businesses. create another channel for us. But, yes, it's a non-relationship business for us. And those opportunities that make sense to us are very few out there. But the grease guy will invest for the economics of the transaction in place.

Got it. That's super helpful. Thank you.

Our next question comes from Ken Olson with Jefferies.

Thanks. Good morning. A couple quick ones. First of all, the third quarter momentum marketing program that you mentioned where you used part of that benefit, is that just to get it kick-started? And then would you have ongoing expenses related to marketing built into your forward at work past 3Q?

Yeah, it's Jamie. Yes, the $15 million incremental spend over the second quarter marketing spend level of $20 million. So we expect to spend $35 million of marketing in the third quarter. That should abate going forward. However, if it is successful, then we'll continue the program at that elevated level until we've really captured as much of the first mover advantage with the product as we can.

Okay, got it. Understood. And then do you have any plans to or thoughts on re-securitizing those Ginnie Mae loans that you get the 3-7 that you mentioned? I know some of them are newer, so they might not have quite gotten to that seasoning point yet. But is that at all in your outlook in terms of, you know, whether they stay in loans or move to mortgage banking over time?

So for the $3.7 billion of loans that we've purchased from other third-party servicers, there's a nominal amount of fees assumed in the outlook related to that as they get resold to the servicer. The bigger economic opportunity is on the $750 million of forbearance loans that we bought directly back from Jenny Mae on our own production, as well as within our resi mortgage portfolio to the extent that there are any on non-accrual or delinquents that, sure, we do have. We have had sales this year that generate, you know, several million dollars in fees. And we expect to do that, you know, over the next six, seven quarters as well. So I think it's more of a run rate, normal course of business than it is any one time pop.

That makes sense. Last one, just you redeemed a bunch of debt, mostly at the bank, some at the parent. Is there any more room to do that? That's obviously still the highest cost of funding, but again, you have all the excess deposits. What's the balancing act in terms of where you want that long-term debt footprint to settle over time? Thanks, guys.

Given the excess liquidity that we have, there's clearly not a need to maintain the higher unsecured debt levels that we have. We have an additional maturity in the third quarter we'll most likely not replace. That's about $850 million, almost a 3% rate. So there's a little bit. left to go in terms of improvement along with running down the wholesale CD book. But those benefits are all baked into our outlook, so I would not expect it to get better than what we've guided to from the right-hand side of the sheet. I think the opportunity for us from an NIH improvement standpoint will be on the left-hand side of the sheet.

Understood. Thanks, Jim.

Our next question comes from John Picari with Evercore ISI.

Morning. Morning, Jonathan. Morning. On the loan growth side, on the utilization, I know you expected to improve by about a percent through the year end. Can you just hop out with what is your pre-pandemic utilization level and maybe an expected timing where you think you can get back to that level on that front?

Yeah, that's a great question. I wish I knew the answer to that. I do know the first part of the idea. We would typically run around 36%, 37%. As I mentioned, every 1% is about $750 million in assets. So we're running at 31%, kind of flatline right there. I can't really – we're hopeful, but I can tell my team hope is not a strategy. We're hopeful we start to see that tick up a little bit based on the production levels that we're seeing out there right now. Hopefully get some of these challenges in front of us on the supply chain and labor markets. maybe a baiting little later this year. But once again, it's a tough thing to say. When do we get back to a normalized run rate? You know, it's going to be a while. I mean, it's going to be in quarters, not, you know, maybe a year plus before we get there, I believe.

That's helpful. And on that same topic, on the loan growth guide, it indicated a double-digit consumer growth, stable CRE. You've got PPP impacting commercial. What would be your growth expectation for commercial with PPP and XPPP on that four-year guide?

Relatively stable on commercial growth. Yeah, I would say, John, I would say full-year commercial average loans would be down mid-single digits and XPP a little bit more than that, but ending the year with a little bit of a – a little closer to stable. And then, you know, PPP is – we've been running – steadily down as the year has progressed, where, you know, on an end-of-period basis, you know, we finished the first quarter at $5.4 billion. We finished the second quarter at $3.7. You know, that will continue to drift down to, you know, $2.1 billion at the end of the third, and then $1.7 billion at year-end is our current projection on PPP.

Got it. Okay, thanks. And then lastly, on the M&A front, as you look at incremental opportunities there, Greg, I just wanted to get your thoughts on potential incremental bank and non-bank. And more importantly, curious what you think of President Biden's executive order and the implied added scrutiny around bank deals. Do you believe that could impact a bank of your size looking at a potential whole bank deal?

Yeah, first off, I would respond by saying our focus is on non-bank transactions that enhance our product and service capabilities, like Provide would be a great example of that. So we'll stay focused there for the most part. If the right opportunity presents itself in a market that's attractive to us that kind of solves, would be financial solve for us in Chicago, obviously we always consider those type of opportunities, but the far and few between and not the focus of the organization. As far as advice, executive order, There's a lot of work to be done. The agencies, the OCC, Fed, and FDIC, and DOJ are trying to figure out what that means. So more to come on that, but you can believe, as I do, that the economics of transactions could be more challenging going forward. It's an executive order, and the timeline to get those transactions approved may take a little bit longer. But good transactions will get done.

Got it. Thanks for taking my questions.

Sure.

Our next question comes from Matt O'Connor with Deutsche Bank.

Good morning, guys. Just talk a bit more about the path to the 9.5% CET1 target. Obviously, you talked about the dividend increase, the buybacks back half this year, the 20 basis point drag. But if you put all that together, you know, you're still going to be, it seems like kind of treading water on the capital, just given the good earnings generation and probably not a lot of balance sheet growth the next few quarters. So, Do you think you'll get that target, or are you going to hold back for kind of the low growth and maybe just flush that a little bit as we think about the first half next year?

Yeah, our goal is certainly to get to the 9.5% by June of 2022. And, yes, it is, you know. certainly a large amount of repurchases i think the two factors to bake into it would be there's 20 basis points of cet1 erosion uh from the provide acquisition in the third quarter and then nine basis points of cecil transition um in the first quarter of 2022 so it you know that a little bit of capital gets spent there but yes to your point we have a lot of capital deployment opportunity ahead of us to get to the 9.5%. And certainly if loan growth doesn't materialize, then We'll look to continue to hit the 9.5%. And then we do feel that should loan growth accelerate, we certainly have a buffer from where we think we need to run the company from a capital perspective. Clearly, from the credit outcomes you're seeing, we could run the balance sheet at 9% or so if loan growth were to accelerate. But for now, our focus is just getting to the 9.5% by mid-year next year. Okay. That's helpful.

Thank you.

Our next question comes from Peter Winter, Woodward Bush.

Good morning. I wanted to ask just on the middle market and small business, are you seeing any willingness of them maybe to tap their lines of credit while maintaining higher levels of cash on hand, or is it just an issue of the supply and labor shortages that's holding it all back?

Hey, Peter. It's Tim. You know, I would tell you it's primarily issues with supply chain and labor, like Greg said, and not liquidity. If you're looking for green shoots, I think the borrowers who are either smaller or who rely on structures that look more like asset-based lending structures are are starting to tap their lines. So we are seeing modest improvements in utilization in that sector. Now, in aggregate, that's not a large segment of our balance sheet, which is the reason that you see utilization overall at fifth third being stable. But generally, as these things happen, they happen at the lower end of the book first, and they migrate upward into the larger borrowers. So I at least, when I feel like finding a positive signal, that's where I'm going these days.

Okay. And then, Jamie, can I just ask about the outlook for the margin in the second half of the year, some of the quits and takes?

Sure. The second quarter was obviously very strong from a margin perspective, and We're pleased with how the balance sheet's been performing, but given the high levels of PPP as well as the investment securities prepayment penalties that we don't expect to recur, or at least don't forecast to recur, we would expect to see the NIM decline a bit to a more normalized level, which is that 305 basis point area is what we've talked about. I think pretty much all year in terms of, you know, what we think this balance sheet should stabilize at, certainly for the foreseeable future. So NIMS should come down, you know, call it five pips or so in the third quarter. I would say the big drivers there, certainly the PPP, the prepayment penalties, a little bit of day count. and otherwise still maintain that floor of 305 or better.

Got it. Thanks for taking my questions.

Our next question comes from the line of David Conrad with KBW.

Hey, good morning. Quick follow-up on the securities portfolio. Maybe, Jamie, can you remind us what the remaining duration is for the bullet structured product?

So the total portfolio is a 4-9 duration, and so the bullets, when we quote the 58% number, we're saying it's bulleted or locked out for at least the next two years, but the duration of that portfolio is not that different from the portfolio in total.

Okay, so the lockout is two additional years.

Correct, but there's not a step down. You know, for a while we had quoted a 12-month, and then we got the question, so we expanded to 24, but there's not a cliff here. It's just a, you know, slow erosion over time. Great. Thank you.

Our next question is from Christopher Monalec with J.P. Montgomery-Scott.

Thanks. I just wanted to go back to the regulatory question before, Greg. Is the environment any different than it would have been six or nine months ago, whether it's the CFPB or any of the agencies?

Well, obviously with the debt shares changing right now, there's still a process on the CFPB front from a nomination perspective. So has it changed? You know, listen, it's been – I don't believe it's changed, to be honest with you. I think at the end of the day, these agencies have a job to do and a role to play. I think the focus of the CFPB and the OCC and the FDIC are going to be making sure that there's the safety and soundness, but also the way the banks handle themselves and operate are going to be extremely important. I haven't sensed a big shift with the new administration on requirements and demands of the bank and the tonality, so to speak, from the top as to what they expect from us. So, you know, it's not something that keeps me up at night, let's put it that way.

Good, Greg. Thank you for that, and thanks for all the background this morning.

Thank you.

Those are all the questions we have at this time. Are there any closing remarks?

Yes. Thank you, Christy, and thank you all for your interest in FIFR. If you have any follow-up questions, please contact the Investor Relations Department, and we will be happy to assist you. Thank you.

Ladies and gentlemen, thank you for your participation. You may now disconnect.