Good morning. My name is Dennis, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fifth Third Bancorp third quarter 2022 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. To withdraw your question, please press star one again. I would now like to turn the conference over to Chris Doll, Director of Investor Relations. Please go ahead.
Good morning, everyone. Welcome to Fifth Third's third quarter 2022 earnings call. This morning, our President and CEO, Tim Spence, and CFO, Jamie Leonard, will provide an overview of our third quarter results and outlook. Our Chief Credit Officer, Richard Stein, and Treasurer, Bryan Preston, have also joined us for the Q&A portion of the call. Please review the cautionary statements in our materials which can be found in our earnings release and presentation. These materials contain information regarding the use of non-GAAP measures and reconciliations to the GAAP results, as well as forward-looking statements about Fifth Third's performance. These statements speak only as of October 20th, 2022, and Fifth Third undertakes no obligation to update them. Following prepared remarks by Tim and Jamie, we will open the call up for questions. With that, let me turn it over to Tim.
Thanks, Chris, and thank you all for joining us this morning. Before we turn to our financial results, I'd like to take a moment to express our sympathies for all those across the state of Florida who were impacted by Hurricane Ian. I would also like to thank our employees for answering the call to take care of our customers and communities in the state. In the days since the hurricane made landfall, our employees have made nearly 90,000 customer wellness calls, reopened all our branches, and staffed the Fifth Third Financial Empowerment bus to enable customers who lost power and internet access to apply for FEMA disaster relief. For those of you listening today, your resilience in the face of this natural disaster is awe-inspiring. Thank you for living our core values.
Turning to the financials, earlier today, we reported third quarter results that reflect our commitment to strong performance through the cycle. We generated record adjusted revenue of $2.2 billion, up 10% year-over-year. Credit quality remained strong, reflected in charge-offs at the low end of our previous guidance. We also generated 10 points of positive operating leverage compared to the year-ago quarter and achieved one of our lowest adjusted efficiency ratios over the past decade at 53%. Most all of our core return measures have remained in the top quartile among peers, including an ROA of approximately 1.3% and an ROTCE excluding AOCI of nearly 18%. We also produced strong organic growth during the quarter, sustaining a record pace in adding new quality relationships in commercial and growing new households by 3% across our footprint in consumer.
Our two recent fintech acquisitions, Dividend and Provide, each achieved record quarterly origination levels. Turning to the balance sheet, loan growth was solid across our franchise. Our commercial loan production remains well diversified and supported by the bank's strategic investments. Within our regions, loan production in our Southeast and other expansion markets roughly equaled our Midwest markets. Among our verticals, new production was strongest in energy, including renewables, with a 70% increase in origination volume compared to the year-ago quarter. Small business production was led by Provide, which doubled year-over-year. Average consumer loans were up 1%, led by Dividend Finance, a top five national residential solar lender, and a return to growth in home equity. Dividend recently announced several key national partnerships which will continue to accelerate growth in the future. Switching to deposits.
Consistent with prior guidance, our third quarter end of period balances were stable, with average balances down nearly $5 billion, due primarily to the full quarter impact of our delivered exits in the second quarter. In consumer, we grew households 3% year-over-year, led by our Southeast markets, which grew 8%. We generated consumer transaction balance growth of 5% compared to last year and opened our 1 millionth Momentum Banking account in the quarter. In commercial, our deposit franchise is anchored by our peer-leading treasury management business. We rank number two through number nine nationally in most TM payment types, as shown in EY's annual cash management survey.
We have a strong deposit base and new relationship growth engines in both our consumer and commercial business lines, and we expect deposit production momentum that we built during the third quarter to produce growth in the fourth quarter. Turning to the income statement. The strength and diversification of our fee-based businesses throughout the bank has helped to partially offset the market headwinds all banks are experiencing. In commercial, our gross treasury management revenue increased 6% compared to the year-ago quarter, led by our Expert AR and Expert AP solutions. Our capital markets revenue associated with helping clients hedge their exposure to rates, commodities, and foreign exchange increased 30% compared to the year-ago quarter. In consumer, we generated strong mortgage revenue growth this quarter in an otherwise challenging environment, thanks to the strength of our mortgage servicing operation.
Fifth Third is a low-cost, high-quality servicer, one of the only banks to be recognized as both a Fannie Mae Star servicer and a HUD Grade A servicer. The actions we took to grow our MSR portfolio nearly 30% since the end of 2019 will continue to pay dividends going forward. Finally, in wealth management, excluding tax payments, we have generated positive AUM inflows in every one of the past 13 quarters, and we will recognize this quarter as the best private bank for high net worth clients by The Digital Banker and Global Private Banker magazine. We continue to focus on maintaining our culture of prudent expense management across the company while investing in organic growth and tech modernization initiatives. In the third quarter, we made meaningful progress in our technology and platform modernization journey.
We successfully migrated our core platforms to a new data center and have now virtualized over 90% of our servers, strengthening network resiliency, increasing speed and capacity, and improving the experience for both our customers and employees. In the fourth quarter, we'll relaunch our mobile app in a new cloud-based architecture and with several improvements to the user experience. Credit quality remains strong throughout the bank. Our charge-off ratio was 21 basis points for the quarter, and our non-performing asset ratio declined compared to the prior quarter. We remain cautious with respect to the broader economy, given persistent inflation, the Fed's aggressive monetary policies and global growth concerns. We've continually improved the granularity and diversification of our loan portfolio with a focus on high-quality relationships and companies with more diversified, resilient business models. We continue to proactively monitor our portfolios for signs of potential stress.
Regardless of what comes, I am confident in our ability to outperform peers through the full economic cycle. With respect to capital, we announced a 10% increase to the quarterly common dividend in September. We continue to accrete capital with strong PPNR growth and expect to achieve a 9.25% CET1 by year-end. We also expect to resume share repurchases in the first quarter of 2023, subject to economic conditions. We continue to make decisions with the long term in mind, hold ourselves accountable to what we say we are going to do, and invest in product and service innovations that generate long-term sustainable value for customers, communities, employees and shareholders. With that, I will now turn it over to Jamie to provide additional detail on our third quarter financial results and our current outlook.
Thank you, Tim, and thank all of you for joining us today. We are pleased with our third quarter results. We generated strong loan growth in both commercial and consumer categories and generated record adjusted revenue. NII was positively impacted by higher market rates. Fee income was resilient despite the market-related headwinds, and expenses were well controlled while we continued to reinvest in our businesses. Consequently, we achieved a 53% adjusted efficiency ratio. Excluding net securities losses related to two legacy venture capital investments, we generated core PPNR growth of 13% compared to last quarter and 27% compared to last year.
Net interest income was approximately $1.5 billion, a record quarter, and increased 12% sequentially and 26% year-over-year, primarily attributable to the benefit of higher market rates, growth in commercial loan balances, and the full quarter benefit of securities purchased in the second quarter. Our NIM expanded 30 basis points during the quarter, while interest-bearing core deposit costs increased 32 basis points to 41 basis points in total this quarter. This equates to a cycle-to-date deposit beta of 16% thus far on the first 225 basis points of rate hikes. Total reported non-interest income decreased just 1% sequentially. We generated improved mortgage banking and leasing business fee income, which was offset by softer results in market-sensitive businesses, including capital markets and the impact of higher earnings credit rates in treasury management.
Non-interest expense increased 5% compared to the prior quarter, driven by an increase in compensation and benefits expense, including the impact of the July minimum wage increase to $20 per hour. Higher technology and communications expense reflecting our focus on technology modernization initiatives and the full quarter impact of the Dividend Finance acquisition. Expenses in the quarter included a $7 million benefit related to the mark-to-market impact of non-qualified deferred compensation, with a corresponding offset in securities losses. This compares to a $27 million benefit in the prior quarter. Excluding the NQDC impacts from both periods, total non-interest expense increased $35 million or 3%. Non-interest expense was flat compared to the year ago quarter, despite the impacts of our fintech lending acquisitions of both Dividend and Provide. Moving to the balance sheet. Total average portfolio loans and leases increased 2% sequentially.
Including held for sale loans, total average loans increased 1% compared to the prior quarter. Average total commercial portfolio loans and leases increased 2% compared to the prior quarter. With muted payoffs and a stable revolver utilization rate of 37%, period-end commercial loans increased 1% sequentially and 14% compared to the year-ago quarter. Average total consumer portfolio loans and leases increased 1% compared to the prior quarter, driven by Dividend Finance, which as a reminder, is recorded in other consumer loans, as well as growth in residential mortgage. This growth was partially offset by a decline in indirect secured consumer loans. At quarter end, Dividend loan balances were approximately $1.4 billion.
Average core deposits decreased 3% compared to both the year-ago quarter and the prior quarter, impacted by the intentional runoff of excess and higher cost commercial deposits in the second quarter and lower consumer interest checking balances in the third quarter. Compared to the year-ago quarter, average commercial transaction deposits decreased 10%, while average consumer transaction deposits increased 5%, reflecting our continued success growing consumer households. We grew our securities portfolio approximately $1 billion during the third quarter compared to $6 billion in the prior quarter. We currently expect security portfolio balances to remain generally stable through the rest of the year. We have continued to focus on maintaining structure in the investment portfolio to provide stable and predictable cash flows.
Our overall allocation to bullet and locked out structures at quarter end remained at 67%, and our duration declined to 5.5 in the current quarter compared to 5.8 in the prior quarter. Moving to credit. As Tim mentioned, credit trends remain healthy and our key credit metrics remain well below normalized levels. The NPA ratio of 46 basis points was down 1 basis point sequentially. Our commercial NPA ratio has now declined for eight consecutive quarters. The net charge-off ratio was flat sequentially at 21 basis points. The ratio of early-stage loan delinquencies 30-89 days past due remained relatively stable sequentially, and the amount of loans 90 days past due was approximately two-thirds of what it was a year ago. We continue to closely monitor central business district hotels, nonprofit healthcare, including senior living and office CRE.
We are also monitoring exposures where inflation and higher rates may cause stress, including the impact of changing consumer discretionary spending patterns, as well as the ongoing monitoring of the leveraged loan portfolio. From a balance sheet management perspective, we have continually improved the granularity and diversification of our loan portfolio with a focus on high quality commercial relationships and on homeowners, which are 85% of our consumer portfolio. We maintain the lowest overall portfolio concentrations in both commercial real estate and in non-prime borrowers among our peers. Through the Dividend and Provide acquisitions, we added granular fixed-rate loan origination platforms. We have also focused on positioning our balance sheet to deliver strong, stable NII through the cycle. Our strong deposit franchise, our securities and cash flow hedge portfolios, as well as the additions of Dividend and Provide lending capabilities, should continue to position us to drive strong outcomes.
In the cash flow hedge portfolio, we have added an incremental $5 billion since the end of the second quarter, bringing the total cash flow hedges added this year to $15 billion. The combined securities and cash flow hedge positions will support NII through the end of the decade. Moving to the ACL. Our ACL build this quarter was $96 million, primarily reflecting loan growth as well as a slightly worsening economic outlook relative to June. Dividend Finance loan growth contributed $63 million to this ACL build. Relative to the second quarter, the Moody's GDP growth forecasts are slightly stronger, while the unemployment and home price forecasts have weakened in both the baseline and downside scenarios.
Given our expected period end loan growth, including stronger production from Dividend Finance, we currently expect a fourth quarter build to the ACL of approximately $100 million, assuming no changes in the underlying economic scenarios. The impact of the expected Dividend loan originations to the ACL should be in the $80-$90 million range due to our improved loan growth expectations. Our economic scenarios incorporate several key risks that could exacerbate existing inflationary pressures and further strain supply chains, including continued aggressive rate hikes and quantitative tightening and labor supply constraints becoming more binding than originally anticipated. Our September thirtieth allowance incorporates our best estimate of the economic environment. Future baseline unemployment estimates may begin to be increasingly impacted by the Fed's aggressive monetary policies. Moving to capital. Our CET1 ratio ended the quarter at 9.1% compared to 9% in the quarter.
The increase in capital was primarily due to our strong earnings capacity, partially offset by RWA growth, reflecting robust organic business opportunities. Moving to our current outlook. For the fourth quarter of 2022, we expect average total loan balances to be stable to up 1% sequentially. We expect commercial loans to grow 1%, reflecting strong pipelines in middle market and corporate banking, and assuming commercial revolver utilization rates remain stable at 37%. We expect consumer balances to be stable to down 1%, reflecting our decision to lower auto loan production to enhance our returns on capital and lower residential mortgage balances, partially offset by Dividend loan originations of around $1 billion in the fourth quarter. From a funding perspective, we expect average core deposits to increase 1%-2% sequentially. However, we do expect some continued migration from DDA into interest-bearing products.
Wholesale funding balances should be stable given expected core deposit growth relative to our earning asset base. Shifting to the income statement, we expect fourth quarter adjusted revenue growth of 6% compared to the third quarter, excluding the third quarter security losses associated with legacy venture equity investments. We expect NII to be up approximately 5% sequentially, assuming a 75 basis point hike in November and another 50 basis points in December. We expect a cumulative deposit beta of around 30% by year-end. This should result in interest-bearing core deposit costs rising from 41 basis points in the third quarter to the mid- to high-90 basis point area for the fourth quarter. We expect fourth quarter adjusted non-interest income to be up 6%-7% compared to the third quarter, or stable excluding the impacts of the TRA.
We have a strong M&A advisory pipeline and expect to continue generating strong financial risk management revenue, which we expect will be offset by earnings credits and softer top-line mortgage banking revenue given the rate environment. We expect total adjusted non-interest expenses to be up 3%-4% compared to the third quarter, reflecting continued investments in talent, technology, and our southeast branch expansion. Our guidance assumes we open 17 new branches, 16 of which will be in our high-growth southeast markets. Our fourth quarter guide implies stable expenses for 2022 on a full year basis compared to 2021, and 8% adjusted revenue growth excluding securities losses, resulting in PPNR growth in the high teens. This will result in a mid-50s efficiency ratio for the full year, a 4-point improvement from 2021 and a fourth quarter efficiency ratio in the 51%-52% range.
We expect fourth quarter net charge-offs to be in the 20-25 basis point range, which will result in full year net charge-offs of approximately 20 basis points. In summary, with our PPNR growth engine, disciplined credit risk management, and commitment to delivering strong performance through the cycle, we believe we are well positioned to continue to generate long-term sustainable value for customers, communities, employees, and shareholders. With that, let me turn it over to Chris to open the call up for Q&A.
Thanks, Jamie. Before we start Q&A, given the time we have this morning, we ask that you limit yourself to one question and a follow-up, and then return to the queue if you have additional questions. Operator, please open the call up for Q&A.
At this time, I would like to remind everyone in order to ask a question, simply press star then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question is from the line of Scott Siefers with Piper Sandler. Please go ahead.
Morning, guys. Thanks for taking the question.
Morning, Scott.
I was hoping you guys could sort of address the maybe Jamie, best for you. Kind of walk through the puts and takes with Dividend Finance. I think since that closed, you know, the origination expectations have been great and continue to increase, but so do the reserve build expectations. Maybe just some thoughts on, you know, how much longer will those related reserve builds last? And how, you know, how is the overall accretion from that transaction trending relative to what you would've thought at announcement.
Yeah. Thanks for the question, Scott. It's a good one and timely because the Dividend expectations on loan growth have continued to go up and up. Their performance continues to be very strong from a loan origination standpoint. When we bought them, they were fifth in market share, and our best estimate is that they're top three in market share now today. You know, it's certainly a booming business given the rising energy costs. With that, you know, we had originally modeled a five-year earn back on the acquisition that they'd be profitable in 2023 ex the ACL and in 2024 with the ACL. They're certainly tracking ahead of those expectations. Obviously, the challenge during this quarter and as we look ahead, given their strong loan growth, is the ACL build.
The ACL build and the credit performance is in line with how we modeled the portfolio with, you know, the annual loss rates, you know, speaking at a 1.25% charge-off rate, give or take. But given the elongated nature of the asset, it results in a much higher ACL build than some of our other loan categories. You know, we're going to be providing at a pretty healthy rate in dollars given their strong loan production, and that could be $80 million-$90 million next quarter and perhaps every quarter in 2023, given that, you know, we expect $1 billion or more per quarter from them.
Yeah
I guess that's a long answer to say it. It's a good problem to have in the long term because it's a high returning asset, both from a NII perspective, but also a return on the capital. It's just the unfortunate cost of providing life of loan losses at origination.
Yep. Okay. Thank you for that color. Maybe the follow-up. You guys have really good Common Equity Tier 1 and are anticipating resuming share repurchase early next year. You know, the TCE ratio continues to suffer from the AOCI. Maybe if you can sort of just to discuss the extent to which TCE, if at all, weighs into your capital decisions. You know, I think one of the emerging questions in the market is, you know, if investors are gonna sort of rally behind share repurchase from a low starting point of TCE. Just curious to hear your thoughts there.
Well, thanks for the question because as you know, I do have some opinions on this topic. Bear with me a moment while I walk through it, you know, because we run the company looking at metrics that both include and exclude AOCI, and we've been showing you both sets of metrics for better or for worse consistently over the past decade, you know, whether that's ROTCE or tangible book value per share or TCE. When you look at the tangible book value per share excluding AOCI, we actually grew it in the quarter and for the year, even with the Dividend Finance acquisition. Really, when it comes down to the lower TCE ratio and the tangible book value per share including the AOCI, it really does come down to, you know, how the AOCI is moving.
when Bryan and I, you know, talk about this and have been thinking through it, we think we're really mixing two issues into that one question. The first question when you parse it out is really based on, how do I feel about our investment portfolio's positioning and performance? I would answer that as I feel very good about how we are positioned and especially how we're positioned relative to peers. Would it have been great to time the market perfectly and hit the very best entry points? Of course. our two years of patience definitely paid off for us. On a relative basis, we continue to have one of the highest-yielding portfolios and among the lowest unrealized losses as a percentage of total securities, in the industry.
The potential TCE and AOCI issue from this perspective ultimately comes down to whether you have a low quality or poorly structured investment portfolio that will incur losses in the future. We do not. We will accrete 45-50 basis points or about $1 billion of TCE per year going forward and do not expect to incur any losses in the portfolio. As we've always said, given the high composition of floating-rate loans on our balance sheet, the investment portfolio should act as a shock absorber in a falling rate environment. We believe the nice duration and structure that we have in the portfolio will do just that. The second question that gets mixed into this is then, you know, should we be putting securities into HTM instead of AFS?
As we've said before, as a Category IV bank, the election to put the security into AFS or HTM really doesn't impact regulatory capital other than a small deferred tax asset impact. Nor does it change the economics or the risk of an investment. For the largest banks, clearly there's value to minimizing the risk of regulatory capital volatility by using the held-to-maturity bucket. You know, for banks like us, we believe the benefits of maintaining some flexibility to manage the portfolio through a volatile environment, really does create value for us through the cycle. Given that there's no change in the actual value of a security simply based on the accounting classification that we put the security is in.
it really does come down to, do we think the company from a TCE or value perspective is worth less by simply fair valuing one line item in the balance sheet? Or is it worth less because we placed a security in AFS? The answer to that, we believe, is clearly no. our goal is always optimize the balance sheet to deliver long-term real economic value and not make decisions that optimize accounting outcomes over economic value. with that, I apologize for what may have just been the longest answer in the history of earnings calls.
Yeah.
As you might imagine, we feel strongly about this topic.
If I can put a point on it, no. It that has not factored into the decisions that we make on a day-in, day-out basis and the way that we run the company or as it relates to capital return.
Perfect. No, I appreciate that color. It's an interesting issue to say the least, and it's having kind of wide-ranging ramifications. I really appreciate that.
No problem.
Your next question is from the line of John Pancari with Evercore. Please go ahead.
Morning.
Morning.
I was wondering if you can give us a little more color on your thoughts on deposit growth. I know that you indicated that you do expect growth in the fourth quarter. Maybe you can help size up, you know, that level of growth. Then how do you think about
Growth into 2023, particularly given that you've completed the deliberate deposit balance exits, that you had talked about. How are you thinking about 2023, maybe also in the perspective of the non-interest-bearing mix as a percentage of the total, how you expect that shifting as well? Thanks.
Yeah. Brian, why don't you address the first part of the question, and then I'll talk a little bit about why we think we can grow deposits in 2023. Go ahead.
Yeah. I mean, our goal is always to grow deposits and take share every year. You know, we've obviously got strong consumer household growth, our investments in our southeast markets, our leading TM business. You know, we have confidence that we can take share. We obviously have some full year headwinds on average balances due to the excess commercial balances we intentionally let run off in 2Q. We do expect to grow from these 3Q levels, from end of 4Q, you know, probably up, you know, 1%-2% kind of range. You know, you obviously have normal seasonality, that we should expect to benefit from a commercial perspective as we also continue to grow households and grow our commercial relationships.
Yeah. I think I just would add, John, to put a point on it. We do feel good about our ability to grow deposits the remainder of this year and, as Bryan said about our ability to grow deposits on an ongoing basis. If you just step back and look at the engines that drive deposit growth here, the integration of the branch and the digital offering's been very powerful for Fifth Third, right? Over the course of the past few years, the investments we've been making in the southeast have really accelerated. That is evident in the rate of growth that we see in those markets. Like I mentioned, 8% household growth as an example, there.
The only bank that has built more branches in the last three years in the Southeast than Fifth Third is JPMorgan Chase. Okay. We have a very fresh branch network. We have another 20-plus branches that will be open before the end of this year, and are on pace to do another 35 next year, all of which are in really high growth markets. I mentioned the millionth Momentum Banking household when it was opened in the third quarter of this year. I don't think I could overstate the way in which that sort of a product offering changes the nature of the relationship with a customer.
Like, if you just assume the checking account has a $5,000 average balance, 1% interest on $5,000 equates to about $4 a month. I mean, think about how many other places you spend more than $4 a month and get less value than we're providing now in momentum as it relates to helping you to manage cash flow and achieve savings goals and move money efficiently and otherwise. I think that is gonna be, you know, a very powerful driver of growth. It just makes those core retail deposits stickier than they were in the past. Lastly then, we talked about the treasury management business, and we've shared in some of our investor conference presentations this ratio of turnover to average balances in commercial.
If you just look at ACH volumes over average balances, and compare that across banks in our peer group, Fifth Third has by far and away the highest turnover, which is a really good thing because what that means is that the balances that are sitting here are being used to support the cash flow velocity of the business as opposed to being treated like an investment alternative, right? If you take that as the foundation of the deposit business here, and take into account how hard it is to build those sorts of capabilities over a period of years, it's gonna be a pretty powerful moat for the bank going forward. I think we'll be able to grow from there.
John, on your DDA mix question, you know, when we look back the last tightening cycle, our total DDAs to total core deposits dropped 5 points from 35% to 30%. This cycle, we started at 38%, and we model a similar 5% decline. I should say we're forecasting a 5% decline. We actually model in the rate risk disclosures in the presentation additional migration even beyond that. We're assuming a similar mix shift as last tightening cycle. As Tim mentioned, our product lineup is certainly different and better, and the treasury management market share certainly has improved since the last cycle. Either way, we feel good about how we're forecasting it and think it'll be manageable.
Got it. Okay. Thanks, Jamie. Secondly on credit, if you could just give us some color on the drivers of the higher loan delinquencies in the quarter. It looks like both 90 days and 30-89 went up. Separately, maybe just thoughts on the trajectory of the loan loss reserve ratio, excluding what you're doing with Dividend Finance. Do you expect, you know, additions here on the underlying reserve beyond that portfolio? Thanks.
Yeah. It's Richard. I'll start with the delinquency comment, and I'll let Jamie talk about the ACL changes. Look, starting from a small base, we have a couple deals roll into delinquency. You have a couple roll out. There's really no trend. There's no pattern with respect to industry or borrower type. I think it's just a little bit of seasonality in terms of, or a little bit of just a small change in terms of borrower impact as we get through the end of the quarter. On the ACL, the driver of the coverage ratio this quarter was certainly Dividend more than anything else, but the other impact being a little bit worsening in the Moody's scenario.
From here, Dividend loans, you know, continue to grow and be an outsized portion of our originations. That coverage ratio, just because of that loan mix, will continue to increase. Otherwise, you wouldn't expect the ACL coverage ratio to go up or down unless the economic scenario changes or the credit profile improves or worsens more than what we currently have modeled.
Right. Okay, great. Thank you again, Jamie.
Your next question is from the line of Mike Mayo with Wells Fargo. Please go ahead.
Hi. Tim, you started off the call talking about virtualizing 90% of your workload, or I missed some of what you had to say. What does that mean for your efficiency ratio, 53.3%? Where do you think a terminal efficiency ratio is? How much do you have in stranded costs? And on the other hand, the inflationary costs that hurt your expenses. I guess I'm looking for longer term expense and efficiency guidance and the implications of some of these tech moves.
Yeah. I had you in mind as we were writing that paragraph, Mike, in terms of the data centers and virtualizing applications. I think the way to think about what we are getting to at this point is we have talked for many years now about the opportunities that we have to use the cloud, whether it was private, or public, to take, some of the load off of legacy mainframe, infrastructure and to put it into an environment that allow it to be much more scalable and resilient over time. We hit a couple of important milestones in the quarter in that regard, hence the commentary about the data center move and, having virtualized now 90%, a little over 90% of the servers inside the company.
Long-term, I think we feel very good about the ability to drive efficiency on the maintenance and network infrastructure side of the IT business. But we also intend to be able to continue to invest on an ongoing basis in new front-end application development, and in building new capabilities into the products and services. I think what we said in the past is the technology spend has been growing at, call it 10% on an ongoing basis, that you should expect that sort of growth to continue. That it would be offset by our ability to eliminate manual processes and drive automation into the company. If you look at banks in totality, people expense is about half of our total expense on an annual basis.
There's still a lot of opportunity in front of us in a 3-5-year timeframe to substitute technology for work that has to be done manually today. That's where I think the efficiency opportunities are. As it relates, you know, to the long term, a 53% efficiency ratio, I believe, is, you know, at least as we were looking at it this morning, the best of any of the commercial banks over $100 billion that are reporting. I feel really good about where we're at the moment. The intent is to be able to run the company in that sort of 53%-55% range on an ongoing basis.
Okay. How many data centers do you have left? Is it your goal to eventually have no data centers as-
No, we'll have two
indicated?
We'll have two. We'll always have two. There's a lot of efficiency in being able to run certain applications and then be able to store data in your own private environment. You need to have redundancy.
With the moves that just happened, can you size those cost savings or those savings are simply going to help fund your new tech investments?
They'll be the mechanism to fund the new tech investments.
Okay. All right. Thank you.
Yep.
Your next question is from the line of Betsy Graseck with Morgan Stanley. Please go ahead.
Hi. Good morning.
Morning.
I just wanted to ask a couple of questions. One, I heard the commentary around deposits earlier and the outlook for deposit growth from, you know, effectively benefiting from the new branches, et cetera, that you've been putting in. Could you just give us a sense of that branch, you know, trajectory from here and what you're anticipating over the course of the next year or two? Then also give us a sense as to what your deposit pricing strategies are as well for the next, several, you know, quarters.
I'll take the branch trajectory. Bryan, you can handle it. I think we have been running on a pace to open, call it 20-30 new branches a year. We'd like to see that be in more of the 30-40 range. We'll hit mid-20s this year. The expectation is to end up somewhere between 30 and 35 next year and to have the 30-40 a year range be what we run in the southeast markets until we achieve the market position that we want to be able to achieve in each of the MSAs that we are focused on down there.
Now, on a net basis, the branch network has not been growing that fast because we have taken advantage of opportunities, as customers have done more of the transactional activity online to thin out or relocate branches in the legacy network, which has provided a basis for funding, several of the investments that we're making down in the Southeast. Bryan, you want to talk about rates?
Yeah. Yeah, absolutely. Thanks, Tim. You know, we continue to feel good about what we've been able to do on the deposit front. The pricing is obviously starting to get more competitive, especially in the commercial portfolios. You know, we feel good about the 30% cumulative beta that we have talked about for that first 300 basis points of hikes. You know, certainly as rates move higher from here, we're going to continue to see some increase in betas. You know, we've previously talked about maybe that next hundred and twenty-five basis points of hikes, those betas will get over 50%. We think we're going to be able to manage to below a 40% cumulative beta from here. Certainly a little bit higher on commercial than on the consumer side.
We recognize as rates move higher, you are going to start to see more consumer beta flow through as well.
Right. Yeah, no, I know, I noticed you upped your CD offers and matched JP, which I know is a competitive positioning that you've got in a lot of your footprint. So that's helpful color on the forward beta that you're looking for. Maybe you could just give us a sense on loan growth trajectory. You know, because one of the things obviously we're all thinking about is dollars loan growth and dollars deposit growth and you know any expectation that you would need to lean on wholesale funding a little bit more. You know, I did notice in the quarter your averages went up, but in wholesale funding. But that looks like it was action that you took at the end of 2Q.
Maybe you just give us a sense as to how you see that all projecting? Thanks.
Yeah. Betsy, from my standpoint on loan growth, I think the guide in the fourth quarter is stable to 1%, on a quarter-over-quarter basis. That feels like a pretty good benchmark, right? If you were to start on something for where we see loan growth going. We have really strong production coming out of Dividend, as we mentioned, and are very pleased with the performance there, and also strong production on Provide. On CNI more broadly, I think we have been deliberate about moderating production over the course of this past year. You can see that in the numbers. The production itself is still really good. It's more granular than it had been in the past, which is an important strategic priority for us.
You know what I think I don't see a catalyst for is a material move from here on utilization rates, right? Against the strength in the fintech platforms and you know good core middle market production in CNI, you're going to have the drag from the slowdown in the auto production and mortgages that you know I think we started on perhaps earlier than others, and therefore will make its way into the numbers faster than you may see it in other places. Against that, the goal is always to grow deposits. We like to be able to grow deposits faster than loans. That we as a tenet of the way that we try to grow the company. That doesn't always happen in any one quarter. We do expect fourth quarter you know 1%-2% deposit growth.
While we're still in the early stages of the planning process, we intend to grow deposits next year.
Yeah. Betsy, from an overall funding perspective, our wholesale funding portfolio as a percent of our asset base is obviously down, you know, a decent amount from where we were pre-COVID. You know, it was kind of closer to 9% of total assets pre-COVID. From a long-term debt perspective, that number is down to more like 6% right now. Our loan-to-deposit ratio obviously is still near those historic lows. You know, over time, we do expect to have more structure in our liability base as well as a little bit more long-term debt. Even if we were to see some moments of, you know, loan growth faster than deposit growth, we have confidence in our ability to fund it.
Adding some of that structure to our balance sheet is a decent place to be as well.
Right. No, I noticed your liquidity sources. It's a very fulsome slide, so really appreciate that. Thank you.
Your next question is from the line of Ken Usdin with Jefferies. Please go ahead.
Hi. Thanks. Good morning. Just a couple of questions on the fee side. You know, understanding your guide is flat to the $727. I just want to understand, Tim, in your intro, you mentioned that mortgage servicing will continue to be a benefit. Does the mortgage business, you know, hang in from here going forward? And then the second question is just can you flesh out a little bit for us just the impact of earnings credit rates on service charges and what type of impact that could have going forward as well? Thank you.
Yeah. Hey, Ken, it's Jamie. I'll take that one. Since we've had long discussions over the years on the strength or lack thereof in our mortgage business. Happy to report that the third quarter was a very nice mortgage performance for the third. I do think from a top-line perspective, volumes will be down given the environment into the fourth quarter. But what you're seeing in the strength of the business is really that servicing revenue shining through. As Tim mentioned in his prepared remarks, you know, we're one of the top servicers rated in the industry. You know, the improvement in that revenue stream is part of why we beat the outlook for the third quarter and will help support the mortgage fee business going forward.
We were running, you know, the mortgage banking in the first half of the year. Total mortgage banking fees, I think in the first six months of the year, were $80 million, and we're going to, you know, grow that 60% over the back half of the year, simply driven by the strength of that mortgage servicing business that we operate. We feel good about that's a run rate. You know, servicing fees net of MSR decay should be around $40 million-$45 million a quarter, going forward, and that's going to be a 10% yielding asset for us. Again, the top line will be a little bit challenged.
That net-net, assuming no MSR valuation changes, I would expect the mortgage banking fee line to be in that $60 million-$65 million range in the fourth quarter.
Okay. Sorry, that on the service charges with regards to the ECR impact there, you know, how does that trend going forward?
Yeah. When we look just at the fourth quarter, the top line fee equivalent, you know, as Tim mentioned, we have a very strong pipeline and good business. Top line will be growing 2% or so. To your point, the earnings credit, just given the rising rate environment, will result in total service charges being down 2%-3%. We have earnings credits moving, you know, similar to the deposit betas, and so they'll continue to edge higher as the Fed keeps moving on rates.
Okay. If I can just ask one more just on your slide 24, you added an, you know, $5 billion more swaps since the end of the second quarter, and we can see how you've laddered that all out. Just, can you help us just understand, you know, as you, as you start to look past 4Q in terms of, NII, can you, can you continue to show, positive NII growth given, I guess, the positive beta comments you made earlier and just the trajectory of the protection that you've put onto the balance sheet? Thanks, Jamie.
Yeah, Ken, it's Bryan. Thanks for the question. You know, based on where we stand today, you know, we feel good about our exit rate NIM in 4Q 2022 carrying over into 2023 with some upside as our balance sheet continues to benefit from the 2022 hikes. You know, we've previously talked about that 4Q NIM in that kind of 3.35%-3.40% range. You know, assuming a 4.50% terminal funds rate, you know, we think our NIM will peak in mid-3.40s in the first half of 2023. We do expect to give some of that upside back as deposit repricing lags catch up.
Given the balance sheet actions we've taken to date, to monetize our asset sensitivity, you know, we expect we can maintain a 3.30+ NIM over the next couple of years, even if rates were to fall 200 basis points. You know, obviously 2023 and beyond results are subject to significant uncertainty given the economic outlook. We'll give you additional color on 2023 expectations as part of our fourth quarter earnings in January.
Great. Thanks a lot, Bryan.
Yeah. You know, if I'm just gonna throw one editorial comment in here, Ken, because you hit on two of the topics that we're spending a lot of time talking about internally is, I think perhaps because we operated for 15 years in a near zero interest rate environment, people forgot about what long-term drives performance in the banking business. If there's anything that the current point in the cycle is reminding us, it's that deposits matter and that diversified fee income business lines matter, and that interest rate risk and credit risk management matter.
By those measures, if you look at where we are right now, I mean, the company's been around for 164 years, and this is literally going to be its best year ever in terms of profitability and the strength of some of these fee lines, like mortgage servicing, right? Like what we have been able to do on top line with treasury management. The quality of the deposit base, coupled with the, you know, the prudence that I think that our treasury, which has done an, you know, really an outstanding job here, and that we have in the credit organization, is going to set Fifth Third up to be able to perform very well, regardless of what 2023, 2024, 2025 look like.
Thanks for that color, Tim.
Your next question is from the line of Erika Najarian with UBS. Please go ahead.
Hey, Erika.
Hey, good morning. Actually, my questions have been asked and answered. Thanks so much, guys.
Good. Thank you.
Your next question is from the line of Matt O'Connor with Deutsche Bank. Please go ahead.
Hey, Matt.
Good morning. Any impact to the Dividend Finance business from recent legislation? I guess it's called the Inflation Reduction Act, but there's a lot of climate initiatives in there that I know help some broader areas. Any impact to that business in terms of volumes and reducing the credit versus what you thought it would have been before?
Yeah. It will be a tailwind for the business. When we underwrote the business and entered into the agreement to buy Dividend, the assumption we were using in our base case was that the federal tax credits would expire, and the actions in the Inflation Reduction Act are only going to help support it.
As you think about how big this portfolio can get or you're willing to let it get, obviously there's a lot of room to run. If you're originating over $4 billion a year and it's pretty long duration, the balances could build pretty quickly. Any thoughts on kind of how big, I know I've asked you before, but you know, how big it can get and you're willing to let it get?
Yeah. I mean, obviously there's a lot that can change over the next couple of years as outlooks and things adjust and rate expectations change. You know, as we look at it now and given the capacity that we have on the consumer side because, you know, we are going to continue to let our auto portfolio run down. You know, getting that portfolio north of $10 billion doesn't cause us any concerns. We also know that there is a pretty robust market, whether it's securitizations or whole loan markets, where we're going to have the ability to manage the portfolio risk associated with these assets. We feel good about our options associated with it.
Okay. Actually just following up on my first question, I'm a little slow today. It was always a long week. The benefit of these credits. Does this increase the volume, reduce the kind of long-term expected credit cost? Or what's the, or a little bit about?
It increases the volume.
Yeah.
The way to think about it is that from the homeowner's perspective, clearly there's an incentive to impact your own personal carbon footprint, but these decisions ultimately get made on an economic basis. The trade-off that the homeowner is making is the cost to install the panels and then to service the debt attached to that relative to the cost to pay an energy bill for energy that you buy from a utility company on a month-to-month basis. Anything that reduces the installation costs on the side of solar or that increases the cost of buying energy off of the grid is beneficial to the size of the overall market is the way to think about it, Matt.
You know, Dividend being one of the largest players, anything that positively impacts the TAM for residential solar positively impacts the outlook from an origination perspective. That's where I expect the benefit primarily to be as it relates to the extension of the federal tax credits.
That makes sense. Obviously, higher energy prices could also increase demand.
Yes. Yes.
Would there be an opportunity to securitize or, like, figure out a way to, you know, increase the ability to originate even more without keeping it on balance sheet over time?
Yes.
Maybe it's more, you know, 3-5 years out.
I think Brian mentioned that Dividend has been a top five originator. Jamie mentioned that, again, we believe it's a top three originator today. The other players in the top five are all funding through whole loan transfers or securitizations. There is a very liquid market for the asset. We have the ability to run at an origination level that is above and beyond what we would hold in the portfolio if we elected to do it. But as you said earlier, we have a long way to run between, you know, where we're at today, and, you know, where we would stop and at very attractive yields from the standpoint of NIM enhancement and overall credit performance.
Got it. Okay. Thanks so much.
Yeah.
Your next question's from the line of Gerard Cassidy with RBC. Please go ahead.
Hi, Tim. Hi, Jamie.
Hey, Gerard.
Tim, you talked about Fifth Third is one of the most active branch openers in the Southeast, along with JPMorgan Chase. Can you give us some color on the cost of opening? I know each branch is different, but a typical cost of opening a branch, what type of deposit level you need to reach to make it break even? You know, how long does it take you to reach, you know, to get to that deposit level if you use deposits as the measure for break even?
Yeah, Gerard, it's Jamie. Thanks for the question. We've really reduced the square footage in the branches so that, you know, the cost between land and construction is much lower than it used to be, and it can range from $3 million-$4 million of book value. Maybe a few hub branches would go higher than that. For the most part, that's where the investment cost is. As you know, the people side, the staffing is about half of the cost of operating a branch. You start to make money, you know, when you get into the $25 million+ deposit range. That usually takes us two and a half years or so, sometimes three, sometimes two.
Our recent de novos are tracking well against the model and actually are outperforming on a household growth basis. That's part of the reason why we're continuing the strategy. As we look ahead to next year, you know, we did 22 new branches this year in total, and we should do 35 or so next year, primarily in the Southeast.
Jamie, when you get to that break-even point, how much longer does it take to get to a return on investment or a return on equity, however you measure it, to have it at the level that you're very, satisfied with?
Yeah. Five years is really where, you know, leading up to the five-year mark, you then become profitable, flip over probably at that 4.5 on a cumulative basis. Then, you know, the earnings power really starts to accumulate beyond that.
Very good. As a follow-up. Yeah, go ahead, Tim.
I was going to say, but these are investments with extremely high terminal values, right? If you look at the branches that we have across the network today, it is, especially in the world where I think we have done a very good job of being able to integrate the digital investments that we make and the access to a human being in the local market, right? We've talked a lot about the ways in which we're using analytics and other direct connection points to make sure that that's a seamless experience for customers. It just has proven to be a very strong long-term recipe to grow the franchise. The longer the Fed stays up, the faster the break even on those branches materializes and, you know, the more attractive that the returns look like, right?
Yes, very true. Thank you. As a follow-up on credit, obviously your credit quality is very strong, similar to your peers. May you just remind us why the customers—I mean, you look at all the economic outlooks. You mentioned, Jamie, about Moody's. It was a little worse than what you had in the prior quarter in terms of building up the reserves. How is it that credit just remains so strong, you know, in view of these crosscurrents, particularly, you know, in the housing market starting to weaken? And then second, as part of this, can you just share with us also about the used car prices? Obviously, they're finally starting to come down. You guys are in that market. And how does that impact maybe, future charge-offs or delinquencies if prices continue to fall down?
Yeah. I'm gonna let Richard provide more specificity. Gerard, if you just step back and look at it, 'cause this is the conundrum that I think we find ourselves in as we look forward and think about how we run the business relative to the signal we've got today. On the consumer side of the equation, if you look at Fifth Third consumer checking and deposit balances, they are essentially exactly where they were, about between 60%-80%, depending on the cohort you're looking at above where they were at in February of 2020. That ratio has stayed more or less perfectly constant since the third stimulus check. Okay? There were the temporary spike as tax refunds came in this past year.
That money got spent down by and large over the summer, but it restabilized in that sorta 60%-80% range. At least in our case, such a significant percentage of our consumer exposure is to homeowners, right? It's 85% of total exposure and 75% of our credit card and auto customers are homeowners, that they had an opportunity to lock in, you know, historically low fixed rate mortgages and to manage housing costs in the past couple of years that I will allow them as long as they're seeing 4%-5% wage inflation, which is kinda where we've been running, to manage 7%-8% headline CPI pretty well, right?
The byproduct of that is the liquidity buffer is there, and they have leverage over their costs in a way, you know, that others didn't. I think equivalently, Richard and I have been out together in several markets recently talking directly with customers. What we hear by and large is that demand has stayed very strong and that customers have been able to exercise pricing leverage and to push input costs through to their customers, right? I think the dynamic, in fact, with them in each case that they all remain more concerned by is, although supply chain pressures have eased a little bit, they're still concerned about the stability of global supply chains and are making investments to support that.
Labor is the other primary constraint right now. There again, I think where there is, you know, good activity going on, a lot of it is going on to fund CapEx to drive labor productivity, so that labor requirements can go down at a given level, you know, of demand. Now first principles would tell you that, with the Fed moving as rapidly as it is and with rates having headed, you know, the direction they have, that at some point here, the rate cycle has to turn into a credit cycle. That I think is the reason why we've been maybe more cautious, in terms of some of our actions than, you know, it feels like we hear other people being, because we just think it's prudent at this point in time.
I mean, Richard, do you want to talk a little bit about some of the other specifics?
Yeah. I think the one thing to add on commercial, Gerard, is remember there's a loss emergence period, so it takes a little while for the stress to ultimately roll through loss. I think what we see, and Tim articulated a lot of it, is our customers are adapting, and they've had to adapt honestly for about three years now. Let's go back to 2019. The tariffs were a challenge for a lot of supply chains and manufacturing. They had to adapt. They've learned that. You had COVID. You've had inflation. You know, we see resilient business owners do what they do, and that's adapt to the challenges and run their business as well. I think that's part of the conversation.
That's what we get from our relationship and our relationship managers talking to customers who really get good insight to what's happening on the ground. I think as Tim said, there's more strength there from a fundamental perspective than perhaps people would otherwise believe. Now to your question on auto, I think the answer is auto is gonna be a really classic example of a normalization. Again, you've got a shorter, generally shorter duration in terms of the asset and the loss emergence period, and you have two things that are happening at the same time. One, clearly you can see it with Manheim, used car prices are down 10%-12%, and trending down, normalizing.
At the same time, we're gonna be rolling into originations where we bought at or our customers bought at higher car prices. We don't really see anything abnormal except for an acceleration of this intersection between car values and the originated loan to value getting back to something that looks more normal. Again, it's a super prime book for the most part. We're disciplined on the underwriting. The resilience when you look at things like delinquencies continue to be very, very good. In fact, they continue to be at seasonal lows. I think it's just this intersection of prices coming down and origination prices coming down.
Then just one quick follow-up on that. You know, during the financial crisis with housing and many times houses fell below the mortgage value and, you know, people if they were unemployed and couldn't afford it, walked away from the house. If auto loans really go upside down and loan to values start to get up to 120, 130% because of the Manheim number keeps falling. You know, have you guys seen any history of people literally just turning the keys over to the car because the loan is upside down, or is that really not a factor in the auto market?
It's certainly not a factor today. In fact, Gerard, if anything, think about where auto prices have gone. We're seeing customers, and we see this across the spectrum that we don't lend into, they don't want to have to go turn their car in and buy a new one. It's too expensive. They're doing a lot of things to keep their car and to stay current or work through with the lenders. We don't see a lot of that because we don't really have that situation given the quality of our consumer. Right now, I think people, if they have a job, they want to keep their car. They don't want to go buy a new one.
Great. Okay. Thank you.
Thank you.
Today's final question will come from the line of Bill Carcache with Wolfe Research. Please go ahead.
Hey, Bill.
Hi, good morning. Thanks. Hey, good morning. Tim and Jamie, I really appreciate hearing your thought process on the earlier question about TCE. Would your response to that question change at all if we had a credit cycle and the Fed wasn't able to lower rates due to inflation, so the securities portfolio wasn't able to act as much of a shock absorber as you described earlier? To bring that back to the broader question, is there a point where decreases in TCE would become a concern for you in that scenario in particular?
Well, I guess first off, we've been, you know, accreting capital just through the strong earnings power of the company. That's going to continue. You know, as Tim mentioned, CET1 will grow in the fourth quarter, so obviously that will help the TCE ratio. When we pick up the buybacks next year, we'll run the company at that 9.25 CET1 level. That's our expectation. If there's a credit cycle, a credit event, I think we will be very happy that we have the portfolio we do, given the structure as well as the duration that we have. I'm not worried about the performance of the investment portfolio. I would say that it's probably the best portfolio in the industry. We feel good about that.
That's helpful. Thank you. Separately, on the funding side, can you speak to your ability to bring off-balance sheet client funds back on-balance sheet and the potential amount that is available in theory?
Yeah. Right now there's about $4 billion in our client liquidity portal. There's also opportunity within the wealth and asset management business. That would just come down to the willingness to pay 100% beta type of pricing. At this point in time, there's no need to do that. If we wanted to match money market rates, we could certainly bring more deposits back onto the sheet.
Very helpful. Thank you for taking my questions.
Thanks, Bill.
Thank you.
At this time, I would like to turn the call back over to Chris Doll for any, closing remarks.
Thanks, Dennis. Thanks everyone for your interest in Fifth Third. Please feel free to contact the investor relations department if you have any follow-up questions. Dennis, you can now disconnect the call.
Thank you. Ladies and gentlemen, this does conclude the Fifth Third Bancorp third quarter 2022 earnings conference call. Thank you for your participation. You may now disconnect.