Fifth Third Bancorp
NASDAQ:FITB
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Fifth Third Bancorp
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Good morning. My name is Adam and I will be your conference operator today. At this time, I would like to welcome everyone to the Fifth Third Bank Fourth Quarter 2017 Earnings Call. All lines have been placed on mute to prevent any background noise. And after the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.
Sameer Gokhale, Head of Investor Relations, you may begin.
Thank you, Adam, and good morning and thank you for joining us. Today, we'll be discussing our financial results for the fourth quarter of 2017. This discussion may contain certain forward-looking statements about Fifth Third pertaining to our financial condition, results of operations, plans and objectives. These statements involve risks and uncertainties that could cause results to differ materially from historical performance and these statements.
We've identified some of these factors in our forward-looking cautionary statement at the end of our earnings release and in other materials. And we encourage you to review them. Fifth Third undertakes no obligation to and would not expect to update any such forward-looking statements after the date of this call. Additionally, reconciliations of non-GAAP financial measures we reference during today's conference call are included in our earnings release along with other information regarding the use of non-GAAP financial measures.
A copy of our most recent quarterly earnings release can be accessed by the public in the Investor Relations section of our corporate website, www.53.com. This morning, I'm joined on the call by our President and CEO, Greg Carmichael; CFO, Tayfun Tuzun; Chief Operating Officer, Lars Anderson; Chief Risk Officer, Frank Forrest; and our Treasurer, Jamie Leonard. Following prepared remarks by Greg and Tayfun, we will open the call up for questions.
Let me turn the call over now to Greg for his comments.
Thanks, Sameer, and thank all of you for joining us this morning. As you'll see in our results, we reported full year 2017 net income of $2.2 billion and EPS of $2.83. Our results reflect the hard work of our employees, the support of our North Star initiatives. In 2017, we again took a number of significant steps to improve profitability and better position us for success. We will discuss the economic environment in our fourth quarter results. I would like to take a few moments to review some of the key accomplishments during the year.
First, we continued to optimize and strengthen the balance sheet. We exited approximately $1.5 million in C&I loans that did not meet our targeted risk or return profile and this helped drive a significant improvement in our credit metrics. This fold [ph] the exit of $3.5 billion in C&I loans in 2016. As I mentioned before, we have now completed this process. We also continue to reduce our indirect auto exposure. This reflects our decision over two years ago to curtail originations to improve returns while mitigating credit risk. We have succeeded in improving returns in this business and plan to gradually increase our production volumes in 2018.
These decisions highlight our commitment to building a franchise that performs well with the various business cycles. During the year, we re-launched our brand campaign through print, television, radio, and digital advertising. As we share with you this number, the re-launch was very well received and continues to strengthen our brand in the marketplace. We continue to focus on improving the customer experience by advancing our digital first, customer centric agenda and have made significant progress through several of our North Star initiatives.
We launched our innovation center and just recently introduced an app called Momentum that helps millennials tackle student debt. As you know, student debt is an issue for many millennials. Since we launched Momentum in September of last year, we have had over 40,000 customers download the app. We also replaced our branch teller software platform. The new platform helps to mitigate compliance and operational risk through automation and improves the efficiency and speed of transaction processing.
Our new mortgage loan origination system was launched across all channels in 2017. Although there is more work to be done, this initial will generate both NII as well as fee income opportunities by reducing our cost of originating mortgages. This business remains very important to Fifth Third as an anchor product and a proven tool to acquire households.
We are leveraging analytics to drive both an improved client experience and to enhance our own capabilities. We unveiled several innovative solutions this year, including the rollout of a digital real-time financial risk and equity management platform for our commercial customers. This platform significantly improves the information our customers have access to in a convenient digital format. We implemented advanced propriety data analytics to help in further optimizing our branch network. And we significantly enhanced our use of data analytics and improved the way we market to our customers.
Our continued focus on customer service and creating more durable relationships has a recognizing number of third-party customer surveys. We are rated as one of the best brands in commercial middle market banking, and number one among our peers in relationship manager, product knowledge for Greenwich Associates.
Expenses continue to be well-managed. Excluding [indiscernible] tax reform, full-year expenses were flat year-over-year. We achieved this while investing heavily in key initiatives in the project North Star. We expect to generate further efficiencies in 2018 as we continue to implement our North Star initiatives.
In 2017, we increased the pace in which we delivered better price and services through our buy partner build philosophy. We completed several acquisitions and strategic partnerships this year, including the acquisition of Epic Insurance and Integrity HR and R.G. McGraw Insurance which allowed us to continue to develop our insurance capabilities.
Our strategic partnership and equity investment in NRT and Sightline expand our product offerings within our entertainment, largely in leisure vertical. We are the first bank to join Mastercard's B2B Hub. This Hub provides an end-to-end automated platform that converts payable processes traditionally done by paper into an electronic transaction.
Our CRA rating was upgraded outstanding, reflecting our commitment to improving the lives of our customers and wellbeing of the communities we serve. We received top rankings in several employee satisfaction surveys, including the Gallup Great Workplace Award for the fourth year in a row. Our employees are responsible for recommending our strategies, and we believe that a highly engaged workforce will help us to achieve our strategic and financial objectives. We hosted our inaugural Investor Day in December. Our senior leadership team laid out a detailed roadmap of our strategic parties, how our operations are designed to facilitate our one bank approach, and how we are leveraging technology in order to improve the customer experience.
The strength of our balance sheet and earnings allows to raise our quarterly dividend by $0.02 to $0.16 per share in the third quarter of 2017 and we returned over $2 billion of capital to shareholders during the full-year of 2017. As a remainder, we have Fed approval to increase our dividend and additional $0.02 in the second quarter of 2018, waiting for approval.
Before discussing our fourth quarter results, I want to take a moment to discuss the new tax legislation. There was a uncertainty for much of the fourth quarter as borrowers await to more clarity. We believe new tax law will help energize the economy and further accelerate growth in our businesses. We are optimistic that we will retain most of the run rate benefits of lower taxes with a super pan on the competitive dynamics. At year-end, I was also excited to distribute a portion of the benefits from tax reform to our employees in our charitable foundation.
Moving to the fourth quarter results, we reported net income of $509 million and earnings per diluted share of $0.67. Some non-core items, including additional benefits from the new tax legislation, resulted in a positive $0.15 impact to reported earnings per share in the quarter. Tayfun will provide further details about these items in his opening comments.
Despite the impact of delivered commercial exits as well as a continued decline in indirect auto loan balances, our total average loan portfolio was flat sequentially. Our adjusted net interest margin expanded three basis points sequentially. This improvement primarily reflected higher yields on our investment portfolio as well as a good mix of consumer loans with higher yields.
Excluding the impact of non-core items mentioned in our earnings release, expenses were flat compared to the third quarter 2017, as we continue to focus on managing our expenses diligently. Credit quality remains stable, criticized assets were at the lowest levels in nearly 12 years, while non-performing assets continue to decrease, marking the lowest our NPA ratio has been in over 11 years. Fee income was up 3% sequentially. Adjusted for renewable items mentioned in the earnings release as we had discussed at our Investor Day, we believe fee growth should accelerate as our North Star initiatives are fully implemented and as we pursue additional strategic acquisitions and partnerships.
Our capital liquidity levels remain very strong with our common equity Tier 1 ratio at 10.6%, while our LCR exceeded regulatory requirements by nearly 30%. I would like to once again thank all of our employees for their hard work and dedication as evident in our financial results and our customer satisfaction scores, and our community outreach efforts. I was pleased that we were able to deliver strong financial results in our North Star initiatives, and remain on track.
With that, I'll turn it over to Tayfun to discuss our fourth quarter results and our current outlook.
Thanks, Greg. Good morning and thank you for joining us. Let's start with the financial summary on slide 4 of the presentation. As Greg mentioned, during the quarter, our underlying NIM expansion, continued focus on disciplined expense control, stable credit quality and efficient capital management reflected our commitment to driving improved financial performance and shareholder returns. Reported results were significantly impacted by the items noted on page 1 of our release, including a number of items primarily resulting from the recently passed Tax Cuts and Jobs Act.
The largest item was a $220 million income tax benefit resulting from the re-measurement of our deferred tax liabilities. The detailed benefit was partially offset by a $68 million impairment related to affordable housing investments in the fourth quarter. We also recognized a $27 million reduction to interest income related to the re-measurement of our leverage lease portfolio.
Lastly, we recognized $30 million in one-time discretionary expenses related to employee bonuses and charitable contributions in response to the passage of the tax act. In addition to the items associated with the new tax law, our reported results were impacted by a couple of other items. As we discussed during the last quarter's earnings call, this quarter's taxes reflected additional tax expense of $20 million related to our gain from the Vantiv sale in the third quarter.
Our fourth quarter results also reflected an $11 million reduction to non-interest income associated with the Visa swap. Adjusting for the non-core items disclosed today and in our prior periods, on a sequential, year-over-year, and full year basis, our ROA, ROTCE increased, our efficiency ratio improved, net interest margin expanded, expenses remained relatively flat, and our credit metrics also improved.
We achieved our objective of delivering positive operating leverage, while lowering the risk profile of our company and increasing regulatory capital levels from last year. Relative to last year's fourth quarter, our adjusted net interest margin was up 19 basis points, adjusted NII was up 7%, non-interest expenses were flat, total charge-offs remained stable, NPAs were down 34%, and the criticized asset ratio declined 70 basis points.
These positive results were accompanied by a 22 basis point increase in our common equity tier I ratio and 8% reduction in shares outstanding. Although some of our balance sheet decisions had a negative impact on loan growth in 2017, the benefits of our strategic actions are apparent in our financial results. And we expect them to continue to have a positive impact on shareholder returns going forward.
Moving to slide 5, the environment continues to be challenging for commercial loan growth. Despite the wait and see approach that many clients took during the fourth quarter while the tax bill was being debated, we generated the highest commercial origination volume since the second quarter of 2015. Although our loan production was strong, net loan growth was muted as payoffs also remained elevated. As the tax legislation is now final, companies have begun to adjust their capital investment plans.
We are optimistic that increased spending will drive higher loan demand. Average total loans were flat sequentially. Growth in C&I, commercial real estate, residential mortgage, credit card, and other consumer loans was mostly offset by a continued reduction in home equity and commercial lease balances, deliberate commercial exits and the planned decline in our indirect auto loan portfolio.
Average commercial loan balances were up approximately $150 million compared to the third quarter and were down 1% year-over-year, including the impact of our planned exits. Excluding the impact of these exits, average commercial loans were up 1% sequentially and 3% year-over-year. We continue to see strong middle market originations in our regions, especially in Florida, Indiana, North Carolina, Chicago, and Tennessee markets.
The sequential increase in average C&I balances along with 1% growth in commercial real estate loans was partially offset by a 1% decline in commercial leases. As we mentioned in December, given our focus on profitable relationship-oriented growth, we have halted originations in non-relationship based equipment leasing. We expect end-of-period commercial leases to decline $400 million to $500 million by the end of 2018.
Average growth in commercial real estate loans in the fourth quarter was mainly driven by drawdowns at the end of the third quarter as commercial construction balances were down 2% on an end-of-period basis. We continue to maintain a conservative risk profile in construction lending as we are in the later stages of the cycle. As of year-end, we have completed our balance sheet optimization initiatives, which has resulted in over $5 billion in deliberate loan exits since the first quarter of 2016.
This includes approximately $200 million of commercial exits in the fourth quarter of 2017. Growth patterns in 2018 and beyond will now reflect business as usual activity. Commercial loan production across the board has been strong. We remain competitive and are maintaining our focus on profitable relationships, particularly in our middle market lending business, which is a focus area in 2018 and beyond.
We recently expanded our middle market lending footprint to California and are in the process of evaluating other geographies. This should provide future loan and revenue growth opportunities. Additionally, as we mentioned in December, we plan to launch two new verticals this year to augment C&I loan growth within our corporate lending portfolio. We currently expect our end of period total commercial total portfolio to grow about 1% from yearend in the first quarter and about 3% by the end of 2018, which includes the impact of the run off of our national leasing business.
In consumer, including the planned decline in the indirect auto loan portfolio, average loans were up 1% sequentially and down 1% year-over-year. Excluding auto, average consumer loans were up 3% year-over-year. Auto loans were down 10% year-over-year, reflecting the ongoing impact of our decision to curtail indirect originations and redeploying capital. Our pace of origination activity will continue to be correlated with risk adjusted returns in this business.
Given current spreads and returns on capital, we currently expect our total production to be closer to $4 billion and at the end of period auto portfolio declined approximately $500 million by end of 2018. Residential mortgage loans were flat sequentially and up 5% year-over-year as we continue to retain jumbo mortgages, ARMS as well certain 10- and 15-year fixed rate mortgages on our balance sheet during the quarter.
Our home equity loan origination volumes were 2% lower sequentially and up 2% year-over-year. As loan pay downs in our legacy continue to exceed origination volumes, our portfolio decreased 2% sequentially and 9% year-over-year. Our credit card portfolio increased 3% from the third quarter. Purchase active accounts were up both sequentially and year-over-year, reflecting stronger growth from new card rollouts at the end of 2016.
We continue to expect our new card offerings and our enhanced analytical capabilities to drive faster growth in 2018. While we expect balances to be flat sequentially in the first quarter reflecting seasonally higher pay downs, we currently expect card balance growth in the mid to high single-digits by the end of 2018. Other consumer loans increased 28% sequentially. Growth was driven by the personal lending portfolio primarily through loans generated from our GreenSky partnership.
We continue to expect personal lending balances to grow to $2 billion by the fourth quarter of 2019 from approximately 900 million at the end of 2017. Loan originations will remain focused on high quality prime customers with GreenSky providing first loss coverage as we have discussed before. Growth in personal loans should allow us to generate a higher ROE revenue stream and help us achieve a better balance between our commercial and consumer portfolios.
In the first quarter, we expect total end of period consumer loans to be stable relative to the fourth quarter. For 2018, we expect end of period loan growth of between 2% and 3%. Excluding indirect auto loan balances we expect consumer growth north of 4% driven by the initiatives we have previously discussed. Our investment portfolio balances remain relatively stable in the fourth quarter as we had expected. We expect to continue to maintain our investment portfolio at roughly the same level in the first quarter.
We had strong deposit performance in the fourth quarter. Average core deposits were up 2% sequentially. The sequential increase in commercial interest checking deposit and commercial demand deposit account balances was partially offset by lower consumer savings and commercial remarket account balances.
Typical of rising rate environments, deposit markets remain comparative. We continue to make rational decisions between pricing appropriately for profitability and maintaining and growing relationship based LCR friendly deposits. Despite the environmental pressures, we believe we have an opportunity to steadily grow the consumer book while accelerating growth in commercial deposits.
Our modified liquidity coverage ratio continue to be very strong at 129% at the end of the quarter. Taxable equivalent net interest income of $963 million was down $14 million from the previous quarter, primarily due to the leverage lease re-measurement triggered by the change in tax law. Excluding this item, adjusted NII was up $13 million or 1% from last quarter and up 7% compared to the adjusted NII from the fourth quarter of 2016. Our strong NII performance primarily reflects the positive impact of higher interest earning asset yields as well as the continued shift into higher yielding consumer loans.
The NIM adjusted for the same lease item increased three basis points from the third quarter to 3.1%, exceeding our previous guidance by five basis points. The sequential improvement was driven by improving investment portfolio and loan yields predominantly from our consumer categories. The NIM in the first quarter of 2018 should be approximately 3 to 5 basis points higher compared to the fourth quarter. We expect full year 2018 NIM in the 3.15% range, exceeding our December guidance including the impact of two rate hikes one in March and another one in September.
Absent any Fed moves in 2018, we would expect full year NIM to be consistent with the fourth quarter of 2017 at around 3.1%, five basis point impact of these two partial year moves approximate the full year impact of a 25 basis point move in the fed funds rate for us. Supporting this outlook, overall deposit pricing so far has remained relatively muted with cumulative betas since the first fed move at the end of 2015 in the low to mid-20% range on a blended basis.
Consumer has been in the mid teen range with commercial in the low-40s. The incremental blended data for the last move in December is in the high-20s and we project a beta in the 45% to 50% range for subsequent rate hikes. If we see betas at lower ranges, our margin could exceed our guidance. We expect our first quarter net interest income to be between $975 million and $980 million or down approximately 1% from fourth quarter's adjusted NII, which is largely driven by day count.
For 2018, we expect NII growth to be approximately 5% from the adjusted 2017 NII of between $4 billion and $4.07 billion, exceeding -- again exceeding our December guidance. Credit spreads continue to pressure margins across the banking sector, but the strategic actions we have taken during the last two years have led to a redeployment of capital away from lower returning loans and help us achieve a very good NII and NIM profile.
Excluding the impact of the Visa swap and Vantiv gains, non-interest income in the fourth quarter was $587 million compared to $571 million in the third quarter or up about 3% sequentially. The sequential increase was primarily due to the $44 million Vantiv TRA payment in the fourth quarter of 2017 and an increase in wealth and asset management revenue, partially offset by a decline in corporate banking due to the lease residual impairment and seasonally lower mortgage banking revenue.
Mortgage banking net revenue of $54 million was down $9 million sequentially. Origination fees were down $8 million sequentially, reflecting lower rate lock volumes and tighter spreads. Originations of $1.9 billion were 10% lower than the third quarter with a fourth quarter gain on sale margin of 206 basis points compared to 228 basis points in the third quarter.
During the quarter, 57% of our origination mix consisted of purchase volume. Approximately two-thirds of our originations continue to be sourced from the retail and direct channels and the remainder through the correspondent channel. Corporate banking fees of $77 million were down $24 million compared to the third quarter. The sequential decline was due entirely to a lease remarketing impairment which was previously disclosed at our Investor Day.
Excluding the impairment of $25 million, corporate banking revenue was up $1 million. Despite the continued challenging market environment, we grew FICC revenue 20% sequentially. We saw broad based growth with derivatives, commodities and institutional brokerage, all up from the last quarter and last year. FX revenues were also up 16% sequentially. This was offset by lower other capital markets revenue from deals that were pushed out from the fourth quarter to the first quarter of this year, primarily with an ECM and DCM.
We currently expect corporate banking fees to increase between 5% and 10% sequentially, excluding the lease remarketing impairment from this quarter, driven by an already solid pipeline that was augmented by deals pushed out from the fourth quarter of 2017. Deposit service charges remain unchanged from the third quarter. Card and processing revenue was up 1% sequentially, reflecting a seasonal increase in credit card spend volume and debit transactions, offset by higher rewards.
Total wealth and asset management revenue of $506 million was up 4% sequentially, reflecting the equity market improvement during the quarter. Recurring revenues in this business have increased to 83% of fees from the mid-70s last year. We plan to continue to shift our product and service offerings toward more recurring revenue streams to mimic our reliance on transactional activity. In the first quarter, we expect to record an approximately $415 million pre-tax step up again, given the recent close of Vantiv’s acquisition of Worldpay. This gain is greater than previously expected and leaves us with an additional unrealized pretax gain of roughly $0.5 billion at current market prices. Given the post-acquisition name change, we will be referring to the company has Worldpay going forward.
As our ownership percentage of the new company will be approximate 4.9%, we will continue to benefit from utilizing the equity method of accounting going forward related to our ownership in a larger and now global company. For the first quarter of 2018, we expect fees to be between $560 million and $570 million excluding the Worldpay step up or down approximately 4% from our fourth quarter adjusted non-interest income shown in the release.
Recall that this comparison incorporates the impact of the TRA payment which was $44 million this quarter. Excluding the impact of the TRA, we expect core fee income growth of 4% in the first quarter relative to the fourth quarter. For the full year of 2018, we expect fees to grow between 5% and 6% from adjusted 2017 levels and grow to approximately $2.4 billion. Implicit in this guidance is a $20 million of TRA related income in the fourth quarter of 2018 rather than the $44 million level in 2017.
Despite subdued client activity, we are optimistic about our fee growth trends given the investments that we are making to grow the scale and scope of our fee producing products and services. We remain focused disciplined expense management while continuing to invest for revenue growth. Reported non-interest expense increased 10% sequentially. Excluding the onetime items that were recorded in the aftermath of the tax law changes, expenses were flapped from the third quarter of 2017 against our October guidance of 1.5% growth.
Overall, expenses were well managed in 2017 and our focus on operational efficiencies along with our revenue growth led to positive operating leverage for the year. Our adjusted efficiency ratio for 2017 was under 62% in the fourth quarter and under 64% for the full year. Recall that the amortization of our low income housing investments is recognized in expenses, which most of our peers reflect in their tax line which adds approximately 2.5% to our efficiency ratio relative to our competitors.
We will focus on continuing to drive positive operating leverage while still making strategic investments that position us for long term out performance. We expect that strategic investments in technology will continue to differentiate us from our peers, while also supporting revenue growth and cost saving opportunities across our company. As we have evidenced over the course of 2017, we will continually scrutinize other areas to reduce run rate expenses in order to achieve our long term efficiency target of sub 60%.
We currently expect total expenses in 2018 to be between $4 billion and $4.1 billion. This guidance largely matches our guidance in December except for the impact of the minimum wage increase that we implemented and higher amortization on low income housing investments triggered by the change in tax law, which in total is about $30 million. Furthermore, our outlook also includes about $20 million in expenses associated with insurance acquisition that we closed late in the fourth quarter.
First quarter expenses are expected to be up about 9% from adjusted fourth quarter expenses, mostly related to annual seasonality associated with the timing of compensation awards and payroll taxes. The quarterly expenses are expected to be coming down meaningfully from the first quarter levels every quarter as the year progresses.
Turning to credit result on slide nine, fourth quarter credit results followed the positive trend that we've seen all year as the charger offs remain at pre-crisis levels impacted by our strategic decision to focus on reducing volatility and charge offs. Net charge offs were $76 million or 33 basis points, up four basis points from the third quarter of 2017 and up two basis points from last year. Commercial charge offs were 22 basis points, up one basis point from the third quarter and two basis points year-over-year.
Consumer net charge offs of 51 basis points were seasonally up eight basis points sequentially and were up two basis points year-over-year. Total portfolio non-performing loans and leases were $437 million or down $69 million or 14% from the previous quarter and down 34% from last year. Our NPL ratio of 48 basis points was at a 10 plus year low.
Total C&I NPLs at were down 19% sequentially and 42% on a year-over-year basis. Nearly all loan categories showed a sequential improvement. At the end of the fourth quarter, the criticized asset ratio improved significantly from the previous quarter to 4.6% of commercial loans which will continue to strengthen our balance sheet and improve our performance in stressed environments.
Our loss provision was flat compared to the third quarter, reflecting among other factors improvement in criticized assets and non-performing loans, offset by an increase in net charge offs and higher period end loan portfolio balances. The reserve ratio declined one basis point to 1.3%. Our reserve coverage over NPLs has now increased in three consecutive quarters to 274% and is one of the highest among our peers.
While we remain in a relatively stable credit environment and the economic backdrop continues to support a continued benign credit outlook, we nevertheless caution you that we could potentially experience some upward pressure in the future. That being said, in light of our strength in balance sheet, we believe that our provision expense will be primarily reflective of loan growth and some normalizing of credit losses. Our capital levels remained very strong during the fourth quarter.
Our common equity Tier 1 ratio was 10.6%, essentially flat quarter-over-quarter and up 22 basis points year-over-year despite the $273 million share buyback initiated during the quarter and a declaration of our $0.16 dividend. In 2017, we returned over $2 billion to common shareholders in the form of dividends and repurchase or 95% of earnings. Recall that we have another potential $0.02 dividend raise scheduled for June pending approval from our board. Our tangible common equity ratio, excluding unrealized gains and losses, increased five basis points sequentially and increased seven basis points year-over-year.
At the end of the fourth quarter common shares outstanding were down 12 million shares or 2% compared to the third quarter of 2017 and down 57 million shares or 8% compared to last year's fourth quarter. Book value and tangible book value were both up 9% from last year. Effective capital management is a very important component of our overall strategic approach. As we mentioned in December, we believe that the improved overall credit profile of our company has translated into an ability to operate our company at lower capital levels.
Our goal is to always be very prudent with the amount of capital that we keep on our balance sheet and aim to maximize the long term return on that capital through varying environments. Business environments change and we have to make sure that our balance sheet remains resilient. With the lessons learned from the financial crisis, we will remain focused on creating long term shareholder value.
With respect to taxes, our fourth quarter rate was impacted by the BTL re-measurement and other items disclosed in our release. These items grow the tax benefit for the fourth quarter. Excluding the BTL and the Vantiv tax recognition carryover from the third quarter, our tax rate was 25.5%. We expect our full year 2018 tax rate under the new legislative environment to be in the 15.5% to 16% range, which is impacted by the step up gain from the Vantiv Worldpay deal.
Excluding this onetime impact in 2018, we project our normal run rate to be between 14% and 14.5%. Our guidance in December based on the 20% marginal tax rate was 12.5% to 13.5%. With the 21% corporate tax rate, this outlook is very close to our previous guidance. Overall, our tax credits continue to impact our effective tax rates. As Greg mentioned, net of the increased compensation that he announced at year end in conjunction with the tax reform and the trigger change in our low income housing and acquisition, we expect most, if not all of the tax benefits to fall to the bottom line.
This should by definition increase our long term return targets. On a normalized run rate basis, a 12% to 12.5% reduction in our effective tax rate should have a positive impact of 1.5% to 2% on our North Star ROTCE targets. This moves the upper end of the ROTCE target to the 15.5% to 16% range for the fourth quarter 2019 and beyond and increases our ROI targets by approximately 15 basis points to a range of 1.35% to 1.45%. Our revenue growth outlook, our ability to achieve positive operating leverage without changing our risk appetite, our strong balance sheet and our strategic positioning give us confidence in our ability to create additional shareholder value.
With that, let me turn it over to Sameer to open the call up for Q&A.
Thanks, Tayfun. Before we start Q&A, as a courtesy to others, we ask that you limit yourself to one question and a follow-up and then return to the queue if you have additional questions. We will do our best to answer as many questions as possible in our time we have this morning.
During the question-and-answer period, please provide your name and that of your firm to the operator. Adam, please open the call up for question.
[Operator Instructions] And your first question comes from Gerard Cassidy. Gerard, your line is open.
Thank you. Good morning, guys.
Good morning.
Tayfun, can you share with us with the step-up process that you pointed out of $415 million in the first quarter of 2018, in the past, if I recall, the gains that you've been able to garner from this investment have been used to repurchase your common stock. Do you plan to -- go back to the Fed intra CCAR period to do that again, or would you wait until the next CCAR, and possibly use it at that time to buy back the stock.
Gerard, given that we are getting -- we're past the half-point and we're getting closer to the end of this CCAR period, we would plan to do that in the next CCAR period.
Okay, very good. And then second, on the commercial loans. I think you said you had elevated payoffs in the quarter. Can you give us some color what you're seeing where your customers are paying off the loans vis-à-vis what you saw maybe earlier in the year?
Yes, Gerard, good question. We did see, I think along with most of our other peers in the industry, significantly elevated pay-downs and payoffs. Over half of that I'd characterize in -- I would direct to our commercial real estate portfolio line of business. The majority of that were asset selling, very low cap rates, high quality assets. Also, a number of those that were moving to the permanent market with a continued flat yield curve, the balance of that would be some of those end-of-year movements that you've seen in the industry, where companies were simply de-levering and maybe positioning themselves relative to the new tax policy. Frankly, we're still trying to figure that one out and see where that one goes. But I would say that was widespread though across geographies and across our businesses, but nothing out of the ordinary beyond that.
Great. Thank you, guys.
Sure, thank you.
And your next question comes from Erika Najarian. Erika, please let us know your company name too. Your line is open.
Yes, good morning. Bank of America.
Good morning, Erika.
Thank you so much for the detailed outlook. And I'm wondering, you were very specific in terms of reiterating a dollar expense range for 2018. And as we think about the NII outlook and the NIM outlook, it appears as though there's some conservatism baked into either the number of hikes or the deposit reprising assumptions. And the question here is, if the revenue results in 2018 are better than what's outlined on slide 11, does the $4 billion to $4.1 billion range hold regardless?
With respect to the expenses, I would say, yes. I think more movement on the expense base related to variable revenues comes more from the fee line items. But in general, the impact of a higher-than-guided NII performance should still keep that expense range intact.
Got it. So just to be clear, if you outperform an NII that expense range is intact, but if you outperform on fees then that's when you may be at the high end or out of the range but still keeping with the positive operating leverage target?
Absolutely.
And Erika, this is Greg. We continue to focus on expenses as evident on our 2017 performance of flat year-over-year growth. This is an area of heighted focus in the organization. We continue -- will continue to focus on that as we move into 2018, and do a better job of managing expenses on as we move into the year.
And just so you know, in general, if during the year we outperform NII, everything else being equal, only, and only due to rate changes, our variable compensation typically does not move.
Thank you. That was clear, appreciate it.
Your next question comes from John Pancari. John, please let us know your company name. Thanks. Your line is open.
Evercore ISI. Wanted to get your thoughts on the payout target, longer-term post tax reform, any change to your targeted 120 million to 140 payout.
Look, I think in general, the more money we make, you would expect a higher payout in dollars. We're still clearly waiting for the Fed’s CCAR assumptions and background, and we will run that through our numbers. But we are still targeting a sort of mid 9-type cap -- CET1 position for 2019. And our payoffs will correlate to that target.
Okay, thanks. And then my follow-up is around North Star. I know initially, when you laid out the program and in several of your updates posted, you were commenting on the 800 million in pretax income that you were targeting under North Star, but you didn't focus on that 800 million at the Investor Day. So is that still a target, that dollar amount? And does it change at all with tax reform, and if so what is the new number?
It does. And I don't necessarily have an updated number for you as to the impact of the tax reform. But as you recall, in December, during our Investor Day, we discussed that there were some adjustment to revenue expectations, especially related to loan growth assumptions. And we did say that, both in 2016, and '17, and also in '18, our loan growth assumption is somewhat lower than the initial estimate that we had when we laid out our expectations. But in return, we also mentioned the lower asset growth enabled us to purchase a higher amount of capital, which continues to support the same ROTCE targets that we laid out. And as the tax reform also is moving these targets out, we are actually ahead of our initial expectations with respect to that.
Okay, thank you.
And your next question comes from Matt O'Connor from Deutsche Bank. Please, your line is open.
Good morning.
Hi, Matt.
Sorry if I missed it. The expected TRA in the fourth quarter going forward, should we assume it stays at the $44 million, which I think came in higher than expected or what's the expectation on that at this point?
Yes, Matt, this is Jamie. The fourth quarter of '17 number was $44 million. That is what we guided to all throughout 2017, because it's based off of the Vantiv tax return from a year prior. So that number is locked in a year in advance. So the 4Q '18 number is also fairly close to being locked in, and that's about $20 million. And then going beyond 2018, given the change in tax rate from 35% down to 21%, the go-forward number on those TRA cash flows would be in the $24 million range.
And then those numbers shouldn't change appreciably as long as Worldpay has sufficiency of income to utilize and tax rates don't further change. And the only then variable to all of this would be whenever we would sell our remaining Worldpay interest, it would generate another $340 million or so of cash flows over the next 16 years. So, really look at $20 million for 4Q '18, $24 million beyond and until another disposition occurs.
Okay, that's helpful. And then just separately, if we look at your [Technical Difficulty] seeing at some peers, as we think about reserves to loans. And I'm just wondering if you feel like that gives you a little more flexibility to essentially grow into the reserves levels or how you're thinking about those. You've obviously been de-risking, the loans have not been growing, and most of the credit metrics have been improving, and you've had very good release. So just wondering how your thought of those levels going forward. Thank you.
And I'll ask Frank to comment on the credit profile of that, but in general, we believe that the reserve levels are at the right level. So in that sense, I wouldn't characterize a future flexibility associated with the ratio. But, Frank, do you want to comment on credit?
Yes, I mean, our charge-off are a crazy number. Our commercial losses over the last five quarters have ranged from roughly 20 to 30 basis points. Our consumer losses have been in the 40 to 55 basis points range. Those have been slightly higher actually than our peers. Again, it's a trailing number. Our NPAs have been coming down nicely, and in fact, we talked about criticized assets. That will come down, but now the other remainder is from our perspective, we’re nine years into a recovery, and I think we will continue to see some early signs that we will continue forever. And so, there certainly is conservatism. I view this realism, that's nine years is far beyond where we typically would see a pressure. So overall, we feel we are not where we are, but 130 coverage we are comfortable with that that covers 275% [Technical Difficulty] we feel that that's prudent based on where sit today.
Your next question comes from Scott Siefers from Sandler O'Neill. Scott, your line is open.
Hey, good morning, guys. This is actually Brendon on the line for Scott. Just I wanted to start with the commercial loan outlook, I believe just compared to the outlook you gave in December, if you look, you've improved the outlook for commercial growth a little bit, can you just talk about what's underlying that improvement in the commercial outlook?
Well, first of all, I will tell you that as I look at the activity levels that we had in the fourth quarter, they were substantially elevated. It was a very strong quarter of production, and it was across all of our corporate banking verticals, it was across nearly all of our geographies. If the tax policy changes, beginning to come into play, I frankly -- I had a lot of conversation with a number of CEOs and CFOs, middle market corporate relationships over the last few days, and various -- unquestionably a growing optimism, that can create a tailwind I believe for us as we look at 20018.
But I'd also remind you that we've continued to reallocate our resources. We've, consistent with our North Star strategy, have built out new verticals, our TMT vertical continues to frankly accelerate, and we are developing a very strong name there. Our healthcare vertical had a great quarter. I think they were well positioned for 2018. The ACA Act, with that kind of becoming a little bit less of an issue; there is more clarity in that industry. We are very active there, and I think that you will see more around that space in the near future; energy -- with energy prices that's clearly creating a tailwind.
And frankly, I'm really pleased we have some leadership, we have recruited additional middle market bankers throughout, some of our footprint, look you know, what we shared in the past around the Floridas and North Carolina, we got Tennessee really moving, Indiana being our strongest region for the year. But some of the markets where we have recruited bankers, we have new leadership such as Georgia, such as Cleveland, Northeast Ohio, such as Chicago, these are markets that frankly had a really good fourth quarter and we believe are very well positioned for 2018. Tayfun shared with you growth in that nominal kind of GDP, I believe that there could be some tailwind there. I'm optimistic we got the right business model, we got great talent and I'm looking forward to again.
I appreciate all the detail and color over there. And then, just turning to corporate bank fee just want to make sure I have the guidance for the 1Q, correct. Is it fair to say you take the 77 million from this question, add back the $25 million impairment and then the growth of 5% to 10% off of that higher level, is that correct?
Yes, it is correct.
And your next question comes from Peter Winter from Wedbush. Peter, your line is open.
Hi, this is actually Anthony on for Peter. My first question on deposit costs. They seem to tick up across most categories again similar pace we saw last quarter. Any of that promotional or what are you seeing there in terms of deposit pricing competition.
Yes, this is Jamie. The betas that Tayfun referenced, cumulative beta, roughly 22% does include some increases in promotional offers, both in the retail segment as well as with some exceptional pricing in commercial. In terms of the acceleration of the beta, the June hike, we experienced about a 35% beta relative to that 22% that we've had cycled to-date and when you break that down by product, commercial accounts experienced above average beta at about 41% cumulatively whereas the consumer accounts have experienced a below average beta of about 15%.
And then add a little more color, when you break it down by the line of business, that 22% cumulative data translates to 6% in retail, 46% in our wealth and asset management line of business and then 52% in commercial. So I think that highlights where we’ve come and as Tayfun I mentioned, we are in that 45% to 50% modeling for the next couple of rate hikes.
Okay. And my follow-up is on the auto charge-off rates, it seems like it ticked up again a little bit this quarter about 10 basis points. I know you're looking to shrink the auto portfolio, but can you give any color on what's driving the continued increase in the charge-off in auto? Thanks.
Yeah. You have to realize that there is a denominator impact of that as well because the portfolio is shrinking and beyond just some seasonality, there is really no, but we’re pretty pleased with what's going out on the auto.
The next question comes from Christopher Marinac from FIG Partners. Christopher, your line is open.
Hi, good morning. Just wanted to ask about the LCR and as it pertains to not being part of your guidance and to what extent that could help if that plays into your hand later this year?
Our LCR target is to operate north of 110 level, so clearly the 129 is a bit elevated driven to some extent by just seasonal inflows and some cash positions, but it certainly gives us some flexibility as the year progresses. But also keep in mind, that’s just a point in time on the last day of the quarter. So it does move around intra quarter. But it would certainly give us some flexibility as 2018 progresses.
Do you think that will drive both margins and NII if that changes in your favor?
Yes.
Okay, great. Thank you very much guys.
Thank you.
And your final question comes from Saul Martinez from UBS. Saul, your line is open. Saul Martinez, your line is open. Please state your question.
All right. Okay, I think we will end the call there. Thank you Adam, and thank you all for your interest in Fifth Third Bank. If you have any follow-up questions, please contact the Investor Relations department and we will be happy to assist you.
And this concludes today's conference call. You may now disconnect.