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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, thank you for standing by and welcome to the Fifth Third Bancorp Second Quarter 2021 Conference Call. [Operator Instructions]
I would now like to hand the conference over to your speaker today, Chris Doll, Director of Investor Relations. Thank you. Please go ahead, sir.
Thank you, operator. Good morning, and thank you for joining us. Today, we will be discussing our financial results for the second quarter of 2021. Please review the cautionary statements on 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 Third's 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 earned $0.98 per share. Once again, our financial results were very strong, continuing the positive momentum from the past several quarters.
During the quarter, we generated sequential PPNR growth of 15% on an adjusted basis, a growth of 6% compared to the year-ago quarter. Commercial loan production increased 10% from last quarter, with strength in 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 income increased 3% sequentially and the underlying NIM increased 2 basis points. We believe that our disciplined approach to managing the balance sheet, including 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 generated positive operating leverage on a year-over-year basis with an adjusted efficiency ratio of 58%.
We are prioritizing investments to drive further operational efficiencies to improve our resiliency, generate household growth, and improve the customer experience. To that end, we recently announced and 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 us in the market. Combining 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 improvement in technology, renewable energy, and manufacturing. However, our strong production was once again offset by elevated pay downs and PPP forgiveness.
While we continue to retain the customer and 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 Third 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; MyAdvance, 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 has put 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 NPAs once again improved this quarter. Criticized assets declined another 16% and our NPA ratio declined 11 basis points sequentially.
Our balance sheet and earnings power remain very strong. Our CET1 ratio of 10.4% was relatively stable compared to last quarter, despite share repurchases 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 an originate to sell model. As a result, the closing of the acquisition will not include a transfer of loan balances.
However, post close, Fifth 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 in our 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 once again like to thank our employees. I'm 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 our last year's report with increased transparency, including enhanced disclosures of 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 will 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 credit. 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 PPNR 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 reserve, 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 a 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 5 basis points and also have 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 1 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 2 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 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 purchased 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 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 we'll 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 are seeing 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 NPA 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 non-essential, leisure and healthcare, as well as in our energy and leveraged 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 that 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 build. 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 remained 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 Four institution, Fifth 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 FCB would be 2.5% effective July 1st, which is the floor under the regulatory capital rules. Without the floor, a 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 in Provide's strong growth prospects.
From an origination standpoint, they have 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 experienced 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 in 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've 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 basis points 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 basis point 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 the Q&A, as a courtesy to others, we ask that you limit yourself to one question and a follow-up and then return to the queue if you have additional questions. We will do our best to answer as many questions as possible in the time we have this morning.
Operator, please open the call for questions.
[Operator Instructions] Our first question comes from the line of Ken Zerbe with Morgan Stanley.
Now, you guys are doing a lot to make Fifth Third more consumer friendly, 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 as the broader industry really continues to wean itself off of consumer fees?
Yes, 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 unit 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 was 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 and that if we were to have any future changes on overdraft policies or fees would only be to the positive and that we would more than make up for it with the incremental volume from Momentum. I don't know, Tim, if there's anything else you want to add?
Yes. No, I just want to emphasize that. I mean, whenever you launch a new product, the trade-off 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 would attempt to follow us here.
And then just maybe a second question. In terms of the Ginnie Mae 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 relative to do a lot - the Ginnie Mae buyouts. But it feels like you guys got a fairly decent benefit from that this quarter. Was that - are you seeing the same trends or do you still see opportunity to continue that going forward?
Very good question actually, because what we've seen is that, given we were a first mover in this product and it's 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.
Our next question comes from line of Scott Siefers with Piper Sandler.
Thanks for taking the question. I just wanted to ask 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 larger regionals like yourself? It's sort of unclear to the degree to which capital markets competition will abate if there are questions regarding the sustainability of the sort of the sugar high that consumers are on right now, meaning demand couldn't 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.
Well, let me start, then I'll forward to Jamie or Tim for additional color. First off, it's - right now, there's a lot of uncertainty out here right now as we're dealing with the labor shortage and the supply chain disruptions, which are extremely real and you see it across the Board in all conversation with our customers. But that said, we back to pretty much pre-pandemic global production numbers, but payoffs continue to be stout, and obviously you got something like PPP.
So when you think about the environment in front of us, I think loan growth, as we continue to beat the challenge as we go through the rest of the year. I think we offset that by our strengths in our fee businesses, as we talked about in the prepared remarks, that compensate for some of those challenges, but I do think this changes over time [technical difficulty] every 1% to $750 million.
So there's a lot of upside opportunity there. At some point, labor shortage and supply chain constraints start to abate, if we pick up the benefit of that. We also added about $2.4 million new commitments since the beginning of the year and continue to acquire new households in commercial relationships. We're very, very positive. As to what the future might hold, we've got some economic and some environmental challenges in front of us that we have to continue to deal with.
Yes. 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 balance.
So in an environment where utilization is down like that now and where rates are low, we have fee businesses that are firing and are providing nice support, and some countercyclical businesses in particular on the consumer side, like autos and mortgages, which are doing very, very well. I think as some of the tailwind from those businesses abates, what you would expect to see is a benefit both, as Greg mentioned, relates to line utilization and ultimately some benefit from rates, which provides a lot of support for the through-the-cycle focus.
Thank you for those thoughts. And then maybe just a thought on overall reserving levels. You guys still maintain a very high and conservative overall reserve. How are you sort of thinking about the steady state? Is it back to where we were CECL day 1 or just given the backdrop and what we've already gone through, can we blow through that a little bit on when you 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, 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, we continue to overweight non-baseline scenarios at 20%. So the upside is 20%, the base is 60%, and the downside is 20%. 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 CECL day 1 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 1, it really is a tale of two portfolios. So when you look at the commercial side, to get back to those Day 1 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 1 level. We're at 1.99% at the end of the second quarter versus the 2.46% on CECL Day 1, 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 for the - at the end of the second quarter, and then we've had an improvement in credit quality in auto and card, as well as in the delinquency rate. So consumer is already there, but commercial, again, we have to have things play out differently than what we - better than what we currently expect.
Your next question comes from the line of Ebrahim Poonawala with Bank of America Securities.
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 do 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 that 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, this replacement of our [indiscernible] core deposit platforms. But we've been on this journey to re-engineer our technical infrastructure, focusing on the actual resiliency, the skills of our businesses, replace our HR platform Workday. We completed our enterprise data strategy, we completely re-platformed mortgage FIS environment.
So the FIS is the natural extension of the continuation of the modernization of those activities. We also re-engineered and restructured pricing agreement of our legacy relationship with FIS that could help make that - the cost associated with that implementation of the new FIS components, a lot more reasonable but guess for us, we will manage our costs going forward. So we're pretty pleased with the way that came out.
As far as a 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 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, I mean it basic table stakes to be the business to be a digital bank.
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 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, are continuing to focus on core modernization, and we're going to be just doing the same thing. We're think we have a great strategy for that monetization and for bringing in new technologies.
We have a buy-partner-build strategy that we work on very hard. If the technology is already out there, we buy it. If we can't buy it, can partner. And if we can't partner, we build it. Momentum is an example of that. You have partnerships like GreenSky and Exchange thanks systems covered bond due to her list and our recent acquisition of Provide.
So we - I think we've got a good strategy for moving quickly, but it is going to take time to get all the legacy stuff re-platformed, but net-net, once again, I think it may not be a competitive advantage at the end of the day, but definitely will be a requirement to be in this business in the future.
That's good color, appreciate it. And just as a follow-up on - to that, when you think about acquisition of Provide, healthcare is obviously a very hot sector. Do you see more opportunities like that across different verticals where you might be - we should expect similar kind of deals which become tools for client acquisitions?
Yes, sure. This is Tim. I'm happy to take that one. So healthcare was the right starting point for us. It's a diverse 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.
I think Provide with 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 that's - 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 - it 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, and so it functions, I guess, a little bit like the Craigslist or the eBay of dental practices today.
Are there opportunities in other verticals? Yes, 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 business in 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 stand-alone entity on that journey.
Your next question comes the line of Gerard Cassidy with RBC.
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, increased sequentially, and I was wondering how you achieve that in this rate environment. Was it due to the derivatives and hedges you have on the books? And then second, I think you 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 2%, if they do, or would you wait until we actually got to 2% before you really move?
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 - of rally in the bond market, decided to maintain that additional leverage throughout the quarter.
So we did grow the book 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 a better entry point, but should the market get there, we would leg into the trade and not do everything all at once. But when you look at our additional $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 $10 billion of purchases done would certainly take some time and we've ramped that up over time.
And 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 to deploying at these low rates, our goal is, let's maximize our NII over the next five years, not over the next 12 months.
And we think ultimately this is the better outcome and the Fed will eventually taper, not sure when that will be, but when the 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-whole provisions provide a nice pickup in investment yield.
And as we - 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 of 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 in 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?
Yes, it's a good question, and honestly, I wouldn't respond immediately with the variant of COVID and what that could mean to the slowing down the economy and not getting the robust recovery we're all hoping for in credit risk.
But I think right now, as I mentioned earlier, Gerard, I think about every customer I sit down with since that we have a conversation. I mean, 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 open, small businesses not open full time, can't get labor.
So it's a big challenge right now. And when does that start to abate? When does that start to correct itself? I'm not sure when that is. I believe it will have to, obviously, but to - when is that, later this year, is that the next year. So I think that's going to put a lot of pressure, inventory levels are extremely low compared with the demand that is out there, we're not seeing that tick up right now.
Line utilization, it looks kind of flat right now, but we are 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, we've been watching that, how the Fed manages through that complexity, and more to come on that. But now, I think, overall the economy is fairly healthy. We just got some challenges still in front of us that haven't been understood yet.
And on that…
I'm sorry, go ahead.
Tim has…
No, I just was going to say, just to 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 wild.
I mean, we have a client, a fuels marketer who 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 the elective portions of their business, which are a really important driver, right, when you think about the revenues 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 freak in Texas this last winter and - it really these - they are 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 if the enhanced unemployment benefits weigh in 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 the materials, you can't invest to grow
Is there any risk, just to follow up quickly, that is a permanent change in the way these companies will manage themselves, which would lead to a lesser need from borrowing from banks like yours because of what they're going through, have you heard that at all from your customers?
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 they operate, and ironically, actually we hear many of them say, hey, 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 borrowing.
So I don't think so, Gerard. It just - we got to see our way through to the other side of this, because you can't get labor, you can't get inventory. It's hard to grow.
Your next question comes from the line of Bill Carcache with Wolfe Research.
Can you relate the fee 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?
Yes, 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 just disproportionately to that 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 on 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 situations. We feel good about both of those fee lines over the near to medium term.
And Greg, you mentioned GreenSky when talking about your partnerships there. 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 credits of that model, or do 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 the 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 - the economics of the GreenSky relationship as we went in as an investor have made a lot of sense for us. This is not how we grow our business over time, we're much more relationship business. That's why the Provide acquisition was extremely important. You think about Provide, that was a partnership originally, we had about $400 million in asset, the 70% of those relationships, we had additional relationship outside the credit facility, whether it be TM or deposit relationship.
So that was important, the relationship type of opportunity for us, and that's what we're looking for to continue to enhance our business and grow our businesses. GreenSky created another channel for us, but yes, that's a non-relationship business for us. And those opportunities that makes sense to us are a very few out there, but the GreenSky one does for the economics of the transaction in place.
Your next question comes from Ken Usdin with Jefferies.
Couple of quick ones. First of all, the third quarter Momentum marketing program that you mentioned where you had 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 outlook past 3Q?
Yes. It's Jamie. The - Yes, the $15 million incremental spend over the second quarter marketing spend level of $20 million, and 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 to program at that elevated level and 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 plan to or thoughts on re-securitizing those Ginnie Mae loans that you - the $3.7 billion 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 added all in your outlook in terms of whether they stay in loans or move to mortgage banking over time?
So for the $3.7 billion of loans that we purchased from other third-party servicers, we have a - there is 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 forbearance loans that we bought going back from Ginnie 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 cure, we do have - we have had sales this year that generate several million dollars in fees and we expect to do that over the next 6, 7 quarters as well. So I think it’s more of a run rate normal course of business than it is any one-time top.
That makes sense. Last one, you redeemed a bunch of debt mostly at the banks, some at the parents. Is there any more room to do that as 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.
Yes, given the excess liquidity that we have, there is 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 3% rate.
So there is a little bit left to go in terms of improvement along with running down the wholesale CD book, but those benefits are 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 NII improvement standpoint, will be on the left-hand side of the sheet.
Our next question comes from John Pancari with Evercore ISI.
On the loan growth side, on the utilization, I know you expect it to improve by about 1% through the year-end. Can you just help out with what is your pre-pandemic utilization level and expected timing where you think you can get back to that level on that front?
Yes, it's a great question. I wish I knew the answer to that. I do know we would typically - run at 36%, 37% as I mentioned, every 1% of our $750 million assets. So, we're running at 31% kind of flat line rate there. I can't really - we're hopeful, but I - like I tell my team, hope is not a strategy, we're hopeful we'll start to see that tick up a little bit based on the production levels that we're seeing out there right now.
Hope we can get some of these challenges that are in front us on a supply chain and labor front maybe abating a little later this year, but when to get it is a tough thing to say. When do we get back to a normalized run rate? It's going to be awhile. I mean, it's going to be in quarters, not - maybe a year plus before we get there, I believe.
That's helpful. And on that same topic, on the loan growth guide, I know you indicated a double-digit consumer growth, stable CRE, you got PPP impact in commercial. What would be your growth expectation for commercial with PPP and ex-PPP on that full year guide?
Relatively stable on commercial. I would say John, I would say, full year commercial average loans would be down mid-single digits, and ex-PPP a little bit more than that, but ending the year with a little bit of a - a little closer to stable. And then PPP is - we've been running steadily down as the year as the year has progressed, where on an end of period basis, we finished the first quarter at 5.4 billion, we finished the second quarter at $3.7 billion. That will continue to drift down to $2.1 billion at the end of the third, and then a $1.7 billion at year-end is our current projection on PPP.
And then lastly on the M&A front, as you look at the incremental opportunities there. Greg, I just wanted to get your thoughts on potential incremental bank and non-bank, and more importantly curious where you think of President Biden's executive order and the implied added scrutiny around bank deals. Do you believe that could impact the bank of your size, looking at a potential whole bank deal?
Yes. I think, 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 consoles would be financial [indiscernible] Chicago, obviously, we always consider those types of opportunities, but the [indiscernible] another focus to the organization.
As far as Biden's executive order, listen, it's still a lot of work to be done. The agencies, the OCC, Fed, FERC, and DOJ are trying to figure out what that means. So more to come on that, but you can believe as I do that transactions - the economics of transactions could be more challenging going forward. It is an executive order and the timeline to get those transactions approved, they take a little bit longer, but good transactions will get done.
Our next question comes from Matt O'Connor with Deutsche Bank.
Just talk a bit more about the path for the 9.5% CET1 target. Obviously, you talked about the dividend increase, the buybacks back half of this year, the 20 basis point drag. But if you put it all out together, just still about the, 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 or so. Do you think you'll get that target? Are you going to hold back for the loan growth and maybe to flush it out a little bit think about the first half of the next year?
Yes, our goal is certainly to get to the 9.5% by June of 2022. And yes, it is 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 from the Provide acquisition in the third quarter and then 9 basis points of CECL transition in the first quarter of 2022, so 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 it at 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, I think, at 9% or so if loan growth were to accelerate, but for now, our focus is just getting to the 9.5% by midyear next year.
Our next question comes from Peter Winter with Wedbush.
I wanted to ask just on the middle market and small business, are you seeing any willingness of them maybe to top their lines of credit while maintaining higher levels of cash on hand, or is it just an issue of supply and labor shortages that's holding it all back?
Peter, it's Tim. 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 that borrowers who are either smaller or who will rely on structures that look more like asset-based lending structures 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, 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, just to ask about the outlook for the margin in the second half of the year, some of the puts and takes?
Sure. The second quarter was obviously very strong from a margin perspective, and we're pleased with how our balance sheet has 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 areas what we've talked about.
But I think, pretty much all year in terms of what we think this balance sheet should stabilize that certainly for the foreseeable future. So NIM should come down, call it 5 basis points 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 basis point or better.
Our next question comes from the line of David Konrad with KBW.
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 of 4.9 duration and so the bullet - when we quote the 58% number, we're saying it's bullet and locked-out for at least the next two years, but the duration of that portfolio is not that different from the portfolio in total.
I guess the locked-out is two additional years?
Correct, but there's not a step-down. For a while, we had quoted a 12-month and then we got the questions, so we expanded to 24, but there's not a cliff here. It's just a slow erosion over time.
Our next question is from Christopher Marinac with Janney Montgomery Scott.
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 a CFPB or any of the agencies?
Well, listen, obviously, with the picture changing right now, there is still a process on the CFPB front from a nomination perspective. So is the changed - this has been - it's - I don't believe it's changed to be honest with you. I think the agencies have a job to do and a role to play, and I think the focus of the CFPB and the OCC and the FDIC are going to be making sure that there is the safety and soundness, but also the way that - the way the banks handle themselves and operate are going to be extremely important. So I haven't sensed a big shift in - with the new administration on requirements and demands of the other bank in the totality, so to speak, from the top as to what they expect from us. So it's not something that keeps me up at night. Let's put it that way.
Okay, Greg. Thank you for that, and thanks for all of 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 Fifth Third. 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.