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Good morning, my name is Caitlin and I will be your conference operator today. At this time, I would like to welcome to Fifth Third Bancorp’s second quarter 2018 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you.
Sameer Gokhale, Head of Investor Relations, please begin your conference.
Okay, thank you Caitlin. Good morning and thank you all for joining us. Today we will be discussing our financial results for the second quarter of 2018.
This discussion may contain certain forward-looking statements about Fifth Third pertaining to our financial condition, results of operations, plans and objectives. These statements involve risks and uncertainties that could cause results to differ materially from historical performance and these statements. We have identified some of these factors in our forward-looking cautionary statement at the end of our earnings release and in other materials, and we encourage you to review them. Fifth Third undertakes no obligation to and would not expect to update any such forward-looking statements after the date of this call.
Additionally, we will also be discussing the proposed merger of MB Financial Inc. and Fifth Third Bancorp. This discussion may contain certain forward-looking statements about Fifth Third, MB Financial, or the combined entity pertaining to our financial condition, results of operations, plans and objectives. These statements also involve risks and uncertainties that could cause results to differ materially from historical performance and these statements. We have identified some of these factors in our forward-looking cautionary statements at the end of the earnings release and in other materials, and we encourage you to review them. We undertake no obligation to and would not expect to update any such forward-looking statements after the date of this call.
The subject matter discussed today is addressed in the proxy statements and prospectus filed with the SEC. We urge you to read it because it will contain important information. Information regarding the persons who may under the rules of the SEC be considered participants in the solicitation of shareholders of MB Financial Inc. in connection with the proposed transaction is set forth in the proxy statement and prospectus filed with the SEC.
Reconciliations of non-GAAP financial measures we reference during today’s conference call are included in our earnings release, along with other information regarding the use of non-GAAP financial measures. A copy of our most recent quarterly earnings release can be accessed by the public in the Investor Relations section of our corporate website, www.53.com.
This morning, I’m joined on the call by our President and CEO, Greg Carmichael; CFO Tayfun Tuzun; Chief Operating Officer Lars Anderson; Chief Risk Officer Frank Forrest, and Treasurer Jamie Leonard. Following prepared remarks by Greg and Tayfun, we will open the call up for questions.
Let me turn the call over now to Greg for his comments.
Thanks Sameer, and thank all of you for joining this morning. Earlier today, we reported second quarter 2018 net income available to common shareholders of $563 million and earnings of $0.80 per share. Included in these results are several items noted on Slide 4 of the investor presentation. On a net basis, these items had a positive impact of $0.17 on our reported earnings per share. Excluding these items, our quarterly EPS was up approximately 11% on a sequential basis and up 37% year-over-year.
Our financial results for the quarter were strong and reflect our continued focus on driving profitable revenue growth, managing expenses prudently, and disciplined underwriting. I am also pleased that we are realizing the benefits of several initiatives we implemented under Project North Star.
Before discussing the highlights of the quarter, I’d like to make a few observations about the macroeconomic environment. Recent economic data has shown acceleration in GDP growth. Labor markets are strong and the unemployment rate is still very low, but the resulting skill labored shortage may constrain GDP growth. Recent discussions about tariffs have also created uncertainty. As many of you know, the U.S. economy is now in the second-longest period of economic expansion on record. It is unclear how long the positive momentum will continue. In the current economic environment, we believe it is prudent to remain cautious and to maintain our disciplined focus on credit quality and profitability.
Moving on to our quarterly results, our financial performance for the second quarter was strong and continued to reflect the benefits of actions we undertook under Project North Star. Commercial loan originations were strong even though we remained focused on disciplined underwriting and client selection during the quarter. Commercial middle market originations were up over 25% year-over-year, the highest levels in years, while corporate banking originations increased by 28% year-over-year to a record high during the quarter. This strong growth partly reflects the benefit of our commercial client experience initiative, or CCEI, which we implemented earlier this year. You may recall that CCEI was an end-to-end process redesign initiative. Recent results show that we have reduced cycle times in middle market lending by 30 to 35%, exceeding our original expectations. The reduced cycle times have allowed our commercial relationship managers to become more productive, helping drive very strong, high quality growth in loan originations.
Average credit card balances were up a very healthy 7% year-over-year while card purchase volume was up 10% year-over-year. One of our initiatives under Project North Star was to deploy advanced analytics in the credit card business in order to improve activation and usage rates. We have already started seeing the benefits as growth in our credit card purchase volume is significantly outpacing competitors in our footprint. This is a meaningful shift from a year ago when we lagged our peers.
Fee income reflected very strong growth in public banking revenue and a strong deal pipeline as we entered the second quarter. Total corporate banking revenue grew 36% sequentially to $120 million. Over the quarter, we have begun to see the benefits of the implementation of Vision 2020, which is also part of North Star. Vision 2020 is the digital redesign of our financial risk management interface which allows our commercial clients to interact in a real time environment and make better decisions using market data. I believe that our continued focus on offering the right products, executing well, and delivering on strong customer experience is helping to drive these results. A great example is Coker Capital, a healthcare M&A advisory firm which we acquired in February. I’m very pleased with our corporate banking results, and we expect to build on this momentum going forward.
We recently completed the implementation of our new mortgage loan origination system across all of our channels. The new mortgage loan system significantly improves our capacity to originate mortgages and enhances the efficiencies of our processes. Although the mortgage business is currently under pressure due to a very tight gain on sale margins and low inventories, we expect to see the benefits of our new loan origination system over time.
During the quarter, we expanded our wealth and asset management pools with the launch of Optify, an automated investment advisory platform. Optify will enable Fifth Third to build upon our established advisor-led approach and offer an integrated digital experience.
One of the areas we talked about at our investor day was the use of enhanced analytics across our bank, including deployment of geosciences capabilities to help optimize our branch network. In the second quarter, we leveraged these newly developed analytical capabilities to evaluate our physical branch network. This evaluation supports a three-year plan which results in the closure of approximately100 to 125 branches, mostly in legacy slow growth areas, while opening roughly the same number in higher growth locations with more attractive demographics. We believe this plan is the right long-term strategy to increase households and further support revenue and deposit growth.
We continue to enhance our digital capabilities but believe the physical branch is still relevant and plays an important role in giving customers an integrated banking experience. As we strategically close branches, we will continue to invest in our digital capabilities.
We’ve already seen positive results from our digital investments. On the consumer front, new checking account production volumes through digital channels were up approximately 50% year-over-year. Additionally, 54% of our total consumer deposits are made through our mobile and digital ATM channels, and nearly two-thirds of all customer transactions are now completed digitally. We are also seeing substantial benefits on the commercial side of the house. We recently launched a managed payable solution and an advanced electronic FX platform. In addition, we continue to see strong enrollment growth in our commercial portal. Although we have primarily focused our digital capabilities in footprint, our architecture is structured to give us the flexibility to expand outside our current footprint.
Our digital transformation efforts have received a significant amount of industry recognition. I was pleased that Tim Spence, who heads our Payments, Strategy and Digital Solutions team was recently named Digital Banker of the Year by the American Bankers Association. This award was well deserved for Tim’s efforts in leading Fifth Third’s digital transformation.
As I touched on earlier, our focus on managing expenses continues while we invest for future growth. During the second quarter, we completed another phase of workforce reductions. These reductions were primarily concentrated in back office and support functions and we incurred a $19 million charge related to severance expense. We expect to reduce headcount to generate an additional $80 million in expense savings over the next 12 months. Although these reductions involve difficult decisions, we believe that they are the right decision for our bank as they not only reduce expenses but also result in more streamlined processes across our businesses.
Turning to credit quality, our results continue to reflect the benefit of actions we took to reduce volatility of credit losses and to improve the resiliency of our balance sheet. In 2016 and 2017, we exited $5 billion of loans that did meet our risk or return requirements. We announced this in 2016 as part of our balance sheet optimization goal within North Star. As we have exited these loans and remained focused on disciplined client selection, we have continued to see an improvement in key forward indicators of credit quality. Our criticized asset ratio decreased significantly to 3.87% from 4.83% in the first quarter and 5.5% in the second quarter of 2017. We believe that our criticized ratio has moved from one of the highest in our peer group to one of the lowest over the last two years. This improvement should bode well for us, especially when the economic cycle turns.
As you can see from these highlights, our North Star initiatives are progressing very well and we are seeing the benefits in our results. We expect most of the remaining initiatives to be executed by the end of this year. This timeline is well in line with our plan to integrate MB Financial as the transaction closes.
In the second quarter, we received the results of our CCAR submission and were very pleased with the outcome. As expected, we received a non-objection to our capital plan, allowing us to increase our dividend by 33% and increase capital deployment for share repurchases by 42% compared to last year’s CCAR submission. We view the non-objection as very positive and we are pleased that we were allowed to continue to return capital to shareholders without waiting for a response to our upcoming submission pro forma for MB Financial.
We continue to make good progress towards the close of MB and have assembled a talented and experienced team from both companies to move forward with our integration plan. Tayfun will provide additional details on our progress, but one of the key areas of focus is on employee and customer retention. As I mentioned when we announced the transaction, Mitch Feiger, the CEO of MB Financial will continue as Chairman and CEO of the combined franchise in Chicago. Several members of Mitch’s current leadership team will lead the business going forward, complemented by members of the Fifth Third team in Chicago. We have identified specific roles for these individuals and the majority of them will report directly to Mitch.
We believe that retaining talented leaders from both organizations will serve to help both employee as well customer retention. We are maintaining regular communication with employees from both companies and are also conducting customer listening sessions on an ongoing basis. The listening sessions are meant to address any questions or concerns that customers may have. We are pleased that we have seen minimal employee or customer disruption since we announced the acquisition. With the organizational structure in place and the right team members to lead the integration efforts, we are confident that we’ll be able to realize the cost savings we announced in May.
At the time of the announcement, we intentionally excluded revenue synergies when discussing the financial impact of the acquisition. Based on our current analysis, which is still ongoing, we expect to achieve between $60 million and $75 million in pre-tax income from revenue synergies by year three. We intend to update you with additional details on these benefits between now and closing. The larger part of these revenue synergies is in our combined commercial banking business. We intend to realize these synergies by leveraging MB’s capabilities in core middle market ABL and leasing across our footprint.
We also plan to expand business relationships with current MB commercial customers in Chicago while offering our more comprehensive set of capital markets and treasury management products and services. With additional revenue synergies, we expect the IRR from the transaction to increase an additional 150 to 200 basis points and tangible book value earn-back to decrease from 6.8 years to 5.9 years. We continue to believe that the economics of this transaction are very compelling and look forward to sharing our progress with you over the course of the year.
I’d like to once again thank our employees for their hard work, dedication, and for always keeping the customer at the center, which is evident in our financial results. We were pleased to have recently received validation of our efforts from two separate, independent third parties. First, Kiplinger just named Fifth Third the Best Regional Bank and runner-up for the Best Private Bank across the entire U.S. based on the strength of our offerings. We were the only bank mentioned in both categories. Our decision sciences team won the 2018 Special Achievement in Geosciences Award, which recognizes organizations across the globe for making significant advancements in the scientific field of geosciences. We received this award for the innovative work related to our branch network analytics.
I was pleased we were again able to deliver strong results, and we remain on track to achieve our North Star targets.
With that, I’ll turn it over to Tayfun to discuss our second quarter results and our current outlook.
Thanks Greg. Good morning and thank you for joining us. Let’s move to the financial summary on Slide 4 of the presentation.
As Greg mentioned, during the quarter NIM expansion, strong commercial loan originations, diligent expense management and significant improvement in key credit quality indicators reflected the progress we have made to enhance our financial performance while maintaining the resiliency of our balance sheet. Reported results were positively impacted by the items noted on Page 1 of our release.
The most significant item was a $205 million pre-tax gain from the sale of the Worldpay shares. We believe the timing of the sale and the expected return of capital via buybacks in the coming quarters will be rewarding for our shareholders, given the recent trading range of our stock. The remaining unrealized gain in our Worldpay stake is approximately $400 million based on their current stock price. Our ownership percentage is about 3.3% and at this level, we continue to use the equity method of accounting. The sale also generated $120 million in incremental pre-tax TRA benefits to be recognized over the 15-plus years.
The gain along with an $11 million positive pre-tax benefit from GreenSky’s IPO was partially offset by a $30 million branch network optimization charge, $19 million in pre-tax compensation expense primarily related to a workforce reduction, a $10 million pre-tax charge related to the Visa total return swap, and a $10 million pre-tax contribution to the Fifth Third Foundation. Excluding these items, our underlying core ROA and ROTCE metrics continue to substantially improve. Core ROA of 1.33% improved 10 basis points sequentially with core ROTCE of 14.6% improving 1.3% from our adjusted first quarter results.
Moving to Slide 5, during the second quarter, average total portfolio loans were flat compared to the first quarter of 2018. Growth in C&I and personal loans was offset by decreases in home equity loans and commercial leases. Commercial loan growth of 1% was driven by strong origination activity in both middle market and large corporate loans. As Greg mentioned previously, our corporate banking originations this quarter were the highest ever and commercial middle market originations were the highest in years. However, pay-offs near the end of the quarter were elevated, which resulted in slightly slower than anticipated loan growth for the quarter. Much of the pay-down activity was the result of clients tapping the capital markets, and we were able to capture capital market fees associated with those pay-downs. Assuming the rhetoric around trade war subsides, we expect to achieve our previously discussed loan growth targets for the year.
On the topic of tariffs, it is still too early to tell whether they will have much of an impact on our clients’ businesses. Our discussions with them indicate that they intend to pass the higher costs onto their customers, but it is unclear whether they will be able to achieve a complete offset, which may affect their profitability and growth plans. We will continue to monitor the situation closely.
Average C&I balances were up 1% or approximately $510 million compared to the first quarter of 2018, and were up 2% or approximately $690 million year-over-year. The sequential increase in average C&I balances was partially offset by a 3% decline in commercial leases. We expect commercial leases to continue to decline another $150 million through the end of the year. This reflects our goal to decrease our exposure to non-relationship based leases that have historically experienced significant fluctuations in asset values.
Similar to prior quarters, price competition in commercial lending remains aggressive. We are continuing to focus on striking an appropriate balance among growth, risk management and profitability.
Average commercial real estate loan balances were flat sequentially in the second quarter with mortgage down 1% and construction up 2%. We will continue to maintain a cautious approach in commercial real estate lending, particularly in certain segments of multi-family given where we are in the cycle. We currently expect our end-of-period total commercial portfolio to grow by about 3% sequentially in the third quarter. For the full year, we expect the portfolio to grow by 4%, including the impact of the planned run-off of our national leasing business.
In consumer, average loans were down 1% sequentially and flat year-over-year, but were up 2% year-over-year excluding auto. Auto loans were down 5% year-over-year, reflecting the ongoing impact of our decision to curtail originations and redeploy capital elsewhere. The rate of decline in the auto portfolio should continue to slow as we expect originations to increase to about $4 billion in 2018 from $3.7 billion in 2017. Higher origination levels reflect the more attractive returns we’ve been seeing so far this year.
Average residential mortgage loans were flat sequentially and up 1% year-over-year with continued balance sheet retention of jumbo mortgages and arms. Separately, we acquired a $2 billion servicing portfolio to be on-boarded in the third quarter, bringing the total acquired servicing portfolio to $14 billion since the beginning of last year.
Our average credit card portfolio was flat sequentially, but balances grew by 7% year-over-year as we are starting to see the benefits of North Star. We expect card balance growth in the mid to high single digits for 2018.
Personal and other consumer loans increased 8% sequentially to $1.7 billion. This quarter, we also launched a new digital lending enhancement that allows our customers to apply for a loan on our mobile app and receive funds almost instantly. We believe that we are one of the only banks to offer this.
In the third quarter, we expect total end-of-period consumer loan balances to be relatively flat compared to the second quarter. For 2018, we expect end-of-period loan growth of approximately 1%, reflecting continued mortgage origination weakness. Excluding indirect auto loans, we expect consumer loan growth of about 2%.
Our average investment portfolio increased 1% in the second quarter as market dynamics led to a few opportunistic purchases. We expect to maintain our portfolio balance at roughly the same level in the third quarter.
We had solid deposit performance and household growth in the second quarter. Average core deposits were up 1% sequentially. An increase in interest-bearing commercial and consumer account balances was partially offset by lower commercial demand account balances. As is typical in a rising rate environment, we continue to experience deposit migration from demand deposits to interest-bearing accounts. Overall, deposit markets have been very competitive, particularly for operational commercial deposits. Despite the environmental pressures, we believe we have an opportunity to steadily grow the consumer book, leveraging our recent success in analytical driven direct marketing. In addition, over the long term our decision to open new branches in high growth markets will enable our retail franchise to support a higher deposit growth rate. From a profitability perspective, these new branches will be more efficient as they will be highly automated, smaller in size, and require lower staffing levels than the branches we are planning to close.
Taxable equivalent net interest income of $1.024 billion was up $25 million or 3% from the first quarter, reflecting higher short-term market rates, a higher day count, and growth in middle market C&I loans. The NIM increased three basis points from the first quarter to 3.21% and has expanded 20 basis points on a year-over-year basis. The sequential improvement was primarily driven by higher short-term market rates and growth in higher yielding commercial loans, partially offset by a higher day count and incremental commercial deposit pricing pressure, as I mentioned earlier.
Our cumulative beta leading up to the June 2018 Fed hike was 29%, with consumer in the low 20s and commercial in the high 40s. The March rate hike resulted in a beta of approximately 45%, and we expect the June rate increase to result in a beta of approximately 50%. We expect incremental increases in deposit betas with additional future rate hikes.
The NIM in the third quarter of 2018 should be flat from the second quarter despite a two basis point negative impact of day count. We expect full year 2018 NIM to be between 3.2 and 3.22%, including the impact of a September rate hike. The slight change in our outlook from last quarter reflects the expectation of increased deposit betas. Embedded in our forecast is about a 10 basis point increase in interest-bearing deposit rates in each of the next two quarters.
We expect our third quarter net interest income to be up approximately between 1 and 2% sequentially to $1.04 billion, which is largely a function of expected commercial loan growth and day count. For the full year of 2018, we currently expect NII to grow by 7% from the adjusted 2017 NII to approximately $4.12 billion.
Excluding the impact of the non-core items, non-interest income in the second quarter increased 3% sequentially. The improvement was driven by a record quarter in corporate banking revenue and solid growth in card and processing revenue, partially offset by a seasonal decrease in wealth and asset management revenues.
Mortgage banking net revenue of $53 million was down $3 million sequentially. Originations of $2.1 billion were 35% higher than the first quarter, but the second quarter gain on sale margin at 166 basis points was tighter than we expected and 23 basis points lower compared to the first quarter. We expect margins to continue to be tight during the remainder of the year. During the quarter, approximately 75% of our origination mix consisted of purchase volume, with two-thirds of our originations sourced from retail and direct channels and the remainder through the correspondent channel.
Sequential growth in corporate banking revenue of $32 million or 36% exceeded our previous guidance of a 20 to 25% increase. The improvement was primarily driven by strong broad-based capital markets revenue growth led by corporate bond fees and loan syndication revenue. With the roll-out of the North Star initiatives, we believe we have the right long-term strategies in place to generate sustainably higher growth in corporate banking revenue in the future. Our solid pipeline of deals as well as the impact of the strategic investments in acquisitions should help us generate corporate banking fees between $110 million and $120 million in the third quarter, even as it tends to be a slower quarter in the capital markets, and of course subject to market conditions.
Deposit service charges remained unchanged from the first quarter. Card and processing revenue was up 6% sequentially, reflecting seasonally higher credit and debit transaction volume partly offset by higher rewards expense. Results in our credit card business reflect the benefit of continued investments in card analytics driving faster growth compared to the industry.
Total wealth and asset management revenue of $108 million was down 4% sequentially, primarily driven by seasonally strong tax-related private client service revenue in the previous quarter. Year-over-year growth in wealth management was 5%.
For the third quarter of 2018, we expect fees to be about $600 million or up approximately 6% from adjusted non-interest income in the second quarter. For the full year of 2018, we continue to expect fees to be approximately $2.35 billion.
We remain focused on disciplined expense management while continuing to invest for revenue growth. Reported non-interest expenses decreased 1% sequentially. Excluding the one-time items recognized in both quarters, expenses were down 3% and lower than our guidance for a 2% decline. Third quarter expenses are expected to be down another 1% from the reported second quarter level even though we expect to invest more in marketing to support household growth.
Our direct marketing efforts have been very successful and have driven year-over-year household growth of 4%, generating IRR significantly higher than even our most optimistic assumptions. Leveraging this success, particularly in our high growth southeastern markets, we will continue to invest in additional marketing efforts. Close to 1% of our expense growth in 2018 is expected to come from the increase in our marketing budget.
In addition to higher marketing expense, we also expect to have higher incentive compensation expense directly tied to performance and elevated business activity. This increase in marketing expense should be partly offset by reduced compensation expenses related to the headcount reduction. This dynamic reflects our desire to achieve expense saves to invest in revenue growth opportunities in all business lines. The reduction in compensation expenses will start impacting our run rate in the third quarter, with a greater impact in the fourth quarter and beyond. At this time, our expense guidance range for 2018 remains the same as last quarter, adjusting for the non-core items disclosed in our earnings release.
Our adjusted efficiency ratio for the second quarter was 63%. Excluding the low income housing amortization expense which all peers reflect in their tax line, our efficiency ratio was 60%. We expect our efficiency ratio to continue to decline in the second half of this year. For the full year of 2018, we expect it to be slightly above 60% excluding the impact of low income housing amortization expense. Of course in 2020 and beyond, the combination of the North Star outlook and the MB Financial acquisition significantly changes the direction of our efficiency ratio.
Wrapping up the expense and revenue discussions, I want to reiterate that we expect to achieve positive operating leverage for the year as well as for the last two quarters of the year.
Second quarter credit results continued to follow a positive trend, reflecting the impact of deliberate actions that we executed to reduce high risk exposures during the past two years and an ongoing emphasis on disciplined client selection as a credit risk management tool. The criticized assets ratio, a key leading indicator of credit quality, continued to improve. At the end of the second quarter, criticized assets declined $562 million sequentially, with the criticized asset ratio decreasing to 3.87% from 4.83% last quarter, its lowest level in almost 20 years.
Net charge-offs were $94 million or 41 basis points, up five basis points from the first quarter of 2018 and up 13 basis points from last year. Commercial charge-offs were 34 basis points, up 13 basis points from the first quarter and up 17 basis points year-over-year. Consumer net charge-offs of 52 basis points were down 8 basis points sequentially and were up 6 basis points year-over-year.
Total portfolio non-performing loans and leases were $437 million, down 28% from last year and down 3% from the previous quarter. The sequential decrease was primarily due to a 35% decline in C&I NPLs. As a result of the historically low criticized assets and low level of NPLs, the reserve ratio declined 7 basis points to 1.17%.
As we remind you every quarter, the current economic backdrop continues to support a relatively stable credit outlook. We nevertheless caution that we could potentially experience some upward pressure in the future as we are generally in a very benign credit environment. Having said that, for the second half of the year, we expect both our charge-off ratios and dollar charge-offs to be below the first half numbers.
Capital levels remained very strong during the second quarter. Our common equity Tier 1 ratio was 10.9%, up 9 basis points sequentially, reflecting the partial sale of our remaining Worldpay stake. Our tangible common equity ratio excluding unrealized gains and losses increased 19 basis points from last quarter to 9.33%. During the quarter, we initiated and settled a $235 million share repurchase which concluded our 2017 CCAR plan. We also raised our common dividend by $0.02 during the quarter to $0.18 per share. As Greg mentioned, we are very pleased with the CCAR 2018 results, including our ability to continue to return capital to shareholders under our original CCAR submission while we resubmit our capital plan to include MB’s results. At this time, we are waiting to hear from the Fed regarding the details associated with the resubmission process. Our near term and long term capital targets remain the same as before.
At the end of the second quarter, common shares outstanding were down almost 7 million shares, or 1% compared to the first quarter, and down 61 million shares or 8% compared to last year’s second quarter. Book value and tangible book value were up 8% and 7% from last year respectively.
With respect to taxes, our second quarter rate of 15.5% was impacted by the Worldpay gain and other items disclosed in our release. Excluding these items, our tax rate was approximately 13.3%. We expect our tax rate for the full year to be in the 16 to 16.5% range. Excluding the items that are specific to 2018, we would expect our long term tax rate to be in the 15.5 to 16% range.
Slide 13 provides an update on the primary North Star focus areas we discussed at investor day, our progress in implementing those initiatives and the remaining work we have left to do between now and the end of 2018. As Greg discussed previously, we expect to be substantially complete with the work prior to the acquisition closing and conversion. In fact, as you heard from him earlier, we have already begun to see substantial benefits from implementing several of these initiatives across middle market loans, capital markets, credit card analytics, and credit quality improvements.
Recall that last quarter, we revised our fourth quarter of 2019 ROA and ROTCE targets to reflect our confidence in retaining the vast majority of the benefits from the 2018 tax legislation. During our announcement of the MB acquisition, we further raised our fourth quarter of 2019 target to reflect the expected impact of the additional cost reduction initiatives we announced on our last earnings call.
The completion of the remaining North Star implementation work this year aligns well with the timing of the MB Financial integration. One of our key strengths as an organization is the ability to execute against our goals, as we have demonstrated over the last two and a half years. Given the number of items in our line of sight that are expected to positively impact our results over the next two years, including the MB acquisition, we simplified our financial targets to provide guidance for the full year of 2020. We believe this will provide the most appropriate and informative view of our expected outcomes from all activities. Based on our current forecast and given the assumption that the MB merger closes in the early part of 2019, we expect to achieve an ROTCE of 18%-plus and ROE between 1.55 and 1.65%, and an efficiency ratio in the low 50s range excluding the LIH expense for the full year of 2020.
Slide 14 provides more detail on the expected financial benefits of additional actions I touched on briefly. As Greg mentioned in his remarks, we are implementing a comprehensive plan to redesign our retail branch network by reallocating our resources to higher growth markets. Utilizing the results of our proprietary technology to assess the health of our branch network across thousands of dimensions, we plan to open 100 to 125 branches predominantly in the southeast and close 100 to 125 branches within our midwest footprint, excluding MB, over the next 36 months. We expect that these actions will enable us to preserve the profitability of our retail franchise in the north and invest in the southeast for higher household revenue and deposit growth.
During the quarter, we reduced headcount primarily in the back office and staff areas. We expect these actions to result in an approximately $80 million pre-tax reduction in annualized compensation expenses. We are also evaluating additional expense saves in the procurement area and are using a third party consulting firm to help during this process. We hope to share the results with you later this quarter. Combining the reduction in compensation and the work in procurement, as well as other ongoing efforts, we expect to achieve expense efficiencies of between $100 million to $125 million on an annualized basis when fully implemented.
As I mentioned earlier, we intend to reinvest a portion of these savings in marketing to boost our household and revenue growth opportunities. We expect our forward-looking guidance on revenues to reflect these benefits. The impact of all of these actions are all incorporated into our 2019 and 2020 performance targets. As expected, the composition of expense savings and new investments change with the market conditions and new capabilities as we develop them, but we intend to keep all of our targets at the levels we previously forecasted or better going forward.
Now that we’ve discussed our update on North Star, I want to spend a few minutes reviewing our recently announced acquisition of MB Financial with a focus on updates since the call in May. As Greg mentioned, this transaction adds significant value to our shareholders. We remain very confident in our ability to reduce expenses by $255 million, reflecting the in-market nature of the acquisition.
When we announced the transaction, we discussed several expected financial metrics without assuming any revenue synergies. With revenue synergies included, the economics of the transaction become even more compelling. We estimate that by the third year of the acquisition, we can drive incremental annual pre-tax income of $60 million to $75 million based on these synergies. We plan to leverage MB’s expertise in national asset-based lending and leasing through our footprint with a focus on middle market companies. We believe we can also generate additional benefits from utilizing our larger balance sheet and leveraging our capital market capabilities across MB’s customer base. The impact of these additional opportunities on deal economics is substantial, as Greg mentioned previously.
Post-announcement, we have continued to make steady progress towards completing the transaction. We have focused on finalizing the structure of the management team and organization post-close, developing integration teams and retaining employees and customers. We believe we have very complementary capabilities and plan to adopt a blended approach with best practices from both organizations.
In summary, I would like to reiterate a few points. We reported strong financial results for the quarter and the benefits of North Star are becoming more apparent in our performance. We shared our progress on North Star and remain on track to substantially complete the initiatives by the end of this year. This timeline aligns well with the start of the MB integration work after the transaction closes. The economics of the MB acquisition are compelling even without revenue synergies, but we shared expectations for revenue synergies with you today to provide a more complete picture of the economic benefits of the deal. In addition, we took additional measures to reduce costs and generate significant annual savings. Today, we also announced another step towards optimizing our branch network.
Over the last two and a half years, we have communicated what we intended to achieve, set a timeline for implementation, and executed very effectively on those plans. We expect to continue to do so and are confident in achieving our financial and strategic objectives.
With that, let me turn it over to Sameer to open the call up for Q&A.
Thanks Tayfun. 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. During the question and answer session, please provide your name and that of your firm to the operator.
Caitlin, please open the call up for questions.
[Operator instructions]
Your first question comes from the line of Geoffrey Elliott with Autonomous Research. Your line is open.
Hello, good morning. Thanks for taking the question. It kind of feels as if there are a couple of changes on the outlook, the reference to expenses being at the low end of the 4.0 to 4.1 is gone, then the net interest income outlook is a bit lower. I know you touched on some of that in the prepared remarks, but can you just summarize in a nutshell what’s behind those changes, what’ s changed since the last time you spoke on this?
Sure, let me start with the expenses, Geoffrey. As we have disclosed, we’ve taken a couple of actions this quarter on headcount reduction. I think you will probably see the full impact of that in the fourth quarter, and obviously we said it has an $80 million impact on a full year run rate basis, and we will see that obviously in 2019. But at the same time, we have increased our investments in marketing. We are seeing very good results in our retail business. We are also allocating a little bit more money into credit cards and marketing. These are direct marketing actions that we’ve been developing internally with heavy analytical content, and it’s impacting our household growth relative to the industry, fairly significantly, so we decided to push that button a little bit harder for future revenue growth.
The procurement savings are--the study is going on. That probably is also going to have a broader impact in 2019, and then relative to our performance, the activity levels, as you’ve heard from us, in loan production and capital markets is quite high, and the compensation expense for this year is a little bit higher than before, so that all resulted in us keeping the same range. But you know we are very focused on expense management and will continue to make sure that the progress there is in line with revenue growth elsewhere.
In terms of NII, obviously we’ve changed our outlook slightly, and most of that is due to the competition in deposit markets, the little bit higher rate, the commercial deposit markets, the migration from DDA to the interest-bearing accounts as well as just in terms of the rates paid is a little stronger, so we reflected that in our outlook and that impacted NII. Mortgage continues to be a tough one, the portfolio growth numbers there, so that impacted the numbers as well.
Is there anything else, Jamie, that you want to add?
Maybe the only other factor, Geoffrey, is that the forecast does include some of the funding activity for the MB acquisition now post-announcement, which was May 21, so there are some funding costs in there.
Also related to MB, they’re not much, but there are some trickling costs associated with the MB transaction, whether it’s in legal, etc., so that’s also impacting the expenses a little bit this year.
Thanks. Just following up on the NII side, you’ve got 3% commercial loan growth baked in for 3Q18. That feels like quite a bit pick-up in pace. What gives you confidence that you’re able to deliver there and not kind of struggle on the NII side because you’re not getting the commercial loan growth you were hoping for?
Yes, so one technical comment and then I’ll turn it over to Lars for him to comment on activity. Our loan growth towards the end of the quarter was a bit weaker because we had pay-offs that really happened at the end of the quarter, so obviously the growth in Q3 will be on that weaker ending balance for Q2. But besides that, obviously, we’re seeing good activity.
Lars, you want to comment on the state of business there?
Yes, to your point, the end of period was substantially impacted by two things. One, we had a very active and constructive capital markets that allowed us to leverage the investments we’ve made in our platform in investment banking and, frankly, monetize that, and that’s part of what helped us lead to a really exceptional capital markets quarter But let me remind you, we had a record quarter of production in corporate banking, we had a record quarter of growth in middle market outstandings, one of the highest production quarters that we’ve had in years in middle market banking. Our pipelines continue to be very strong. I think a lot of the economic environment, the tax reform and other geopolitical issues are very positive and have positioned us very well.
As I look at the third quarter as well as the second half of the year, I think we’re very well positioned. We selected industries, geographies, we’ve recruited talent and, frankly, have positioned ourselves, I think to accelerate our growth into the third quarter and beyond. I have a high level of confidence that we will be able to deliver, albeit the macroeconomic environment will need to cooperate.
Thank you.
Your next question comes from the line of Gerard Cassidy with RBC. Your line is open.
Thank you, good morning guys. Tayfun, can you share with us, you look at your demand deposits, and this is similar to your peers, it’s not just you folks seeing lower demand deposits on a year-over-year basis. Today they represent about 31.6% of total deposits. Why do you think--if we get to a normalized rate environment, say by the end of ’19 Fed funds is 3%, where do demand deposits go as a percentage of total deposits? Where do they bottom out?
Hard to tell, Gerard, because a lot of that also depends on your activity on the treasury management side and your ability to take market share in treasury management, which some of our newly introduced products will help us to achieve. There will probably be still continued migration on the commercial side more so, obviously, from demand to interest checking.
Jamie, any comments there?
Yes Gerard, I would say that the DDA migration we experienced in the second quarter was perhaps more elevated than what we’ll see the rest of this year, in part because we did increase our earnings credits rates during the quarter, so the beta on the ECR was about 45%, so that allowed and created excess liquidity for our customers that permitted them to pursue alternative investment options to help generate better income for those companies. That was predominantly in the large corporate and mid-corporate space, and with that adjustment in our managed rates during the quarter, we feel really good about where our ECs are positioned competitively, so I would expect the migration to slow a bit as the Fed continues to raise rates. But to Tayfun’s point, if the Fed continues to raise rates and we get to a 3% terminal Fed funds rate, then certainly the DDA as a percent of the total will continue to go down, but I don’t think you’ll see that type of compression that we’ve experienced in the past year.
Very good. Then in the expansion into the new markets with the 100 to 125 branches over the next 36 months, can you guys talk to us on the proprietary technology you mentioned? What gives you the advantage over--obviously you’re going into markets that are going to be very competitive with other banks. What edge do you think you’ll have to be able to maybe garner some market share at the expense of others?
Gerard, this is Greg. First off, on the geosciences front, some of the advancements that we’ve made in that area that we were recognized for, they do a great job of really assessing the market opportunities, where best to locate that branch based on business opportunities, consumer growth, directional trends, competition and so forth. It’s a very advanced model, so that gives us a high level of comfort when we go into these markets where to put those physical branches.
The other thing I’ll mention is the branches we’re putting in are very different from the branches we’re closing - much more efficient branches, smaller real estate footprints, smaller square footage of the branch itself, lower staffing levels, and very highly automated when we go into these markets. But if you think about what we’ve accomplished, we solved the Chicago density issue with the MB Financial acquisition. We think a smart way to expand in the southeast is to build on the franchise that we currently have there through a de novo process, so repositioning 100 to 125 branches from higher density legacy markets where we can continue to serve our customers with less branches and reposition them into the southeast. We’re very comfortable we can continue growing households.
Tayfun mentioned the marketing spend, increasing market spend. We’ve seen some great results on our investments in marketing. When you look at household growth over the last six quarters, we’ve added net 118,000 new households. Consumer deposits over the last six quarters, I think are up close to $3 billion, so we’ve been very successful. Our preferred banking platform is growing significantly, so we’re encouraged by what we’re able to accomplish. It’s really about repositioning and giving our southeast markets more opportunity to better serve their communities.
Great, thank you.
Your next question comes from the line of Erika Najarian, Bank of America. Your line is open.
Hi, good morning. I also wanted to get some clarity in terms of your guidance relative to the deal when I compare the slides from the deal presentation and the updated slides today. When I look back at the MBFI deal presentation, you noted 4Q19 North Star targets of 16% ROTCE and ROA of 125 to 135, and you mentioned that you thought that the deal would be 200 basis points enhancing to ROTCE and 12 basis points enhancing to ROA. I’m a little bit confused on a couple of fronts. One, you’re telling us that North Star will be substantially complete by this year and that implies consensus with an ROTCE of 13.8 to an ROA of 1.25. But you did retain your ROTCE target for the combined company and you even increased the ROA range, so I guess I’m wondering what the moving pieces are there. Is the deal going to be really the substantive catalyst to get to this range, and what happened to those 2019 enhanced North Star targets?
Yes, so there is absolutely no change in the way we described the deal, the impact of the deal on our North Star targets. When we made the comment about the North Star initiatives coming to a conclusion here at the end of 2018, that comment was really related to the internal work that is going on to be able to introduce the products and services and also the expense initiatives, but we will see the impact of that effort throughout 2019, basically leading into our end of 2019 North Star target. Assuming that the transaction closes in the early part of 2019, then the full year of 2020 clearly has all the expenses that have been associated with the transaction itself, so that’s it.
We’re not changing the impact of the North Star initiatives in terms of their timing, all we’re saying is that the effort to finish the work internally, whether it’s IT, whether it’s organizational design or whatever, are coming to a conclusion. That was the comment. It was not meant to be a comment on financial metrics.
Got it. As a follow-up question to that, your 2020 targets look better than what we saw during the deal presentation, but the stock is down 5% at the moment. I’m wondering, going back to Geoffrey’s question on the NII guide, it does look like a modest step down in terms of the NII guide, but I think some investor observed that you added a September rate hike. Is the market reading it correctly that you did add a rate hike in there but did downgrade the NII outlook, and therefore the step-down on an apples-to-apples basis is a little bit more severe, and if that’s the case, is that really because of all the pricing dynamics you mentioned during the prepared remarks?
Erika, it’s Jamie. We did pull forward in line with market expectation a rate hike that was previously expected in December to September in our current guide, and we did reduce the NII outlook predominantly driven by the commercial deposit migration and cost, but also inclusive of some wholesale funding activities related to the MB acquisition. But yes, you are reading that correctly.
The one item I would clarify on our forecast, however, is that we do assume in the third quarter one month LIBOR to Fed funds, or OIS spread, compresses from the 16 or so basis points we experienced in the second quarter down to 8 basis points or so in the third quarter, and that’s a significant assumption that we would obviously do significantly better, given asset sensitivity and the C&I composition of the portfolio being heavily tied to one-month LIBOR. But each basis point of spread there is about a million dollars per quarter, so that is a significant assumption that is also in the outlook.
Got it. If I could just slip one more in, Jamie, you keep mentioning the wholesale funding impact. Could you give us a sense of what the full-year wholesale funding impact would be as we think about the moving parts of the guidance?
I would say of the $30 million or so change in our outlook on NII, I would call it $25 million related to commercial deposits and $5 million related to wholesale funding activities.
Got it, thank you.
Your next question comes from the line of Ken Usdin with Jefferies. Your line is open.
Hi, good morning guys. A couple just near-term questions for you. First of all, Tayfun, you talked about the third quarter on the fees, $600 million despite continued weakness in mortgage, and I think you said earlier that’s with an expectation that corporate banking would hang in this $110 million to $120 million zone. Off of a 567, can you just help us understand what the nice lift will be to get you from the second to the third and that $600 million number?
Yes, there is a couple of other line items in corporate. We are forecasting potentially a little bit in private equity gains here in a couple of transactions that we have, and obviously the improvements in--the current success in capital markets will continue, so that’s sort of--there’s a few other items, nothing big significant. We’re expecting pretty decent growth relative to the seasonal changes, so there’s nothing more than that.
Got it, okay. Then on the expense side also, you mentioned that for the third quarter, just from a starting point perspective, that you’re expecting down 1% from the reported 1037. Are you expecting there to be continued restructuring costs in there and even MBFI-related costs? I would have thought that the core expense number would be coming down more than just 1% off of a GAAP number that you just reported at 1037.
Yes, the MB Financial-related expenses are just trickling down. That is going to probably continue through the remainder of the year. There’s a little bit of an increase in technology expenses into the second half of the year, similar to our guidance before, and then we’re also expecting continued good business activity driving--you know, these strong capital markets and strong origination levels typically result in higher performance comp-related expenses, so that’s what’s driving it. We’re expecting since this headcount reduction is going to drive a more run rate number for the fourth quarter, we’re expecting that to be a little bit more stronger in the fourth quarter relative to the third quarter, and then as I mentioned before, the marketing expenses clearly are going to drive the quarter-over-quarter change. We will be seeing a fairly sizeable increase in our third quarter marketing expense relative to the second quarter marketing expense.
Okay, got it. One last one, just on the incremental $100 million or so of savings. You mentioned spending part of it on all these initiatives that you continue to have. Can you help us understand, is that this continuous improvement type of thing, where you save another 100, you spend another 100? How are you expecting the Fifth Third legacy expense base to traject past 2018, I guess?
We clearly are intending to achieve efficiencies through those cost savings. We’re not going to use those entire savings in order to invest in the business. Our guidance of an efficiency ratio in the lower 50s in 2020 clearly shows that we intend to maintain a good chunk of those expense saves as our bottom line. Even excluding the MB transaction, we are expecting a pretty decent move in our efficiency ratio, which leads to the conclusion that we intend to keep a good amount of these savings.
The other thing that I think needs to be realized is these investments in marketing are going to have an impact on revenue growth going forward, which obviously also positively impacts our efficiency ratio.
Yes, that’s fair. Thanks very much.
Your next question comes from the line of Matt O’Connor with Deutsche Bank. Your line is open.
Good morning. I wanted to follow up on just the last line of conversation. As we think about expense growth in 2019 and 2020 for Fifth Third standalone, I realize we won’t see the numbers because of the deal, but obviously there is some upfronting of the investment this year, there is some cost saves coming in. You are coming off of what will be a pretty high expense growth this year, so I was hoping maybe you could shed some light on what you think the standalone trajectory of expense growth will be at Fifth Third over the next year or two.
I think you are right that when you look at the expenses this year with all the investment back into the company, we have seen a little bit higher expenses. We anticipate that our 2019 expense growth will be definitely below the levels that you’re seeing in 2018, and we would hope that it would be meaningfully so. The year-over-year change in total compensation expense of $80 million is close to a 2% number on our total expense base off of this year, so those types of actions are intended to slow down expense growth moving into 2019 and 2020, even before you take into account the expense saves associated with MB Financial.
It is a little bit too early to provide guidance for expenses in 2019, but as a management team, we are extremely focused in achieving a significantly lower expense growth in 2019.
Okay, because if you take the 4 to 5% expense growth you’re looking for this year, layer in the synergies or cost saves that you’ve talked about, it kind of will get you into maybe that 2, 3% if they all fall to the bottom line, which I think would be both more reasonable and well received, so any further color on that down the road, I think would be helpful.
Separately, you laid down some revenue synergies related to leveraging the MBFI franchise. What about potential loan run-off? I mean, they’re quite large in commercial real estate, has some multi-family, has some indirect consumer that you guys haven’t really done in the past. I guess you could argue either that could be synergies to you guys or there might be some right-sizing of that acquired book to align to your underwriting and strategy.
Matt, it’s Jamie. I think a good way to think of the revenue synergies is that it’s inclusive of customer attrition, just normal branch closure type of activity. When it comes to the actual loan book coming over, through due diligence and through the last two months of efforts since the deal’s been announced, we’re comfortable with the indirect portfolio that they have coming over and maintaining, but our revenue synergies don’t assume any significant changes to that book of business. The revenue synergies that are outlined on Slide 15, the first two categories really highlight what MB brings to the table in terms of our ability to link and leverage their products and experience, predominantly in the business banking and ABL and leasing, whereas the next three categories are more of what Fifth Third brings to the table. We just wanted to frame up where we see the opportunities on the combined business, and we’re confident in our ability to drive those synergies.
Okay, that’s helpful. Thank you.
Your next question comes from the line of John Pancari with Evercore. Your line is open.
Good morning. Thanks for taking my questions. Regarding the MBFI deal, I know you indicated so far a minimal disruption in the deal. Regarding the banker lock-ups, I know it was asked about on the deal call and Mitch Feiger was--you know, it was unclear if Mitch was indicating that there was definite lock-ups or not. Were key bankers locked up, and can you give us a little bit of detail around that? Thank you.
This is Greg. I’m really pleased--as we get further into this transaction and discussions with MB Financial, we were extremely pleased with the talent that they have and our ability to bring together the best in class in our Chicago market, so part of the retention of these bankers starts with the leadership and our model in the Chicago market and how we’re going to run that business, starting with Mitch as the CEO of that business going forward. The senior commercial middle market banker from MB Financial will lead that market for us, so it starts from a retention perspective to find the leadership team, which we’ve done, and communicate out how we’re going to operate in that market. Also, the combined opportunities when we bring these two franchises together that can be leveraged across the market and the advanced capabilities we have in capital markets and so forth with our customer base, the capabilities to leverage their ABL and equipment financing in our core middle market on a national level, those things when you put it together are extremely attractive, I believe to the MB Financial team and to the Fifth Third team. So the environment that we’re creating in best in class to better serve our customers there and give our sales people and our teams more resources to offer into the marketplace, so that’s going very well.
In addition to that, in key situations we have provided lock downs for those individuals through the transition and beyond to make sure that we have the right talent in place to lead the organization. But once again, I want to stress the key thing is our business model and combined best of breed talent in that marketplace, as I mentioned, a significant portion of the current MB Financial team will be in place from the combined perspective when we close this deal in a leadership role, so I think net-net we feel real comfortable. We haven’t really seen any concerns in that area yet. We’ve worked hard to get that right, we’ve worked to communicate effectively to all the MB Financial employees, as well as our own Chicago employees, which is extremely important, and we’ve done a nice job, I think. Mitch and his team have done a fantastic job of really putting their arms around the customer base.
Okay, got it. Thanks Greg. Then on the large corporate side, you mentioned the record corporate banking activity and originations that you’re seeing. What are the yields that you’re seeing, new money yields on your corporate paper that you’re bringing onto the balance sheet, and then separately, what’s the total size of your shared national credit balance as of June 30? Thanks.
Yes, a couple things there. First of all, what we’re seeing in the corporate banking space is extremely aggressive - there’s no question about it, so we’re needing to be very selective. We shared with you our industry verticals, the new industry verticals which we have introduced where we tend to get outsized returns. We’re not just looking at it from a credit perspective, we look at it from a total relationship perspective - that’s our strategy, but I would tell you that largely the commercial originations that we’re seeing today, while they are under some pressure, largely reflect our overall portfolio that we have at our company. What we are being able to execute on, again getting back to relationship, is we told you we were going to make North Star investments in capital markets and other capabilities. We’re leveraging those successfully into that corporate banking space specifically. That’s helping to drive a record level, not just corporate lending activities but also capital market activities for our company.
In terms of the coupon, John, it’s sort of between 4 and 4.5% in terms of production, so they are fairly close to where the portfolio yields are.
Correct.
John, the other question you had was the shared national credit balance. Our balance is actually down a couple billion over the last several quarters. It’s roughly $26 billion to date, and again as Lars said, the vast preponderance of those credits are tied to deep relationships and not credit only. We feel very good about it. From an asset quality perspective, the shared national credit portfolio has less than 3% criticized assets and continues to perform exceptionally well, and it diversifies our portfolio across the enterprise.
Yes, one thing I would just add to that is the single largest driver of our commercial loan growth this quarter was core middle market, it was not corporate banking growth.
Got it, okay. And that SNC balance, that’s based on the newer definition, correct?
Correct.
Got it. All right, thank you.
Your next question comes from the line of Scott Siefers with Sandler O’Neill. Your line is open.
Morning guys. Thanks for taking the question. One quick question on just the profitability program you guys detailed this morning. Tayfun, I think you guys had said total $100 million to 125 million in cost savings, although Greg you had mentioned some of the procurement stuff you guys would detail through the quarter. That latter procurement stuff, that’s already included in the $100 million to $125 million, right?
That’s correct, yes.
Okay, so there’s no new dollar amount coming out in the next 90 days or anything?
No, that’s correct.
Okay, perfect. Then I just want to get back to the new 2020 targets for a second, I just want to make sure I’m clear, because I think I still don’t understand exactly what has changed from the enhanced targets back when you announced the MBFI transaction. I guess as I look at it, the standalone outlook is a bit weaker, but we have the additional profitability program you guys detailed this morning, and then you guys had also detailed the revenue enhancements from MBFI. Are those the three changes that have taken place since--
Yes, with respect to the current year numbers, Scott, some of these are obviously a little bit elevated on an annual basis for 2018, so some of the incentive comp numbers, etc., are a little bit elevated beyond what the normal run rates would be. These are not all negatives as we look into 2019 and 2020. It’s important to consider that.
Also in terms of year-over-year expense growth, when I was answering a previous question, the expense growth expectations into 2019 are clearly going to be below what we have here in 2018, and then revenue growth associated with both North Star initiatives and other investments, those are all baking into our performance targets for the end of next year and into 2020.
Okay.
So all of these are--I mean, I think we’ve been consistently raising these targets as we see our performance moving up, whether it’s due to some environmental factors such as tax rates or higher expectations on other efforts, and then now plus MB we are moving onto that 18-plus range in return on tangible capital, and then we’re raising our ROA guidance along those expectations.
Yes, okay. All right, that’s helpful. Thank you.
Your next question comes from the line of Mike Mayo with Wells Fargo Securities. Your line is open.
Hi. Could you elaborate more on the increase in marketing? I think you said it related to credit cards, but why now and which markets, and does that tie into your expansion strategy in the southeast? Can you just confirm your expansion strategy in the southeast is more commercial than consumer, or maybe it’s consumer too? Just shed more light on that if you could.
One comment on the marketing - a large majority of the marketing spend, Mike, is related to the retail deposit household growth. There is a portion that goes into credit cards, but a significant amount of those dollars actually are intended to generate retail consumer deposits and household growth.
The only thing I would add to Tayfun’s comment there is we’ve been very successful, Mike, as we alluded to, growing households and it’s really across not just our legacy footprint but also in our high growth markets in the southeast. We’ve been very successful. We measure everything here, as you know, and when you look at the advanced analytics we’ve put in place and learning how best to market our opportunities and where we’ll get the best returns, we’ve tested that over the last year plus. It’s worked extremely well, and there’s a bigger ask there because there’s a bigger outcome there and opportunity for us. So we’ve decided to invest some resources, additional resources than planned to continue marketing at a higher level, given the success rate that we’ve already had, and you’re seeing that in our consumer deposit growth we’ve had over the last six quarters, as I mentioned earlier, and our household growth and especially our preferred banking platform, in the customer acceptance of that platform and what we’re seeing there from a growth perspective, so that’s positive.
When we talk about repositioning in the southeast, obviously we’re going to continue to invest in our commercial business, especially core middle market. It’s extremely important to us, and we’re seeing, as Tayfun mentioned and then Lars reiterated, we’re seeing record performance in loan originations across our footprint, but especially in those markets also. But the investments we’re going to make to reposition our branch network is just thoughtful thinking about how best to serve our customers and grow our business, and as you know, coming out of the crisis we hadn’t invested heavily into those higher growth southeast markets coming off of some acquisitions. We think the smart way of growing that is being additive to those markets, using some of the advanced analytics that we have to place those branches, a much smaller footprint of branch, a higher automated branch, a lower cost branch in those markets to better serve the consumer-based customers there, and the business banking customers.
When you say those markets in the southeast, which specific markets?
Obviously the Carolinas, the Georgia, Atlanta area, northern wedge. You’ve got to look at Tennessee and Nashville in particular, parts of Florida are where the opportunities sit for us.
So this is de novo branch expansion in states where you don’t have currently branches, except for Florida?
No, we have branches in all those areas I mentioned before, we’re just once again not the level of density that we need, I think to better serve that market and create more leverage of our products and services and marketing spend in those markets. So it just goes back to markets like Nashville, there’s additional branches necessary in Nashville. If you look at Atlanta, once again the northern wedge of Atlanta, we’ve got 38, 40 branches there. There’s more needed to support those communities, so it’s just being thoughtful how best to grow in those markets from a retail perspective and a business baking perspective is what we’re looking at.
Last question on that. Longer term, over three to five years, how much larger would you like consumer to be in the southeast?
Well I’d tell you, from a growth perspective--how are you measuring that growth, Mike? When you say how much larger, from a deposit perspective?
Consumer revenues, consumer deposits. I mean, are we thinking about doubling the share there, reallocating capital to grow--
We would like to grow significantly. I think we can grow significantly in those markets and take market share in the southeast markets, based on the teams we have in place, our capabilities, and what we’ve seen with some of the advancements that we’ve made, our marketing capabilities, and the products and services that we offer. So we think we can take share, we can even grow the deposit base at a disproportionate level than our legacy markets, and we think we’re well positioned to do that. We’ve just got to be smart about how we add to it, but it’s really going to be a balanced mix.
Maybe, Mike, one data point to help frame up the size of the opportunity in the southeast. We have roughly 300 financial centers in the southeast today that average about $35 million per branch in consumer deposits. The rest of our franchise, or if you look at the midwest, we have almost 900 branches and they average about $53 million in average deposits per branch, so it highlights the weakness of the network, the overall network in the southeast and what that opportunity might look like when you’re finished building out the network and what that consumer deposit book could grow to.
In terms of the sort of--if you look at it from a branch growth perspective, you’re looking at growing the branches in the key south markets by approximately 35 to 40%, so that’s the next two, three years worth of expansion.
Great, that’s very helpful. Thank you.
Your final question comes from the line of Christopher Marinac with FIG Partners. Your line is open.
Thanks, good morning. As you expand in the southeast with the new branches, to what extent does that influence the deposit beta? Do you have rate specials embedded as you execute these?
Chris, you have to realize that we’re talking about a two to three-year expansion, so at this point I think the expansion itself is not going to have an impact in this rate environment. We will update that for you as this continues, because obviously unlike branch closings, branch openings take a little bit longer, so let us wait and see how that process goes before we show you an impact on deposits.
Sounds good, Tayfun. Thank you. Do you expect any change on LCR as these next couple quarters unfold?
Are you asking from a regulatory standpoint or from Fifth Third specifically?
Well really both, but I guess regulatory first would be great.
Well, Randy Quarles’ comments yesterday obviously have received some attention. We’re just going to have to wait and see whether there are any changes associated with LCR. Within his comments, he appeared to refer to liquidity measures. We’re just going to have to wait and see.
And for Fifth Third specifically, the one item that you saw in the quarter is the LCR did increase as we begin to position the portfolio to greater allocation to level 1s as we prepare for MB’s balance sheet to come over, which at the deal announcement we said there would be some LCR dilution from the composition of their investment securities portfolio, so we will continue to migrate ours a little bit higher in advance of a first quarter close.
Sounds great, Jamie. Thank you very much, guys, appreciate it.
Okay, well thank you all for your interest in Fifth Third Bank. If you have any follow-up questions, please contact the Investor Relations department, and we would be happy to assist you. Thank you.
This concludes today’s conference call. You may now disconnect.