Fifth Third Bancorp (FITB) — Q4 2022 Earnings Call Transcript

Good morning, everyone. Welcome to Fifth Third’s fourth quarter 2022 earnings call. This morning, our President and CEO, Tim Spence; and CFO, Jamie Leonard will provide an overview of our fourth quarter results and outlook. Our Chief Credit Officer, Richard Stein; and Treasurer, Bryan Preston have also joined the Q&A portion of the call. Please review the cautionary statements on 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 January 19, 2023 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 good morning, everyone. To start, I would like to thank our employees for the job they did, supporting our customers, communities, and shareholders in 2022. You really held true to our core values and our vision to be the one bank people most value and trust. JUST Capital and CNBC recently released their annual study of America's Most JUST Companies, a comprehensive ranking that recognizes companies who do right by all stakeholders as defined by the American public. Fifth Third ranked 23rd out of the roughly 1000 companies covered in the study and was the highest ranked category four bank. It’s a great achievement. Thank you for it. Earlier today, we reported financial results for the fourth quarter and full year 2022. The strength and quality of our franchise are evident in the numbers. We generated record full year revenue of $8.4 billion, up 6% over the prior year. We managed expenses down 1% year-over-year, producing positive operating leverage of 700 basis points and an efficiency ratio of 56%. Net charge-offs for the year were below 20 basis points. As a result, we achieved a full year return on tangible common equity ex AOCI of 16.5%, which places us in the top quartile of our peer group. Just as importantly, we did what we said we were going to do. We have a culture of accountability at Fifth Third, and it makes me proud that our full year results exceeded the guidance we provided you last January in every major caption, including total revenue, expenses, and net charge-offs. As a result, PPNR increased 18% compared to our original guidance of 7%. We also made important progress on our growth strategies in 2022. We grew consumer households at a peer-leading organic growth rate of around 2.5%, led by our Southeast markets at 7%, and surpassed last year's record for new quality relationships in our Commercial segment. We opened 18 new branches in the Southeast in 2022, bringing our three-year total to over 70 new branches in those markets. During the year we also made meaningful progress in our technology modernization initiatives and enhanced our peer-leading digitally enabled treasury management managed services and our momentum banking product offerings. You may have seen that most recently we extended momentum's early pay feature to include income tax refunds. Our FinTech platforms, Dividend Finance, and Provide continue to scale and achieve top national market shares, with Dividend ranking third and Provide ranking second in their respective markets. Our fee-generating businesses are better diversified than most peers and continue to be a key focus for investment. Strong performance in our capital markets business related to helping client hedging activities, mortgage servicing and treasury management all helped to offset market headwinds that all banks faced, as did continued net AUM and flows in our wealth management business. During 2022 we remained focused on delivering stable long-term results instead of chasing short-term earnings. We maintained our discipline in our credit underwriting with continued focus on granularity and diversification. The outcomes of this are evident in our NPA, NPL and early stage delinquency ratios, all of which have remained well behaved and well below normalized levels. Our balance sheet management approach remains centered on providing strong and stable NII performance across various rate environments. We extended our advantage in our securities yield by waiting to deploy excess liquidity until we could earn positive real yields and we added derivatives to provide hedge protection through 2031. These actions will provide significant long-term benefits in the event of a lower rate environment. With respect to capital, given our strong PPNR growth and benign credit losses, we exceeded our target CET1 ratio in the fourth quarter and resumed share repurchases. Our capital priorities for 2023 are to maintain a 9.25% CET1 ratio and support organic balance sheet growth, pay a strong dividend, and continue our share repurchase program. We expect repurchases to steadily increase each quarter for a total of approximately $1 billion during the year. Jamie will provide you with the detail on our financial outlook for 2023, but it is a strong one that is consistent with our priorities of stability, profitability, and organic growth. We expect to produce another year of strong revenue growth and operating leverage with full year PPNR growth in the mid to high teens, a return on tangible common equity ex AOCI exceeding 17% and an efficiency ratio below 53%. We will continue to invest in organic growth and efficiency initiatives. We'll add another 30 to 35 branches in our Southeast markets, including our first three in Charleston, South Carolina, and several more in the Greenville, Spartanburg, South Carolina corridor. We'll continue to increase investments in marketing and product innovation to accelerate household growth and we'll invest in scaling Dividend and Provide. Lastly, we'll make significant progress on our tech modernization journey and begin to realize savings and improve the client experience by leveraging these investments to drive automation into our most labor-intensive processes. You have my commitment that we will continue to make decisions with the long-term in mind to invest where we can strengthen the value and resiliency of our franchise and to hold ourselves accountable for doing what we say we will do. With that, I'll now turn it over to Jamie to provide additional detail on our fourth quarter financial results and our current outlook for 2023.

Thank you, Tim and thank all of you for joining us today. Our quarterly and full year financial performance reflect focused execution and resiliency throughout the bank. We generated strong loan growth in both commercial and consumer categories and generated record revenue. NII was positively impacted by higher market rates as deposit repricing has lagged the repricing of our earning assets, combined with the benefits of fixed rate asset generation at higher rates. Fee income has remained resilient despite the market-related headwinds and expenses were well controlled while we continue to reinvest in our businesses. We achieved a full year adjusted efficiency ratio of 56%, which improved throughout the year with the fourth quarter adjusted efficiency ratio below 52%. Our fourth quarter PPNR grew 12% compared to last quarter and 40% compared to last year. Net interest income of approximately $1.6 billion was a record for the bank and increased 5% sequentially and 32% year-over-year. Our NIM expanded 13 basis points for the quarter. While interest-bearing core deposit costs increased 64 basis points to 105 basis points, reflecting a cycle to date interest-bearing core deposit beta of 24% in the fourth quarter. Total non-interest income increased 9% sequentially driven by our TRA revenue and commercial banking fees. That growth in commercial banking fee income was primarily driven by higher M&A advisory revenue and client financial risk management revenue, and it was partially offset by softer results in mortgage banking origination fees. Non-interest expense increased just 1% compared to the year ago quarter. This expense growth was driven by our acquisition of Dividend Finance during the year combined with continued investments in Provide, compensation associated with our minimum wage hike, as well as higher technology and communications expense, reflecting our focus on platform modernization initiatives. Excluding the impacts of Dividend and Provide, total expenses would have been down 1% year-over-year. Moving to the balance sheet. Total average portfolio loans and leases increased 1% sequentially. Average total commercial portfolio loans and leases increased 1% compared to the prior quarter, reflecting an increase in C&I balances. Growth was led by our corporate bank and was robust in almost all of our industry verticals. Among our verticals, production was strongest in energy, including renewables, which increased over 50% year-over-year. Healthcare growth was led by Provide with Provide balances up 150% year-over-year. The period end commercial revolver utilization rate remains stable compared to last quarter at 37%. Average total consumer portfolio loans and leases increased 1% compared to the prior quarter, led by Dividend Finance as well as growth in home equity. This was partially offset by a decline in indirect secured consumer loans. Average total deposits increased 1% compared to the prior quarter as an increase in commercial deposits was partially offset by a decline in consumer deposits. Period end deposits increased 1% compared to the prior quarter. After the deliberate runoff of surge deposits in the middle of the year, we have achieved solid deposit outcomes throughout the second half of 2022 reflecting our strong core deposit franchise. Moving to credit. As Tim mentioned, credit trends remain healthy and our key credit metrics remained well below normalized levels. The MPA ratio of 44 basis points was down two basis points sequentially, and our commercial MPA ratio has now declined for nine consecutive quarters. The net charge-off ratio increased just one basis point sequentially to 22 basis points within our guidance range. The ratio of early stage loan delinquencies 30 to 89 days past due also increased only two basis points sequentially and remains below 2019 levels. From a balance sheet management perspective, we have continually improved the granularity and diversification of our loan portfolios through a focus on high-quality relationships. In consumer, we have focused on lending to homeowners, which are 85% of our consumer portfolio. We also have maintained the lowest overall portfolio concentration in non-prime consumer borrowers among our peers. In commercial, we have maintained the lowest overall portfolio concentration in CRE. Across all commercial portfolios, we continue to closely monitor exposures where inflation and higher rates may cause stress and continue to closely watch the leverage loan portfolio and office CRE. We have focused on positioning our balance sheet to deliver strong stable NII through the cycle. Our strong deposit franchise, our investment portfolio positioning, and our cash flow hedge portfolios will provide protection against lower rates well beyond just the next few years, as well as the addition of the fixed rate lending capabilities from both Dividend and Provide should continue to support our strong through the cycle outcomes. Moving to the ACL. Our ACL built this quarter was $112 million, primarily reflecting loan growth. Dividend Finance loans contributed $96 million to the ACL build. As you know, we incorporate Moody's macroeconomic scenarios when evaluating our allowance. The base economic scenario from Moody's assumes the unemployment rate reaches 4.2%, while the downside scenario underlying our allowance coverage incorporates a peak unemployment rate of 7.8%. Given our expected period end loan growth, including continued strong production from Dividend Finance, we currently expect a first quarter build to the ACL of approximately $100 million, assuming no changes in the underlying economic scenarios. Moving to capital. Our CET1 grew from 9.1% to 9.3% during the quarter. The increase in capital reflects our strong earnings generation, which was partially offset by the impact of a $100 million share repurchase completed in December. Moving to our current outlook. We expect full-year average total loan growth between 3% and 4% compared to 2022. We expect most of the growth to come from the commercial loan portfolio, which is expected to increase in the mid-single-digits in 2023. We expect line utilization to be stable in the first half of 2023, but then decline slightly to 36% as capital markets conditions improve a bit in the second half of the year. We expect total consumer loans to increase modestly as an expected increase from Dividend Finance and modest growth from home equity and card will be mostly offset by a decline in auto and mortgage reflecting the environment. For the first quarter of 2023, we expect average total loan balances to be stable sequentially. We expect commercial loans to increase 1%, reflecting strong pipelines in middle market and corporate banking, and assuming commercial revolver utilization rates remain generally stable. We expect consumer balances to be stable to down 1%, reflecting lower auto and residential mortgage balances, partially offset by dividend loan originations of around $1 billion or so in the first quarter. From a funding perspective, we expect average core deposits to be stable to down 1% sequentially, reflecting seasonal factors before resuming modest growth in the subsequent quarters of 2023. We expect continued migration from DDA into interest-bearing products throughout 2023, with the mix of demand deposits to total core deposits ending the year in the low 30s. Shifting to the income statement. Given our loan outlook and the benefits of our balance sheet management, we expect full year NII to increase 13% to 14%. Our forecast assumes our securities portfolio remains relatively stable from the second half of 2022 levels and reflects the forward curve as of early January with Fed funds increasing to 5% in the first quarter and the first 25 basis point rate cut occurring in the fourth quarter of 2023. Our current outlook assumes total interest-bearing deposit costs, which were 112 basis points in the fourth quarter of 2022, are expected to increase in the first half of 2023 before settling in around 2% or so in the second half of 2023. Our outlook contemplates an environment of continued deposit competition, which would result in a cumulative deposit beta by the end of 2023 of around 42%, given the two additional rate hikes in our forecast over our October guidance. The future impacts of deposit repricing lag combined with the dynamics of our loan portfolio should result in our full year 2023 net interest margin increasing five basis points or so relative to the fourth quarter of 2022 NIM. We expect NII in the first quarter to be down 1% to 2% sequentially reflecting the impact of a lower day count in the quarter combined with stable loan balances. We expect adjusted non-interest income to be relatively stable in 2023, reflecting continued success taking market share due to our investments and talent and capabilities resulting in stronger gross treasury management revenue, capital markets fees, wealth and asset management revenue, and mortgage servicing to be offset by the market headwinds impacting top-line mortgage revenue and higher earnings credit rates on treasury management, as well as subdued leasing remarketing revenue. If capital markets conditions do not improve, we would expect to generate improved NII and lowered expenses in the second half of 2023. We expect our fourth quarter TRA revenue to decline from $46 million in 2022 to $22 million in 2023. Our guidance also assumes a minimal amount of private equity income in 2023 compared to around $70 million in the prior year. We expect first quarter adjusted non-interest income to be down 6% to 7% compared to the fourth quarter, excluding the impacts of the TRA, largely reflecting seasonal factors. Additionally, we expect to continue generating strong financial risk management revenue, which we expect will be offset by a slowdown in M&A advisory revenue and the impacts of higher earnings credits and softer top-line mortgage banking revenue given the rate environment. We expect full year adjusted non-interest expense to be up 4% to 5% compared to 2022. Our expense outlook includes a one-point headwind each from the FDIC insurance assessment rate change that went into effect on January 1st, the mark-to-market impact on non-qualified deferred compensation plans, which was a reduction in 2022 expenses, and the full year expense impact of Dividend Finance. We also continue to invest in our digital transformation, which should result in technology expense growth of around 10% consistent with the past several years. We also expect marketing expenses to increase in the mid-single-digits area. Our outlook assumes we close 25 branches in the first half of 2023 that will deliver in-year expense savings and also add 30 to 35 new branches in our high growth markets, which will result in high-single-digit growth of our Southeast branch network. We expect first quarter total adjusted non-interest expenses to be up 6% to 7% compared to the fourth quarter. As is always the case for us, our first quarter expenses are impacted by seasonal expenses associated with the timing of compensation awards and payroll taxes. Excluding these seasonal items, expenses will be down approximately 2% in the first quarter. In total, our guide implies full year adjusted revenue growth of 9% to 10%, resulting in PPNR growth in the 15% to 17% range. This would result in a sub 53% efficiency ratio for the full year, a three-point improvement from 2022. We expect 2023 net charge-offs to be in the 25 to 35 basis point range with first quarter net charge-offs in the 25 to 30 basis point range. In summary, with our strong 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.

Good morning, guys. How are you?

Morning Gerard.

Can you share with us, Tim, when you talk to your business customers, there seems to be a real disconnect between everybody's outlook for loan loss reserve building. We understand, of course, at CECL, and you're going to be proactive about life of loan losses. And you and your peers are building up the reserves, but then you look at the spreads in the high yield market, they're coming in. One of your competitors yesterday pointed out that the commercial loan spreads haven't widened out. Where is the disconnect? Or are we just going to fall off a cliff possibly in the second half of the year? But can you share with us what your commercial customers are seeing in their day-to-day business? And are they seeing the weakness that everybody is projecting that will happen later this year?

Yes. Sure, Gerard and thanks for the question. I don't think we're going to fall off a cliff in the second half of the year. That's certainly not consistent with what I hear. I was out and looked at the calendar the other day. I got to get into eight of our 15 markets in the fourth quarter of this past year. And I think I probably saw 40 or 50 clients while I was out there. Here's what I hear. If you look at the manufacturing clients as an example, they're all feeling much more optimistic about moderation as it relates to raw materials. By and large, they seem to have resolved the supply chain issues they were facing either through inventory builds, restructuring the supply chain, or because the overseas suppliers they were relying on have come back online or the issues at the ports are resolved. I think the issues they're running into are twofold. One, labor continues to be a challenge and it's both labor cost and labor availability. Two, because they solved their supply chain challenges through building inventory, when you think about lower inventory turns, you add in rising interest rates, now debt service costs are a higher proportion of revenue. While they got the costs associated with raw materials through this last year in price increases, they're all looking to the next 18 to 24 months to try to figure out how they pass on just this sort of continued slow grind on labor and debt service costs. The services clients are having no problem pushing through costs, which I think is evident in the inflation data and personally to anybody who took a vacation over the holidays this year. And they continue to be optimistic because demand has remained strong. I think what I hear more than anything else is that we're going to have a little bit of a slow grind down here in terms of growth, and if anything, the thing I'm more worried about is not whether we end up with plus 5%, 0.5% GDP or minus 0.5% GDP, but rather that the market may be overly optimistic about how quickly the Fed is going to be able to bring rates down. And the byproduct of that is from an operating standpoint, you have to be thinking a lot more about how you position the balance sheet for the next three to five years and for more tepid growth and higher rates rather than worrying about the next, call it, 12 months in terms of the outlook.

Very good. Very helpful. Jamie, circling back to you on one of your favorite topics, AOCI. Can you share with us two things? One, what does the accretion look like coming into 2023 for the AOCI number? And second, in your securities portfolio, I think you showed in your release that the taxable securities are yielding 3% today. What are you seeing in new yields as you put money to work?

Yes. Thanks, Gerard. Yes, I knew when we put you in the queue, I was going to get an AOCI question, so thanks for living up to that. In terms of the AOCI, if you look at year-end levels with the 10-year at roughly 387, the AOCI earns back with our duration at 5.4. It accrues back pretty evenly across that time period. So, about a billion or so of TCE earn back per year. Obviously, no capital impact given that we're category four. If you fast forward to today and where the 10-year is, certainly we've had a significant improvement in the AOCI just in the first 19 days of January. So that would be helpful to the TCE as well. In terms of the securities yields, obviously, we're very pleased with how the portfolio is positioned at a 3% yield. I would expect that what's going to happen with the investment portfolio is that it will continue to grind higher each quarter and finish the year at a 310 level. So, the average for the year is probably in the 305 range because as we're reinvesting cash flows or seeing opportunities on new investments, we're looking at entry points in that 475 area right now.

Great. Thank you.

Hi. I remember you mentioned that the securities held to maturity were like being in a motel, and that you have very few securities set aside, which provides you with flexibility. I'm curious about how significant that flexibility is as you look forward. Additionally, you're one of the few banks guiding for higher net interest income compared to fourth quarter levels, based on the midpoint of your guidance. Is there a relationship between your management of the securities portfolio and that guidance, or are they unrelated? My main question is about how your guidance on net interest income relates to your securities.

Yes, it's Jamie. I mentioned the ROTCE motel a few quarters ago. Today's theme is that held to maturity is more about hiding the maturity. It certainly helps to have the flexibility to adapt as circumstances change. However, there isn’t a single factor driving our strong net interest income outlook and net interest margin expansion. This is the result of years of careful work positioning the balance sheet for various potential outcomes amidst ongoing uncertainty, and it’s truly a collective effort across the company. Contributions include household growth, new commercial relationships, product innovation, FinTech acquisitions, and effective sales execution in both loan pricing and deposit generation. These factors enable us to increase net interest income throughout 2023 while also expanding net interest margin. This capability of Fifth Third has been evident over the past decade, though it may be undervalued by the market. The securities will generate a greater level of gross income in 2023, partly because we were patient in deploying our excess cash and refrained from purchasing securities when the 10-year yield was below 2% or even 1%, unlike some other banks. A significant differentiator for us is our fixed-rate loan businesses, which we can emphasize or deemphasize as needed. Currently, we are focusing on auto loans, projected to generate about $6 billion this year, and on dividends, where gross income will increase over $200 million in 2023 compared to 2022. When we consider all this, along with an investment portfolio in a net discount position of around $1 billion and a dividend portfolio that will have unamortized fees rolling through net interest income of about $1 billion by the end of 2023, we have considerable downside protection and a core franchise with a proven ability to grow loans and deposits. In all of this guidance, we do not factor in spread widening, so if that were to occur, as Tim mentioned, it would simply be an added benefit to our guidance.

And then, Tim, just at a broader level. I mean, do you see a recession based on your bottom-up analysis based on all the markets you're visiting, based on the clients you're talking to? I mean, we hear so much recession talk and then we hear about your loan growth and everything else. What do you just think from a high-level standpoint? And then what are your assumptions for reserves in terms of unemployment?

Yes. I'll let Jamie fill the question on the specific assumptions on reserves, Mike. But I probably lost my crystal ball when I moved offices earlier this past year. So, I have to rely on what I hear from clients or what we get from our friends at Moody's and otherwise. If you asked me today, I would tell you we're going to have a shallow recession, I think. But I don't know that there's a big difference between a half a percent of growth and a half a percent of GDP decline in particular, given the amount of derisking that's been done inside the banking sector and certainly inside Fifth Third over the course of the past decade. I think the more interesting dynamic really is going to be this question about the duration of a recession if we see it, and what happens if we don't get a typical recovery, right? If you have several years of below trend growth and inflation that sits above the historic, certainly above the historic 2% target. But Jamie, you want to fill the question on the inputs on the reserves?

Yes. Mike, as you know, we used the Moody scenarios. Their baseline scenario is maintained with an 80% weighting and we maintained our weightings at 80.10% with the upside, and the S3 their adverse scenario or 10% probability scenario. So in the adverse, the unemployment gets almost up to 8% in the baseline unemployment ratchets is up to 4.2%. And then we blend those scenarios together to drive the ACL. So, I think it meshes well with what Tim's comments were of a shallow or mild downturn in the economy and then a recovery.

So that's 20% for the 8% unemployment, and 80% for the 4.2% unemployment.

10% on the upside, which is the upside scenario is that the Fed delivers a soft landing, so unemployment stays in the high threes. So 10% in the high threes, a baseline at 4.2% peak, and then a downside at 10%, at a 7.8% unemployment.

Got it. Alright. Thank you.

Good morning everyone. Thank you for the question. Jamie, it seems based on your comments that it might not happen anytime soon. In the past, you mentioned a margin floor of 330 in scenarios of low rates. I'm curious, considering all the recent changes in expectations and the adjustments you've made to your balance sheet, how are you viewing that lower bound as we move forward with the 330 level?

Yes. We feel very good about the ability to have a floor on the NIM at that 330 level and a 200 down scenario should that play out, given all the work we've done on the investment portfolio with the bullet locked out cash flows along with being in a fairly sizable net discount position and the duration that we have combined with the fixed rate loan origination platforms with auto, Dividend and Provide, those should all provide yields. And then as we've talked in the past, we've layered in $15 billion of received fixed swaps that will also provide additional protection from 2025 through 2032. And that may be one other differentiator for us relative to peers is that we've been focused more on protecting that downside over a longer period of time and therefore, the duration of our swap book as well as our investment portfolio may be better positioned should that downturn occur at the end of the decade.

Thank you. Now, I'd like to discuss the trajectory of fees as we progress through the year. You usually experience seasonality that benefits the fourth quarter while impacting the first. However, I anticipate a significant increase starting in the second quarter. I'm also interested in your views on capital markets normalizing or recovering in the latter half of the year. What do you see as the main drivers as the year unfolds?

Sure. Thanks. When it comes to the fee income, we did say relatively stable over the course of the year and probably it's helpful to look at it from two components. The first would be a category I'll call the factors in our control that do deliver nice growth, both from a strong customer acquisition perspective as well as overall fee generation from a combination of the branch network, our wealth business, and the commercial business. That will drive both credit card income as well as wealth and asset management fees in the mid-single-digit area and top line fee-equivalent growth in the treasury management area in the high-single-digit area given our strong product lineup. From there, transitioning to mortgage, that's actually going to be the largest growth item for us in 2023. It really goes back to all the work that we put into growing the servicing business in 2020 and 2021 when levels were more depressed. It was a good buying opportunity. Given our strong mortgage servicing platform, we'll increase those fees from $125 million in 2022 to the $160 million area. So, that's a growth of almost 30%, whereas top line mortgage should be relatively stable off very low levels. So, we feel good about those items. Capital markets, certainly the wildcard in our guide, given that we do expect mid to high-single-digits growth in the first half of the year relative to the first half of 2022. Then we assume a little bit of additional growth in the back half of the year under the assumption that the capital markets disruption should abate once the Fed reaches its terminal Fed fund level. If that were to not happen, then we would expect a little bit better loan growth, a little bit better NII and lower expenses. In terms of PPNR on a relative basis, I feel confident in that should the capital markets improvement not occur. The other category when it comes to fees would be the headwinds facing us. They're really environmental given the increase in interest rates and that's on the earnings credit. We're managing earnings credits to about a 20 beta, which is a little bit better than what we thought as we entered the cycle. But even with that, service charges ultimately will be down mid-single-digits for the year, which will more than offset that strong top line fee equivalent growth. On the consumer overdraft and NSF side, we probably do a little bit better relative to peers, just given that we moved sooner on some of those fee and structural changes. But overall, the first half of the year will be a little bit softer as we lap those changes that occurred mid-year 2022. Our fourth quarter TRA revenue is also expected to decline in 2023 as well our expectations on lower private equity income, so that other fees will be down 20%, 25% or so.

I would like to add that while we anticipate an improvement in capital markets this year, we do not expect them to return to normal or fully recover based on the investments made in that sector. A complete recovery in capital markets would lead to a much larger business and revenue than we are expecting this year. However, we do not foresee it being as difficult or restricted as it was in 2022.

Excellent. That’s terrific color. Thank you guys very much.

Hey, good morning.

Good morning.

I was wondering, can you just walk through the puts and takes around deposit growth in 2023? I mean, it seems like the expansion in the Southeast is definitely a tailwind here. So, how are you thinking about deposit growth, especially given the more challenging macro backdrop?

Yes. This is Bryan. Certainly, we feel good about our franchise and the improvements that we've made over the years. We have a very strong new customer origination engine, both across consumer and commercial. We've got strong new consumer household growth and strong QRs from a commercial perspective. We have a very high performing treasury management business that provides a lot of deposit support as well as growth. As you mentioned, our Southeast branch expansion, obviously, is going to create a tailwind for us as well. Finally, we have proven and analytically driven customer offers that have done a really nice job through the cycle and driving the balances when we need them. So, we continue to maintain a lot of confidence in the environment that we're going to be able to deliver and gain our fair share of deposits as the environment changes. Obviously, we can't grow in all environments, but we are cautiously optimistic and well-positioned.

Yes. To provide some specifics, we grew consumer deposits by over 6% in the Southeast this past year, which has been beneficial for us.

Got it. Helpful. And then, maybe the flip side of that is the wholesale funding. We saw you had some wholesale funding earlier in the year. So, are those balances where you'd like them to be for now? And how does that fit into the overall funding strategy?

Yes. We're very comfortable with where we are from a wholesale funding perspective. We continue to have very significant contingent liquidity sources that help us manage through uncertainty in the environment. If we see decent deposit growth, we could see those wholesale funding balances come down over time. But we have a lot of flexibility across our funding base to help us manage through both liquidity needs as well as net interest income.

Great. Thanks so much.

Good morning. I guess, I just had one follow-up question on the credit comments earlier, Tim. You mentioned about the resiliency of the bank. But when you think about your scenario of higher for longer rates, do you think that begins to weigh on your customers when you look at either on C&I or on the CRE book that the longer the Fed has to stay at the five-plus rate, their cost of equity, capital is going higher, demand is falling off? And does that lead to a lot more pain on credit, maybe not in later in the year into 2024 absent Fed rate cuts?

Yes. Let me give you the quick answer, and then I'll let Richard comment. Absolutely. I think that is our view is that it's more of a slow-growing dynamic here than a cliff, right, as Gerard mentioned earlier. The longer that we go with rates at elevated levels, the more pressure that it places on commercial borrowers, in particular. I think our consumer borrower is a little bit different because such a significant share of our consumer lending is done to homeowners that they've had the ability to inoculate themselves a little bit from inflation because they locked in these historically low fixed-rate costs of housing. Richard, do you want to talk a little bit about where specifically you think that grind may take a toll?

Yes. Ebrahim, there are a few important points to consider. To address your question directly, higher interest rates persisting for an extended period will exert pressure across the board. This is somewhat intentional from the Federal Reserve's perspective to induce a slowdown. The most significant impact will be felt in the leverage lending portfolio, as we are starting from elevated levels of leverage. Higher interest rates definitely affect free cash flow. As part of our underwriting and quarterly monitoring, we examine the rate curve. Specifically, we underwrite based on the forward rate curve plus an additional 200 basis points to ensure there is sufficient cushion in free cash flow. This allows our underwriters to believe that the borrowers can handle the stress of increasing rates through their margins and free cash flow. Another aspect we are monitoring is the economy, particularly regarding labor costs and availability, which continue to pressure margins. This is especially true for industries that struggle with balancing revenue management and expense management, particularly those with long-term fixed-price contracts and short-term labor. A notable example of this is in sectors like healthcare and senior living. We've previously discussed not-for-profit hospitals, which operate with low margins, and the costs associated with delivering care have surged. Nursing availability and wage rates illustrate this well, as there's often a delay in reimbursement rates, whether public or private, affecting these companies' ability to maintain margins and profitability. In such situations, we also consider factors like the health of the balance sheet, liquidity, and liquidity burn rates. Higher rates for an extended period undoubtedly pressure businesses. Lastly, part of our client selection process includes assessing our borrowers' ability to adapt and their resilience. It's not just about higher rates; it's also about how businesses and consumers adjust. This forms a critical part of our relationship model and how we engage with our customers, offering advice and exploring alternatives to finance them. This resilience through challenging times will be essential moving forward.

That was helpful. And I guess, just one quick follow-up, Jamie, on Dividend Finance. About $100 million of provisioning. Anything else around Dividend Finance in terms of growth outlook this year versus last year that we should be aware of? Are things picking up or slowing down as we think about just the underlying growth in the business?

Yes. We feel very good about the business that Dividend is doing, especially on the solar side of the aisle. For us, we're expecting roughly $4.5 billion of originations in 2023 with a weighting of 90% solar and 10% home improvement. Home improvement we're less enamored with. But again, it's a good product offering for other points in the cycle. So, it's being deemphasized, and solar continues to do incredibly well. If anything, there’s perhaps a little bit of upside to our NII guide on Dividend for 2023, just given the strength of the business as well as the pricing power.

Noted. Thank you.

Morning.

Morning.

On the credit front, I know you gave us really good detail on delinquencies and non-accruals. Do you have what criticized assets did in the quarter? And what areas of criticized have migrated negatively?

Yes. This is Richard. Thanks for the question. Criticized assets were flat for the quarter, both nominally. I think we had a little bit of loan growth, so about three basis points of commercial improvement across the board. I would also point out that in addition to credit being stable, delinquencies 30 to 89, 90 and above, NPAs charge-offs were all down for the quarter on the commercial side. I think the things we're watching, and I hit on it a little bit, healthcare, specifically not-for-profit hospitals and senior living for the reasons we just talked about, have seen some pressure there because of the mismatch between the revenue management and expense management. A little bit of pressure in watching in commercial specialty products, consumer specialty products, right? That's a function of consumers shifting from durables and discretionaries to consumables and non-discretionary and supply chain and inventory management issues. That's the trading down issue. That’s where we've seen most of the movement. The leverage portfolio from an asset quality standpoint has been stable and operating within our expectations.

Okay. Thank you. That's helpful. And then sticking to credit, just my follow-up is around both commercial real estate and home equity. In commercial real estate, it looks like you did see a pretty noteworthy move up in delinquencies as well as the non-accruals. So, can you guys talk a little bit about property types within commercial real estate where you're seeing the distress and where your loan-to-value ratios are? And then in home equity, it looks like you also saw a pretty noteworthy increase in delinquencies there. Just want to get color around that portfolio. Thanks.

Let me discuss commercial real estate. When examining the delinquencies, particularly on slide 30 of our deck, we see that the 90-plus category is still at zero. We have none. The movements in the 30 to 89 range are only six basis points, coming from a very low starting point. Therefore, we are not overly concerned from a commercial real estate standpoint. We are keeping an eye on the office segment, even though it represents a small portion for us. Our performance in that area is in line with, or better than, the broader commercial banking sector. However, there is some pressure due to falling occupancy, attendance, and lease rates. We have a minimal amount of office space in urban central business districts, where subletting rates are facing the most pressure. Our focus here is on Class A properties, which are newer and environmentally responsible, meeting platinum and gold standards with modern amenities. We are confident in these assets. Meanwhile, our office portfolio is primarily in suburban markets, where we don't experience the same lease and sublease rate pressures. In general commercial real estate, multifamily housing continues to thrive, supported by strong demographic trends and household formation, leading to rental rates increasing faster than construction costs—this provides a positive momentum. The industrial sector is also thriving, driven by reshoring trends, with strong demand and stable lease rates. Hospitality is stable and showing good trends, while retail remains steady. Overall, we feel optimistic about our position in commercial real estate. Would you like to add anything?

John, I just was going to say on the equity side, all you're seeing, I think, in the consumer for us at the moment is just seasonality. A sequential comp from the third quarter to the fourth quarter are the wrong comparisons. Just given the natural seasonality in those businesses, I think it's better just to look at year-over-year. We expect consumer credit to normalize over time. That's reflected in the guide that we gave. But the delinquency dynamics there are really no different than what you would have seen pre-pandemic, other than the fact that they're still muted relative to what we would have had in the past. Personally, home equity is not the area that's been an area of focus for me. That's for certain.

Yes, yes. No, I got that. I just saw the reserve addition as well to the home equity allowance.

Well, actually, the dynamic there is that for the first time in as long as I've been at the bank, we actually had quarter-over-quarter home equity growth. What's driving that outcome, but not a change in perspective for us on the quality of the credit or the likely outcomes there.

Good morning. I might have misheard the comment on the indirect auto kind of loan growth expectations for this year. Can you just repeat that, what the strategy is and what you're seeing in the spreads there?

Yes. Actually, spreads have done well and are actually off to a very solid start in 2023. We finished the year in 2022 with $7.1 billion of production, if you take auto as well as the RV, marine, and specialty business combined. So, that fixed-rate consumer secured loan category. Our expectation for 2023 for that asset class is to be down to about $6 billion or so. Loan balances in that caption, we would expect to be down. However, yields, we expect to improve by 100 basis points from the fourth quarter 2022 levels to fourth quarter 2023 levels. So, it is a nice accelerator to the earlier question around how are you able to deliver both NII growth and NIM expansion. That certainly is a helpful driver.

Got it. And then just separately on the capital level, we're seeing some divergence in targeted capital out there. Obviously, there's like upward pressure at the biggest banks, not really relevant to you. But then some of your peers are targeting closer to 10%. And I'm certainly on board with 9%, seeming very high. But I'm wondering, is there any kind of behind-the-scenes pressure whether it's rating agencies or regulators to just hold a little bit more, given some of the macro uncertainty or anything else that we're not seeing?

Yes. Great question, Matt. Thanks for asking. I would say that as this environment unfolds, it really is, to your point, going to create differentiation in both performance execution and overall balance sheet positioning. We've, I think, for a number of quarters and years now been discussing how cautious our outlook is. That has really informed what we're willing to do from a credit risk appetite perspective. So, the capital levels ultimately are a factor of the credit profile of what's on the sheet as well as the reserve levels that we have. The CET1 level at 9.25% and an ACL level of 198 creates a very sufficient loss absorption capacity. Given our SCB level at the minimum, I think external factors or forces would say that we're very well-positioned from a credit profile perspective as well as from a loss absorption capacity. So, we feel good about that.

Okay. Thank you very much.

Hey, guys. This is Ben Reseck on for Ken. Just a quick follow-up on the Dividend Finance. As those originations continue to ramp up and mortgage loans go on balance sheet, when do you ultimately see that NII benefit overcoming the reserve builds and becoming accretive to earnings? And then, can you just remind us of what type of loss rates you're assuming on those dividend loans? Thanks.

Yes, that's a great question. The PPNR levels for Dividend will be positive in the latter half of 2023. The net income of Dividend after ACL will also be positive or accretive in 2024. If prepayments happen more quickly than we have projected, the unamortized platform fees will be reflected in the P&L, which would enhance the return profile. However, this is how we currently see it unfolding. We are modeling roughly an eight-year life on the dividend asset and expect loss rates to be around 125 basis points annually on a blended basis for the portfolio over those eight years.

Great. Thanks for taking the question.

Thank you operator, and thanks everyone for your interest in Fifth Third. Please contact the investor relations department if you have any follow-up questions. Operator, you can now disconnect the call.