Fifth Third Bancorp. (NASDAQ:FITB) Q1 2023 Earnings Conference Call April 20, 2023 9:00 AM ET

Company Participants

Chris Doll - Director-Investor Relations
Timothy Spence - President and Chief Executive Officer
James Leonard - Executive Vice President and Chief Financial Officer
Bryan Preston - Treasurer

Conference Call Participants

Scott Siefers - Piper Sandler
Gerard Cassidy - RBC Capital Markets
Ken Usdin - Jefferies
Erika Najarian - UBS
Michael Mayo - Wells Fargo Securities
John Pancari - Evercore
Manan Gosalia - Morgan Stanley
Ebrahim Poonawala - Bank of America
Christopher Marinec - Janney Montgomery Scott

Chris Doll

Good morning everyone. Welcome to Fifth Third’s First Quarter 2023 Earnings Call. This morning our President and CEO, Tim Spence and CFO, Jamie Leonard will provide an overview of our first quarter results and outlook. Our Treasurer, Bryan Preston has also joined for the Q&A portion of the call. Please review the cautionary statements and our materials which can be found on our earnings release and presentation. These materials contain information regarding to 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 April 20th 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.

Timothy Spence

Thanks, Chris. And good morning, everyone. Thank you for joining us today. The past six weeks have seen a great deal of volatility in the banking sector. Markets have been trading on narratives over fundamentals and the term regional bank has been used to describe such a broad cross section of business models that it has lost any real descriptive value. While we at Fifth Third take any instability in our sector very seriously, there was no crisis inside our four walls. We’ve been running the company with the expectation for a higher, for a longer rate environment for many quarters now. We’ve consistently communicated in these calls and at investor conferences. As our first quarter results demonstrate our balance sheet remains well fortified, and our capacity to generate strong profitability through the cycle is strong.

Excluding items noted in the release, we reported earnings per share of $0.83, a 20% increase compared to the year ago quarter. We generated nine points of year-over-year positive operating leverage driven by an 18% increase in revenue. During the quarter we held average and period end deposits flat sequentially despite the industry wide impact of quantitative tightening and normal seasonal pressures. Our key credit metrics remain near historical lows with net charge-offs of 26 basis points coming in at the low end of our guidance range. NPAs NPLs and early stage delinquency ratios remained below normalized levels, and criticized assets decrease modestly during the quarter.

Moreover, we accomplished all this while also being recognized by Ethisphere as one of only two U.S. banks on their world's most ethical companies list. We were named by Fortune as one of America’s most innovative companies. And we saw our FinTech platform provide named by Fast Company as one of the world's most innovative businesses. The strong outcomes achieved this quarter and in particular in the month of March highlight the strength, granularity and well balanced nature of our deposit franchise.

In the weekend, following the failure of Silicon Valley Bank alone, we open more new commercial deposit accounts than we would in a typical month. Similarly, our consumer household growth accelerated after the March turmoil. Our commercial deposit franchises led by our peer leading treasury management business where we rank in the top 10 nationally and most major commercial payment types, 88% of our commercial deposit balances are attached to relationships that utilize TM services today, and the average age of our commercial deposit relationships is 24 years. These characteristics contribute strongly to stability regardless of balance size.

Our consumer deposit base is granular with nearly 90% of total consumer deposits, FDIC insured and is anchored by our flagship mass market momentum banking offering and strong branch presence in the markets we serve. Annual consumer household growth finished the quarter above 3% led by our southeast markets above 7%. During the quarter, we opened five branches in our southeast markets on top of the 70 add ins in the past three years, and we expect to open an additional 30 branches by the end of 2023.

All said, end of period total deposit balances ended the quarter above the level on March 8. Looking forward while we face the same headwinds that all banks do from increased deposit competition, economic uncertainty and the potential for regulatory change, I am confident in Fifth Third’s ability to achieve top quartile returns through the cycle with a focus on stability, profitability and growth. Our long-term discipline managing interest rate and liquidity risks positions us well to generate differentiated outcomes in a range of economic environment.

From a credit risk perspective, our low CRE concentration and commercial and in particular in office CRE, along with our focus on homeowners in consumer should prove to be significant advantages. Jamie will provide more information on our forward guidance, but the implied profitability and return metrics for our full year 2023 expectations are well ahead of our core 2019 results. Considering the uncertain and environment, we have elected to deposit [Ph] share repurchases for the second quarter and we’ll evaluate resuming them in the second half of the year.

Last, but certainly not least, I want to thank our 20,000 employees for their hard work and dedication and supporting our customers, communities and shareholders. Your commitment to living our purpose and making sure we do the right thing every day is evidence.

With that, I’ll now hand it over to Jamie to provide more details on our financial results and outlook.

James Leonard

Thank you, Tim. And thank all of you for joining us today. Our first quarter results were strong despite the market volatility during the quarter. Average and period and total deposit balances were flat compared to the prior quarter. Average core deposits declined in line with our guidance of down 1%. We grew loans modestly during the quarter while adding new quality relationships in both commercial and net new households and consumer. We achieved an adjusted efficiency ratio of 59% and a seasonally challenged quarter, which is a six point improvement compared to the year ago quarter.

Our first quarter core PPNR grew nearly 40% compared to last year, reflecting the diversification and growth of our revenue streams combined with disciplined expense management. Net interest income of approximately $1.52 billion increased 27% year over year, but declined 4% sequentially. Our sequential NII performance was impacted by our shift to a more defensive balance sheet position given the volatile environment, the impact of lower day count and seasonally strong investment portfolio income in the prior quarter. Fee income exceeded our expectations despite the market related headwinds, and we remain disciplined on expenses while continuing to invest in our businesses.

PPNR was impacted by the expenses associated with higher than expected fee income. Our NIM declined six basis points for the quarter, while interest bearing deposit costs increased 64 basis points to 176 basis points, reflecting a cycle to date interest bearing deposit beta of 36% through the first quarter, which includes the impact of CDs.

Total adjusted non-interest income increased 2% compared to the year ago quarter driven by -- commercial banking and mortgage fee income, which more than offset a decline in deposit service charges due to the elimination of consumer NSF fees last year and the impact of higher earnings credits from higher market rates this year. Growth in commercial banking fee income was primarily driven by increased loan syndication, fixed income sales and trading and M&A advisory revenue, partially offset by a decline in corporate bond fees.

The improvement in mortgage revenue was driven by increased servicing fees and lower asset decay. Adjusted non-interest expense increased 6% compared to the year ago quarter, excluding the impact of non-qualified deferred compensation expenses from both periods. Expense growth was elevated due to the dividend finance acquisition in the second quarter of 2022 and growth in the provide franchise. Excluding the FinTech growth impacts and the FDIC assessment, total expenses increased approximately 3% compared to the year ago quarter as discipline throughout the bank, combined with automation initiatives were offset by compensation associated with our minimum wage hike, higher fee income and higher technology and communications expense, reflecting our focus on platform modernization initiatives.

Moving to the balance sheet, total average portfolio loans and leases increased 1% sequentially reflecting growth in both commercial and consumer portfolios. Commercial was led by C&I where payoffs were muted and production was stable in our regional middle market banking business but down in our corporate bank. The subdued production and the corporate bank reflects our focus on optimizing returns on capital in this environment, combined with less robust demand. Compared to a year ago quarter, C&I loans, excluding PPP have increased 13%. The period and commercial revolver utilization rate remains stable compared to last quarter at 37%.

Average total consumer portfolio loans and leases increase 2% compared to the prior quarter led by dividend finance while balances from the rest of our consumer captions remained relatively stable. Average total deposits were flat compared to the prior quarter, as increases in CDs and interest checking balances were offset by a decline in demand deposits. By segment, wealth and asset management average balances increased sequentially, consumer was stable and commercial modestly declined consistent with normal first quarter seasonality.

Period and total deposits were also flat compared to the prior quarter. Notably, we have grown deposits 1% since the end of last June compared to a 4% decline for the top 25 banks as shown in the Feds AJ data. We have included additional materials in our earnings presentation to highlight some of the key attributes of our high quality deposit franchise that may be relevant in this environment.

Moving to Credit, as Tim mentioned, credit trends remain healthy and our key credit metrics remained well below normalized levels. The ratio of early stage loan delinquencies 30 to 89 days past due decreased four basis points sequentially to 26 basis points and remained below 2019 levels. The net charge-off ratio of 26 basis points increased four basis points sequentially, and was at the low end of our guidance range. The NPA ratio of 51 basis points was up two basis points compared to a year ago.

From a credit 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 have also maintained the lowest overall portfolio concentration in nonprime consumer borrowers among our peers.

In commercial, we have maintained the lowest overall portfolio concentration in CRE at 14% of total loans. Across all commercial portfolios, we continue to closely monitor exposures where your inflation and higher rates may cause stress and continue to closely watch the leveraged loan portfolio and office CRE.

Office loans of $1.6 billion represented just 1.3% of total loans, with a criticized ratio of 8.2% and only one basis point of delinquencies. While the leveraged loan portfolio has declined 65% since 2016, and is now less than $3 billion outstanding today. We have focused on positioning our balance sheet to deliver strong, stable results through the cycle.

Moving to the ACL. Our reserve change this quarter was a net increase of $37 million, or a build of $86 million excluding the onetime impact of adopting the accounting standard eliminating TDR accounting, which reduced the reserve by $49 million. Our bill primarily reflected loan growth, notably from dividend finance loans which contributed $88 million of the increase. The ACL ratio increased one basis point sequentially, or five basis points excluding the accounting change.

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% while the downside scenario underlying our allowance coverage incorporates a peak unemployment rate of 7.8%. We maintained our scenario weightings of 80% to the base and 10% to each of the upside and downside scenarios.

Moving to Capital, our CET1 ratio remained relatively stable compared to last quarter, and in the first quarter at 9.25%. Our capital position reflects our strong earnings generation offset by the impacts of returning capital in the form of dividends and repurchases, risk weighted asset growth primarily in consumer loans and a seven basis point decline from the CECL phase in.

Our tangible book value per share increased 11% sequentially, partially impacted by our AOCI position, which improves 17%. Tangible book value grew 7% excluding AOCI compared to the year ago quarter.

Moving to our current outlook, we expect full year average total loan growth between 2% and 3% which reflects our cautious outlook on the economic environment. We expect total commercial loans to increase in the low to mid-single digits area compared to 2022 which implies modest incremental growth from the first quarter through year end given our outlook for a tempered lending environment in the second half of the year. We expect line utilization rates to remain stable. We expect total consumer loan growth to also be modest as a strong increase from dividend finance will be mostly offset by a decline in auto and mortgage.

We continue to expect approximately $4.5 billion in dividend loan production for the year given the secular tailwinds and our investments in the business combined with market share gains. We expect deposits to be stable or grow from the first quarter average level as we progress throughout 2023 consistent with our strong customer acquisition trends. Within that, we expect continued migration from DDA into interest bearing products throughout the remainder of 2023 with the mix of demand deposits to total core deposits, declining from 32% today to 30% by year end.

For the second quarter of 2023, we expect average total loan balances to be stable to up 1% sequentially with growth fairly balanced between commercial and consumer portfolios. We expect average deposits to also be stable to up 1% on a sequential basis.

Shifting to the income statement, we expect full year NII will increase 7% to 10%. As other banks have noted, industry wide deposit pricing pressures intensified in the wake of the Silicon Valley and Signature Bank failures. Therefore, as shown in our presentation materials, we are providing NII guidance under a range of deposit betas given potential diverging levels of intensity with respect to deposit competition going forward. The upper end of our NII guidance assumes an approximate terminal beta of 43%, and the lower end assumes approximately a 49% terminal beta compared to our January expectation of 42%.

The midpoint of our NII outlook translates to a 47% beta with total interest bearing deposit costs increasing 45 basis points or so in the second quarter, and another 25 basis points in the second half of the year. Our outlook also considers the lag effects from previous rate hikes and continued DDA migration and assumes the Fed hikes 25 basis points in May, and then holds short term rates of 525 basis points for the remainder of the year.

Our guidance assumes that our securities portfolio balances decline a couple billion dollars between now and year end, and that we hold closer to $10 billion in excess cash for most of the year. Assuming we continue to defensively position the balance sheet for the remainder of the year by maintaining an elevated excess cash position combined with continued intense deposit competition, we are assuming NIM will be in the 320 to 325 range for the year. We expect second quarter NII to be down approximately 1% sequentially reflecting the deposit loan and cash dynamics I mentioned.

We expect adjusted non-interest income to be stable to up 1% 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 partially offset by higher earnings credit rates on TM, subdued lease remarketing revenue and a reduction and other fees reflecting lower TRA and private equity income this year. We expect our fourth quarter TRA revenue to decline from 46 million in 2022 to 22 million in 2023. We expect second quarter adjusted non-interest income to be up 2% to 3% compared to the first quarter. We expect to continue generating strong revenue across most fee captions and that will be partially offset by a slowdown in debt capital markets revenue.

We continue to expect full year adjusted non-interest expenses to be up 4% to 5% compared to 2022. Our expense outlook incorporates the FDIC insurance assessment rate change that went into effect on January 1. The mark-to-mark can impact on non-qualified deferred compensation plans which was a reduction in 2022 expenses, and the full year impact of investments to grow the dividend finance and provide businesses.

Excluding the dividend acquisition, FDIC assessment and NQDC impacts, we would expect our full year 2023 core expenses to be up less than 3%. Our guidance reflects continued investment in our digital transformation, which should result in technology expense growth in the low double digits for the year. We also expect marketing expenses to increase in the mid to high single digits area. Our guidance also factors the run rate benefits from the severance expense recognized in the first quarter, which reflected proactive actions taken to reduce on-going expenses given the operating environment. We expect second quarter adjusted non-interest expenses to decrease 8% to 9% compared to the first quarter.

In total, our guide implies full year adjusted revenue growth of 6% to 8%, resulting in PPNR growth in the 9% to 10% range. This would result in an efficiency ratio below 55% for the full year. We expect second quarter PPNR to increase 10% to 11% compared to the first quarter, and for second quarter efficiency ratio to be around 54%. We continue to expect second quarter and full year 2023 net charge-offs to be in the 25 to 35 basis points range.

Given our expected period and loan growth, including continued strong production from dividend finance we continue to expect a quarterly build to the ACL of approximately $100 million, assuming no changes in the underlying economic scenarios.

In summary, with our strong PPNR growth engine, discipline, 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.

Chris Doll

Thanks, Jamie. Before we start Q&A, given the time we have this morning, we ask that you limit yourself to one question and one follow up and then return to the queue if you have additional questions. Operator, please open the call up for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Scott Siefers from Piper Sandler. Please proceed.

Scott Siefers

Good Morning, guys. Thank you for taking the question. Let’s see, Tim, you talked about the much higher than typical commercial account openings in during all the turmoil. Can you talk about sort of early reads on what has happened with those and sort of generally speaking how you’d expect commercial customers to behave going forward, whether they’ll keep the same amount with their primary institution or diversify sort of permanently? How would that all work in your mind?

Timothy Spence

Yes, so good. Good morning, Scott. Thanks for the question. Just a note for everybody. We know you have a busy day here. So with the exception of the soliloquy that Jamie has prepared on regulation going forward, we’re going to try to keep our answers. pretty crisp. We were delighted to see the activity obviously and to see that continue to carry forward through the end of the quarter. All but I literally had single digits you could count on, I think one hand and two fingers, the number of the accounts that we opened, that didn’t fund up between the that weekend immediately following Silicon Valley and the end of the quarter. So I’m very pleased with the activity level there.

I think in terms of account behavior going forward, I think we’re going to see a much more prominent bifurcation and behavior between operational accounts and non-operational accounts, right. In effect on the corporate treasurer side, cash as an investment versus cash as a tool in terms of the way that you manage the business. And that is reflected in the operational account behavior that we saw during the period I think probably contributed very significantly to the stability. The Fifth Third experienced in terms of commercial account balances. But Jamie, you have anything you want to add?

James Leonard

Yes, and Scott, what we also saw in the first quarter was that clients were focused on getting money to the best vehicle possible. So for us during the quarter, we moved almost a billion dollars more into the money market portal that we manage for them. And even with that incremental movement, we were only down about a billion dollars in commercial and a seasonally challenged quarter when last year, we were down 2 billion in the quarter, seasonally and the year before that we were down 3 billion. So to Tim’s point, the money has been moving to the optimal investment vehicles. But the good news for us is we were able to overcome that headwind and actually posted a very solid commercial deposit quarter.

Scott Siefers

Perfect, thank you. And then Jamie, maybe additional color on you gave the thoughts on non-interest bearing the total deposits and certainly that go forward mixer and of your mix. What in your thinking makes that the right number? Why not -- why not lower, why not higher? What was sort of the inside baseball on that?

James Leonard

Yes, the last tightening cycle, we moved down five points. This time we’re forecasting to go down eight to finish the year at a 30% DDA to core deposit level. Given that our rate outlook now has the 525 and a lot longer hold with no cut. We think we’ll see continued migration and higher earnings credit rates that will result in more DDA migration. And then the challenge over time is, can you sell enough treasury management services to rebuild that DDA balance and given our strong treasury management business, we feel confident in our ability to do it. So hopefully, we do bottom out at 30. But for every 1% more than that, it translates to 40 to 50 million of NII erosion. So, it’s, while not tremendous impact, we would still want to ensure that we get that 30% higher as we head into 2024 and things like that.

Scott Siefers

Perfect. All right. Thank you, everyone.

James Leonard

Thanks.

Operator

Our next question comes from the line of Gerard Cassidy from RBC Capital Markets. Please proceed.

Gerard Cassidy

Hi, Tim. Hi, Jamie.

James Leonard

Morning.

Gerard Cassidy

Jamie, you’ve touched on the credit and how strong it is particularly in the commercial real estate office. I think when you guys look at the scene I portfolio is there anything on the horizon whether it’s I know your leverage loan balances, as you pointed out, are down dramatically from 2016. What are you guys seeing or sensing on the scene in the C&I portfolio not CRE?

James Leonard

Yes, on C&I, that was the driver of the NPA increase this quarter. So on the surface NPAs, were up seven basis points, this sector that drove it the most within C&I would be restaurants, entertainment as well as professional services. But with that said, the delinquency levels in commercial and certainly in C&I continue to be benign. And Tim and I were looking back at where we were on NPAs. In the fourth quarter of 2019, we were at 62 basis points versus the 51 that we’re at today. And if you look at the 10 year average, for us, we’re at a 69 basis point average. So while we’re up that seven basis points sequentially, it’s really more of a normalization. And we’re still 25% or so below a normal run rate when it comes to commercial NPA. So it’s really normalization within some of these sectors. And for us, at least right now, it’s entertainment and professional services.

Timothy Spence

And if I if I just add one thing on that drawing, scale is going to matter in terms of the clients that you bank, in C&I, because if you think about the dynamics that are creating headwinds for the economy, they’re related to your ability to manage input costs, or production. And ultimately, right the higher costs of carrying inventory to offset concerns around supply chain resiliency on an on-going basis. So when you the sense you get I do when I’m out talking with clients is the manufacturing businesses and the businesses attached to the resurgence of manufacturing in the U.S. are doing really, really well. The businesses that are attached to more discretionary spending. The larger clients have been able to pass input cost increases higher cost of labor through the smaller ones are having a more difficult time. And I think that arm wrestling we're seeing going on right now as an example between the not for profit hospitals and the health. The health care insurance companies is a really good example of where the larger not for profits are having a easier go of extracting concessions to cover increases in nursing costs and otherwise, and the smaller ones, it’s – it’s been more of a standoff.

Gerard Cassidy

Very good. Then, as a follow up question, Jamie in the outlook on in interest revenue obviously, you guys got it down a little bit. But if you’ve had to paint two scenarios, one is the bullish scenario, what would rates have to do where you could actually see maybe deposit betas stall out faster? Or net interest revenue picks up? And then what’s the more cautionary view? Is it higher rate, not the frozen rate, five and a quarter, but we get the six and a half or something like that on Fed Funds rates in the first quarter of 2024? Can you give us those two variables?

James Leonard

Yes, I would say that. On the positive side of net interest income, if the industry and the competitive dynamics settled down over the next couple of months, couple of quarters, then we would expect that we would operate in that low to mid 40s beta and that would deliver the higher end of our NII guide. We’re a little cautious though, in what we’re seeing from a competitive standpoint, as banks are clearly focused on driving, more insured retail deposit growth, and therefore the retail beta is the wildcard in our guide, and why we show the range of deposit betas that could play out and therefore the range of the NII guide is a little wider than what we normally would do just given the uncertainty with how competition will react.

So in the near term, that is the wildcard that perhaps retail deposit betas which had been very well behaved actually double by the end of the year. And that would take us to the low end of the guide. I think longer-term when it comes to rates progressing beyond five and a quarter. It really comes down to what are the credit implications as the Fed reaches an even higher level. We think the magnitude of the rate increases have certainly created some shock across the country. And you saw that obviously, in what we’re calling the March Madness. But I think from an NII perspective, those higher rates could continue to be productive as long as the deposit beta dynamics stay in the 40% range. But if competition heats up, and we get into a 60% plus beta environment, that would be unproductive to NII.

Gerard Cassidy

Very good. Thank you.

Operator

Our next question comes from the line of Ken Usdin from Jefferies. Please proceed.

Ken Usdin

Hey guys, good morning. As you as you as you think further out, I know Jamie would talked about that, that trying to channel that downside, NIM. Obviously, the rate environment has changed and all the points about the mix and the deposit growth have as well. But just in terms of just how the how you expect the balance sheet mix to change over time, given that you’re running down the securities book and your points about the DDA mix. How do you just think about that NIM protection angle, and does it make you think any differently about your, the way you built the swaps portfolio and protecting that? Thanks.

James Leonard

Yes, we feel very good about how the balance sheet is positioned, especially for a downgrade environment. Obviously, the swaps we’re very pleased with the entry points there. We’ve talked at length about in 2025, there’ll be a nice increased NII as the new swaps kick in. In terms of the investment portfolio positioning, we’ll have a bit of a decline in the second quarter as we don’t reinvest cash flows, but from there should be relatively stable. We may continue to reposition non-HQLA and the level ones but ultimately that’ll be regulatory dependent, but overall feel good about the bullet locked out nature, the structure that we have. So I think for us, it’s going to be more of operating in a high 70s loan to deposit ratio and continuing to maintain that while being very disciplined on credit which is why the loan growth guide was trimmed a bit to that up, up 2% to 3% level.

Ken Usdin

Got it. And then on the same point about that deposit repricing isn’t when the Fed does got in and obviously a lot of banks are guiding with the with the curve right now, how does your models work in terms of timing of Fed cuts versus your ability then change the direction of deposit pricing?

James Leonard

Yes, I mean, in general, it’s going to be, it’s a balance of that nature of when the cuts actually occur. If you’re in a foreign liquidity environment where things still are relatively tight, the Fed has gotten inflation under control, but there’s not a big credit event obviously, the measured cuts would be one where you’re going to have a little bit more challenging time, reversing all the beta, you’re still going to get some of the beta out. But in this scenario, where the Fed is having to loosen liquidity conditions pretty rapidly, you’re going to have an opportunity to get a little bit more aggressive on your rate cuts from there and get some more of that beta out. So it really is going to be a little bit of a balance of how things play out.

We’ve spent a lot of time positioning the commercial book in particular, to make sure that we stay with the appropriate amount of price sensitivity there so that we can reprice down as necessary. We’re up to about $20 billion of index deposits. So we’re taking a lot of actions to make sure that we’re well positioned, whether they stay high, or if they cut that we’ve got the flexibility to navigate through those different environments.

Ken Usdin

Understood, thank you.

Operator

Our next question comes from the line of Erika Najarian from UBS. Please proceed.

Erika Najarian

Hi, good morning.

James Leonard

Morning, Erica.

Erika Najarian

My first question is on the potential coming regulatory environment. And Jamie, you probably need something stronger than coffee for this question. But the first is on CT1, you generated 30 basis points of capital organically this quarter. And I’m wondering as there’s no NPR yet, but the market is anticipating tighter capital and liquidity standards. Tim, how do you think about the endpoint of capital for an institution like [Indiscernible] from this nine and a quarter? And how should we think about, what that sort of endpoint is over the medium term, and the role of share repurchases, and potentially more RWA optimization?

Timothy Spence

Sure. I’m going to let Jamie start on that one, Erica, and then I’ll follow.

James Leonard

So from a short term perspective, obviously pausing the buybacks, and given the second quarter guide, we would expect to your point that we would continue to generate, call it 25 basis points of capital, even with some RWA growth in the second quarter. I do believe that it will be dependent on what the regulations ultimately come out with in order to then answer the medium term part of your question, because if I were king for a day, I would not change the AOCI opt out rules because this was not a capital crisis. I think the capital regime works as stated. But should they decide either to eliminate, held to maturity and force everybody in the AFS and then force AFS into an AOCI mark, perhaps the core earnings capacity of the company along with you, we included in the deck additional capital accretion measures, that we would improve the AOCI levels by 45%, by the end of next year. But it would be a manageable item for us; we just don’t believe it’s necessary. We have a balance sheet that our target capital level is 9%. All stress testing says 9% is great. But, in this environment, we’re going to accrete capital here in the short term and will get to 950. And hopefully have a little more clarity for everybody next quarter.

Timothy Spence

And I think just to add two thoughts. Our capital stress testing indicates you could run the bank at below 9%, which is the reason that hasn’t been the binding constraint for us. We just elect to do it at the level we do because we like stability, right? And I think we were clear with everybody when we reset the capital target last year, we did it because we were concerned about uncertainty in the Outlook, and we felt that it was prudent to start building capital early as opposed to having to do it later.

So I am pleased in our positioning, I think more broadly one caution I would give everybody is I think some will take the discussion about change in regulation on capital liquidity and just bake it into models. Without assuming that there’s any sort of evolution in the business model. The FDIC has been publishing quarterly data on the sector, I think since 1934. At least the dataset goes back that far. And there’s been more than one regulatory regime change during that period. And if you adjust for tax, the tax policy at a given point in time, the return levels in the sector have been remarkably consistent. So to the extent that more banks are required to hold more capital, or more liquidity, or to change the structure of funding, I think it’s reasonable to expect that the business model is going to evolve, as well.

Erika Najarian

Got it. It’s amazing how resilient banks can be when there’s some level to rates. Right. And just a follow up question to that, for -- this management team is sort of well known for being more forward thinking, whether it’s your balance sheet resilience to what’s been happening in the right environment, or that, ACL ratio. And as we think about, like you mentioned Tim sort of the market trying to force the regional banks into a tighter regime in terms of how they’re valuing the stocks, versus what we know to be, what tends to be a very slow regulatory process in terms of NPR comment period season, how do you balance that sort of market demand for higher capital? And TLAC eligible debt, greater cash liquidity versus the, the regulatory timeline? And what, that we don’t know, nothing concrete today?

Timothy Spence

I mean, I think the answer is you the way that you manage that proactively as you would have started doing something on each of those topics last year, right. So we were in the market, after every earnings call last year, four times. And as a result, have the lowest incremental need in the event that TLAC had no phase in period, right. As an example, you were deliberate about the way that you manage the ACL to reflect uncertainty in the forward outlook, and therefore you’re carrying good coverage today, right, which we certainly feel we are. And you would have allowed yourself to a CRE capital during a period when the market was certainly more robust for regional banks, which I think, of course we did as well.

I think lastly, what we’re going to see here coming out of this, even if there is no change in regulation, as we all will flow, the empirical data from March Madness, through our models, and it’s going to dictate a very different value for non-operational money and operational money, right. And the by-product of that is the banks that have good core retail deposit franchises, and who have good commercial operational commercial franchises.

So linked to payment activity, treasury management services, and otherwise, that that is going to be the place that you want to be because while we think the Fed obviously at some point, rates are going to stay higher than zero on an absolute basis, and our ability to make money on both sides of the balance sheet is going to be a big driver who does well if there is more capital requirements or liquidity requirements are higher. Thank you.

Erika Najarian

Thank you.

Operator

Our next question comes from the line of Mike Mayo from Wells Fargo Securities. Please proceed.

Michael Mayo

Hi. So you think you expect deposits to be stable or increased from here but for NII to go down in the second quarter. Did I get that correctly? So the driver on NII is really twofold. One is the DDA mix, into interest bearing. And then the second element of the guide is that the movement up in rates in March to have a full quarter effect of that rate increase will bleed through into the second quarter and then that’ll be offset by some benefits from day count as well as some of the consumer loan growth. And how are you or are you becoming more cautious, firm wide and why? So you trend your loan growth guidance down by 1% and in terms of maybe expenses, are you ratcheting that back? Are you preparing for tougher times? Or are you preserving the infrastructure for the potential for growth? That maybe others don’t expect?

Timothy Spence

Yes. So I mean us, Mike, we like to try to toe the line. We’re an and company more than we are and more companies. There’s no question that I think we all feel more cautious about the prospect for loan growth. Part of that is the Feds been abundantly clear, they’re going to tamp down demand, right, no matter what it takes that but I note that the 1% decline for us comes on top of what I think was already the lowest full year loan growth guidance. So we have been pretty cautious as it related to loan growth. And in terms of expenses, I think you noted the actions we took during the quarter; we continue to be surgical about pruning the branch network, which creates the capacity to invest in the southeast. We had little more than 12 million bucks and severance that rolled through attached to expense actions that were designed to take capacity out of businesses that we just don’t believe are going to need it, given the outlook.

And I think the discipline that we have had, which is we believe in self-funding investments, because it drives good discipline around capital allocation, and effort is going to be the same here. So we do not intend to pause, the strategic investments we’re making in the southeast or the investments we’re making in the technology platform, those are going to be too valuable for the franchise in the long-term. But we are not going to be spending money on a discretionary basis that we don’t think, is going to generate a near term return, outside of our strategic investments.

Michael Mayo

And then last one was interesting, as you talked about, you said, you could go ahead and recognize your security losses and AFS. It’d be manageable. And I guess you could sell those or do all sorts of things with that. So you have the capacity. I guess, how much more in TLAC would you need? You said you’ve been in the market for the last four quarters. And if you had to go ahead and do that and be the only bank that did that, would that set you apart? Would that just be uneconomic?

James Leonard

Yes, just to clarify on the AFS, my comment was about the AOCI, should it be a capital requirement that we would have significant improvement based on the implied forward curve through the end of 2024 about 45% of that would roll down the curve, given the bullet structure of the portfolio, not necessarily selling at all. So we do like the portfolio. But in terms of the TLAC challenge. At the end of the year, our gap to the 6%, RWA bank level would be about $4 billion. So for a bank our size that is certainly manageable, and then the question then becomes, what would the regulations change with what you would do with the proceeds.

So right now, we’re sitting on $10 billion of excess cash, which is, frankly, the biggest driver of the NIM erosion as we look forward on a full year basis, because that 10 billion of excess cash costs about 16 basis points of NIM. And so if we were to issue 4 billion more in debt, obviously, we would prefer to lend it to customers. But if the liquidity rules tighten, and we have to hold a higher Reg YY liquidity buffer, then we will be forced than any of their just holding an in cash or buying more level ones.

And so it starts to become a challenge with the distribution of the proceeds. When you say what, what it sets you apart, and what your earnings profile improve, I think it would just be a gross up on the balance sheet and, and really not productive. And so that’s why we haven’t done it.

Michael Mayo

That’s clear. Lastly, $4 billion gap for TLAC, how much have you issued or obviously have?

James Leonard

We haven't issued any this year, but total long term debt is $13 billion right now.

Bryan Preston

Yes, Mike this is Bryan. That’s about 6.6% of assets, pre-COVID, we were at 9% of total assets. And that gap is about $5 billion. So we’re just getting back to levels where we were before COVID. So that TLAC requirement is just not a big deal for us relative to our historic balance sheet structure.

Michael Mayo

Right. All right. Thank you.

Operator

Our next question comes from the line of John Pancari from Evercore. Please proceed.

John Pancari

Good morning.

James Leonard

Good morning, John.

John Pancari

Just a question on the securities book, I appreciate the detail you gave on 525 on the commercial mortgage backed securities, I know there are 52% of your securities book. Can you maybe give us an update there? Are you seeing any stress there in terms of the performance of those securities amid the commercial real estate stress? And then, what type of stress and would be needed to pose risks to valuations or other than temporary impairment in that portfolio? Thanks.

Bryan Preston

Absolutely. It’s Bryan again, so you need to break the CMBS portfolio into two components, the agency portfolio, which is effective it is Fannie, Freddie, and Ginnie guaranteed, so that portfolio looks just like RMBS that many people are invested in. So from a credit perspective, no issues on $29 billion of that portfolio, as its GSE guaranteed. The non-agency portfolio, which is only $5 billion, it is all super senior AAA rated. And we perform very significant analysis from a stress perspective, and from an underwriting perspective, every time that we buy and, and as well as when we monitor the portfolio.

To give you some color on our recent stress tests that we’ve performed. We assume a 50% decrease in property values across all the underlying properties within the structures. And even in that scenario, we would record we would realize no losses on that portfolio and still have 23% heart enhancement. The Office loans within that portfolio are about 30% of the underlying loans. If we assume that from a weighted average perspective that does office loans, that the underlying properties would experience a 90% decrease, that’s when we would get to our first dollar of credit loss on that portfolio.

So we feel very confident and there would be significant loan losses across the entire industry before we’d even recognize our first dollar loss on this on the structure associated in this portfolio.

John Pancari

Got it? Thank you, it’s very helpful. And then separately. I was just wondering if you can update us on the status of your core systems conversion, the March Madness at all impact the progression of the conversion of the timing of the expected conversion? And then lastly, can you maybe help us with the sizing up of the cost of the conversion and how much is expected to be capitalized?

James Leonard

Yes, John it’s Jamie. Thanks for the question. As you saw in the expense numbers, this quarter, we did have continued ramp up in technology cost that ultimately is a good thing, because it means we’re getting things accomplished. And we continue to track on all of our deadlines for this year. We have new ledger going in in the third quarter, followed by CD platform as well as continued rollout of the nCino platform across the commercial business.

And then we’re really at this point about halfway through the game, because 2024, 2025 has additional deadlines associated with it on ATM and TM billing as well as the core checking conversion, but so far, so good. We do capitalize and follow the appropriate accounting standards on the total spend here. I think the spend over a multiyear period could reach as much as $100 million, of which a little less than half would be capitalized. And from there, I think you just continue to see us invest in cloud core technology. And that’s part of what’s driving that expense growth. You’re seeing both in the first quarter and for the year.

John Pancari

Got it. Thank you, Jamie very helpful.

Operator

Our next question comes from the line of Manan Gosalia from Morgan Stanley. Please proceed.

Manan Gosalia

Hey, good morning. I was wondering if you could give us some more color on why you expect deposits to grow as we get into the remainder of the year, what are you seeing in your underlying account openings and conversations with clients that gives you the confidence in that outcome? I guess my question is, why shouldn’t some of these new deposits just go back to the banks, where they have longer relationships? So once the volatility in the in the system settles down.

Timothy Spence

Yes good question. So I don’t think we took a lot of deposit share from banks that were non-operational in nature. The new accounts that we opened Manan were linked to treasury management sales and inclusive of our embedded banking business. And we’re had been on the sales pipeline, in some cases for as long as 18 months, and there had been technology work that ended up getting accelerated. In a handful of other places like we do a very good business with payroll processors. We were a net beneficiary of folks who needed the payments infrastructure that Fifth Third provides, and those relationships which were not on the sales pipeline previously moved. And because they’re embedded in the day to day operations of the business, they tend to be very sticky. And I mean, look that you kind of have to go back to first principles for us on the deposits to say why do we believe that we can continue to be stable or to generate a little bit of growth.

So big part of the growth that we’re generating on the retail side is coming out of that sort of sustained primary household growth that we’ve been able to generate. We’ve run in the 2% to 3% range for several years now. We’ve breached 3% in the first quarter. We were running faster than that. And that is led by the southeast markets where I think the year-over-year growth rate was like 7.3%. So very significant there.

In addition to that, the branches we’ve added in the southeast are driving really, really strong growth. So if you look at the southeast, overall, same store sales and deposits were a plus 5% year-over-year for the quarter, if you include the de novo the markets like North and South Carolina, Georgia and Florida in totality grew 10% year-over-year, and if you just annualized the first quarter, over the fourth quarter, they grew 20% in terms of deposits, so really strong production come in from those investments. And then I think we’ve talked a lot about the treasury management business, but that on the commercial side of the equation continues to be the thing. That is the driver, we have a disclosure in one of the slides here on the percentage of commercial relationships that are linked to Treasury Management, it’s about 88%. If memory serves, maybe slide nine.

And then the length of a that balance weighted average relationship tenure and commercial is 24 years. So we’re not talking about people who were parking money here, because we were a ratepayer, I think we have only about a half a billion dollars in total in all deposits in the bank that are priced ahead of Fed funds. And it’s reasonable to assume that whether it’s because the Fed raises or because we take other actions that that number is going to be zero by the end of June. So we just have a very stable deposit base, the growth is coming from investments that are multiyear in nature, and that are proven in terms of their ability to support the company and very little deposit gathering activity that would have been on economic relative to alternative funding sources, less than a half a billion dollars, I believe in total.

Manan Gosalia

Got it, very helpful. And then maybe as a follow up, and maybe the response to this is the same. But as I look at the deposit beta assumptions on slide 11, they look pretty conservative relative to the rest of the street. But if I look at the slope of their line, it is flattening as we look into the forecast period. So why shouldn’t we expect the same rate of change that we’ve seen there more recently?

Timothy Spence

Yes, our base view, as I said in our prepared remarks are the midpoint of our guide is a 47% beta. And that is really driven by our assumption that the battle for retail deposits continues to be very competitive, and that that retail beta actually doubles over the course of the year. If that were to not happen, then we would be at the at the low end. So on the commercial and wealth and asset management side, the betas have been running, 65% to 70%. And those betas will flatten out as the Fed stops hiking. So part of what’s assumed in the slide is that the Fed gets to 525 and stops and so that would have a flattening effect. And the reality here is that there’s a lot of uncertainty as to how competition is going to behave over the next several quarters. And you can see on the slide thus far, we’ve done well versus the industry from a deposit beta standpoint, but we definitely want to defend our book as well as continue to have strong new customer acquisition.

Manan Gosalia

Got it. Thank you.

Operator

Our next question comes from a line of Ebrahim Poonawala from Bank of America. Please proceed.

Ebrahim Poonawala

Good morning.

Timothy Spence

Morning, Ebrahim.

Ebrahim Poonawala

Just two quick follow ups, one on credit. I think, Jamie, you mentioned about 80% base case, unemployment 4%. Give us a sense of just sensitivity if that 4% were to be 5%, what does that mean for your allowance or the consumer allowance?

James Leonard

Yes, the ACL would go up 250 million for every 1% assuming all other assumptions stay, as is.

Ebrahim Poonawala

Okay, helpful. And other quick follow up on going back to Tim, your comments around capital. And Matt, given just the uncertainty around regulations, Mac, macro economy, the nine and a quarter CT1 like, do you? Should we anticipate that drifts higher at least for the next few quarters until there’s more visibility? Or do you expect to be more proactive and return back to sort of buybacks in the back half of the year?

Timothy Spence

Yes, I think just given the guidance that we provided, if you assume no buybacks in the second quarter, which is right, it would imply we get to nine five by June 30. Ebrahim, I, Jamie and I both feel confident we could run the business at nine and a quarter, it just feels prudent at this point in time to make sure that the environment does fully settle out before we resume repurchases.

Ebrahim Poonawala

And just on the environment. I think last quarter, we talked about things worsening maybe back half of this year into 24. Do you have any better visibility in terms of just the shape of the credit cycle, how deep it could be? And just when we begin to actually see the first sort of deterioration, show up in the numbers on credit metrics.

Timothy Spence

We continue to think the back half of this year it is the beginning of next is probably the right period. I think we have been operating under the belief that some of the rosier data that came out in the winter was a little bit of a head fake because you had unseasonably good weather and the by-product of that was you had spending in a variety of under other indicators, Flash more positive than I think people had anticipated. And in part, that’s why you saw the Fed, ramp up rhetoric. Again, the IFM indices are, from my point of view, the best thing to watch here, they certainly are in our footprint, and they all are signaling a slowdown. And the Fed is not going to be able to relent and get inflation under control just based on what we hear from clients without sticking at, a five plus level for some extended period of time. And when that happens, that’s very restrictive, right things are going to break.

My own view is that this is light, we’re likely to return to a period where there’s more regional divergence than you’ve seen. And the most recent two cycles. I’m I am very happy to be Midwest and southeast Bank is a moment like the data that’s come out of the Census Bureau on spending on factories, right, we had 108 billion in spending on factories last year, which was an all-time record that Financial Times did nice work on commitments that have been made, there’s more than 200 billion in capital commitments. This is all stuff that’s tied to the $2 trillion that the government intends to invest and rebuilding supply chains here in the U.S. And if you just look at the manufacturing jobs that were added last year, like there were 348,000 manufacturing jobs added in the U.S., compared to I think 6000 in 2010, as an example and 60% of those were in our footprint.

So the markets that are going to benefit from the government’s investment in infrastructure and domestic supply chain. And that sort of broader trend and reshoring are going to do better than markets that were more reliant on technology and professional services or that have more profound challenges as it relates to state budget deficits, or challenged city centers, there just is going to be a divergence that materializes there. So I at least think you should be more focused on regional economic data than on the economy overall, as you think about where losses may materialize.

Ebrahim Poonawala

That’s great color. Thanks.

Operator

Our final question comes from the line of Christopher Marinec from Janney Montgomery Scott. Please proceed.

Christopher Marinec

Thanks for taking my question. Tim, just want to ask about dividend finance kind of skewing the loan growth this year maybe in a positive way to where the loan growth ex dividend is very conservative. Is that a fair way of thinking it through?

Timothy Spence

Yes. Yes, the two areas of the portfolio where there is any material loan growth this year Chris are the dividend finance portfolio as we see the benefit of the balances rolling on because we are portfolio in their production. They were originated to sell before we bought them. And then in C&I which is really good core steady production in the middle market where I have been a part because of the dynamics around manufacturing, you’re seeing really solid production out of our legacy markets in the Midwest and the continued growth and provide right which is of course linked to healthcare and primarily, non-elective dental invent.

Christopher Marinec

Got it. And the rest is rolling off and not…

Timothy Spence

It’s kind of receivable or in modest decline.

Christopher Marinec

Got it? Very well. Thank you, Tim. I appreciate it.

Operator

I would now like to turn the call over to Chris Doll for closing remarks.

Chris Doll

Thanks, Molly. And thanks everyone for your interest in Fifth Third. Please contact the IR department if you have any follow up questions. Molly, you can now disconnect the call.

Operator

Thank you ladies and gentlemen. This does conclude today’s call. Thank you for your participation. You may now disconnect.