Fifth Third Bancorp
NASDAQ:FITB
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Fifth Third Bancorp
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Ladies and gentlemen, thank you for standing by, and welcome to the Fifth Third Bancorp Third Quarter 2020 Earnings Conference Call. [Operator Instructions] I would now like to hand the conference over to your speakers today. Chris Doll, you may begin.
Thank you, Marcella. Good morning, thank you for joining us. Today, we'll be discussing our results for the third quarter of 2020. Please review the cautionary statements on our materials, which can be found in our earnings release and presentation. These materials contain reconciliations to non-GAAP measures, along with information pertaining to the use of non-GAAP measures as well as forward-looking statements about Fifth Third's performance.
We undertake no obligation to and would not expect to update any such forward-looking statements after the date of this call. I'm joined this morning by our President and CEO, Greg Carmichael; CFO, Tayfun Tuzun; Chief Risk Officer, Jamie Leonard; and Chief Credit Officer, Richard Stein. Following prepared remarks by Greg and Tyson, we will open the call up for questions. Let me turn the call over to Greg now for his comments.
Thanks, Chris, and thank all of you for joining us this morning. I hope you are all doing well and staying healthy. Once again, our financial results were strong despite the challenges associated with the current environment. As an essential business, we continue to take appropriate actions for our customers, our employees and our communities during the pandemic. Earlier today, we reported third quarter net income available to common shareholders of $562 million or $0.78 per share.
Our reported EPS included a negative $0.07 impact from the items shown on Page 2 of our release. Excluding these items, adjusted third quarter earnings were $0.85 per share. Tayfun will provide more details on the quarterly financial results in his remarks. But I will share some highlights. Our reported adjusted return metrics were solid, reflecting our strong operating results, including a provision for credit loss performance.
Our credit losses were significantly better than expectations. At 35 basis points, our third quarter charge-offs were the lowest level in over a year, with improvement in both consumer and commercial portfolios. Consumer net charge-offs of 40 basis points is the lowest in the past 15-plus years, reflecting our consistently strong approach to underwriting, as well as the benefits of fiscal stimulus and payment deferrals. Our already strong capital position further improved this quarter. Our CET1 ratio of 10.1% is well above our stated target of around 9.5%, and our income levels, combined with the outcomes from our quarterly stress test continue to suggest that we will maintain our current dividend. Furthermore, we have grown tangible book value per share for 6 consecutive quarters.
Our PPNR results were better than our previous expectations, reflecting the strength and resilience of our diverse revenue mix in retail, commercial and wealth and asset management. Based on our fee-based businesses, many of our fee-based businesses are generating strong results that are helping to cushion the impact of lower rates. For instance, wealth and asset management revenue increased 10% sequentially as we generated positive AUM inflows again this quarter as we have done in 9 out of the last 10 quarters. Capital markets revenue was up 8% from last year, and was down slightly relative to the record second quarter. On a year-to-date basis, total commercial banking fee revenue was up 16% compared to last year. Topline mortgage revenue is up 45% from the year-ago quarter, with a low rate environment impacting servicing revenue and the MSR valuation. Deposit fees increased 18%, and processing revenue increased 12% sequentially, both better than our previous guidance as we are seeing early signs of normalization in business and consumer spending patterns. While we continue to streamline our operations and position the bank for long-term success, we continue to assess strategic investments in non-bank acquisitions and our fee-based businesses to accelerate revenue growth.
For instance, we recently increased our strategic investment in Bellwether Enterprise, a national multiproduct CRE firm, which we originally announced in April. This investment provides clients with a broader set of permanent financing solutions without Fifth Third being exposed to the balance sheet risk associated with longer duration CRE assets. Commercial loan production was relatively stable this quarter compared to the second quarter, offset by further declines in line utilization. Total average loans declined 4% sequentially. Within our previous guidance range, we expect near-term pressure in the loan portfolio to continue.
Despite the tepid loan environment, net interest income exceeded our previous guidance as we aggressively reduced our deposit costs in excess of our prior expectations. While the environment remains uncertain, our commercial loan pipelines are beginning to improve in certain areas, particularly in technology, telecom, health care and industrials, which should provide support as we head into next year. Before I turn it over to Tayfun to further discuss the results and outlook, and I'll review our guiding principles, strategic actions and key strategic priorities, which will enable us to continue to generate long-term shareholder value. We have consistently communicated our through-the-cycle principles of disciplined client selection, conservative underwriting and overall balance sheet management approach focused on long-term performance.
Our unwavering adherence to these principles and our balance sheet strength gives us confidence as we navigate this environment. We have executed numerous strategic actions over the past five years in anticipation of a downturn, which will continue to serve us well. We've reduced our credit risk exposures and built strong reserve coverage. We've built long-term protection to mitigate the impact of lower interest rates. We took decisive actions to reduce our expense base, and we successfully invested in and diversified our fee businesses. From a commercial client standpoint, we continue to focus on generating relationships with clients who have more diversified and resilient businesses. We are confident in our client selection process and proactive approach to credit risk management.
We continue to believe we are well positioned relative to peers in commercial real estate, an area where we have been named disciplined. We have focused predominantly on top-tier developers with a track record of resiliency. Our portfolio is well diversified by geography and property type. And as we have discussed before, we continue to be at the low end of peers as a percentage of total capital. In addition to the CRE portfolio, our other lending portfolios continue to do well, be well positioned, combining our strong retail and regional commercial banking franchises in the Midwest and Southeast with our national lending businesses. These portfolios will be instrumental in delivering a differentiated credit performance, given the likelihood of an uneven economic recovery.
We're mining our exposures across our total commercial loan portfolio, utilizing early warning systems through a combination of internal portfolio analysis, and third party data. Our relationship teams receive timely alerts that we detect any sign of credit deterioration. This helps us make prompt, prudent and accurate credit rating determinations proactively without waiting for customer statements. Looking ahead to 2021, we continue to expect full year net charge-offs to come in well below 1%. We have also strengthened our balance sheet that building long-term protection, the positioning of our securities, and hedge portfolios. With high likelihood of lower rates for the next several years, our prudent interest rate risk management should help preserve our core margin.
Our very strong balance sheet liquidity has enabled us to decisively act in aggressively lower deposit rates. Given the industry wide revenue headwinds, including a strong likelihood of persistently low interest rates, we recently announced an expense optimization plan. We are taking decisive and appropriate actions to reduce our expense base, both temporarily reflecting the weaker revenue environment, and also permanently based on long-term structural saving opportunities. Our four key strategic priorities remain intact, leveraging technology to accelerate our digital transformation, driving organic growth and profitability, expanding market share in key geographies, and maintaining a disciplined approach on expenses and client selection.
We will put the appropriate level of prioritization and focus on the areas that have the highest probability of driving strong financial returns and generate long-term value for shareholders in order for us to emerge from the current environment, a top performing regional bank. Our balance sheet strength, diversified revenues, we continue focus on disciplined expense management to serve us well as we navigate this challenging environment. I would like to once again thank our employees. I'm very proud the way you have responded in extraordinary ways to support our customers, our communities, and each other during these unprecedented times.
Our commitment to generate sustainable value for our stakeholders is evident in our inaugural, environmental, social, and governance report as we also became the first U.S. commercial bank to join the SASB alliance in the GRI community report, and other health disclosures are available for your review on a dedicated ESG page on our Investor Relations' website.
With that, I'll turn it over to Tayfun to discuss our third quarter results, our current outlook.
Thank you, Greg. Good morning and thank you for joining us today. Let's move to the financial highlights on slide three of the earnings presentation. Reported results for this quarter were negatively impacted by three notable items, a $30 million after-tax charge related to our previously announced restructuring plan, a $17 million after-tax negative mark related to the Visa total return swap, and $4 million after-tax from COVID-related expenses. Strong operating results for the quarter reflected solid business performance throughout the bank, as well as the impact to provision, which resulted from our best quarterly charge-off performance since mid-2019 stabilization and key forward looking macroeconomic indicators compared to the past several quarters as well as lower period end balances.
Although we are seeing relative stability in the key macroeconomic variables used in our reserve calculations, we continue to take a cautious approach, given remaining uncertainties related to the pandemic and the economy. Our base case macroeconomic scenario assumes GDP remains below the end of 2019 levels until the second quarter of 2022, with an unemployment rate worse than the current environment, remaining elevated above 8% through 2021. Our base case is generally more conservative than the Fed base scenario published last month.
Our downside scenario assumes that GDP will remain below the end of 2019 levels until the second quarter of 2023 with unemployment further deteriorating from the third quarter exceeding 12% through the first half of improving until improving to 11% by the end of 2021 and reaching 8.4% by the end of ‘22. If we were to assign a 100% probability to the downside scenario we would likely require an additional $1.2 billion in reserve based on our balance sheet exposures. Reported and adjusted revenue grew 2%, despite the generally weak environment, as we outperformed our previous fee and NII expectations. Total non-interest income excluding the impact of security gains was up 5% sequentially, 3 percentage points better than our previous guidance. With respect to the outside securities gains this quarter, it is important to note that our unrealized gains in the portfolio at the end of the quarter remained very high at $2.7 billion. Our very deliberate actions over the past few years that focused on structuring the portfolio in an anticipation for a lower rate environment should continue to give us a strong advantage as a very effective hedging tool to help mitigate the rate headwinds. Having said that, even continue to be prudent in managing the gains for the best outcome for our shareholders, cognizant that these gains will continue to be subject to future volatility, especially to fluctuations in the current pre-payment environment.
This quarter, a small portion of our portfolio gains cushion the impact of the restructuring charges that we incurred -- related to our expense reduction plan, which we believe was a prudent risk based action in light of the current environment. Reported and adjusted non-interest expenses were flat year over year. On a sequential basis, adjusted expenses increased slightly more than our previous guidance of up 2%. We are in the midst of executing our expense reduction actions announced last month, which will generate annual efficiencies of $200 million starting in 2021 with an additional $100 million, $150 million of annual efficiencies to be generated starting in 2022. As a result of our strong revenue performance and continued expense discipline PPNR increased sequentially and outperformed our July guidance by approximately $15 million.
Given the strong PPNR performance combined with the credit related improvements, we generated strong reported and adjusted return metrics. Adjusted ROA of 1.24% and an adjusted return on tangible common equity of 18.2% excluding ALCI despite growing our regulatory capital of 42 basis points during the quarter. Excluding the security gains, our adjusted ROTC was nearly 17% even on a credit normalized basis, our underlying ROTC performance is indicative of the strength of the franchise and our ability to successfully navigate a low rate environment.
Moving to slide 4, total average loans declined 4% sequentially within our previous guidance range. CNI loan balance trends continue to reflect lower revolve utilization rates, which declined by 15% from the minute April peak to 33% at quarter end and declined by 5% since the end of June. The decrease in average CNI loans was partially offset by an increase in average auto loan balances. Due to the uneven nature of revolving utilization rates and the impact of PPP loans, we are providing period-end loan balance performance. Revolving line of credit balance has decreased in excess of $3 billion, which constituted approximately three-fourths of the end of period balance quarter-over-quarter decline.
Line utilization trends so far in the first two weeks of the fourth quarter indicate continued low utilization levels, which we expect will likely persist at least through the end of this year. C&I client pipelines remain generally soft, but have somewhat improved relative to last quarter. Average and period-end CRE loans decreased 1% sequentially. As we discussed before, we believe that the commercial real estate sector is particularly vulnerable to the current economic environment, and potential changes in the post-pandemic economy, which continues to favor low exposure and focus on high quality borrower in this sector.
Average total consumer loans, increased 1% sequentially continued growth in the auto portfolio was offset by declines in home equity and credit cards. Auto production in the quarter was strong at $1.8 billion with average FICO scores around 780, and lower advanced rates, higher internal scores, better spreads and a higher concentration of new versus used autos compared to recent quarters. Most of the other consumer loan categories continue to reflect the generally subdued borrower demand. Our securities portfolio of around $35 billion decreased 2% compared to the prior quarter, reflecting the impact of the sales, as well as continued pay down. Unless the market environment changes, we are unlikely to use any of the excess liquidity to grow our investment portfolio in the long-term. The underlying risk return profile of many of the investment options is not attractive in light of the impact of the aggressive monetary actions that the Fed is executing.
Average other short-term investments, which includes interest bearing cash increased $10 billion, compared to the prior quarter and increased $27 billion, compared to the year ago quarter, the significant increase in excess cash is the outcome of the ongoing decline in loan balances combined with record deposit growth over the past six months.
Moving on to slide 5. Compared to the prior quarter, average core deposits increased 4% with growth in all deposits captions, except other time deposits. Average demand deposits represented 33% of total core deposits in the current quarter, compared to 31% in the prior quarter. Average commercial transaction deposits increased 6% and average consumer transaction deposits increased 3%. The deposit growth, came from improvement in every line of business, and was very granular across product types and customer size.
Overall, the deposit performance reflects our strong long standing client relationships, and our customers desire to remain liquid. In addition to growth in deposit dollars, we once again generate consumer household growth during the quarter, reflecting strong production, as well as limited attrition. As shown on slide 6, we have continued to take proactive steps, which are predominantly focused on the right side of the balance sheet to mitigate the impact of lower rates, which should provide additional support in the coming quarter, compared to the second quarter, we lowered our interest bearing core deposit rates 14 basis points, more than our expectations, while continuing to generate strong deposit growth.
As a result, our September interest bearing core deposit rate is now just 11 basis points with total core deposit costs of just seven basis points, both well below the floors from the previous rate cycle. We expect fourth quarter interest bearing core deposit costs to benefit from our actions and decline another few basis points. Our loan to core deposit ratio improved to 72% as our short-term investments predominantly interest bearing cash were approximately $31 billion at quarter end. Excluding PPP, our loan to core deposit ratio was 69%.
Currently, there are no strong indications that the liquidity profile of our balance sheet is likely to change soon as loan growth continues to be elusive and investment opportunities relatively unattractive, we will remain -- we will maintain our short-term cash balances at these levels until further notice. Turning to slide seven, reported and adjusted NII decreased 2% compared to the prior quarter. The decline was primarily attributable to lower C&I balances and the impact of lower market rates. These impacts were partially offset by the reduction in deposit costs, the full quarter impact of PPP loans, day counts, and the favorable impact of previously executed cash flow hedges.
As you can see on the slide, the hedges added an incremental $10 million to our third quarter NII for a total contribution of $72 million during the quarter. Purchase accounting adjustments benefited our third quarter net interest margin by three basis points this quarter. Our adjusted NIM decreased 16 basis points sequentially, driven by the unfavorable impacts from elevated cash balances, which created an approximate 15 basis point drag on NIM compared to the prior quarter, lower market rates, and lower C&I balances, partially offset by benefits from our actions to lower deposit costs, and the previously executed cash flow hedges.
As we have been highlighting all along our interest rate risk hedging strategy has two pillars, the structure and composition of our investment portfolio and the size and duration of our derivative portfolio. As I stated earlier, our swaps and floors contributed $72 million this quarter. Our portfolio premium amortization was only $1 million and our portfolio yield declined only seven basis points. You can easily see that our investment portfolio does not erode the protection provided by derivative portfolio like it has for many of our peers. And importantly, we have protection in both portfolios longer than our peers.
Excluding the impact of excess cash relative to historical averages and the lower yielding PPP loans, normalized NIM was approximately 3.03% for the third quarter. We expect that we will continue to be able to generate a normalized NIM of around 3% for the foreseeable future helped by our interest rate hedges and investment portfolio composition. The fourth quarter NII and NIM are both expected to remain stable. Our guidance has no accelerated benefits from PPP loan forbearance [ph].
Moving on to slide eight, we once again had a strong quarter generating fee revenues that offset the pressure on interest income. The resilience in our total fees continues to highlight the level of revenue diversification that we have achieved. Adjusted non-interest income, excluding the benefit of securities gains increased 5% sequentially, exceeding our previous guidance by approximately $20 million. The strong performance reflected another solid quarter in capital market. Strong performance in wealth and asset management and rebounds in deposit service charges, card and processing revenue and in leasing business.
In our commercial business, the strong capital markets revenue was down from the record set last quarter but was up approximately 8% from the year-ago quarter. Mortgage banking net revenue decreased $23 million sequentially primarily driven by an unfavorable MSR net evaluation adjustment and an increase in MSR resulting from higher prepayment fees. Current quarter mortgage originations up $4.5 billion, 32% compared to the prior quarter. Asset management fees increased 10% sequentially, benefiting from stronger market conditions, improved brokerage fees and the continuation of positive AUM flows. With strong wealth and asset management performance over the past several quarters reflects our prioritized investments in this business both in talent upgrades as well as acquisitions to improve the ROE profile of our company.
Card and processing revenue increased $10 million or 12%, reflecting increases in credit and debit transaction volumes resulting from continues normalization in consumer spending patterns. Deposit service charges increased $22 million or 18%, with improving commercial deposit fee reflecting a partial loan realization of treasury management service volumes and lower earning credits as well as elevated consumer deposit fees compared to the prior quarter which included hardship-related fee waivers. We expect processing revenues and deposit fees to be stable to slightly higher in the fourth quarter.
Moving on to slide 9, third quarter reported pretax expenses included restructuring charges of $8 million, intangible amortization expense of $12 million and COVID-related expenses of $5 million. Adjusting for these items and prior-period items shown in our materials, non-interest expense increased 3% sequentially and decreased $1 million compared to the year-ago quarter. As we discussed first in September during the Barclays Conference, in light of revenue headwinds, we are taking action to reduce our annual 2021 run rate expenses by approximately $200 million.
We have started taking appropriate actions in September and expect to finalize all actions by the end of this quarter. We will share with you the full set of details in January during our fourth quarter earnings call when we will also give you an outlook for the direction of our expenses in 2021. With respect to personnel decisions, we expect to generate the full run-rate savings beginning in the first quarter of 2021. In addition to the staffing optimization, we remain on track to deliver the remaining savings through accommodation of process re-engineering, rationalization of certain smaller non-core businesses, vendor re-negotiations and corporate real estate rationalization which are all progressing as well as the savings associated with reduction in our branch network.
While we will continue to open branches in our existing high growth southeast markets to generate household and revenue growth, we expect to further optimize our network by closing an additional 37 branches in the first quarter of 2021, predominantly in the Midwest. As we have discussed before, the recent acceleration in customer digitals adoption trends, raising the returns on our technology investments made over the past several years. This gives us increased conviction that we can continue to optimize our branch network while also expanding our presence in high growth markets.
Also, our investments and focus on process re-engineering and our areas of our operations will allow us to permanently optimize our expenses in our middle office and back office functions. We believe that approximately 20% of the 2021 savings are environment dependence. When the market rebounds and sustains economic recovery, we will re-adjust these resources accordingly. In addition to a near-term savings target, we also announced a longer-term expense strategy which will help us achieve an additional $100 million to $150 million in run rate savings, starting in 2022 through investments in lean process automation.
Slide 10 provides an update on our COVID-19 high impact portfolios. The amounts on this page represent approximately 10% of our total loans and our down 8% from last quarter excluding PPP loans. As you can see, the paydowns during the quarter reduced our balances relative to the second quarter in all sub-categories, except for leisure travel where we have a rather small overall exposure, all to larger operators. The total balances on this slide include approximately $1 billion from our leveraged loan portfolio which remains below $4 billion and has decreased 7% sequentially. The information on this slide lays out the reasons why we believe that our client selection in these portfolios has been very disciplined with a focus on larger companies that have access to capital in stressed environments and where we have the appropriate credit mitigants in place to limit the ultimate loss content in these portfolios.
On slide 11, we provide an updated view of the consumer and mortgage portfolios. The FICO scores clearly indicate the high credit quality of the portfolio with over 57% containing FICO scores of 750 or higher on a balance-rated basis. Approximately 90% of the consumer portfolio is secured. And as you can see by our FICO band distributions, our portfolio is heavily weighted in the high prime/super prime space. As we have previously discussed, we have taken proactive steps to enhance our underwriting standards, specifically on minimum FICO scores and maximum LTV levels in addition to increasing our efforts in collections.
Turning to credit results on slide 12. The net charge-off ratio, were 45 basis points improved, 9 basis points sequentially. The sequential improvement reflects stable outcomes in both portfolios with the commercial credit favorability coming from better resolutions as well as expansion and consumer credit continuing to exhibit results that are more commensurate with a strong or employment environment. Borrowers have been clearly helped by the stimulus and COVID-related relief programs. And those who request an additional 180 days of mortgage payment assistance as provided under the CARES Act will benefit into next year.
NPAs remain generally well behaved at 84 basis points. The sequential increase was entirely in commercial with growth coming predominantly from our COVID high impact portfolios and some credits in the energy portfolio, which we believe will ultimately result in a low-loss content. Our ACL ratio declined only by 1 basis point sequentially to 2.49% reflecting the stability in both the current macroeconomic environment, as well as the drivers of the forward looking scenarios. The low level of net charge-offs, combined with the $116 million decline in the allowance, reflecting a lower period end loans resulted in a net $15 million benefit to the provision.
Slide 13 provides more information on the allocation of our allowance and the composition of the changes this quarter commercial. In commercial, higher reserve coverage was warranted due to ratings migration during the quarter. This was partially offset by lower end-of-period balances compared to last quarter. In consumer, the change in reserve coverage reflects improvements in the expected loss content in the portfolio. Including the impact of approximately $150 million in remaining discount associated with the MB loan portfolio, our ACL ratio was 2.62%. Additionally, excluding the $5 billion in PPP loans, with virtually no associated credit reserve, the ACL ratio would be approximately 2.75%.
Our reserves reflect the current macroeconomic expectations embedded in the scenarios that we deploy in this exercise. But the outlook does not further deteriorate; there should not be a need to increase our reserve coverage beyond the current levels. Turning to slide 14, our capital and liquidity positions remain strong during the quarter. Our CET1 ratio ended the quarter at over 10.1%, above our stated target of around 9.5%. Given the dynamics during the quarter, we providing you a CET1 reconciliation between net income, risk weighted assets and the impact of dividends.
As you can see, dividend payouts constitute a very small portion of the change in CET1. We expect to have adequate capital and trailing reported net income to maintain our current dividend for the foreseeable future. We will be resubmitting our stress tested in early November, with the rest of the CCAR banks. We have been very consistent in stating our view that given our very strong capital ratios, balance sheet strength, earnings power and relatively modest pre-COVID dividend payout ratio, we expect to fare well. We believe that our performance in this downturn ultimately will prove the resiliency of our model.
Our tangible book value per share was $23.06 this quarter, up 9% year-over-year. At the end of the quarter, our unrealized pre-tax gain in our securities and hedge portfolios was approximately $3.8 billion, which is not included in our regulatory capital ratios. From a liquidity perspective, we have over $100 billion in total liquidity sources. Slide 15 provides a summary of our fourth quarter outlook. We expect a decline in total loan -- average loan balances of approximately 2% on a quarter over quarter basis, with a 4% to 5% decline in commercial loans and a 1% to 2% increase in consumer balances.
The decline in commercial balances is a result of expected paydowns in commercial credit lines. Net interest income and NIM are expected to be stable to last quarter, assuming no benefits from accelerated amortization of PPP fees. We expect non-interest income to increase 7% to 8% sequentially, including the recognition of our TRA of approximately $70 million. We expect our expenses to be flat to slightly up. Total net charge offs are expected to be in the 40 to 50 basis point range.
In summary, our third quarter results were strong. And continue to demonstrate the progress we have made over the past few years, improving our resiliency, diversifying our revenues, and proactively managing the balance sheets. We will continue to rely on the same principals. We settle in client selection, conservative underwriting and a focus on the long-term performance horizon which gives us confidence as we navigate this environment.
We fully intend to preserve the optimal level of efficiency of our operations in this weak revenue environment, while we maintain the investments that we believe are vital to preserve the earnings power and the operational resilience y of our company.
With that, let me turn it over to Chris, to open the call up for the Q&A.
Thanks, Tayfun. [Operator Instructions] Marcella, please open it up for questions.
[Operator Instructions] Your first question is come from Ken Zerbe from Morgan Stanley. Your line is open.
Great. Thank you. In terms of your expense initiatives, just given that most of that falls to the bottom-line, is it possible that we see expenses down on an absolute basis in 2021?
Ken this is Greg. First off we provide 2021 guidance after our fourth quarter, earnings net call. We'll talk more about that. As we talk about our expense optimization plans, 200 million that we expect to be out by the end of first quarter, 75% of the actions necessary to accomplish that objective have already been completed.
So we're highly confident in our ability to take out that $200 million, by the end of the first quarter. And then we mentioned another 100 million to 150 million that will show up in 2022.
Once again we focused mainly on automation, investing in our technology platforms. So we're very confidence. But we'll provide guidance as far as our expense numbers as we get through the fourth quarter.
Yeah. I think Ken and the other point that I want to make about the program is, we stated that the composition is 80% to 20% between currently in savings and environment-related savings of 20%. But that environment-related savings number is really, how we see 2021. So the other lever that we have here is if things actually look worse or will be worse next year compared to our assumptions, we still will continue to adjust those numbers.
So we say that part of it is going to be variable. And it does have more potential, depending upon the economic environment. Obviously, our preference would be that the, be stronger. And we don't have to necessarily go back to that world. But we do have the availability.
All right, great. And just one follow-up, Tayfun you mentioned that you don't expect invest the excess cash, can you just help us understand like why not invest in it sounds like something very short-term securities with little risk that would generate a lot more than or at least a little more than cash returns?
Ken, we don't believe that the tradeoff between the small NII incrementality versus the market exposure is worth taking at this point. It really does not -- from your perspective, our ability to invest the money in the short-term, doesn't really add much to the long-term performance to the company. So, because we believe that, that cash is going to ultimately leave the company over time. So therefore we are more interested in shielding ourselves from a market-to-market exposure because the market volatility continues to be a concern for us related to all investments.
All right. Great. Thank you.
Ken Usdin with Jefferies. Your line is open.
Hey, thanks, guys. Good morning. A follow-up on the loan side. So obviously you guys have I think been more or fort rite than other about the declines in loans that you're expecting and the quality of the commercial book. Can you just give us some thoughts just as you look across the footprint of where, if at all, you see activity starting to change from a pacing perspective and at what point would you see the loan book especially the commercial side C&I starting to bottom out?
This is Greg. First off, on the loan side on commercial, look at our pipelines, we're seeing some growth in positive forward progress in the area of healthcare, telecom and technology would be two other areas that we're seeing some good growth. And also, the industrials would be the areas that we're most encouraged by as we look ahead here. So we feel pretty good. As we mentioned on the consumer side, we expect the growth 1% to 2% the next quarter and that business continues to perform well. So that's where I think we have the biggest opportunities.
Okay. Got it. And then in terms of the deposit side, you've got so good growth and you mentioned some opportunities to still re-price. What other offsets do you have on the right side of the balance sheet, if any to continue to roll down either the fixed term – fixed short-term borrowings, long-term debt footprint in addition to deposit pricing?
We don't really have a lot of long-term debt opportunities other than just running the maturity schedules at this point. So, you know, we've pretty much executed what was available to us. We're looking at some small items maybe bad debt we securitized in the past. But those are small opportunities, so there's not a whole lot remaining there.
Okay. And then last quick one, Tayfun you mentioned that you're not really interested in building the securities portfolio. Other banks have started to put some of their liquidity to work in contrast. Can you just walk through your philosophy on that and how you expect to just manage overall balance sheet size then if you are not – net reinvesting?
Again, as I mentioned, when can ask the question. At this point, we don't believe that the trade-off between incremental NII associated with margin investments and continuing to expose ourselves to an unattractive mark-to-market environment related to those investments is as attractive. So, at this point, we will continue to watch. Now, those decisions are made on a week-to-week, month-to-mouth basis. If you find opportunities, we will be in the market. But at this point, given what we know today, we are currently choosing to be on the sidelines.
Understood. Sorry, I missed that one.
Mike Mayo from Wells Fargo. Your line is open.
Hi, Mike.
Hey. I guess, I have a wow on the positive side and a wow on the negative side. So the wow on the positive side would be only 35 basis points of loan losses and lowest consumer charges off in 15 years. So that's quite noteworthy. But the wow on the negative side is, a negative provision seems like an outlier. And do you really want to set a tone at this stage of the cycle of taking a negative provision? I mean, you might be right, but you might be wrong. But we don't really know, how this is going to play out. So I guess, my questions are, you said if you had your downside scenario at 100%, that would be 1.3 billion of additional reserves. How much overlay do you have for that downside scenario now? That's number one. Number two, when you mentioned that there were commercial extensions, what does that mean? Is that delaying some of the inevitable? And you did say that loan losses would go up from year. And then third, just the whole tone perspective like it set the tone that that things are okay.
So, this is Tayfun. Let me take the first part of that and then I'll turn it over to Jamie for his comments. Look, I mean I think as you know at the end of the first quarter, at the end of the second quarter, we came out much more aggressively in terms of building reserves relative to the peers. And when you look at our coverage, it is 2.49% or 2.62% or 2.75%, we are still above the median levels of our peers. And internally obviously when we look at the risk profile of our loan book, we feel very good about it. And, two, we really did not take the cover ratio down. It's only from 2.50% to 2.49. And the balances obviously are lower at the end of the quarter, which have an impact.
In terms of rating of the base scenario, we actually increased the lowest wage of the base of the base scenario this and increase the wage of the scenario this quarter. So we are quite cognizant of potential downturns in the economy. But, look, I mean, the underlying profile, credit profile of our balance sheet and the outstanding balances resulted in a release. And we have to abide by certain accounting principles and do the right thing. So that's from my side. Jamie, any comments from your side?
Yeah, and Mike, thanks for the question. When we looked at the net provision, it really is an output. And when we break it down into the two inputs, the CECL reserve, the release was 116 million in the quarter. And as we said, it's driven primarily by the payoffs and paydowns in the commercial loan book. And as Tayfun mentioned, the economic outlook did improve during the quarter, both from unemployment and GDP perspective, which does lower our loss expectations in the portfolio.
But given the uncertainty in the environment of especially related to additional government support, we increased the weightings on the upside and downside in the scenarios from 10% last quarter to 20% this quarter. And those scenarios really have an asymmetrical profile, so it ultimately increases the required CECL reserve and essentially offsets the benefit from the improvement in the economic outlook.
And to your other question then, if we were to run a scenario where it's -- there are no upside or downside scenario and we just said 100% is base, then the reserve requirement would be 250 million less than what it is today. So to your point, the downside scenario does result in a higher CECL reserve than roughly 250 million or so range.
The other part of the question, I mean it's your job to work with the borrowers, try to bridge the gap between the pre and post-COVID economies, but when you have commercial extensions, I think that's where a lot of people are focused, do you accept that you extend -- you drop covenants, you looseen covenants, I don't really -- there's a whole litany of things that you can do to make the life for borrowers easier, in some cases, probably most cases that will make sense, but in some cases that might not make sense. So what are you doing when you mentioned commercial extensions earlier?
Hey, Mike, it's Richard, I'll take that one. It really is, as you described, working with the borrowers, trying to understand their cash flow needs, their cash flow availability, the collateral that's available that maybe we don't have as part of a security package. So it's really just reworking the transactions, making sure that we're being thoughtful about things like maturity dates and extending maturity dates so that or reamortizing transactions with the cash flow. So it's really part of the workout process to make sure that we can be as accommodative as we can within the risk appetite support our customers and minimize losses over the long-term.
All right. Thank you.
Matt O’Connor from Deutsche Bank. Your line is open.
Good morning. Sorry if I missed it, but did you guys say, how much of the 200 million of savings is in the third quarter runrate?
In the fourth quarter run rate or third quarter?
I guess…
There's nothing in the third quarter and large majority of the savings will come in the first quarter of 2021.
Okay. So not now and most of the 200 will be in 1Q on average and then in the second quarter.
Correct. That's correct.
Okay. And then looking ahead to the kind of -- so most of that has already been identified I think you said in your earlier comments. And then looking ahead to the $100 million and $150 million, remind us what some of those drivers might be and could identified?
The opportunity is great, really focuses on our investments in technology, artificial intelligence. You look at our operations, we've done a really good job of being very efficient, but we still have more opportunities over there to reduce our people-related costs and really automate a lot of functions and processes and create more resiliencey and high quality outcomes. So we are very focused on process reengineering, automation. We've identified those process opportunities. We've got teams working aggressively on them. And we fully expect to achieve those objectives going forward. That will show up more in 2022 than it will in 2021 and give the time it takes to put some of these process, these re-engineering exercises in place.
Okay. Thank you.
Scott Siefers from Piper Sandler. Your line is open.
Good morning guys. Thanks for taking my question.
Good morning, Scott.
Hey. Appreciate you taking the question. You guys are one of the few guys that have offered a charge-off assumption for next year and you said it a few times well below a percent. So, I guess in that vein, curious how you guys are thinking about how this cycle will end up trajecting? In other words, will we be taking care of most of the losses from this cycle next year? Or will they bleed into 2022 at a higher rate, as well?
And I guess part of that question is because you guys have such a strong reserve that if losses indeed stay well below a percent, I guess I'm curious under CECL, at what point it becomes more challenging even to substantiate today's reserves? In other words, you don't just look adequately reserve, but potentially very over reserved. So I'm just curious about how you just think about those dynamics?
There's a lot of moving pieces, Scott, as you think about what's occurring right now with the amount of stimulus that was thrown at on the pandemic, whether we get the CARES Act next iteration of that, how's that going to be distributed with respect to PPP potential, consumer stimulus opportunities. So, there's a lot of variables involved here.
But what we have visibility of right now as you think about the consumer side. We can see forward looking our roll rates, and we think we're in pretty good shape. The consumers are in a pretty good shape as we get into the – until we get into the second half of next year and it’s going to depend on the variables I mentioned and some of the actions that are being taken. So more to come there, that's probably more of the second half of 2021, and we start to see those losses creep up if we don't get next iteration in the CARES Act.
On the commercial side once again, a lot of challenges with respect to how we think about the sector because it really gets back to when do we see a vaccine out there? How effective is it? How is it being distributed certain parts of the economy are opening reopening quicker than the other parts of the economy? Southeast is reopened quicker right now. We’re seeing positive outcomes there from a production standpoint. So this is a lot going on right now, which you can show yourself, because that's going to be very cautious. We came out with aggressive reserve levels. We're going to be very thoughtful and mindful about how we map our environment looks going forward and expectations are. And what's happening with some of the [indiscernible]. Jamie if you want to give more color on it.
Thanks for the question. As we look out at 2021 and we say well below 1%, that for us our models would indicate loss rate in the 70 basis points to 80 basis points range and that's as we sit here today with obviously a lot of uncertainty between the path of the virus and the path of stimulus. And when we look at and analyze a lot of data, especially consumer portfolios as Greg said a little bit easier to predicted model, but we get through all the data, really the simple answer when you pulling it out down as that if you were delinquent going into the pandemic you're going to be delinquent coming out.
And if you're healthy going in, you're going healthy coming out. And that's what we're seeing and internally we call it the wind-chill effect. So if it's 50 degrees outside and it could be you get a pretty big tailwind and it feels like it's 30 degrees outside really from an un unemployment perspective, the wind-chill was reported numbers of 13% and now we're sitting around 8%. But the wind-chill, because of all of the stimulus programs and hardship relief, it's actually behaving at a 3% level. And that's why you see such good loss rates from us and our forecast assumption for next year has some stimulus round two backed into it. But if we get more than what we've assumed then those numbers could continue to improve from there.
All right. That's perfect. Thank you guys very much for your thoughts.
Gerard Cassidy from RBC, your line is open.
Good morning, everyone.
Good morning Gerard.
Thanks. Can you share with us, I know you touched on the capital position in your prepared remarks and your CET1 ratio now is over 10%. Can you remind us what your ideal ratio would be in terms of the amount of capital you want to carry to run the company?
And then second, obviously the Fed has suspended buybacks for all the large banks including your own. What's your view that once the gate is lifted, assuming it will be, how quickly would you go back into re-purchasing your stock?
Gerard, we are at the 10.1% to 4% of CET1 today. I suspect as we look ahead by the end of the year, we will be approaching 10.5% likely and we entered this year coming out of 2019 with a capital ratio target of 9.5%. And that was actually elevated relative to our 9% target just about a year ago before that and we think that even then, back in 2017 and '18, we were making comments that we can run this company with an eight handle capital ratio, but we are very cognizant of where the peers are and the regulators are? So we said okay, 9% probably.
And then as we saw the probability of a recession going up, we lifted back to 9.5%. So from 10.5% to 9.5% assuming that we look ahead to a normalized economy, that's 1% of capital that we either consume by growing loans or we return to shareholders. Tough to predict the timing of the regulatory change in their current position, but I suspect that when we see the results of this CCAR run and when we find out what the regulators are going to do. If the gate opens, I don’t why it would take us a long time to go back to a buyback scenario environment.
Very good. And the follow-up, your comments about extending out on the securities portfolio or the cash portfolio, your preference not to do that is very understandable. Would that suggest to us that you are all thinking that interest are likely to rise to 11 [ph] and we'll see a positive yield curve?
So our perspective on the interest rate outlook is that we will be in this environment for two, three years. I think it's hard to disagree where the market is pricing the next rate moves. Our concern about -- I mentioned, our concern around not exposing ourselves to a market-to-market. We're also very concerned that in the current environment, the spreads do not reflect the actual risk-return profiles, but they are very skewed by the Fed's aggressive actions. And they turn the credit spreads upside down. And in this environment with that kind of uncertainty, despite the fact that we are expecting this low rate environment to continue for a while, we're choosing to be on the sidelines.
We also expect that down the road here, whether it's going to happen in 2021 or 2022, once the sort of Fed starts either stepping back a little bit, slowing down their aggressiveness and once the market builds a certain level of expectation, whether it's about inflation or about the other end of this rate cycle. The yield curve will start to steepen. We are not necessarily expecting that to happen in the near-term. So a combination of the fact that portion of this cash flow -- cash will leave the bank and also we believe that weighting out until a better investment environment is the better alternative for us. That's why we're sitting out.
Very helpful. Thank you.
Saul Martinez from UBS. Your line is open.
Hey, good morning. What weighted average remaining maturity are you using in calculating your CECL results?
I’m sorry. Can you repeat that question again?
Yeah. What is the weighted average remaining maturity of your loan book that you are using as the basis for your CECL calculation?
I don't necessarily have a number ready, sort of, to give you right now. But I suspect that number is between three and five years.
Okay. So -- and I would think a portion of your C&I book is much shorter because it is, you know, it's based on contract maturity. You do have a fair amount of revolvers -- annual revolvers. If it is in that -- I mean, is one way to think about it than, sort of, what's implicit in the loss content. If you were to use a four years [indiscernible] it would imply that, you know, the 2.5% reserve ratio, implies an average annual loss ratio or charge-off rate is about 60 basis points. Is that -- and you'll be higher than that during the peak and maybe lower than that when the credit cycle, kind of, -- really goes back to normal. Is that, you know, a fair way to think about it? Because three and five years, you know, would have -- depending on what number you use, it does have a pretty material difference in terms of what the underlying assumption is for annual loss content. So, I guess, I mean, is that a good way to think about, sort of, what's interesting, in your estimate?
I think, so I think directionally your comment is logical. If you look at page 13. And look at the difference -- that portfolio is within the commercial book. You see that, you know, the commercial mortgage loans, there's a coverage ratio for that one to 3.4%, whereas the -- for the C&I book, it's 2%. It appears, again, your question, and the logic that you're using is reasonable, it gets a little bit skewed in this environment because you know, the we are within -- for the commercial book the bigger impact comes from the reasonable supportable period, which is driven solely by the economic outlook. So the reason why I'm hesitating to say you are correct, is because that relationship does not necessarily readily fail translate to a reasonable annual loss content. So I just want to make that comment on that.
Got it. You know that well understood. But I guess my point is, that the weighted average the main maturity is arguably the most important input into this calculation. And this isn't a comment on two-thirds of the general comment. And we you know, we received virtually no information on that from any bank. So it is, you know, it is a little bit of a disconnect that. I think..
We can actually -- important, we can provide you that information. And we can do that -- in a couple [ph] for your basis, which will give you a little bit flow of content.
Yes. One additional question. I want to ask on expenses. I mean, 200 million is almost 5% of your current expense base. And I think in the past, you guys had talked about, you know, the vast majority of that flown into the bottom-line. And then you have the additional expense saves. Is this fair to say we should when all said done expect your run rate expenses to be lower than what they are now? And can you just give us a sense as to the timing, I know you're not going to get one -- you're going to wait to get 2021 guidance, but you know, next quarter you see it costs a little bit but [indiscernible] first quarter has some seasonality. So we're likely pushing closer to 12 billion and expenses going 11 [ph], by the first quarter, potentially, maybe I am wrong. But, you know, is my logic, is right that we should expect expense to be lower on a dollar basis at some point in 2021 versus where we’re at now. And any color on timing and magnitude of that?
So, we will maintain our discipline and not give you color on 2021 today.
All right.
But what goes against that $200 million expense save is going to be some natural built-in inflation, whether it's related to merit increases or other compensation-related inflation. And, two, is going to be investments in our company. We will continue to make investments in our company. And the technology line item for all the right reasons is going up. What we feel good about it, though, is that we have now established a discipline the company, so look at those investments that are technology-related with a very disciplined return requirement. So, whatever the built-in expense growth is, is not going to be driven by head count increases.
Right.
It's going to be driven by very reasonable investments in our business that have a return profile that we all feel comfortable with and that we believe is prioritized based on our corporate objectives.
Yeah, okay. Helpful. Thank you very much.
Erika Najarian from Bank of America. Your line is open.
Hi. Just one follow-up question, I know we're almost over time. As we think about that adjusted NIM of 255, assuming no impact from PPP and also, assuming a static balance sheet, how close are we to the trough?
I believe we are close, Erika. As we look ahead, we believe that we have now a level of stability that we're comfortable with. Could it be within 2, 3, 4 basis points? Yes, it could be. And obviously the margin itself today is probably less meaningful of the metric than it has ever been because it's the influence of the cash balances that we're sitting on.
But I do believe that with an assumption that we will live in this highly liquid environment for a while, we are now pretty close to achieving stability here even if we sort of maintain the level of cash. And the faster we get out of the cash position, the faster we're going to start moving towards that 3% number that we believe are natural NIM stands out.
But what gives us confidence there, when you think about it, we have $35 billion in the investment portfolio. Our sort of normal level of earning assets is about $150 billion. So, and we have -- I believe it's going to take us, two, three years to get down to where our peers are in their investment portfolio in this low rate environment.
We have a huge advantage there. And then we have a significantly longer derivative portfolio compared to most of our peers. Those two give us a pretty reasonable confidence that once we get out of this liquidity environment, we will actually show you a pretty decent margin performance.
Got it. Thank you.
Bill Carcache from Wolfe Research. Your line is open.
Good morning. Thanks for squeezing me in. If we set hedging benefits aside, could you discuss the impact of rates at the long end of the curve remaining low, how much are you receiving each quarter on loan and securities portfolio paydowns from your back book? And what's the yield differential between what's coming off and what you're putting on across products that should also give us a sense of how much you could benefit from curve steeping?
Yeah. So, on the investment portfolio, you have seen our yields went down by 7 basis points and we're not investing anything. And the cash flows are reasonably small, so that's the step down in portfolio yields could be relatively small compared to that's what I will say about that.
In terms of the other fixed portfolios, in the auto portfolio, which is really the portfolio that is growing right now, we are probably the current coupons are probably about 20 basis points or so below the portfolio yield. So when you think about that, that really is the portfolio, loan portfolio, that's the only one that's exposed to a fixed rate repricing.
Thanks, Tayfun.
Yep.
John Pancari from Evercore. Your line is open.
Good morning. Just a couple on the credit front. Do you have what you're criticized or classified assets did the third quarter?
Yeah. Hey – it's Richard. We had a slight uptick in the third quarter we'll give you the details in the Q. It was – it was really around the things that you would imagine across leisure as the cycle continues to extend.
Okay. All right. And then the other thing on the credit front, but it's not on the loan side, you – I know commercial mortgage back securities make up a larger percentage of your securities portfolio than peers. And I know you indicated that Tayfun, you indicated that commercial real estate is particularly vulnerable. Do you have any concerns around how that credit dynamic within commercial real estate could impact your bond investments?
We don't, I think we've – the commercial real estate the non-agent commercial – I'm sorry, non-agency commercial real estate book that we have is smaller portion. It's about $3 billion or so in the portfolio. And it's all superseding. So the built in credit content of that portfolio does not give us any concern.
And John, it's Jamie, I guess since I bought a lot of those bonds, I can tell you that I keep an eye on them in the delinquency rates, like high single digits in the book. And the credit enhancement is approaching 40%. So we are a long way away from having any credit issues in that portfolio it.
All right, Jamie. Thank you. That's helpful. If I can ask just one more question, I know you mentioned you're prioritizing investments in your asset and wealth management, including acquisitions, and we actually have seen some asset manager deals, larger ones, in the industry recently. Is that something you will consider as a potential acquisition of an asset manager for your business there?
Yeah. This is Greg. First off, as I mentioned in my prepared remarks, we’ve invested heavily in our fee businesses and registration of our fee businesses and diversification of our fee businesses. That's going to shoot well, wealth and asset management is one of the areas that we're very focused on with respect to additional opportunities both from the acquisition of an entity of nature speaking up or account NIM in that business, and as you've seen, that business has grown really well for us over the years, up 10% sequentially. So we'll continue to look for those opportunities. And, yes, that will be included in that potential opportunity.
Anything that was slightly larger than our size? So appetite, so we just read that one, right?
Yeah, got it. All right. Thank you, appreciate.
Christopher Marinac from Janney Montgomery. Your line is open.
Excited similar question that Jonathan Callie asked about classified and criticized. So when you have the commercial extensions, do those get picked up a special mention? Or there is something else has to happen before those would migrate?
It's Richard again. If the two words are separate, we think about, when we think about workouts. The rating is the rating and then the workout strategies to workout strategy. Now, I think when we think about things that impact or reduce charge offs, clearly that's going to be in the criticize category, whether it's special mention or substandard. But we don't have the details about around the breakup, between those two. Remember, if you think about as Tayfun mention that is a potential weakness. And there's a ton of judgment of what a potential weakness looks like. It just effectively means higher probability of default, substandard, again another step down in terms of the fault probability. But again, that's a place where we're mitigates like collateral starts to come into play.
Great. So some of the extensions could be there now, but others could transition later. It's just …
Absolutely. And as I said, before, we start thinking about extensions. We're also looking at structural and other mitigates like structural enhancements, guaranteed, collateral. There's other ways we can work with a borrower to help them and protect the day.
Got you. Sounds good, Richard. Thank you very much for the insight. Thanks for all the information this morning.
Thank you.
Your last question comes from the line of Vivek Jain from JPMorgan. Your line is open.
For squeezing me in just a couple of questions. Jamie, I think you mentioned if you're healthy going in, you'll be healthy going out, we're referring to consumers, corporates. And how are you thinking about, what the pandemic does change in the economy. And the way things work?
Yeah, I was referring to the consumer portfolio, where we have, so much me of information. And then we are just trying to make it as simple as possible. No matter how you slice and dice the data. The bottom line is and there was such a big focus on hardship related and hardship programs and deferral ways all of those things.
And no matter how you slice and dice the data. The bottom line is, you know, and there was such a big focus on hardship, relief and hardship programs, and re-default rates, referral rate, all of those things.
But no matter how you slice it, it really just comes down to something as simple as you're coming in, you're going to be helping coming out, from a consumer perspective. And that's why that consumer performance really does reflect, frankly, credit losses and credit projections, as if unemployment weren't 3%. So we feel very, very good about that.
I think, to your point about, how this ultimately plays out in the economy, it really is the competing forces of the path of the virus versus the path of further stimulus. So if we get an additional round of stimulus, we think the loss curves continue to flatten, perhaps elongate.
But again, the peak charge-offs, aren't going to be all that high, relative to the great financial crisis, especially for a bank like the third. Where we've put a lot of thought and effort over the last five years to position the company, as well as we have so that we think our loss rates are a fourth of what they were in the great financial crisis. So we feel good about that.
So that means even with, if you think post pandemic, even if un unemployment runs at a higher run-rate, you think you'll be fine is what you're assuming?
We do, but again the stimulus and what that looks like will certainly be a big swing factor in those loss projections. So, for example, on the consumer side, we also are in different model efforts where we took out stimulus altogether, and so, we modeled that as a 20 basis point change in our outcomes if they are going to be no stimulus, so just to put guardrails on what these outcomes might look like.
One more, if I may, completely different topic. What are you seeing in terms deposits on the pure end basis were flattish, but more if you think about consumer and corporate deposits, Tayfun, Jamie, what are you all seeing in terms of the trends there? Slowing static? Still growing? Any color on that?
Vivek, we are seeing stable consumer deposits. They're not going down, but we're not seeing any noticeable increases in consumer deposits at very healthy levels there. But we are not seeing further increases. The commercial balance has continued to pick up and I suspect that will in the fourth quarter. It's an election quarter. And there's a lot of hesitancy on the corporate side to do anything different at this point. I do believe that come early 2021, hopefully we will see some more emerging signs. It’s hard to predict yet which side it will go. But that will be dependent on the economy. So for the foreseeable future, we see maybe small upticks in corporate balances and stable consumer balance.
Thank you.
There are no further questions at this time. I turn the call back to Chris Doll for closing remarks.
All right. Thank you all for your interest in Fifth Third. If you have any follow-up questions, please contact the IR department.
This concludes today's conference call. You may now disconnect.