Ladies and gentlemen, thank you for standing by, and welcome to the Silk Third Bancorp Second Quarter 2021 Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. I would now like to hand the conference over to your speaker today, Chris Dahl, Director of Investor Relations. Thank you.
Please go ahead, sir.
Thank you, operator. Good morning and thank you for joining us. Today, we'll be discussing our financial results for the Q2 of 2021. Please review the cautionary statements in 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 5th 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 2nd quarter net income of $709,000,000 or $0.94 per share. On an adjusted basis, we earned $0.98 per share. Once again, our financial results were very strong, continued to pause momentum from the past several quarters. During the quarter, we generated sequential PPNR growth of 15% on an adjusted basis and growth of 6% Compared to the year ago quarter, commercial loan production increased 10% from last quarter 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 Point reflecting improvement in both our commercial and consumer portfolios. We generated an adjusted ROTCE of nearly 20% for the 2nd 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 Walton 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 manage the balance sheet, Including in our securities and hedge portfolios, we'll 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 that drive further operational efficiencies to improve our resiliency, generate household growth and improve the customer To that end, we recently announced an expanded partnership with FIS to modernize our core deposit And wealth systems to the cloud, which will enable us to further our digital transformation.
This will significantly improve the flexibility and scalability of our technology structure and accelerate our speed to market. Combine this agreement with the renegotiation of our existing Payment processing relationship allows us to modernize our platforms while maintaining an efficient overall cost structure. From a commercial standpoint, in technology, renewable energy and manufacturing. However, our strong production was once again off and PPP forgiveness. While we continue to retain the customer in their core banking relationship, loan growth remains muted due to the environment.
Our commercial We continue to see strong performance in our business and we continue to see strong growth in our business and we continue to support the potential for improved loan growth 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 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 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 2 days early.
Extra time, which allows customers to secure 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 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 It reflects disciplined client selection, conservative underwriting and continued support from fiscal and monetary government distinguished programs. In addition to historical 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 remained very strong. Our CET1 ratio of 10.4% was relatively stable compared to last quarter despite share repurchases of $347,000,000 In the Q2, 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 Q3. 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 $850,000,000 In the second half of twenty twenty one, we 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, provided previously utilized and originate the sale model. As a result, the closing of the acquisition will not include a transfer of loan balances. However, post close, 5th Third will retain all loan originations.
We currently hold around $400,000,000 in loans generated I provide and have non credit relationships with over 70% of these borrowers through deposit and or treasury management products. The acquisition It is expected to close in early August and will utilize approximately 20 basis points of capital. In summary, we believe our balance sheet strength, diversified revenues and continued focus on discipline throughout the company will serve us well this year and beyond. We remain committed to generating sustainable long term value and consistently producing top quartile results. I would once again like to thank our employees.
I'm very proud of the way you have continually risen to the occasion to support our customers. Our commitment to generating sustainable value for stakeholders is evident in our 2nd annual ESG report published in June. This expands on last year's report with increased transparency, including enhanced disclosures on priority topics Such as inclusion and diversity, our climate strategy and our commitment to fair and responsible banking. We remain guided by our purpose, vision and core values and expect
Thank you, Greg, 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 30 $7,000,000 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 percent 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 $159,000,000 release to our credit reserves, resulting in an ACL ratio of 206 basis points Compared to 219 basis points last quarter, with historically low charge offs of just 16 basis points this quarter And an improved economic outlook, we recorded a $115,000,000 net benefit to the provision for credit losses. Moving to the income statement. Net interest income increased $32,000,000 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 $11,000,000 of incremental prepayment penalty benefits from our bullet and locked out cash flow strategy in our investment portfolio, which that position remains at 58% at quarter end.
Our loan balances benefited From the additional $1,000,000,000 of Ginnie Mae forbearance loan buyout purchases in early April, bringing the total third party purchases to $3,700,000,000 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 Unchanged relative to the prior quarter. On the liability side, we reduced our interest bearing core deposit cost by another basis point this quarter to 5 basis points and also had maturities of approximately $2,300,000,000 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 $30,000,000,000 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 $8,000,000 sequentially, reflecting incremental margin pressure. Production was strong during the quarter in both the retail and correspondent channels with 2nd quarter originations of $5,000,000,000 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 Q1, reflecting declines in compensation and benefits expenses, lower card and 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 $12,000,000 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 $50,000,000 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 Q2 of 2019, total adjusted fees have increased 14% compared to expense growth 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 We're 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 Q2 of 2019. Excluding the impact of PPP, Our end of period C and 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%. 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 2nd half of twenty twenty one and an eventual Fed tapering of bond purchases will present more attractive risk return opportunities in the future. Average short term investments, which includes interest bearing cash, remain elevated due to continued strength in core deposit balances, Which have grown 10% year over year. We have seen strength in both consumer and commercial deposits.
Compared to the prior quarter, average core deposits increased 3%. About 2 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, We're also benefiting from continued fiscal and monetary stimulus and improvement in the broader economy. The 2nd quarter net charge off 15% or $126,000,000 The NPA ratio declined 11 basis points sequentially assets declined 16% with significant improvements in retail non essential, We continue to focus particularly central business district hotels.
Moving to the ACL. Our base case macroeconomic scenario assumes the labor market continues to improve And job growth continues to strengthen with unemployment reaching 4% by the Q1 of 2022 and ending our 3 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 $169,000,000 reserve release. Conversely, applying 100 percent to the downside scenario would result in a $763,000,000 bill.
Inclusive of the impact of approximately $108,000,000 in remaining discount associated with the MB loan portfolio, Our ACL ratio was 2.15%. Additionally, excluding the $3,700,000,000 in PPP loans with virtually no associated credit reserve, the HCL 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 30 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 2nd quarter. Our CET1 ratio ended the quarter at 10.4%, which is $1,300,000,000 above our stated target of 9.5%. Our tangible book value per share, Excluding AOCI, increased 3% during the quarter. As a Category 4 institution, 5th Third was not subject to the latest Federal Reserve stress And we did not opt in.
At the end of June, the Fed notified us that our SCB would be 2.5% Effective July 1, which is the floor under the regulatory capital rules, without the floor, our buffer would have been approximately 2.1%. During the quarter, we completed $347,000,000 in share repurchases, which reduced our share count by approximately 9,000,000 shares compared to the Q1. As Greg mentioned, we expect to repurchase approximately $850,000,000 of shares in the second half of twenty twenty one, while also increasing our common dividend in We also announced our acquisition of Provide this quarter. We will utilize approximately 20 basis points of CET1 upon closing. This financially compelling acquisition of an asset generation engine dovetails perfectly with our Existing strategic focus on digital enablement and generating profitable growth on our balance sheet.
We believe and provide Strong growth prospects. From an origination standpoint, they have produced $300,000,000 in the first half of twenty twenty one, of which 5th Third purchased approximately 80%. We expect second half originations to be around $400,000,000 and given the expected early August closing, virtually all of that will go on our balance sheet. We expect over $1,000,000,000 in originations in 2022 and could grow to over $2,000,000,000 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 Our underlying NIM to be in the 3 0 5 basis point area for the full year. Combined with our loan outlook, we expect NII to 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 2nd 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 $165,000,000 in PPP related interest income for 2021, Of which $106,000,000 was realized in the first half of the year compared to $100,000,000 in 2020 and approximately $50,000,000 expected in 2022. For the Q3 of 2021, we expect approximately $40,000,000 in PPP income. Therefore, excluding PPP impacts, We would expect 3rd quarter NII to decline around 1% compared to the 2nd quarter or up over 2% from the Q3 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 Set by mortgage declines.
Additionally, as we discussed in January, we expect to generate private equity gains from several of our direct investments and venture capital funds Throughout 2021, potentially exceeding the 2020 level of $75,000,000 We have recognized around $30,000,000 in gains through the first half of fees to be relatively stable from the 2nd 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 Ex gain of approximately $60,000,000 associated with the sale of our HSA business that is expected to close in the 3rd quarter. We do plan to redeploy half of that gain in the 3rd quarter, split evenly between a $15,000,000 donation to the 5th Third Foundation that will Complete our previously announced philanthropy commitment to accelerating racial equality and inclusion in our communities And a $15,000,000 additional marketing program supporting momentum given the upside potential we see in that product. We expect full year expenses primarily in our legacy Midwest footprint, which we expect to complete in early 2022.
Additionally, we've opened 5 branches so far This year and plan to add approximately 25 more Southeast end market de novo branches in the second half of twenty twenty one. All run rate branch impacts are included in our outlook. We generated year over year positive operating leverage this quarter, and we Back to continue to generate positive operating leverage for the second half of twenty twenty one, reflecting our expense actions, our continued success Growing our fee based businesses and our proactive balance sheet management. We expect total net charge offs in 2021 to be 20 to 25 basis points given the strong first half performance and assuming our base case scenario continues to play out. 3rd quarter losses are likely to be in the 15 to 20 basis point range.
In summary, Our Q2 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 and A.
Thanks, Jamie. Before we start Q and A, as a courtesy to others, we ask that you limit yourself to one question and a follow-up and then return to the queue if you have additional questions. We will do our best to answer as many questions as possible in the time we have this morning. Operator, please open the call up for questions.
Our first question comes from the line of Ken Zerbe with Morgan Stanley.
Hi, thanks. Good morning.
Good morning, Ken. Good morning.
Now you guys are doing
a lot to make 5th 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? Is the broader industry really continues to wean itself off
Ken, it's Jamie. Thanks for the question. The one thing we are proud of At 5th Third is how much we've reduced our exposure on the consumer side from a punitive fee standpoint and how we are, I would say, a very consumer focused and consumer friendly bank. I think 3% or so of our revenue is in consumer overdrafts And our peers are significantly higher than those levels. We expect to continue to improve upon that With the Momentum Bank offering and some of the features that Greg talked about in his prepared remarks, so I think you can continue to expect that from us in that if If we were to have any future changes on overdraft policies or fees, it would only be to the positive and that we would more than make 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 Benefit of the franchise growth and more households from momentum, with comparatively substantially less impact than any of our large competitors Would have to the extent that they were attempt to follow us here.
Got it. Okay.
And then just maybe a second question. In terms of the January buyouts, I think some of the other banks this quarter have mentioned they just didn't see the opportunity or they didn't have or They couldn't find the opportunity whatever to do a lot of the Ginnie Mae buyouts, but it feels like you guys got a fairly decent benefit from that this quarter. Was that Are you seeing the same trends? Or do you still see opportunities to continue that going forward?
Very good question, actually, because What we've seen is that given we were a first mover in this product and Far back as the Q3 of 2020 when we bought our own pools and then helped structure these additional purchases that we've done totaling 3 point I would say that the economics were certainly more attractive if you were in the 1st mover Stage and the economics have really waned to the point that we would not be pursuing additional purchases at these levels.
Got it. Okay. Thank you very much.
Our next question comes from the line of Scott Sievers with Piper Sandler.
Good morning, guys. Thanks for taking
the question. Just wanted to ask at sort of a top level on sort of the eventuality of a commercial recovery, what's Your best guess as to what that will look like for 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 could decrease the further we go. 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
Let me start, then I'll go to Dave or Tim for additional color. First off, it's right now, there's just a lot of Uncertainty out there right now is we're dealing with the labor shortage and the supply chain disruptions, which are extremely real. You see it across the board in all conversations with our customers. But with that said, we're back to pretty much pre pandemic level production numbers, but payoffs continues to be stout and obviously you got something to happen with PPP. So when When you think about the environment in front of us, I think loan growth is going to continue to be a challenge as we go through the rest of the year.
I think we offset that by our strength in our fee businesses as we talked about in the prepared remarks, to compensate for some of those challenges. But I do think this changes over time. Every 1 percent $750,000,000 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 $2,400,000 in new commitments since Beginning of the year, I mean, we continue to acquire new households and commercial relationships.
So we're very, very positive as to what the future might hold, while we got some economic And some environmental challenges that we have to continue to deal with.
Yes. No, 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 focus There was on business mix, right? It was about constructing a business portfolio that had ballast. So in an environment where utilization is down That now and where rates are low, we have fee businesses that are firing and providing nice support and some countercyclical businesses in In particular on the consumer side like autos and mortgages, which are doing very, very well, right.
I think as some of the tailwind From those businesses abates, what you would expect to see is a benefit both as Greg mentioned, as it relates to line utilization, and ultimately some benefit from Rates, which provides a lot of support for the through the cycle focus.
Perfect. Okay, good. Thank you for those thoughts. And then maybe just a thought on overall reserving levels. You guys still maintain a very high end conservative Overall reserve, how are you sort of thinking about the steady state?
Is it back to where we were CECL Day 1 or just given the backdrop and what we've already got Drew, can we kind of blow through that a little bit on meaning go lower than that? How do you think about those dynamics?
Yes. It's Jamie. I'll take that one. When you look at the quarter with the ACL release of 159,000,000 We had that split fairly evenly between the consumer portfolio and the commercial portfolio, and the decline It 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 that the 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 eightytenten on CECL day 1 generates about a $90,000,000 Higher reserves. 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, 2020, while this period of uncertainty continues to exist. And then relative to day 1, It really is a tale of 2 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 199 at the end of The Q2 versus the $246,000,000 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 forecast at the end of the second quarter. And then we've had improvement in credit quality In auto and card as well as in the delinquency rates. So consumers already there, but commercial, again, we'd have to have things Play out differently than what we better than what we currently expect.
All right. Thank you guys very much for those thoughts.
Your next question comes from the line of Ebrahim Poonawala with Bank of America Securities.
Good morning.
Good morning.
I just wanted to go back, Greg, on your announcement partnering with FIS on the modern core On the Wealth Management side, if you could give us some visibility on three things. 1, 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 5th Third when you get to that point?
Or is it table stakes given that the industry is
Okay. That's a lot there. So let me try and dissect a little bit for you. First off, the FIS announcement we just made is a continuation of That's been in place for quite some time, just a replacement of our WAM through our core deposit platforms. But we've been on this journey To reengineer our technical infrastructure, focusing on the actual resiliency and the skill of our businesses, Replaced our HR platform with Workday.
We completed our enterprise data strategy. We completely replatformed our mortgage LOS environment. So the FIS The national extension of the continuation of the modernization of those activities. We also re engineered and restructured The pricing agreement of our legacy relationship with FIS
is going
to help make that the cost associated with that implementation of the new FIS Components a lot more reasonable, digestible for us and we'll manage our costs going forward. So we're pretty pleased with the way that came out. As far as the competitive advantage, Listen, I think at the end of the day, this is a long game. We have to continue to refresh our platforms. We're going to continue to modernize our platforms to the I think every bank is trying to get this right.
So whether it comes to competitive advantage or not, I think it's a requirement. And it's basically table stakes to be in a business, to be a digital Our customers expect to bank anywhere, anytime. We have to have platforms that are always on. So that's just a retransformation of our business. We have to repurpose our expense dollars from the legacy brick and mortar infrastructure, and we've got to continue to reinvest in technology.
So So we're going to continue to do that. And I think the banks that don't do that are going to be a competitive disadvantage. But many banks, as you've already heard, will continue to focus on Of core modernization, we're going to be doing the same thing. We think we have a great strategy for that modernization and for bringing in new technologies. We have a Buy, partner, build, strategy that we've worked on very hard.
And if the technology is already out there, we buy it. If we can't buy it, we partner. If we can't partner, we build it. And the momentum is an example of that. Partnerships like GreenSky, Avtexchange, Dated Systems, CommonBond getting on the list This is a 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 replatform. But net net, once again, I think it's it may not be a competitive advantage at the end of the day, but it definitely will be a requirement between this business in the future.
That's good color. Appreciate it. And just as a follow-up on that to that, when you think about acquisition of Prowide, 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 Provisions?
Yes, sure. This is Tim. I'm happy to take that one. So healthcare was the right Starting point for us, it's the 1st 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 was an important next step With a big focus on dentists, vets and otherwise, and Provide was a little bit unique in that it had, As a fintech company, actually already grown into one of the largest lenders into that market, driven primarily by their technology and their expertise.
And just as a point of example there, the digital experience that they offer enables them to get loans approved and closed about 70% Faster than a typical lending process would in that market. And in addition, because of the sector focus, they And growing digital marketplace that actually allows existing practice owners who would like to transition into to post their practices for sale and to get connected with folks who are interested in buying an established practice. So functions, I guess, a little bit like the Craigslist or the eBay Dental practices today. Are there opportunities in other verticals? Yes, we do think there are.
And we have been pretty As Greg mentioned, in partnering with many of those firms, whether those relationships Evolve from a partnership into an outright acquisition. I think it depends a lot on the circumstances of the business at a given point in time. But in the case To provide their next leg of the growth journey was going to be about the delivery of the broad, the full set of products and services and it Absolutely makes sense for them to be part of the bank as opposed to a standalone entity on that journey.
That's helpful. Thanks for taking my questions.
Your next question comes from the line of Gerard Cassidy with RBC.
Good morning, Greg. Good morning, Jamie.
Good morning, John.
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 achieved that in this rate environment. Was it due to the derivatives and hedges you have on the books? And then 2nd, I think you said that obviously you're going to keep your hand keep the liquidity in the portfolio until rates start to rise.
I think you may have mentioned the 2% rate. Would you lean into it as rates were to go to 2% if they do or would you wait until we actually got to 2% before you really
Yes. I think if you look back at our actions in the Q1, to answer the second part of your If you look back at our Q1 actions, we did lag into a little bit of additional investment portfolio build up at that point in time. We pre invested $1,000,000,000 of our 2nd quarter cash flows and then given the entry points and the rally in the bond market decided to Maintain that additional leverage throughout the quarter. So we did grow the book a little bit in the Q2. Our guide assumes we Hold it fairly stable as the year progresses because we don't expect to get to those 2% or better entry points.
But Should the market get there, we would lag into the trade and not do everything all at once. But when you look at our Additional $30,000,000,000 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 $10,000,000,000 of purchases done would certainly take some time, and we'd ramp 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 of deploying at these low rates, our goal is, let's maximize our NII over the next 5 years, not the next 12 months, and we think ultimately that 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 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, Yes. The growth in the yield this quarter in the investment portfolio is really the benefit of what we did 5 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 $2,000,000,000 in gains in the investment portfolio.
Very good. Thank you for the color. And then Greg, I've asked this question in the past, but I'll ask it again, which is, When you sit down with your senior management team and you guys look out over the risks that you foresee on the horizon, and if we take The delta variant and the COVID risk off the table, since that's an obvious one, what are some of the risks that you guys wrestle with I should 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. Obviously, I would have responded immediately with the variant of COVID and with that community, the slowing down of the economy I'm getting the robust recovery we're all hoping for, I mean, creating risk. I think right now, as I mentioned earlier, Gerard, think about Every customer I sit down with, Tim sits down with, we have a conversation, and you're seeing it in various ways, labor shortage, supply strength, Supply chain constraints, significant issues out there right now. You're seeing that in backlogs, Order delays, restaurants not being able to be open, small businesses not open full time can't get labor. So it's a big challenge right now.
And when does that start to abate? When does that start to correct itself? And I'm not sure when that is. I believe it will happen obviously, but to whether that's later this year, is it next year? So I think that's going to pull a lot of pressure.
Inventory levels are extremely low Compared to what the demand is out there, we're not seeing that tick up right now. Line utilization is kind of flattened right now, but we're not seeing that tick up that we were hoping to see. So those are all kind of concerns that I have right now. Obviously, inflation is another concern out there as we watch that, and how the Fed manages through that And more to come on that. But net net, I think overall the economy is fairly healthy.
We just got some challenges still in front of us that haven't been understood yet. I'm
sorry, go ahead.
No, I just was going to say if you just add A little bit of color. Greg and I together were out we spent a full day in 12 of our 13 regions This quarter, which makes for a busy travel schedule, but a lot of good input in terms of what we're actually hearing from clients On the ground, I mean, some of the stories that you hear about how people are dealing with the labor shortages or inventory supply issues A while, I mean, we have a client, a fuels marketer who's had to open their own driving school so that they can get people Enough folks with qualified commercial driver's licenses to do fuel deliveries. You have hospitals who are operating at 50 percent capacity on the elective portions of their business, which are really important driver, right, when you think about the revenues.
The elective room.
Yes, 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 backlog Oh, into the hard freeze in Texas, this last one. I mean, it really these they're not theoretical concepts. When you get out and you Talk to our middle market clients. They are really hard realities that they are grappling with.
And I think as Greg We all hope that especially as the enhanced unemployment benefits wane and as we work through some of these supply chain challenges that Our clients are able to invest in their business, but if you can't get the people, you can't get the materials, you can't invest to grow.
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 Borrowing from banks like yours because of what they're going through, have you heard that at all from your customers?
No, no, not yet. I think we hear them exploring opportunities to be less reliant on manual labor and to drive automation, but that drives CapEx, right? So that helps We hear them exploring opportunities to secure more captive supply and otherwise through M and A, but that also drives Borrowing in terms of the way that we 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. 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 WaitDrives borrowing.
So I don't So, Gerard, it's 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.
Thank you for all the color. Appreciate it.
Your next question comes from the line of Bill Quachitch with Wolfe
Research. Thanks. Good morning. Can you relate the fee income strength
that you saw this quarter to
the growth you're seeing in the 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 key 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 disproportionately to the incremental fee income, but I wouldn't tell you that it is focused Exclusively on the Southeast.
If you look at our new commercial relationships, about 30% of them this year are lead with treasury management. And then there's another percentage, which I don't have off the top of my head, but which has come to us primarily through the capital markets business. So We are having good success using those products as wedge opportunities To drive new relationships, if you look forward, I think we're trying to build what is a really nicely diversified Aftermarket business with low activities like rates and commodities hedging and otherwise, to complement the M and A advisory business and what we do in 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 and A Pipeline now, which is almost double what it was in January 1 this year.
So we do have a nice M and 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 2 to 3 percentage points. I am of the belief that we can do better than that, but But it's definitely better to be taking share there over time than it is to have the alternative situation. So we feel good about both of those beelines over the near to medium term.
That's very helpful. Thank you. And Greg, you mentioned GreenSky when talking about your partnerships earlier. Can you give us an update on how you're thinking about And direct lending partnerships more broadly and the opportunity to leverage these partnerships to continue to grow nationally beyond your footprint. Critics of that model Argue that you really need to own the relationship and are at a disadvantage when all you're doing is putting up your balance sheet and somebody else has a relationship with the customer, but
First off, there's not a lot of these opportunities out there. We had the economics of the GreenSky relationship, as we wanted as an investor, made a lot of sense for us. This is about how we grow our business over time. We're much more of a relationship business. That's why the Provide acquisition was extremely important.
You think about Provide, that was a partnership originally. We had about $400,000,000 in assets, but 70% of those relationships, we had Additional relationship outside the credit facility would be PM or deposit relationship. So that was important. It's a relationship Type of opportunity for us and that's what we're looking for to continue to enhance our business and grow our businesses. GreenSky created another channel for us, but yes, that's a non relationship business And those opportunities that make sense to us are very few out there, but the GreenSky one does for the economics of the transaction we've done in place.
Got it. That's super helpful. Thank you.
Your next question comes from Ken Usdin with Jefferies.
Thanks and good morning. A couple of quick ones. First of all, So the Q3 momentum marketing program that you mentioned, where you used part of that benefit, is that Just to get it kick started and then would you have ongoing expenses related to marketing built into your forward outlook past 3Q?
Yes, it's Jamie. Yes, the $15,000,000 incremental spend over the 2nd quarter marketing spend level of $20,000,000 So we expect to spend $35,000,000 in marketing in the 3rd quarter. That should abate going forward. However, If it is successful, then we'll continue the program at that elevated level until we've really captured as much of the first mover advantage with the product as we can.
Okay, got it. Understood. And then do you have any plans to or thoughts on re securitizing those Ginnie Mae loans that you get, the 37 You mentioned, I know some of them are newer, so they might not have quite gotten to that seasoning point yet. But is that at all in your outlook in terms of whether they stay in loans or move to mortgage Banking overtime?
So for the $3,700,000,000 of loans that we've purchased from Other third party servicers, we have a there's a nominal amount of fees assumed in the outlook related to that as they get resold To the servicer, the bigger economic opportunity is on the 750,000,000 of forbearance loans that we bought directly 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 $1,000,000 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 Business than it is any one time pop.
That makes sense. Last one, just you redeemed a bunch of debt at the mostly at the bank, some at the parent. 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 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's clearly not a need to maintain the higher unsecured debt levels that we have. We have an additional maturity In the Q3, we'll most likely not replace, but it's about $850,000,000 almost a 3% rate. So there's a little bit 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 ag improvement standpoint, we'll be on the left hand side of the sheet.
Understood. Thanks, Jamie.
Our next question comes from John Fakhour with Evercore ISI.
Good morning.
Good morning, John. Good morning.
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 Maybe an 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 the first part of the year, we would typically run around 36%, 37%. As I mentioned, every 1% is about 750,000,000 So we're running at 31, kind of flat line right there. I can't really we're hopeful, but I can tell my team, hope is not a strategy.
We're hopeful we start to see that Based on the production levels that we're seeing out there right now, hopefully get some of these challenges in front of us on the supply chain and labor fronts, Maybe abating a little later this year, but once again, it's a tough thing to say. When do we get back to a normalized run rate? It's going to be a lot. 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 impacting 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 XPP a little bit more than that, but ending the year with a little bit of a little closer to stable. And then PPP is we've been running steadily down as The year has progressed where on an end of period basis, we finished the Q1 at $5,400,000,000 We finished the 2nd quarter at 3 7, that will continue to drift down to $2,100,000,000 at the end of the 3rd and then $1,700,000,000 at year end is our current projection on PPP.
Got it. Okay, thanks. And then lastly, on the M and A front, as you look at incremental opportunities there, Craig, just wanted to get your thoughts on potential incremental bank and non bank. And more importantly, curious what you think of President Biden's executive order And the implied added scrutiny around bank deals. Do you believe that could impact a bank of your size looking at a Potential whole bank deal.
Yes.
I think first off, I would respond by saying our focus is on non bank transactions that enhance our product and service It presents itself in a market that's attractive to us. They kind of solves with FB Financial sold versus Chicago. Obviously, we always consider those type of opportunities, but The foreign key between and not the focus of the organization. As far as Avaya's executive order, it's still a lot of work to be done. The agencies, the OCC, Fed and FDIC and DOJ are trying to figure out what that means.
So more to come on that, but you can I believe, as I do, that transactions the economics of transactions could be more challenging going forward based on executive order and the timeline to get those transactions It may take a little bit longer, but good transactions will get done?
Got it. Thanks for taking my questions.
Our next question comes from Matt O'Connor with Deutsche Bank.
Good morning, guys. Just talk a bit more about the path For the 9.5 percent CET1 target, obviously, you talked about the dividend increase, the buybacks back half this year, the 20 basis point drag. But if you put all that together, you're still going to be, it seems like, kind of treading water on the capital, just given the good earnings Generation and probably not a lot of balance sheet growth in the
next few quarters. So do
you think you'll get that target or are you going to hold back for Kind of the loan growth and maybe just flush it out a little bit as we think about the first half 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 3rd quarter and And 9 basis points of CECL transition in the Q1 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 To get to the 9.5% and certainly if loan growth doesn't materialize then we'll look to continue to hit the 9.5%. And then Yes, we do feel that should loan growth accelerate, we certainly have a buffer from where we think we need to run the company From a capital perspective, clearly, from the credit outcomes you're seeing, we could run the balance sheet at 9% or so if loan growth were But for now, our focus is just getting to the 9.5% by mid year next year.
Okay. That's helpful. Thank you.
Our next question comes from Peter Winter with Wedbush.
Good morning. I wanted to ask Just on the middle market and small business, are you seeing any willingness of them maybe To tap their lines of credit while maintaining higher levels of cash on hand or is it just an issue of The supply and labor shortages that's holding it a while back.
Hey, Peter, it's Tim. I would tell you it's primarily issues with supply chain And then labor, like Greg said, and not liquidity. If you're looking for green shoots, I think the borrowers who are either Smaller or who rely on structures that look more like asset based lending structures are 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, 5th 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 when I feel like finding a positive signal, that's where I'm going these days.
Okay. And then Jamie, can I just ask about the outlook for the margin in the second half of the year, Some of the puts and takes?
Sure. The second quarter was obviously very strong from a margin perspective, and We're pleased with how the 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 area is what we've talked about. I think pretty much all year in terms of what we think this balance sheet should stabilize at certainly for the So NIM should come down, call it, 5 bps or so in the 3rd quarter. I would say the big drivers there, certainly the PPP, the prepayment penalties, a little bit of day count, And otherwise, still maintain that floor of 305 or better.
Got it. Thanks for taking my questions.
Our next question comes from the line of David Conrad with KBW.
Hey, good morning. A quick follow-up on the guidance
duration. And so the bullets when we quote the 58% number, we're saying it's bullet or locked out for at least the next 2 years, but The duration of that portfolio is not that different from the All I know in total.
Okay. So the lockout is 2 additional years?
Correct. But there's not a step down. For a while, we had quoted a 12 month and then we got the question, so we expanded to 24. But there's not a cliff here. It's Just a slow erosion over time.
Great. Thank you.
Our next question is from Christopher Marinotta.
A question before, Greg. Is the environment any different than it would have been 9 months ago, whether it's the CFPB or any of the agencies.
Well, this is obviously with the deck chairs Changing right now, and they're still in the process on the CFPB front from a nomination perspective. So has it changed? Listen, it's been I don't believe it's changed, to be Josh, with you, I think at the end of the day, these 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's the safety and soundness, but also the way that banks 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 bank and the totality, so to speak, from the top as to what they expect from us.
So I don't it's not something that keeps me up at night, let's put it
Good, Greg. Thank you for that and thanks for all the background this morning.
Thank you.
Those are all the questions we have at this time. Are there any closing
Yes. Thank you, Christie, and thank you all for your interest in 5th 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.