Fifth Third Bancorp
NASDAQ:FITB
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Fifth Third Bancorp
Earnings Call Analysis
Q3-2024 Analysis
Fifth Third Bancorp
In the third quarter, Fifth Third Bancorp reported earnings per share of $0.78, or $0.85 excluding certain items, surpassing previous guidance. The bank demonstrated strong fundamentals with a return on equity of 12.8%, which is the best among competitors, reflecting their resilience in a dynamic economic environment. The adjusted efficiency ratio improved to 56.1%, illustrating enhanced operational efficiency.
Tim Spence, the Chairman and CEO, emphasized the bank's commitment to consistent strategic growth investments which have fostered long-term organic growth independent of macroeconomic conditions. Consumer households grew by 2.7% year-over-year, and retail deposits surged nearly 16% year-over-year, driven largely by market expansion in the Southeast, where the bank also plans to open 19 new branches in the upcoming quarter.
In its commercial banking sector, Fifth Third saw a remarkable 20% sequential increase in middle market loan production, marking its highest output in five quarters, bolstered by a 30% year-over-year increase in the Southeastern markets. Furthermore, the Wealth and Asset Management business achieved record revenues, a notable 12% year-over-year growth, and total assets under management reached $69 billion, up 21% from the previous year. These results underscore the solid positioning of Fifth Third across vital sectors.
The bank's profitability allowed it to return capital to shareholders through a 6% increase in the common dividend to $0.37 per share. Additionally, a $200 million share repurchase program was executed, with future repurchases expected to increase to $300 million in the fourth quarter, contingent on loan growth. The CET1 ratio stands strong at 10.8%, well above the regulatory minimum, indicating solid capital management.
Looking ahead, Fifth Third has optimistic projections for net interest income (NII), with expectations for a 1% sequential increase in the fourth quarter. NII growth is anticipated due to lower deposit rates and benefits from fixed-rate asset repricing, despite expectations for slight yield compression. The bank correctly noted that loan production stabilized, and fourth quarter adjusted non-interest income is forecasted to rise by 3% to 4%, driven by strong performance in capital markets.
In terms of credit quality, the bank's net charge-offs were 48 basis points, slightly better than expectations, while early-stage delinquencies remained low at 24 basis points. The bank anticipates similar net charge-offs in the fourth quarter, showcasing its ability to maintain a balanced approach in a potentially volatile economic landscape. The management expressed confidence in handling external challenges, including recent natural disasters.
Fifth Third aims for higher loan growth, projecting stability in loans for the fourth quarter, with expectations of market-level growth in the coming years. Executives indicated a focus on maintaining competitive rates and enhancing customer relationships to capture market share. The bank remains well-positioned to capitalize on economic recovery and expects to achieve record results in net interest income by 2025, barring major disruptions.
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Thank you for standing by. My name is Jay, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fifth Third Bancorp Third Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions]
I would now like to turn the conference over to Matt Curoe, Senior Director of Investor Relations. You may begin.
Good morning, everyone. Welcome to the Fifth Third's Third Quarter 2024 Earnings Call. This morning, our Chairman, CEO and President, Tim Spence; and CFO, BryanPreston will provide an overview of our third quarter results and outlook. Our Chief Credit Officer, Greg Schroeck, has also joined for the Q&A portion of the call.
Please review the cautionary statements in our materials, which can be found in our earnings release and presentation. These materials contain information regarding the use of non-GAAP measures and reconciliations to the GAAP results as well as forward-looking statements about Fifth Third's performance. These statements speak only as of October 18, 2024, and Fifth Third undertakes no obligation to update them. Following prepared remarks by Tim and Bryan, we will open up the call for questions.
With that, let me turn it over to Tim.
Thanks, Matt, and good morning, everyone. At Fifth Third, we believe great banks distinguish themselves not by how they perform in benign environments, but rather by how they navigate on certain ones. Our focus on stability, profitability and growth in that order has served us well in this dynamic operating environment and continues to produce strong and predictable results.
This morning, we reported earnings per share of $0.78 or $0.85, excluding certain items outlined on Page 2 of the release, exceeding the guidance we provided in our second quarter earnings call. We produced a return on equity of 12.8% the best among peers who have reported thus far and the most stable on a trailing 12-month basis. Our adjusted efficiency ratio improved to 56.1% in the third quarter. Headcount declined 1% year-over-year despite continued investments in our growth strategies. We achieved sequential positive operating leverage for the second consecutive quarter without the need to expand shareholder capital on an investment portfolio restructuring charge and are in a position to achieve positive operating leverage on both a sequential and the year-over-year basis in the fourth quarter.
Despite changes throughout the year on interest rates, economic activity and market demand, as we come into the home stretch for 2024, I am pleased to say that Fifth Third should deliver NII, fees, expenses and credit costs within the full year guidance ranges we provided back in our January earnings call.
Before I hand the call over to Bryan to provide additional detail on our financial results and outlook, I would like to take a minute to highlight the ways in which our strategic growth investments, which have been consistent over several years are providing long-term organic growth that is not macro environment dependent.
In our consumer bank, consumer households grew 2.7% over the prior year, punctuated by 6% household growth in the Southeast. The release of the FDIC's annual summary of deposits during the quarter provided an additional means to benchmark our performance. For the second year in a row, Fifth Third was #1 among all large banks in year-over-year retail deposit growth, measured on a cap branch deposit basis. We maintained or improved our market position in every market where we compete. In our Midwest markets, we maintained our #2 overall position behind JPMorgan. In our Southeast markets, we maintained our #6 overall position and significantly closed the gap to our top 5 goal. We grew retail deposits nearly 16% year-over-year and gained meaningful market share in 14 of our 15 focused MSAs in the Southeast.
We will open up 19 de novo branch locations in the fourth quarter, and plan to accelerate the pace of openings through 2028, at which time we will have nearly half our network of more than 500 branches in total in the Southeast.
In our commercial bank, we continue to expand our middle market presence and to invest in commercial payments. Over the past 12 months, we have increased relationship manager headcount by over 20% in our Southeast and expansion markets including opening commercial banking offices in Birmingham, Kansas City and in the Central Valley. Third quarter middle market loan production was the highest in 5 quarters, led by the Southeast markets, which were up 20% sequentially and over 30% over the prior year.
Our Commercial Payments business grew net fee equivalent revenues by 10% year-over-year in the quarter, and we processed $4.3 trillion in dollar volume. Newline in our managed service offerings continue to lead the way in terms of growth that is delinked from our balance sheet. Over 40% of all new commercial payments relationships added this year have been payments led with no credit attached.
In our Wealth and Asset Management business, we achieved record quarterly revenues growing by 12% year-over-year. Total assets under management have grown $12 billion in the past year or up 21% to $69 billion. Our Fifth Third Private Bank, Fifth Third Securities and Fifth Third Wealth Advisors business units, all continue to generate strong performance.
Turning to capital. Our strong profitability and disciplined balance sheet management are providing growth capacity and the opportunity to increase capital return to shareholders. This quarter, we increased our common dividend by 6% to $0.37 per share and executed $200 million in share repurchases. Even with these actions, our CET1 ratio increased to 10.8%. This will allow us to increase share repurchases in the fourth quarter to $300 million with the potential to increase further depending on the level of loan growth realized during the quarter.
Looking ahead to the remainder of the year and the beginning of next, while we feel more optimistic today about the near-term outlook for the economy, we also recognize that cross currents, including reversals and interest rate rallies, volatility in job reports, stickiness and inflation and geopolitical uncertainty could produce a wide range of potential economic outcomes. We will continue to manage Fifth Third with a focus on stability, profitability and growth in that order and to stay liquid and conservatively positioned while investing with the long-term mind.
Lastly, I'd like to take a moment to express our sympathies to all those who have been impacted by Hurricane Helene and Hurricane Milton. We recognize the hardships that arise from such devastated events. And I would like to also thank all our employees who have answered the call to support our customers and communities at this time. The day since the hurricanes, you worked tirelessly to reopen branches and check in on customers. We staffed the Fifth Third financial empowerment bus to enable those who lost power and Internet access to apply for FEMA disaster relief. Your dedication to serve in the face of these natural disasters is inspiring. Thank you for living our core value.
With that, I will turn it over to Bryan to provide more detail on the quarter and our outlook.
Thanks, Tim, and thank you to everyone joining us today. We're pleased that our third quarter results once again demonstrate the strength of our company. Our well-positioned balance sheet and diversified fee income streams drove 3% sequential adjusted revenue growth. That revenue performance, combined with our ongoing expense discipline, resulted in 5% sequential pre-provision net revenue growth in the third quarter on an adjusted basis.
As Tim mentioned, our profitability remains strong which allowed us to continue to accrue capital while we're purchasing shares and raising the quarterly common dividend 6%. Our CET1 ratio grew to 10.8% at the end of the quarter, and our tangible book value per share inclusive of AOCI increased 14% compared to June 30, and 47% from a year ago.
Highlighted on Page 2 of our release. Our reported results were impacted by certain items including costs related to the Visa MasterCard interchange litigation and some severance recognized during the quarter as we continue to work to drive efficiencies and automation. Net interest income for the quarter was over $1.4 billion and increased 2% sequentially and net interest margin improved 2 basis points. Increase yields on new loan production were the primary driver of this improvement and more than offset the impact of increased interest-bearing core deposit costs, which were well managed and up only 2 basis points compared to the prior quarter.
With the Fed funds rate cut at the end of the quarter, in September, we experienced our first month-over-month decrease in interest-bearing core deposit costs during this rate cycle. While total average portfolio loans and leases were flat sequentially, we are seeing some signs of life. Loan production rebounded for both Middle Market and Corporate Banking, with strong contributions from the Georgia and Chicago regions as well as the energy and TMT verticals.
For the commercial portfolio, average loans decreased 1% primarily due to increased pay downs and softness in revolver utilization, which declined 1% during the quarter to 35%. Average total consumer portfolio loans and leases were up 1% from the prior quarter, primarily reflecting an increase in indirect auto originations, which continued to be a significant contributor to our fixed rate asset repricing. During the quarter, we saw a 200 basis points of pickup on the front book, back book repricing in this portfolio.
Diving further into deposits. Average core deposits were up 1% sequentially driven by higher money market balances, offset by a decrease in savings and CDs. This core deposit balance performance, combined with our well-timed long-term debt issuance during the quarter has allowed us to pay down higher-cost short-term wholesale borrowings. As a result, our rates paid on total interest-bearing liabilities decreased 1 basis point sequentially. Our current focus remains on prudently managing deposit costs as we have officially entered the rate-cutting cycle. Since mid-2023, we have been increasing our testing of price sensitivity on our deposit book to be well prepared for this phase of the cycle. We remain confident in our ability to manage liability costs to drive net interest income performance in the fourth quarter and beyond.
Demand deposit balances as a percent of core deposits were 24% during the third quarter, down 1% from the prior quarter. This level is consistent with our expectations from July, and we expect DDA mix to stay around 24% for the remainder of the year. By segment, average consumer and wealth deposits were stable sequentially, while commercial deposits increased 3%. We ended the quarter with full Category 1 LCR compliance at 132% and our loan to core deposit ratio was 71%, down 1% from the prior quarter.
Moving on to fees. Excluding the impact of the security gains and the Visa total return swap, adjusted noninterest income increased 2% compared to the year ago quarter. As Tim mentioned, our Commercial Payments and Wealth Businesses delivered strong fee results with both achieving double-digit revenue growth over the prior year driven by our sustained strategic organic growth investments in products and sales personnel.
In Commercial [ payments ], revenue increased 10% as we continue to acquire new clients and traditional treasury management products our managed service offerings and in NewLine.
In wealth, our AUM increased to $69 billion, up 21% over the prior year, driven by strong inflows from Fifth Third Wealth Advisors and market performance. Fees of $163 million this quarter were a record high led by strong transactional activity at Fifth Third Securities and the fee benefit from the AUM growth. Our Capital Markets business rebounded this quarter as bond issuance and trading as well as rate hedging activities picked up. Fees grew 9% over the prior year, also led by our [indiscernible] Capital Markets business. The security gains of $10 million were from the mark-to-market impact of our nonqualified deferred compensation plan, which is more than offset in compensation expense.
Moving to expenses. Excluding these items noted on Page 2 of our release, our adjusted noninterest expense was up 3% from the year ago quarter and increased 2% sequentially, primarily due to increases in performance-based compensation due to the strong fee generation, the impact of the previously mentioned nonqualified deferred compensation mark-to-market and continued investments in technology, branches and sales personnel.
Shifting to credit. The net charge-off ratio was 48 basis points, slightly better than our expectations from early September and down 1 basis point sequentially. Commercial charge-offs were 40 basis points, down 5 basis points sequentially and consumer charge-offs were 62 basis points, up 5 basis points from a seasonally low second quarter. Early-stage delinquencies 30 to 89 days past due decreased 2 basis points to 24 basis points which remained near the lowest levels we have experienced over the last decade. NPAs increased $82 million during the quarter, and the NPA ratio increased 7 basis points to 62 basis points, in line with our 10-year average and remains below the peer median level.
Commercial NPAs increased $60 million from the prior quarter, within our C&I portfolio, NPAs increased $20 million due to increased inflow activity, which given the nature of the commercial business will be uneven from quarter-to-quarter.
On a year-over-year basis, C&I CPAs are down $7 million. Our CRE portfolio continues to perform well with no net charge-offs during the quarter and an NPA ratio of only 46 basis points. The increase in our commercial mortgage NPAs is related to a single senior living credit in our owner-occupied portfolio. Consumer NPAs increased $20 million from the prior quarter. Approximately half of this increase was driven by a recent change in policy related to our consumer nonaccrual processes to better align our policies across asset classes and primarily enacted our return to accrual timing for loans that are paying in full and current.
Overall, we are not seeing any broad credit weakening across industries or geographies. From a credit perspective, we do not expect Hurricane Helene to have a material impact on losses, and we are continuing to assess the impact of Hurricane Milton.
Our ACL coverage ratio increased 1 basis point to 2.09% and included an $18 million reserve build. We continue to utilize Moody's macroeconomic scenarios when evaluating our allowance and made no changes to our scenario weightings.
Moving to capital. We ended the quarter with a CET1 ratio of 10.8%, significantly exceeding our buffered minimum of 7.7%, reflecting strong capital levels. Our pro forma CET1 ratio, including the AOCI impact of the securities portfolio is 8.7%. We expect continued improvement in the unrealized losses in our securities portfolio given that 59% of the AFS portfolio is in bullet or locked out securities, which provides a high degree of certainty to our principal cash flow expectations. Assuming the forward curve is realized, approximately 24% of the AOCI related to securities losses will accrete back into equity by the end of 2025, increasing tangible book value per share by 6% before considering any future earnings, 61% of the securities-related AOCI should accrete back to equity by the end of 2028.
During the quarter, we completed $200 million in share repurchases which reduced our share count by 4.9 million shares. As we assess our capital priorities, we continue to believe that 10.5% is an appropriate near-term operating level.
Moving to our current outlook. We anticipate continued growth in NII and NIM during the fourth quarter with NII up 1% sequentially, reflecting the impact of lower deposit rates and the continued benefit of fixed rate asset repricing and partially offset by the decrease in yield from our floating rate loan portfolio. This outlook assumes a 25 basis point cut in November and a 30 basis point cut in December. We would not expect any change to this outlook if fewer rate cuts were to occur. We expect average total loan balances to be stable to up 1% from the third quarter with middle market and auto production offsetting mixed demand in other asset classes. Fourth quarter adjusted noninterest income is anticipated to rise 3% to 4% compared to the strong third quarter largely due to a continued rebound in capital markets revenue and continued growth in commercial payments. Additionally, we expect fourth quarter TRA revenue to be $10 million down from $22 million in the fourth quarter of 2023.
Fourth quarter total adjusted noninterest expenses are expected to be stable compared to the third quarter as the increases in revenue-based compensation and the investments in branches and technology are largely offset by efficiencies achieved in other areas. Fourth quarter net charge-offs are projected to be similar or slightly down from the third quarter. Given the expected increase in loans during the fourth quarter, we anticipate an ACL build of $20 million to $40 million, assuming no major change to the economic outlook. We expect to deliver positive operating leverage in the fourth quarter on both a sequential and a year-over-year basis, and our PPNR guidance for the full year remains in line with our guidance from back in January. Our net interest income trajectory exiting the year continues to position us for record results in 2025, assuming no major economic or interest rate outlook changes.
Finally, moving to capital. With our consistent and strong earnings, we now expect to increase our share repurchases in the fourth quarter to $300 million, with potential further repurchases depending on the level of loan growth throughout the quarter. In summary, with our well-positioned balance sheet, growing revenue streams and disciplined expense and credit risk management, we are set to generate strong and stable capital accretion, top quartile profitability and long-term value for shareholders, customers, communities and employees.
With that, let me turn it over to Matt to open the call up for Q&A.
Thanks, Bryan. [Operator Instructions]
[Operator Instructions] Your first question comes from the line of Scott Siefers of Piper Sandler.
I was hoping you might be able to discuss sort of -- just the main puts and takes you see in the fourth quarter NII guide. In particular, curious about how you're thinking about the further trajectory of deposit betas and sort of how that evolves over time, given that you've had -- you've been very transparent about it and have an optimistic outlook there as well.
Yes, absolutely. We continue to feel really good about the trajectory of the NII as well as the performance on the deposit front. As you know, we've spent a lot of time being prepared for this point in the cycle and things are playing out basically as we expected. When we look at both our results and peer results, the natural transition that you would expect is broker deposits, wholesale funding borrowings to start to come down. That's what we're seeing at the same play out. And then also then to start to see when that has been fully realized, that movement in the beta. And that's exactly what we're seeing from our standing the competition.
For us, $35 billion of the index deposits, we were able to get the beta out of those as expected. To date we're about in the mid-40s in terms of the betas that we've achieved since the 50 basis point rate cut. And we still have $13 billion, $14 billion of CDs that will be approaching maturities about 75% of our CD portfolio matures between now and the end of the first quarter as well as some additional promos that we'll see maturities on, and we'll continue to grind through the deposit costs in other areas of the book.
So we continue to feel really good about that as the trajectory plays out.
And then the fixed rate asset repricing that benefit continues to be a sequential tailwind for us, and that's going to continue into the fourth quarter of next year. And that will be a big driver of the increase in NII from here.
Okay, perfect. And maybe looking out a little further. I know you've discussed generating record NII in 2025. Would love to hear any updated thoughts there, I guess, including what kind of lending rebound might be required to achieve that? It sounded like maybe a bit more optimistic on what lending demand might look like given some of the signs of life you referred to in your opening remarks.
Yes. We are seeing some more activity there. We don't need heroic loan growth to deliver record NII. The -- how the NII is delivered is obviously going to be very environment dependent. So shape of the curve is going to matter. We do expect to start to see some tailwinds on the loan growth side given what we've seen. The decreases from a commercial perspective, we think for the most part are behind us, and we're seeing nice tailwinds in the consumer businesses. That will be a big driver of how we transition into loan growth from here. So we would like to see a little bit of loan growth. That certainly would be helpful in terms of delivering that record NII, but we feel a bit about the trajectory from here.
Your next question comes from the line of Gerard Cassidy of RBC Capital Markets.
Can you guys -- I posed this question to one of your peers yesterday and when I framed it out, part of the response was it was a rosy outlook. So I'll give that as a caveat to you. But can you share with us I'm curious, and we're not -- I'm not asking for a specific '25 guidance, but if the Fed continues with dropping rates the way they appear to be in terms of the forward curve and their own outlook and we actually go from an inverted yield curve that we've lived with for over 2 years now to a positively sloping curve where the front end drops to 3, 3.5 the long end stays around 4% to 4.5%. Can you share with us what kind of impact that may have on your net interest income growth for '25?
Yes. Obviously, Gerard, we'll give more detail in next year on 2025. But if we can actually get a little bit more steepness in the curve, get the inversion out of the curve, that is very powerful for us from an NII perspective from here. Because we would expect to see some relief on the liability side of the balance sheet. We do continue to have confidence that we will get cost sell. And the thing that's not reflected in our forward guidance right now is an assumption that we're going to be able to maintain the fixed rate asset spreads. We do assume that there is compression as rates come down. And if we were to get to a normal shape curve, there would be even more benefit then from the fixed rate asset we're pricing. And we would also have a little bit of opportunity to get some a little bit more economics out of duration in the security portfolio and then the swap portfolio over time.
So that would be a really productive environment for us, and we would see it over time, you would see a significant expansion of our [indiscernible].
And at least for what it's worth Gerard. I don't know that I see your outlook as being overly rosy in that regard. I just think it's probably a reflection of what both the Fed's actions and the data would tell us is realistic. It probably feels rosy because we just haven't seen an environment like that over a very long time, a very long time period, 20 years or something like that, right, either we had absolute rates of zero, on the front end and a little bit of slope. But we've had this situation now where the front end was elevated and you had a historic level of inversion without a recession.
If the Fed manages [indiscernible] in the plane here, the front end comes down, I think our view has been that the 10-year was probably going to be stickier. Just you're talking about on an intermediate term basis, inherently more inflationary dynamics including the domestic manufacturing, industrial policy, the green energy transition the historic level of fiscal deficits that we're running, like those are all things that should work against the long end of the curve moving meaningfully lower. And potentially even you could see if the Fed settles out of the 3 or 3.5, the long end of the curve move up a little bit. So you get more of a normal term premium. That sort of an environment, if it doesn't come along with some other issue would be a really wonderful one for the balance sheet portion of our revenue.
Very good. And then can you guys remind us, you talked about lifting up the buyback a bit in the fourth quarter. Bryan, you talked about how the tangible book value accretion, how it's going to come through just the burn off of that part of the securities portfolio through the end of '25. Can you remind us in an environment where you know what the Basel III end game requirements are, which hopefully we will obviously, by this time next year, what should we expect in terms of how much of the capital that you guys are comfortable giving back to shareholders as a percentage of earnings, for example, in dividends and buybacks?
Yes. Our target right now in normalized environments, we like being in, say, a 35% to 45% range from a dividend payout ratio perspective. The share buyback ultimately is driven by how much capacity we have relative to organic growth because we do -- our preference would be to continue to invest on the organic front when we see good risk-adjusted returns. And then with what's left, we manage capital via the share buyback.
Continue to feel good with the capital generation that we've been seeing, that $200 million or $300 million of share buybacks feel about the right level. This quarter, we saw a little bit of benefit in RWA, which allows us to potentially have a little bit more share buyback. But with some loan growth coming in next year, hopefully, we'll be talking about a little bit lower buyback over time just because we've got a lot more organic opportunities to invest in.
Your next question comes from the line of Mike Mayo of Wells Fargo Securities.
Just to follow up on the -- you said the loan production is the highest in 5 quarters, and then quarter-over-quarter loan growth was flat, right? So if you could just give a little bit more detail like how much would loans have grown without paydowns? And why aren't you seeing more of this? It sounds like you said there's signs of life, but the bigger than bread box sort of what you think might come ahead.
Yes. Thanks, Mike. The paydowns for the quarter were around, say, $900 million, a bit elevated from what we would typically see in some of the portfolios as well as we had a utilization headwind of about 1% because we did see the revolver utilization moved down. That 1% decrease is in other, say, $800 million. So the combination of those two we're a decent driver ultimately, from an overall average loan growth and a period long growth perspective. We're not expecting continued pressures at this point, and we've seen utilization stabilize in the second half of the quarter and in the beginning of this quarter. So that doesn't feel like a headwind for us right now.
The capital markets activity, obviously, it was a very robust capital markets activity in the second quarter. Third quarter, we do think that fed into some of the paydown behaviors that we're seeing. But from here, we're expecting to get back to a little bit more normalized level, and we think that helps then with loan growth from here.
And as far as the [indiscernible] depends when kind of expectations for the next several quarters over the next year? Are you willing to give us any number yet? Do you think it will be more than 1% or 2%? I mean I'm sure you're going to...
We gave average loan growth guide, obviously up 1% sequentially. We'll get into 2025 in more detail next year. But in general, our objective would be to grow with a market plus a point or 2. Historically, the banking industry grows in line with GDP, nominal GDP type levels. And if we get back to that kind of environment and the industry gets back to overall aggregate growth, we would expect to be in line, if not outperforming the industry.
Yes. I think Mike, it's Tim. The one thing maybe I'd add here. I am of the view that the factors that would lead to a more favorable environment for loan growth inside the banking system are potentially in front of us. Subject to, one, who wins the election and probably more importantly, one of the things that both candidates are campaigning on actually make their way into policy and how they elect to govern.
What we hear from clients when I'm out in the field is that it's one, the elevated level of rates have been challenging because there's capital investments that don't make sense that just don't pencil out in an environment where rates are higher. Two, because they are uncertain about what we're going to see in the election, they have been using cash flow from the businesses to pay down debt in lieu of investing it in other places. And three, you have this big buildup in inventory in the '21, '22, '23 time frame associated with people moving. I think we referred to it as the shift from just in time to just in case in inventories.
As rates came up, we have seen, I think, the term for it that one of our distribution clients, our wholesale distribution clients use them last week was destocking. So less inventory, less gold material across supply chains, which in turn and a focus on more inventory turns, just getting the balance sheet to work harder, which reduces the revolving credit borrowing needs. But that can't go to 0. So you're not going to have a headwind there. If interest rates come down and more M&A and capital investment starts to make sense that hasn't worked. You should see a pickup on that front.
And then if we continue to see more certainty as it relates to the trajectory of the economy and have the uncertainty attached to the election out of the equation, I think we could see a better environment across the banking system and that coupled with the sales headcount that we continue to make, we referenced that in the prepared remarks, should support the at to above market growth rate on the lending side of the equation that Bryan referenced earlier.
Your next question comes from the line of Ebrahim Poonawala of Bank of America.
Good morning. I guess just a couple of follow-ups. One, maybe starting with loan growth. Tim, you mentioned -- two things. One, from a Fifth Third standpoint, are we still lapping derisking or running off the Shared National Credit book? I think it's down 11% year-over-year. Just give us your sense of is that book going to continue to decline as you kind of reduce your exposure there? And secondly, in your business, are you seeing any competition from nonbank direct lenders, private credit that looks different today than it would have 3, 4, 5 years ago?
Yes, sure. Good question. So we should be at the inflection point on the sort of impact of the RWA diet by the end of the year. I think we talked last year about the fact that we were trying to get everything done in the fourth quarter, there would be a little bit of a spillover into the first as you just got through normal timing. But we should be reaching the inflection point on that front where you don't have the less derisking, you them bring enough focus on what would the profitability, the unit economics of those relationships look like in a world where you had a different perspective on capital levels and the value of the corporate cash that comes along with some of those larger relationships.
As it relates to private credit, but we do see it at the margins, principally in leveraged lending space. What I would tell you has happened is their focus on less structure, faster execution that has a little bit of a bleed over in the areas. And there is no question that the things that some of the private lenders are willing to do are not in line with the way that we want to run our portfolio. I think it was the financial times -- the journal. But there was a piece about a week ago in the paper that talked about payment incline or where I come from negative amortization lending was between 1/4 and 1/3 of the portfolios at most of the major private credit shops. That is definitely not something you'd ever see at Fifth Third in an environment where the economic backdrop is benign and where you don't have a large percentage of your company is operating at distressed levels.
It's just odd to see that amount of PIK lending going on. So they're willing to do those things, and we're not, the definition, they're going to scrape the most indebted companies out of the banking sector.
And Ebrahim, it's Bryan. The -- we put a little bit of detail on the [indiscernible] portfolio on Slide 24 of our slide. And a $31 billion portfolio, it's down 11% year-over-year. but we are still facing lapping some of that headwind.
But was the point that we are at a point where the 31.2 is close to where this book should bottom out?
I think you're going to continue to see some runoff, but we do think you're getting back to the point where you'll start to see some production coming on and off setting. It may not be exactly at the floor, but the decreases should definitely be moderating.
The CIB pipeline -- the middle market pipeline which I think we referenced in response to Mike's question. Is that an all-time record level and the CIB pipeline, which would be where the majority of the shared national credits. We originate is at the highest level it has been in the year. So you're seeing the turn there, which should support the decline in run-off increase in production and an inflection point in loan balances.
And just the other question on capital allocation means your stock has done well. I'm not saying it's expensive, but it stayed well on tangible book. When you look at it, why not hold excess capital as opposed to picking up the pace of buybacks given that we might be in an improving economy, if that happens more capital good for growth. If it's worse, it adds defensibility. Just talk through in terms of how you go through capital allocation and the whole discussion or analysis around holding on and building some more excess dry powder as opposed to accelerating buybacks from here?
Yes. I mean we feel really good [indiscernible] about the earnings trajectory of the company. And we think given that, we feel like our stock is continues to be a good bargain for us, and we think it's a good investment for us from a corporate perspective. We look at a couple of things on that front. We're generating a lot of capital every quarter. And so that actually gives us the ability to be very dynamic with our capital allocation decisions. We have a lot of confidence that we're going to be able to generate the capital necessary for organic growth. And then if we wanted to slow down capital distribution via share buybacks because we see more opportunity or we need to get more defensive, we would be able to do that.
Another component is just when you think about our industry and the 10% cost of equity, sitting on excess capital is a high cost for our shareholders. And so being in a position as we are right now and being able to go ahead and make some decisions and deploy at a time where we continue to feel really positive about the trajectory as a company and knowing that we have the flexibility with the income profile and the stability that we have going forward to degenerate the capital when we would need to. And if we think different opportunities will present themselves. That's really the thought process on how we're thinking about capital allocation [indiscernible].
Your next question comes from the line of Erika Najarian of UBS.
My first question is for you, Bryan. So you indicated that your deposit beta so far on the recent cuts are in the mid-40s. As we think about the speed of index deposit repricing and then retail, could you give us a sense of what you think the cadence could be as you go through the next 5 quarters? So a few of your peers have noted that it might not be a straight line path to the terminal beta given how quickly the corporate can reprice and retail has sort of been awoken so to speak, in terms of higher rates.
So if you could speak to that and maybe speak a little bit to -- as you think about your deposits, we haven't seen a neutral rate that's not 0 for so long. So maybe help us get a sense of if we get a neutral rate of 2.75% or 3%. What do you think your natural spread is or natural deposit rate is in that environment?
Yes. That is -- that is obviously a very interesting question. The shape of the curve is going to matter a lot in that scenario as well. When we think about the pacing of how the beta will come through. Like you said, it is the -- the commercial deposits will come through very quickly. The retail takes a little bit longer. The two primary drivers for us on that. It's the guarantee period on the promotional offering, which tend to be between, say, 45 and 90 days. And then it's the maturities of your CD portfolio. And as I mentioned earlier, 75% of our CDs will mature between now and the end of the first quarter.
So to get the rest of the beta and get to that kind of cumulative beta that we have been targeting where high 50s kind of beta. For us, it will take about 2 quarters because the CD repricing is going to be a component of that. Now that that's $13 billion of book. From a natural level perspective, I think that is really tough to estimate. I mean we're sitting here. At peak rates, we were at a 299-ish was our peak interest-bearing core deposit costs versus a 5.50 fund level. We would expect to see a little bit of compression potentially in that spread. But being able to maintain 150 to 200 basis points of deposits spread seems like a potentially achievable scenario.
One big question on that, Erika, and another one that would obviously be a big question is just where it does -- how does the magnitude of loan growth change over time. And if you've got a decent curve shape back to Gerard's question, and you've got opportunities for loan growth, you've got to have some opportunities to be a little bit more competitive to raise more deposits and ultimately drive better NII. And at the end of the day, we're not managing the deposit betas, we're managing to NII and profitability trajectory and those are the positions and the trade-offs we'll make.
Got it. And my second question is for Tim. From the feedback from investors has always been quite positive in terms of the forward-looking way of how you look at the world. And as we think about 2025, I guess, it doesn't -- it feels like given record NII and your fee income should benefit if activity levels come back in general in an even bigger way next year. It feels like the expense run rate that you posted year-over-year this quarter, the 3% sounds -- it feels more appropriate, obviously, assuming that revenues grow above that.
As we think about 2025, is it right for us to -- until we get guide from you put growth in expenses as a placeholder. And as we think about 2025, what are the big projects that you feel like you're ready to retackle and revisit that you may have pulled back on in '24 because the NII dollars were coming down?
Yes. So thank you. I think there was a complement and question in there, I appreciate both. And you've heard me reference, I think, the old saying that [ Cincinnati ] invented [ hustle ] in the past, that dates back to [ Pete Rose's ] nick name and the fact that he's sprinted, that's a first base on a walk. I think that ethos is, I think, a part of the way that we try to run the company, right, is to sprint to first on walk. So we try to work on next year's problems in the year after that this year as opposed to waiting for that environment to materialize. And that's part of why I think we made the NIM turn right, our NIM trough and then grew in the first quarter before most of our peers. The NII inflected positive in the second quarter over the first quarter, which was before most of the peers. We got to real sequential positive operating leverage this quarter versus the last quarter, and we're saying we'll get there year-over-year next year.
Like none of that involved us holding back on investments we thought were important to the company or would make sense, right? We have -- we're going to have built 30-plus branches this year in an environment where we were trying to manage expenses. We continued forward on the platform modernization, the acquisitions we made and on the commercial payment side of fintech companies last year, we've continued to feed this year and the hiring, as I mentioned, on the sales force and both in Wealth Management and in the middle market have been pretty significant. So you should expect us to do the same sorts of things next year and to expect the company through other efficiency initiatives to help self-fund the investments along the way. And we don't view strategic planning as an investment request process. It's principally a resource allocation process.
So I don't know that I helped you with a specific number for 2025, you have to wait until January to get that. But the annualized expense run rate of the bank over a period of time has been, call it, 3% if you look at it. So that's certainly you were going to use the past average through more benign periods and more challenging periods would be where you'd start.
Your next question comes from the line of Manan Gosalia of Morgan Stanley.
I wanted to ask about index deposits. Can you talk about how they've behaved over time? So I guess the question is that as rates fall and the rates on those index deposits fall, is there a chance that some of those move into other deposit products with exception pricing? Or does that not really happen based on historical experience?
You'll see some people that try to do some negotiations on deposit costs. Those are things that always occur. But those are things that we are typically able to manage fairly well. The reality is you get paid a better spread as a depositor on an index deposit because you're taking the risk ultimately on market movements, whereas on a managed account, it's typically a wider spread because we have more ability to manage it. So we have something that we have had good experience with behaving, controlling it through our pricing and our discipline around that process. We're not overly concerned about reverse migration from index back into [indiscernible] being a headwind from a beta perspective.
Got it. And then maybe just separately on credit. On Slide 28, you're showing [indiscernible] and NPAs reaching normalized levels. I know you noted that you're not seeing any signs of credit weakening. Can you give us some more color there? What gives you some confidence that things are just normalizing here? Is it that rates are going down. So that helps you on the credit side? Is it just what you're seeing on the roll rates? Maybe what helps this to stabilize from here?
Yes, it's Greg. I'll take that one. A couple of things. Look at our delinquency, the delinquencies continue to be at all-time low levels. Our criticized assets actually went down by $8 million quarter-over-quarter. We had the increase in NPAs. On the commercial side, those were driven by 5 names and 5 different industries. We've been very consistent in talking about a very diverse portfolio, and it continues to be very diverse.
On the consumer side, we're seeing a little bit of softness on dividend, so a little bit of softness in the RV portfolio. When you look at the '22, '23 origination vintages they're underperforming across many of the consumer asset classes. We see the same thing in the portfolio, specifically in dividends and RV. But the securitization data from other originators will tell you the same thing. We're actually outperforming those indexes that securitization data by almost 50, 60 basis points.
And so I would expect dividend to be a little bit elevated for the next quarter or 2, but I'm highly confident that we'll work through those vintages and it comes back down to a more normalized level in that 125 level. So we're just not seeing anything within the portfolio is commercial or consumer that's causing additional concerns, it's been pretty stable. Our borrowers have continued to behave. We've seen the commercial real estate portfolio, we've got virtually low delinquencies, very, very minimal nonperforming assets in that commercial real estate portfolio. So across the board, that diversification, that strategic play of building out a through-the-cycle portfolio has played well for us, and I would expect that to continue in the future.
Your next question comes from the line of Matt O'Connor of Deutsche Bank.
Good morning. On Slide 10, you've got some pie charts you showed before, just showing the mix shift from the Midwest to being more balanced. And I guess the question is, as we look out in the next few years, you showed the split getting to 50-50 which is still a pretty meaningful reshift from here. So how do you get there? Is it simply harvesting what you've done, a combination of harvesting and building. Is there a buy component of that as well?
Yes, there's no buy component in there. That's the old-fashioned way, which is one new branch at a time and the right marketing and product strategies to support the increase in distribution. So if you look at the branches we've built, Matt, they're performing very well. We've talked in the past about the fact that the performance at this stage and having built more than 100 of them is pretty predictable. And they reach a point where they sort of saturate their catchment area in about 7 years, right? They break even within 2 and then they make this pivot to continuing growth.
So the average age of the de novo right now is going to be like, call it, 2 years, 2.5 years at most. So there is a 5-year tailwind we'll get from the 100 that are already in the ground and operational. Plus, we have been building about 30 to 35 a year. That number should move up into the sort of 40 to 50 range on an annualized basis just based on what we have in the pipeline. And as those branches come online, you will see that mix shift play out first in the allocation of the physical distribution. And then behind that over time as they mature the mix of the deposit base on the retail side overall.
Okay. That's super helpful. So a lot of maturing of what you've already got will move the needle quite a bit. And then just...
[indiscernible] see it on your retail deposit growth that I cited from the FDIC summary of deposits, that's visible there.
And then just separately, I know there's been a lot of discussion on net interest income and kind of drivers of the NIM. And I'm sorry if I missed it, but have you guys talked about the concept of like normalized NIM looking out a few years as you get the fixed rate asset repricing and whatever rates do versus the forward curve, any concept of normalized NIM?
Yes. I mean that's -- again, it's another tough one because what does the environment look like? What does the shape of the curve look like out in the future? If you just take the cash position that we're holding today, we're north of $20 billion of cash, we're up almost $9 billion year-over-year. Every $1 billion of excess cash that we're holding is a basis point [indiscernible]. So just getting $10 billion out over the next year and hopefully having some opportunities to deploy that into the loan portfolio that could add 15 to 20 basis points to our NIM alone. We're going to see NIM growth for the year, just with the continued repricing of the portfolio.
From a fixed rate asset perspective, that will continue to take -- that just takes a little bit more time to play out. But if you get a little bit of relief on the front end or a more normalized curve, get front and down, I mean, it's not unreasonable to think we could be talking about getting back to what was 315, 325 [indiscernible] in a reasonable time horizon.
Your next question comes from the line of Christopher Marinac of Janney Montgomery Scott.
I wanted to ask about some of the large banks who have been placed under regulatory orders this year. Does that create new business opportunities for you beyond your already organic pipeline?
I mean I think any time there's a limit on someone else's ability to grow. It means that the rest of the industry has to have the capacity to be able to absorb the growth in the market. So I guess in that sense, Yes, just tactically, I think more strategically, the more disciplined you are about the way you run your business. The better you do in moments when there's any sort of disruption somewhere else, right? So I wouldn't wish significant regulatory problems on anybody. There's no fun to work through but they do tend to create opportunities at the margins for other banks that are in a strong position and have the ability to grow in an environment where others may not.
Great, Tim. And just a quick follow-up on sort of invested returns over time. Does lower interest rates help you get your returns? Or does it make it more challenging?
Lower interest rates as long as that comes along with a normalization of the yield curve would certainly be very helpful to returns over time. A low [indiscernible] curve, a low flat curve is a challenging environment for the banking system.
Great. Thank you, Bryan. Appreciate it, everybody.
We have a follow-up question from the line of Mike Mayo of Wells Fargo Securities.
I was just wondering, this is a big picture question. You guys give the sense that you're investing more for growth than others. Do you have any metric on how much you make in your organic investments and what sort of returns you get on those? I'm thinking about the Southeast branches or Wealth to Commercial payments. And I kind of goes back to our earlier question, maybe you shouldn't buy back so much stock if you have so many opportunities for growth or a high-class problem if you get there.
Yes, I mean, we look at all of these things, the easiest comparable across the different investment types is probably just IRR, Mike, right, and time to breakeven. So the IRR of the branches in the Southeast has been running in the 18% to 20% range and the time to breakeven has been a couple of years, right? If you were to look at the small acquisitions we've made to support commercial payments, we were targeting IRRs in the 20s, in those cases in part because you had a more nascent business and it's less predictable after than when you build 100 branches and you know what you're going to get out of the next location that you build.
So in general, we feel really good about anything that we can get done in that sort of 15% to 25% range, subject to the execution risk that's attached, the more uncertain the more nascent the strategy, the higher the return you would expect to get out of it and more proven strategies, obviously, the lower the execution risk premium that you would need to place on. I don't think we are constraining the investment rate. Like if you just look at the Southeast, JPMorgan has built the most branches down there over the course of the past 5 years, they're at 180 or something like that. I think Fifth Third is #2 and I believe BofA is #3, and then there's a pretty wide gap between that and everybody else. And I know I don't have to tell you that we're a little bit smaller than BofA and JPMorgan.
So we are -- we think being appropriately aggressive in terms of the investment rate down there. and at least at the moment, I don't know that we said, hey, we're not going to buy back stock. We don't have an alternative use for that capital on an organic basis that we would be thinking that we would deploy it toward.
And Mike, we are accelerating the investments, as Tim mentioned, on the proven strategy. It's part of why we're going from what was 20 to 30 branch build a year to 50-plus branch for over the years. As we have more confidence that gives us going to be of an area we want to invest in. And then the other limiter for us is always going to be the analysts that are worried about positive operating leverage because that's the trade-off we care about as well.
Just to push back on that last point. I mean I hear you if you get the sort of IRRs and you're accelerating your branch build, but it's come at a time, but I think some of the Southeast competitors have woken up, recovered like you, less unrealized securities losses going from defense to offense. Do you have that change versus the last few years. And you also have the likes of some of those big banks that you mentioned with spending so much more in technology and digital. So you think it might be tougher in the next 2 years than it's been in the past few years?
I don't know. I don't think that the Southeast was uncompetitive the last 5 years, right? I think that what you're just -- you're constantly looking at is are we making the right set of investments given the competitors that we have and our value proposition relative to others. I completely agree the amount of money that is getting deployed into technology investment on the part of the large banks is eye-popping.
But if you look at the value proposition, might go pull up the consumer lead consumer checking account offering for any of those large banks and for Fifth Third or some other regional and tell me how that materialized into some substantially better value proposition. I actually think, in many cases, what you would see is the opposite as it's been the regionals who led on consumer-friendly product innovation. It's definitely been true of Fifth Third, but it's not just been Fifth Third in terms of the offerings there.
So we are not running the bank to be able to take share. And on competitive environments, we run the bank to be able to take share in very competitive environments. And I expect the level of competition is going to stay high, not that it's going to get better or for that matter, get worse.
That concludes our Q&A session. I will now turn the conference back over to Matt for closing remarks.
Thank you, and thanks, everyone, for your interest in Fifth Third. Please contact the Investor Relations department if you have any follow-up calls or questions. Operator, you may now disconnect the call. Thank you.
This concludes today's conference call. You may now disconnect.