Fifth Third Bancorp (FITBI) 2016 Q1 法說會逐字稿

Good morning. My name is Scott, and I will be your conference operator today. At this time I would like to welcome everyone to the Q1 2016 earnings call. (Operator Instructions) Sameer Gokhale, Head of Investor Relations, you may begin your conference.

Thank you, Scott. Good morning and thank you for joining us. Today we will be discussing our financial results for the first quarter of 2016.

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 have 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 and would not expect to update any such forward-looking statements after the date of this call.

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 to questions.

As a courtesy to others, we ask that you limit yourself to one question and the 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 the time we have this morning. During the question-and-answer period, please provide your name and that of your firm to the operator.

With that I will turn the call over to Greg.

Thanks, Sameer. And thank all of you for joining us this morning. Today we reported first-quarter net income to common shareholders of $312 million and earnings per diluted share of $0.40. We had some non-core items that added $0.03 to earnings per share in the quarter.

Our Q1 results were solid, especially considering the market volatility we experienced during the quarter. Income levels, including capital market fees, were stronger despite market disruptions.

As you know, we have been building out our capital market capabilities for the last few years. We are seeing our investments pay off.

During the quarter we closed on the largest M&A Advisory(corrected by company after the call)deal in the history of our Company. Interest income was also stronger-than-expected. We have benefited from low deposit betas following the December rate hike and expect to continue to manage deposit rates tightly. Given the outlook for rates, we should continue to benefit from our steady and cautious strategy with respect to rate risk management.

We remain focused on executing our defined strategies. We closed on the sale of the branches in St. Louis, which resulted in an $8 million pretax gain. In addition, we expect to close the sale of the Pittsburgh branches this week. We continue to rationalize our branch network and are on track to deliver $60 million in annual expense savings related to these reductions.

We are introducing new products and services. Our new express banking product, for example, received high accolades directly from the CFPB. Since we launched this product in November 2015 we have opened more than 65,000 new customer accounts.

Our ongoing investments in digital technology continue to accelerate our growth rate in mobile banking. In 2015, our growth in mobile users exceeded the industry average. Indeed, it accelerated while the rest of our industry experienced a slowdown.

In the first quarter, over 17% (corrected by company after the call) of our deposit transactions were executed via mobile devices compared with 12% in the first quarter of 2015 (corrected by company after the call). In addition, we've doubled the number of checking accounts that were opened online from a year ago.

During the quarter, we implemented an early retirement program. This program resulted in a $14 million one-time expense but will generate $9 million in annual cost savings. We will continue to look for more efficient ways to operate our Company.

Achieving operating leverage is our top priority, and we are making progress toward that goal. Our expenses, net of one-timers, were up 2% sequentially, partly reflecting a seasonal increase in FICA and unemployment insurance.

While we are investing in our Company, we are very focused on controlling expenses across all of our operations. We now believe that our expense growth in 2016 will be lower than we had originally expected. Tayfun will provide more details and an update on our outlook in his comments.

As we shared with you in January, we are proceeding with several strategic initiatives to improve revenue growth, generate cost-efficiencies and improve service quality. We remain on track and intend to share our progress with you as the year continues to unfold.

During 2015, we discussed our efforts to reduce our risk exposures. As of March 31, our loans to commodity traders were down to $241 million. That's down by more than 50% from the peak. On energy, oil prices did rebound off lows, but the sector remains under stress. Our balances were stable from the fourth quarter at $1.7 billion.

As expected, we saw continued deterioration in the book. Energy NPLs were $168 million higher from the last quarter, but they represent the bulk of the total NPL increase during the quarter. The loans that have moved into the NPL category were predominantly reserve-based loans. As these loans are generally well collateralized, we do not expect a similar increase in net charge-offs.

At the end of the first quarter, we only had $294 million in loans to higher-risk oilfield services companies. We held reserves of 6.2% against our total energy portfolio and we believe the reserves are more than appropriate.

Our capital levels remain strong with common equity tier 1 of 9.8%. Our earnings contributed to a tangible book value of $16.32 per share, which was up 5% from last quarter and up 9% over last year. During the quarter we also announced a share repurchase of $240 million of our common stock, which settled on April 11. We retired approximately 14.5 million shares.

With that, I will turn it over to Tayfun to discuss our first-quarter operating results and our current outlook.

Thanks, Greg. Good morning and thank you for joining us.

Let's start with the financial summary on page 4 of the presentation. For the first quarter we reported net income to common shareholders of $312 million or $0.40 per diluted share. There was a net benefit in the quarter of $0.03 per share resulting from the gains on the Vantiv warrant and the branch sales, offset partially by the cost of the voluntary retirement program. We are pleased with the results, especially given challenging market conditions during the quarter.

So let's move to the average balance sheet on page 5 of the presentation. Average commercial loan balances were relatively flat sequentially but up about 5% year-over-year. Our end of period balances were up by $1.5 billion or 3% sequentially. The decline in average balances was partly due to higher paydowns and delays in closing at the very end of last year. We experienced healthy activity in the latter half of the first quarter.

Average consumer loans were down 1% from last quarter and up 1% year over year. Residential mortgage loans grew by 2% sequentially as we continue to portfolio only jumbo mortgages and ARMs and up 11% year over year. Indirect auto loans are down 3% from last quarter and 5% year over year, in line with our lower origination targets and focused on improving returns in this business. The return profile of our first-quarter production was one of the best in the last few years within the super prime market that we mainly focus on.

Average investment securities increased by $317 million in the first quarter or 1% sequentially. Average core deposits decreased $1 billion from the fourth quarter. This decrease was driven by seasonally lower demand deposits, partially offset by higher interest checking balances. Our liquidity coverage ratio was very strong at 118% at the end of the quarter.

Moving to NII on page 6 of the presentation, taxable equivalent net interest income increased by $5 million sequentially to $909 million, despite the negative day count impact. The increase was primarily driven by improvement in variable-rate loan yields due to the increase in the Fed funds rate in December with deposit betas remaining at low levels.

Quarter over quarter, our earning assets yield increased by 8 basis points, accompanied by a 3 basis point increase in cost of interest-bearing liabilities.

These benefits were partially offset the effect of a reduced Fed stock dividend payment and continued spread compression from the mix shift to lower yielding, higher-quality credits, which we have discussed previously. NII also benefited from the timing of the investments in the portfolio as cash flows were invested earlier in the quarter, and the late debt issuance during the quarter.

Overall, we are pleased with our NII growth over last quarter and the 7% growth year over year. NIM improved 6 basis points to 2.91% quarter over quarter.

Shifting to fees on page 7 of the presentation, first-quarter noninterest income was $637 million compared with $1.1 billion in the fourth quarter. Our fee income adjusted primarily for Vantiv-related items and the annual $31 million TRA payment in the fourth quarter was $578 million, a decrease of $14 million or 2% sequentially. Despite seasonal headwinds and challenging market conditions, our results were strong.

Corporate banking fees of $102 million were relatively flat sequentially and adjusted for the write-down of a residual lease in the first quarter of 2015 were up 10% year over year. As we mentioned in January, corporate banking fees are seasonally lower in the first quarter and overall market conditions were weak during the quarter. So our performance was strong despite the challenging backdrop.

Mortgage banking net revenue of $78 million was up $4 million sequentially. Originations were $1.8 billion in the first quarter with 46% of the mix consisting of purchase volume. About 75% of the originations came from the retail and direct channels, and the remainder came through the correspondent channel.

Gain on sale margins were up 57 basis points sequentially to 347 basis points and net servicing asset valuation adjustments were negative $16 million, similar to last quarter. Deposit service charges decreased 5% from the fourth quarter, reflecting seasonal trends in consumer deposit fees, and increased 1%, relative to the first quarter of 2015.

Total investment advisory revenue of $102 million was flat sequentially, mostly reflecting weaker equity market activity during the quarter. This impact was offset by seasonally higher trust tax preparation fees. Excluding certain one-time items, our year-over-year revenue growth reached nearly 5%, a very good outcome in a challenging environment.

Next, I would like to discuss noninterest expense in page 8 of the presentation. Expenses were $986 million compared with $963 million in the fourth quarter. The sequential increase was partly due to seasonally higher FICA and unemployment insurance expense and a $14 million expense related to the voluntary early retirement program.

The early retirement program was well-received by our employees, and approximately 160 employees participated. As a result, we expect a $9 million decrease in annual compensation expenses.

As Greg said earlier, we continue to look for other similar opportunities to improve our expense run rate. I will provide an update on our expense outlook a little later.

Turning to credit results on slide 9, net charge-offs were $96 million or 42 basis points in the first quarter compared to $80 million and 34 basis points in the fourth quarter of 2015 and $91 million and 41 basis points in the first quarter a year ago. The sequential increase was due to a $16 million increase in C&I net charge-offs.

Of the total net charge-offs, $9 million were in energy. Nonperforming loans excluding loans held for sale increased $195 million from the previous quarter to $701 million resulting in an NPL ratio of 75 basis points. Commercial NPLs increased $202 million from the fourth quarter, driven by $168 million in energy NPLs. Consumer NPLs declined by $7 million sequentially.

Overall credit conditions, excluding energy, remain within our expectations. Consumer credit continues to improve and commercial credit, excluding energy, is stable. Our provision was $23 million higher than the total charge-offs in the first quarter and our reserve coverage moved up 1 basis point to 1.38% of loans and leases.

It is important to note, as Greg mentioned, that an increase in energy NPLs should not necessarily translate into an increase in charge-offs of the same magnitude. This is because the majority of energy NPLs are well-collateralized and consist of reserve-based loans.

On slide 10, we have provided a breakdown of our energy portfolio. Our energy-related loans at the end of the quarter were $1.7 billion with total commitments of $4 billion. As you can see, our loans to oilfield services companies were only $294 million or 17% of our total energy loans outstanding, and leaves only $170 million in unused commitments.

We believe that we are appropriately reserved for losses in the energy portfolio, based on detailed stress analysis that our teams continue to update, not only on the oilfield services portfolio but also on our reserve-based loans. Based on detailed analysis, we believe that our energy reserves, which are currently at 6.2%, up from 4.8% at the end of last year, are adequate. Our stress case scenario over a nine-quarter period assumes that oil prices will be at $20 in 2016 and $25 in 2017. This stress scenario would add approximately $50 million to $60 million in net charge-offs over and above our current reserves.

On slide 11, we provide a breakdown of our commercial real estate portfolio. It is important to note that our commercial real estate business today is much different than what we had pre-crisis. At the end of 2007, 21% of our total loans and leases were in commercial real estate. Today we are at 11% below our peer levels. At the end of 2007, over 40% of our non-owner-occupied exposure was in land and residential developments. Today that exposure is slightly above 4%.

As you can see, our nonperforming assets continue to decrease both within the commercial mortgage and commercial construction portfolios. At the end of the first quarter, NPAs in our commercial mortgage portfolio decreased to 1.84% from 2.56% a year earlier. NPAs in our commercial construction portfolio decreased to 23 basis points from 67 basis points over the same period. During the last two years, we significantly upgraded our credit resources in commercial mortgage and construction underwriting, which increased our focus on client selection, geographical diversity and multifactor stress analysis.

Moving on to capital on slide 12, our capital levels remain strong. Our common equity tier 1 ratio was 9.8%, an increase of 30 basis points year over year. At the end of the first quarter, common shares outstanding were down approximately 15 million. During the quarter, we announced and settled a common stock repurchase of $240 million and reduced the first quarter's share count by 14.5 million shares.

Now moving to outlook, the drivers of our overall outlook remain unchanged. We expect year-over-year commercial loan growth to exceed 3% and the consumer loan portfolio to decline. The decline of our consumer loan portfolio will primarily reflect lower auto loan originations, as we have previously discussed, and includes the impact of the sales associated with the St. Louis and Pittsburgh transactions.

Our interest rate outlook now has only one rate increase in June, as opposed to the two increases that we had in our original base case. For the second quarter, we would expect relatively stable net interest income compared with the first quarter but despite one late rate increase, we still expect a 2.5% to 3% increase in NII year over year.

In our base case we would expect to see 3 to 4 basis point of NIM decline in the second quarter and then hold relatively steady, in line with our results in 2015.

Although deposit betas are expected to remain low, our outlook assumes incremental spread compression due to our continued emphasis on originating higher-end quality loans. This update improves upon our January guidance as it includes one less rate increase. Without a rate increase, we would expect NII to grow around 2%.

Our overall fee income growth outlook has not changed. We expect to grow our fees between 4% and 5% on the 2015 base of $2.3 billion, which excludes Vantiv's share and warrant gains that we had during the year. We are lowering our year-over-year expense outlook from 4.5% to 5% to the 4% to 4.25% range. We believe that our intense focus on expense control will result in an improvement in operating efficiency compared to our January expectations. The quarterly run rate will increase from the first-quarter levels, and this will reflect seasonality and the timing of implementation of strategic initiatives. But we will have better year-over-year results than originally expected.

Our second-quarter result will also include a one-time approximately $10 million expense as a result of retirement eligibility changes related to long-term incentive compensation. These changes will align our retirement eligibility provisions with our peer group. This is just the change in the timing of the recognition of expenses and would lower our expense going forward.

We continue to monitor our energy exposures closely. It is likely that we will see higher charge-offs in this portfolio, primarily in the oilfield services sector. Given the relatively modest size of our exposure, future credit losses should be manageable. Credit losses ex-energy should remain in range with some potential variability quarter to quarter due to the historically low level of current charge-offs.

With that, let me open the call for questions.

(Operator Instructions) Ken Usdin, Jefferies.

Tayfun, I was wondering if you could just follow up a little bit more on the credit outlook. You mentioned that -- and we saw a big boost in the NPAs. We don't expect to see a lot more, necessarily, on the energy losses. But can you just flesh out your confidence in seeing the 9 underneath and if you can just parse out the portfolios, what you are expecting in commercial ex-energy and on the consumer side?

Sure. Frank is here. Frank is going to answer the question.

Good question, Ken. As we reported, nonperforming assets are up in the quarter. Almost all of that is energy-related, 90% plus is energy-related. It's all tied to reserve-based lending loans, seven loans. We feel very confident at this point that those loans are protected by the risk-adjusted collateral coverage that we have in place.

All borrowers in the segment that are on NPL that we just moved are current. I think that's important. The regulators, as you have probably heard on other earnings calls, have taken a much stricter view of how they are classifying these loans from an accounting perspective. They are looking to cover both the first and the second-lien positions on these companies.

In our case, we have a super secured first-lien position and we have gone through a very detailed portfolio analysis of bottoms up of all our energy book to ensure that, from a borrowing base perspective, we are well-secured.

So, NPLs are up. However, it's in a segment that is very well-protected from a collateral position, both historically and based on our current outlook.

We could see additional deterioration from an energy perspective in NPLs, given that, in the future, as Tayfun indicated, but we are not changing our outlook on overall credit losses. Beyond that, when you look at the rest of the portfolio, we have talked this morning about commercial real estate. And we feel very good about that book. The performance is holding up very well.

We have very little exposure in commercial real estate in the energy space. We have four multifamily credits that are in Houston, two of which are stabilized, the other two are performing under construction according to the terms that we have set. And we have some exposure in Denver from the commercial real estate perspective, but that market has held up very well, being in an energy sector.

So the overall commercial real estate book at this point is performing to our expectations. Our rental market book is performing very well. We are showing very strong performance in most of our core markets; we are not concerned there. Our leverage book is stable. We'll have some lumpiness quarter to quarter in leverage, but overall it's performing to our expectations as well.

So I hope that was responsive to your question.

It was, thanks. And just one quick follow-up -- you had previously talked about building reserves this year, more reflecting loan growth. Is that also a reasonable expectation?

Again, we will have to look at the reserve situation on a quarter-by-quarter basis. Obviously, we did say that reserve releases are very unlikely and by the end of the year, our provisioning will reflect loan growth, ultimately. But that's a quarter-by-quarter analysis that we will share with you.

Right. Okay, thank you.

Paul Miller, FBR & Co.

On your energy credits, have you seen any deterioration in any of your CRE markets associated with your energy?

Let me speak to that. You are talking about nonenergy credits that are (multiple speakers) --

Yes. It's just the second derivative. A lot of people are worried about the CRE markets and I guess other second derivatives of the energy market, where a lot of people have claimed that a lot of the growth has come out of the energy markets. I was wondering if you saw any deterioration in some of these markets outside of energy that were related to energy.

One thing to keep in mind -- we are really not a Southwest bank. We don't have a retail presence in the Southwest. We do other business there. Our commercial book has held up very well. We don't see any deterioration from a traditional commercial middle-market or mid-cap perspective. I just talked about real estate.

Again, in Texas we just have four transactions, $100 million in total exposure, multifamily to national developers. We see no problems there.

If you switch over to indirect, we have about $1.5 billion in the energy states in indirect exposure, which is 4% of our total indirect --

That's indirect auto loans.

It's $1.5 billion in total indirect exposure, in consumer exposure, and the vast majority of that is in indirect auto loans. We have seen some uptick in past dues in that book. We have cut off a number of dealer relationships in Texas in order to pull in and shrink back that exposure.

But overall, we feel good about the consumer indirect book in Texas. Other than that, we really don't have any substantial consumer exposure in the energy space.

So again, our focus has been -- and if you asked for concerns it would be around what we have in real estate. But it's small and is well-managed. And the direct piece of consumer is 4% of our portfolio.

Thank you very much, gentlemen.

John Pancari, Evercore.

It's actually Steve Moss in for John. Wondering with regard to the mix shift on loans going to lower yielding, higher-quality loans, wonder if you could just quantify what you are thinking about the impact to loan yields over the course of the year.

That's going to be a function of basically the payoffs and originations. Originations are clearly coming at the upper end of our credit spectrum. In March, for example, when we looked at our commercial originations the average grades were very close to the investment-grade spectrum in our underwriting.

Largely, the timing of the impact on margin will also depend on the payouts from the lower end of the spectrum. And that's a little bit tough to quantify. We will quantify that for you each quarter as the quarter goes by. But it's a fairly steady type of tightening at this point.

And one thing on our NIM outlook for the second quarter that's embedded in that is that C&I yields, the expectation will be, would be down a couple basis points as a result of that loan yield compression as we continue to transition to a higher credit profile client.

Okay. And also you mentioned improved profitability in the auto loan book here this quarter. I'm just wondering where you are originating those, at what yields are you originating those loans this quarter, and what were your total originations.

So in terms of the spreads, the spreads this quarter were a good 25, 30 basis points above what we've seen over the past number of quarters. But I just want to remind you that that was a very deliberate decision on our part to lower our annual originations to roughly $3 billion from $5 billion, which enabled us to focus on profitability rather than volume.

Our auto business is a national business. That has not changed. The geographic distribution of originations is roughly about the same, except for what Frank mentioned earlier where spreads have widened. The credit quality remains the same, so we are getting more return on the same type of capital allocation for the loans that we are originating.

And on the first-quarter origination levels it was a little bit ahead of $900 million or so, and that was a little bit ahead of our expectation, frankly, given the pricing changes in the yields we've seen.

So our outlook has increased the originations from about $3 billion at the end of the year to about $3.3 billion for this year. And I think you'll see yield expansion second quarter in that book.

Great, thank you very much.

David Long, Raymond James.

Shifting gears here to the mortgage business and the few weeks into the quarter here, can you give us some color on what the pipeline looks like and maybe what gain on sale spreads look like right now?

The pipeline looks good. Obviously, the rates have stayed under 4% for most of the first quarter. It's a little early to be making a comment on spreads for the quarter. Obviously, Q1 spreads were wider.

We will just have to wait a little longer to get a firmer perspective on gain on sale spreads for this quarter.

Okay. And then just the second question that I had, regarding the effective tax rate that has moved around a bit with the Vantiv-related transactions, any color on how we can expect that to move here for the rest of the year?

Yes. I think actually the tax rate came in pretty close to where we expected. For the year, we are going to be close to these numbers, probably within a half a percentage level, which really is no different than what we expected going into the year.

Got it. Thanks, guys.

Matt Burnell, Wells Fargo.

Just a follow-up on the margin guidance, Tayfun. You mentioned about the effect of the lower loan yields. Can you give us a sense as to how you are thinking about reinvestment yields with the 10-year treasury still visibly below 2%?

Jamie, why don't you take that?

Yes. Right now -- you saw in our book at the beginning of the quarter, January-February, we reinvested some cash flows because we saw a little bit better entry point there. And then you saw we lightened on an end-of-period basis on the investment portfolio as we closed out the quarter.

So frankly, if rates were to stay at these pretty low levels, you could expect from us just to reinvest cash flows because the entry points don't look real good. But if rates were to have a little bit of a sell-off here and present more opportunity, then you expect our investment portfolio to grow in line with earning assets. But I don't think you'll see a lot of movement in the book, one way or another, throughout 2016.

Yes. Remember, when we were building for LCR, Matt, in the last two years, there was quite a bit more movement in the size of the portfolio. But looking out now it's going to be a steadier direction.

And then, if I could just follow up on an energy-related question, I'm curious in terms of the -- it looks like the overall outstanding balance hasn't really changed much quarter over quarter.

Correct.

But within that, are you seeing loan paydowns or other types of cash flows in from those borrowers that is offsetting some potential drawdowns from other clients?

Overall, we've seen pretty steady balances on an overall basis in that portfolio as we continue to work through with our clients. What we did see in this past -- in the past quarter was commitment levels decline as we have repositioned and reduced our exposure level to a number of names. Accordingly, utilization rates moved up a little bit.

But frankly, we would expect that those overall balances committed in loan balances would come down over a period of time as the clients that we continue to work with very closely continue to sell off core, you know, non-core assets, access to the equity capital and debt capital markets, and reduce their profile.

But this is a great long-term business. We've got some expert bankers and we are working very closely with our clients.

Okay. And then just finally, on the auto loan portfolio, you mentioned your focus on prime and maybe even super prime in that portfolio. It doesn't look like, from a 90-day past due volumes, that that's changed very much. But can you just confirm that the asset quality in that portfolio really hasn't deteriorated much over the past six to 12 months?

It has not. We have not changed our position at all. We are predominantly a super prime lender to the top dealers, and it continues to perform very well to our expectations.

Okay. Thanks for taking my questions.

Mike Mayo, CLSA.

I just wanted to ask about operating leverage. You said operating leverage is a priority. But then we see expenses up in the first quarter. The efficiency ratio got worse quarter over quarter and year over year. Your expense guidance is lower than before, but it's still over 4%. And you had closed, I guess, two thirds of your 100 target branches as of last quarter.

So I'm just seeing the disconnect between some of the words -- it's a priority, you are closing branches -- and the result, expense is still growing faster than revenues.

So my question is, why do you still have expense growth over 4% in revenue environment that seems pretty soft? And when will we see the benefits of those branch closings?

First off, we are focused on, once again, continuing to rationalize all of our expenses. The branch closures that we announced last year we should complete through -- we have already sold the St. Louis, we will close on Pittsburgh this week. We expect to be through that exercise by middle of this year, and we are still on target for that $60 million improvement, on annualized improvement on the branches.

We also -- as I had mentioned before, we offered an early retirement program. We are very focused on expense management. But we are also focused on making the strategic investments that we have to make going forward that we hope and we anticipate will continue to drive revenue, improve our operating efficiencies and improve our service quality.

We've got to make those investments. What we want to do is at the best price points, so we have been sharpening the pencil, closely on how we spend that money to make sure we get the return we are looking for. We are very much focused on the execution of those initiatives and driving to the outcomes.

So going forward, we have guided lower on expenses than we initially anticipated for this year, albeit still at 4%. We need to be lower than that, obviously. We need to create positive operating leverage, and that's what we are focused on. And hopefully, as we go into the latter parts of this year, we will turn the corner on positive operating leverage.

And, Mike, remember first quarter has, compared to the fourth quarter, $25 million, $26 million higher just in two line items, which is FICA and unemployment insurance. So first quarter typically is going to be a higher efficiency ratio quarter compared to Q4.

But as Greg said, and he has been talking about this for a couple of quarters now, there is quite a bit of focus on taking out expenses from operations so that we can reinvest back in the Company. So our outlook -- we believe that we will do better than what we told you in January.

That's helpful. Just one follow-up -- Greg, I'm just curious about your style. As the new CEO you start in the position, and expenses are still growing faster than many of your peers'. On the one hand, you wind up with negative operating leverage. A year or two from now we are all going to be saying, wow, you should not have -- not grown expenses that quickly. On the other hand, if some of your expenses pay off then we are going to say, well, this was really forward-looking on your behalf.

So can you talk about your style in terms of this spending for future gains, the risks and opportunities as you think about it in your mind?

First off, as I mentioned before, we have to make the investments to reposition the bank for the realities that we are operating in. We are going to be in this low-rate environment, we believe, for some period of time. We've got to focus on generating quality revenues with the right partnerships, and we also have to focus on making sure that we have efficiencies in our organization.

If you go back and look at our operation cost, we are running our central operations less than we did in 2007, at a much higher volume than we were in 2007. We have a good history of managing expenses in this organization and we will continue that history going forward.

But we have to invest to re-platform our infrastructure, which we are doing, and we will get paid well for that. We are pruning back and leaning back our distribution channels, as we mentioned before, around branches. We are moving to digital and on capabilities for our customers, which will reduce our back-office costs, re-platforming our retail platform, our mortgage platform, which will be significantly more efficient going forward.

We've got to get paid for those investments. So, it's not lost upon me, at the end of the day, that we are making commitments. We've got to get the return on those commitments to the bottom line of the Company, and that's what we are focused on. We've mentioned that, and I mentioned before that this year is a transformational year to make those investments. But we've got to get paid for it.

So my style is this, it's execution, getting it done and making the commitments that we made to the organization, our shareholders and our investors. And we're going to do just that. So that's what we are focused on.

Thank you.

Peter Winter, Sterne Agee.

I'm just curious; how far through are you in terms of the mix shift to higher quality loans? And then secondly, with this mix shift, how do you think about, through the cycle, where your net charge-offs would be in the range versus historically?

Yes. It's difficult to tell you exactly where we are in terms of the de-risking or repositioning of our balance sheet. Part of that is that we have a change in economic environment, interest-rate environment, economic environment. But I would tell you that we continue to stay focused on it every single day. We are reallocating our resources to the businesses that best fit not just our risk appetite but also produce the best returns for our shareholders over a long period of time.

One of the keys here is not just, of course, to achieve the highest returns but also position this balance sheet in our loan portfolio so that it will outperform through the future cycles, which I think leads to the second part of your question, which Frank may want to have a comment on.

Your question regarding loss -- our normal range is 30 to 50 basis points of loss. We performed through that number over the last several years. We've had some lumpiness quarter to quarter, but if you look at year-over-year performance we've stayed within that range, and that's where we expect to be this year.

As Lars said, we are really intensely focused on managing credit really well through the cycle, and so we are looking at investing in businesses that we believe will do that. We are growing our asset-based lending business. We are growing our leasing business. But we are pulling back a bit on our leverage business. Those are all conscious decisions to ensure we have appropriate risk and return, in balance, that will provide good returns and consistent performance through any cycle as we go forward.

Okay. But -- so wouldn't it -- wouldn't it lower it through our normal cycle, just given this change that you are going through?

Well, it should. Over an extended trade of time, it should. But where we sit today is we are managing what we have currently on the books and currently have we are managing the energy book. It's small, relative to the overall size of our Company at less than 2% of our outstandings.

But we are in a choppy environment. Our performance overall is still, I think, very good. And our outlook for this year has continued to be consistent; we haven't changed our outlook where charge-offs are.

Yes. I think also, just on an absolute basis, yes, everything else being equal. But if the environment changes and we get to the other side of this credit cycle, it is our expectation and belief that by doing what we are doing, de-risking the business, our credit performance relative to the industry should be better. That doesn't necessarily mean that at absolute levels it will stay. But relative to the credit cycle, we will do better.

Great. Thanks very much.

Geoffrey Elliott, Autonomous Research.

It looks like the Vantiv stock price almost feels like every day it's setting new highs, and the Fifth Third stock price isn't. So what is the strategic rationale for still holding the Vantiv stake, and how strategically and financially do you think about whether it makes sense to exit that versus where that it makes sense to continue to hold it?

First off, obviously, Vantiv is doing extremely well. And we are proud to have our ownership position that we have in that company. We have been very thoughtful over the last three years of how we monetize that position. I think the returns to our shareholders have been outstanding.

We're going to continue to watch that company. We're going to continue to assess the value of their equity and their forward opportunities strategically, what they have in front of them and their opportunities, and we are going to make the best decision for our shareholders going forward with respect to how we continue to monetize our position.

Consistently we have done that each year and we anticipate to continue that same path. To what extent and what time really gets back to looking at the factors I just discussed, which is our long-term thoughts and projections on what we're going to be able to perform at and how we are performing. And we will continue to monetize that position over time.

In terms of how you think about it now, is it purely a financial calculation around how do you maximize the returns to Fifth Third, or is there any kind of strategic benefit in having a stake at all?

We don't have trigger points where we feel that we are forced to take action. We look at that sector, the drivers of performance in that sector. We look at performance of drivers in the banking sector. We look at Vantiv's opportunities strategically. So it is really a multifactor analysis that we go through and try to make the same type of decisions that we've made in the past for our shareholders.

Great, thank you.

Terry McEvoy, Stephens.

Greg, you were quoted in an article about Fifth Third earlier this week in your local newspaper talking about non-bank acquisitions. I believe that mentioned smaller banks. I was wondering if you could expand upon your interest on the non-bank side as well as the small bank side.

We do have and we continue to look at, once again, ways that we can continue to be a better partner and add value in our business. So when you think about our payments area, we support, obviously, corporate strategic verticals like retail, healthcare and so forth. So we are looking for opportunities in those sectors. We made a small investment in a company called Zipscene. We just made an investment in the company called Transactis that was just recently announced. So those are the type of things I'm looking for.

In addition to that, we are also looking for opportunities in the wealth management sector, insurance opportunities that might make sense for us going forward as we continue to build out our capabilities and those sectors. So we are interested in where those opportunities lie. Once again, for the right value proposition, the right long-term value for our shareholders we are considering those.

On the bank side of the house, as I mentioned in prior discussions, we are really focused on opportunities to be more relevant in the markets that we are in, where we can continue to build out a quality franchise in our higher-growth markets like the Carolinas, Tennessee, Chicago markets. We are interested in when those opportunities materialize that make sense for our shareholders. At the right price, at the right value proposition, we're going to continue to consider those also.

And then just a follow-up question on the corporate banking line -- you mentioned, and we saw this in the results, a strong first quarter despite the, what you normally see, seasonality. How is the pipeline for 2Q? And do you think seasonality in terms of a quarter-over-quarter pickup in the second quarter will occur this year?

We feel good about the pipeline. But I'll turn it over to Lars for some more color around the pipeline.

So if you break down corporate banking and you really look at the significant part of that, capital markets, where we really outperformed -- I think we outperformed the market. We are up 18% from the prior quarter. We are up on a common quarter basis also. And frankly, we grew almost every client solution and every product throughout our capital markets platform other than corporate bond underwriting. Frankly, we are getting a lot of traction there. The pipeline is strong, it's strengthening. And a lot of that is because we're adding additional talent and capabilities. We are able to broaden current relationships and it's putting us into a position, frankly, to be more lead left with a number of our clients.

So I feel good about it over the long term. But I think it's important to keep in mind that for capital markets that the macroeconomic environment does have a significant impact quarter to quarter, and it does tend to be a little bit of a lumpy fee income source. But we need to diversify it, build it out, consistent with our relationship ranking strategy.

Thanks, Lars.

Vivek Juneja, JPMorgan.

Apologies if I am repeating something you said -- too many earnings calls going on at the same time, so we are trying to do the best we can. Just a couple of numbers on energy loans. What percentage are investment grade, and what are your total NPLs on energy as of the first quarter?

52% of our core book is investment grade. Again, as we've talked about before, E&P loans make up 58% of our total portfolio. The vast majority of those are reserve-based lending loans where we feel we are very well-secured. We are continuing to be protected by our risk-adjusted collateral coverage.

The issue we have is not there; the issue we have is on 17% of the portfolio, which is oilfield service. And it's only on the third of that portfolio, or about $90 million, where we have projected losses going forward.

So it's a small book, 2% overall. And the portion that we are concerned about is 17% of that 2% and only a third of that, if that makes sense. So we feel, overall, we are very well-protected.

I'm presuming that's Frank who just spoke. Right?

This is Frank, yes.

Frank, can you give me some numbers on just -- I know you talked about NPAs increase of $168 million. Could you give us the numbers where it was at the end of the quarter?

On nonperforming loans?

Yes, please.

Yes, we were just above $180 [million] at the end of the quarter.

Okay. And switching now to Greg, going back to the question that was just asked, just a little more clarification on your interest in small bank acquisitions. Can you define small banks, sort of what size you are thinking about, for one? Second, Chicago -- was that -- you have cited Southeast. Where does Chicago fit into your interest pattern?

We've got a good franchise in Chicago. There's opportunities to grow in that market. So we are being thoughtful about opportunities that may emerge in markets like Chicago and our other higher mid-South footprint opportunities. So we would consider those type of acquisitions. I don't want to put a size limit or opportunity out there on the size of the deal we do. But obviously, we want it to be something we make sure that fits our franchise and something that we could execute well against. And once again, it gets back to the value proposition of that opportunity for our shareholders long-term.

The market is not unfavorable to recent deals that were announced. We are very mindful of that. We want to make sure we do the right deal at the right time for the right value proposition for our shareholders.

Thank you.

There are no further questions at this time. Mr. Gokhale, I turn the call back over to you.

Thank you, Scott. 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.

This concludes today's conference call. You may now disconnect.