Fifth Third Bancorp (FITBI) 2017 Q2 法說會逐字稿

Good morning. My name is TaShawn and I will be your conference operator today. At this time I'd like to welcome everyone to Fifth Third Bank's second-quarter earnings call. (Operator Instructions). Thank you.

I would now like to turn the call over to Sameer Gokhale, Head of Investor Relations. The floor is yours.

Thank you, TaShawn. Good morning, and thank you all for joining us. Today we will be discussing our financial results for the second 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 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 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 our call by our President and CEO, Greg Carmichael; CFO, Tayfun Tuzun; Chief Operating Officer, Lars Anderson; Chief Risk Officer, Frank Forrest; and 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 second-quarter 2017 net income available to common shareholders of $344 million, and earnings of $0.45 per share. Our reported EPS includes a negative $0.01 per share impact from the Visa total return swap. Our results for the quarter were very strong, and reflected our continued focus on profitable revenue growth, expense management, and credit discipline.

Our ROTCE and ROA metrics improved both on a sequential and year-over-year basis as we made progress toward achieving our North Star objectives. We were also pleased that the Federal Reserve did not object to our capital plan. This will allow us to both increase our dividend and significantly increase capital distributions to our shareholders compared to last year. At approximately 120% of consensus earnings estimates, our expected payout ratio is one of the highest in the industry.

I'd like to make a few observations about the operating environment. Given the political gridlock, the timing of potential changes to the regulatory environment remains uncertain, and expectations for more fiscal stimulus have been tempered. On the other hand, the data on jobs growth is encouraging; and we, like other banks, are benefiting from recent Fed rate hikes. The strong jobs outlook combined with moderate inflation and healthy consumer spending also leads many to believe the yield curve will steepen as long-term interest rates begin to rise.

However, the sustainability of the strong employment data and the prospect for higher interest rates will depend on whether we see acceleration in real GDP growth. We, like many of you, would like to gain more clarity to get a better directional read on the longer-term outlook. We are operating under the assumption that economic growth in the near term will remain muted.

When I laid out our vision for North Star in September of 2016, we announced that we expected to realize significant benefits without assuming any meaningful changes in a regulatory and macro environment.

As our Q2 results demonstrate, we are continuing to make progress towards enhancing our profitability while improving our balance sheet resiliency. In Q2, we have benefited from effective expense management and improvement in our key credit metrics while growing revenues. Our asset-sensitive balance sheet allow us to continue to benefit from increased short-term interest rates. Our commercial loan production in second quarter was the strongest since the first quarter of 2016, with a healthy pipeline as we look ahead to the rest of the year.

Our adjusted net interest margin expanded 3 basis points sequentially, exceeding our previous guidance, reflecting the benefit of higher rates. In addition, we maintained pricing discipline on commercial loans which helped our overall net interest margin. Our pricing discipline partly reflects our focus on client selection, as we are interested in building durable, long-term relationships rather than pricing simply to drive faster near-term loan growth.

Our total average loan portfolio was flat sequentially. This reflected the impact of deliberate commercial exits, as well as continued decline in indirect auto loan balances. The trend in auto loans continue to reflect our decision two years ago to curtail originations to improve our returns on capital.

From a commercial perspective, we announced at the beginning of the year that we plan to exit about $1.5 billion of commercial loans this year, which will impact our net loan growth. In the first half of 2017 we have exited $900 million of loans, split evenly between return and credit-related exits. Excluding deliberate exits, our average commercial portfolio grew 3% year-over-year compared to the reported decline of 2%.

And in the consumer portfolio, if we exclude the auto loans, average consumer balances grew 4% year-over-year compared to a reported decline of 2%.

In terms of fee income, excluding the impact of the items listed in the earnings release, fee revenue was 7% higher sequentially. The sequential increase primarily reflected a $31 million lease remarketing impairment recorded last quarter.

So in the second quarter, we continued to diligently manage our expenses while investing in other areas of strategic importance. For example, we invested in repositioning our brand through print, television, radio, and digital advertising. While it is early, the feedback on our brand launch has been very positive.

In Q2, noninterest expenses were down 3% sequentially and year-over-year. The year-over-year decline partially reflects the benefits of our early North Star initiatives to reduce expenses. We now expect 2017 expenses to be flat year-over-year, and Tayfun will expand on this in his prepared remarks.

Turning to credit quality, during the quarter credit quality continued to improve. Our criticized asset ratio decreased significantly to 5.5%. It is now at the lowest level in over 10 years. Nonperforming assets also decreased, with our NPA ratio at the lowest level since the fourth quarter of 2015. These forward-looking credit metrics suggest that credit quality should remain relatively stable in the near term.

Our net charge-off ratio also decreased significantly, and remains at pre-crisis levels. Our capital (inaudible) levels remain very strong, with our Common Equity Tier 1 ratio at 10.6%, while our LCR exceeded the regulatory requirements by over 20%.

As I mentioned previously, we are very pleased with the outcome of this year's CCAR exercise. Our capital plan allows us to increase our dividend by 29% compared to current levels, and increase capital deployment for share repurchases by 76% compared to last year's CCAR submission. Under the Federal Reserve's DFAST scenario, we again showed less capital destruction compared to the peer group median.

The plan we submitted was prudent from a risk management perspective, but appropriately focused on achieving the right results for our shareholders. The results prove that there is no inherent conflict between those goals.

We are also making solid progress on our North Star initiatives. We expect to generate an ROA near 1.1%, and an ROTCE of roughly 11% by 2018. And we remain confident in our ability to achieve our North Star targets by the end of 2019.

We have previously communicated that with Project North Star, we expect to generate $800 million in incremental annualized pre-tax income by the end of 2019. This was a function of expected base improvement, additional expense saves, and revenue growth initiatives. Base improvements consist of continuing improvements in our core expenses such as vendor management, staffing, and process improvements. The additional expense saves we had mentioned will come from a number of items, such as IT efficiencies and facilities management.

On slide 11 of the earnings presentation, we are providing you with more specifics on North Star revenue initiatives that we expect will drive growth in pre-tax income. We expect these initiatives to drive almost $300 million of annualized pre-tax income growth by the end of 2019.

One area of particular focus is in our commercial business, where we plan to expand the depth and breadth of our client offerings over the next few years. In commercial lending, we are investing to improve fee income as well as net interest income. Our balance sheet initiatives include growth in middle-market lending with expansion into new markets, significant growth in asset-based lending, and additional vertical buildouts.

The objective is to develop a strategic partnership with our clients by providing expertise and delivering a differentiated customer experience. This approach helps build enduring relationships, allows us to manage risk, and drives profitability.

About a year ago, we started expanding our ABL capabilities with investments in infrastructure and talent. We now have the ability to underwrite and service any type of ABL product. And over the past year we have closed a number of complex deals that we could not have done before. In fact, our ABL portfolio has roughly doubled in the past year.

We have also made substantial investments to build out industry verticals. Our go-to-market strategy by vertical has proven to be effective. It allows us to build and leverage sector expertise to better serve the needs of our customers. We continue to evaluate new opportunities to add to our existing verticals in healthcare, TMT, energy, retail, and entertainment, leisure, and lodging.

While we're undertaking these growth initiatives, we're at the same time implementing a project to improve the effectiveness and efficiency of our commercial lending processes to support growth and enhance client service. The objective of this project is to streamline our processes to improve cycle times, reduce our cost to serve, and also provide our relationship managers with additional capacity to generate new business. This will help produce a better outcome for our clients, our employees, and our shareholders.

In capital markets, our investments include significant upgrade to our technology platform, expansion of our sponsored coverage group, and additional ECM and DCM capabilities with added resources and talent.

Our wholesale payments initiatives include recently launched projects to grow our commercial card business, enhance our commercial portfolio with advanced liquidity management tools to better manage cash flows, and leverage technology solutions similar to AvidXchange and Transactis. These investments are all aimed at deepening our relationship and generating higher, more consistent commercial payments revenue.

Insurance is a new initiative for us, with modest but expanding bottom-line expectations. We believe this business is a good complement to our other commercial offerings.

In the consumer business, we are in the process of rolling out a new loan origination system for the correspondent markets channel. In the fourth quarter, the new system will be implemented in our direct and retail mortgage channels; while in the first half of next year, we will work on integrating the new system with our home equity platform. This initiative will create both NII as well as fee income opportunities while reducing our costs to originate consumer mortgages.

As we discussed previously, we are also in the process of digitizing our branch operations in an effort to get to a paperless environment. This will be achieved through branch scanning, the use of electronic signatures, and driving more self-service transactions. When it's completed, this initiative is expected to reduce our paper count by 700 million pages per year. With efficiencies generated from reduced paper and transportation expenses, we expect to save $10 million annually.

This initiative includes replacement of our branch teller software. This new platform will improve the customer experience, mitigate compliance and operational risk through automation, and ultimately improve the efficiency and speed of transaction processing. We have piloted this in 10% of our branch network and are very happy with the results. We will gradually implement this across the rest of our branch network through the second quarter of 2018.

We are working diligently on our personal and small business lending initiatives, and have entered into select partnerships to help drive loan growth. These initiatives will help us achieve a better balance between commercial and consumer loans. We are partnering with fintech companies to reduce cycle times, broaden our product lineup, and expand our distribution channels. Partnerships with companies like ApplePie Capital enhance our product offerings and cover a wide spectrum of borrowers with diverse funding needs.

In consumer credit cards, we have already launched an initiative to upgrade our analytical capabilities focused on growth in our footprint. We are partnering with a consulting firm with deep expertise to enhance our in-house capabilities. And we believe we have an opportunity to significantly grow our consumer payments business.

In wealth and asset management, we are focused on expanding our end market capabilities through acquisitions, additional resource deployment, and a rollout of a digital investment platform that will enhance the economics for certain client segments. We are on target to launch the new digital platform in December.

Overall, we had a very good quarter, and our North Star initiatives remain on track. Tayfun will share additional financial details around these initiatives in his prepared remarks.

I would like to once again thank our employees for their hard work and dedication, evident in our financial results and our customers' satisfaction scores, and our community outreach efforts. We recently launched a series of community advisory forums both at the regional and national level. This gives us a terrific opportunity to increase engagement and better meet the needs of the communities in which we serve.

I am also especially proud of our efforts initiated on May 3, or Fifth Third Day, to provide over 1 million meals supporting local food banks during the quarter. Furthermore, we recently announced a $10 million contribution to support the Cincinnati Cancer Consortium.

This gift is a critical step in supporting an effort to achieve a National Cancer Institute designation for the Cincinnati Cancer Consortium. An NCI designation will lead to more research funding and better outcomes for cancer patients throughout the greater Cincinnati region.

I am pleased that our entire organization is aligned and fulfilling our stated purpose to improve the lives of the people in the communities we serve.

With that, I'll turn it over to Tayfun to discuss our second-quarter results and our current outlook for the remainder of the year.

Thanks, Greg. Good morning, and thank you for joining us. Let's begin with a financial summary on slide 4 of the presentation.

As Greg mentioned, during the quarter our continued focus on disciplined expense management, the expansion of our net interest margin, stable credit quality, and efficient capital management all reflected our commitment to driving improved financial performance. We achieved positive operating leverage, both on a year-over-year and sequential basis during the quarter. We expect to achieve positive operating leverage again next quarter and for the full year.

Overall, average loans were flat sequentially, mostly as a result of continued exits from certain commercial exposures and the planned decline in our indirect auto loan balances. New origination levels were strong, giving us an optimistic outlook for 2018 and beyond; as the deliberate exits, especially in C&I, will be coming to an end this year. Average commercial loan balances were flat sequentially, and down 2% year-over-year. Excluding the impact of the exits that Greg mentioned in his prepared remarks, average commercial loans were up 1% sequentially.

The sequential decline in average C&I balances was partially offset by 2% growth in commercial real estate loans this quarter. Much of the quarterly average growth in construction loans came from drawdowns near the end of the first quarter. With the summer construction season in full swing, we would expect line utilization to remain strong. On the other hand, payoffs will continue in the 2013-2014 vintages as construction loans either sell or move to the permanent market.

We are currently seeing increased pipelines in office and industrial as the demand for multifamily is moderating. We have kept a conservative risk profile in construction lending, and will continue to be diligent in underwriting, as we are at the later stages of the cycle. Expanding new production spreads, combined with the move in LIBOR, resulted in a 24 basis point yield improvement in that portfolio.

At this time, we have roughly another $600 million of exits to go for the remainder of 2017, which should be split about evenly across the next two quarters. Excluding these anticipated exits, we expect to grow total commercial loans in the low- to mid-single-digits in 2017. Assuming that the muted economic environment persists, including these exits, we expect our commercial loan portfolio to grow by about 1% on an end-of-period basis, which is slightly below the guidance we gave last quarter.

We remain competitive in all of our markets and maintain a disciplined approach in pricing and underwriting, which is enabling us to grow profitable relationships.

To further boost future loan growth we are expanding our commercial salesforce in both regional and national businesses. As Greg mentioned, we are also looking to expand to additional geographies in middle market lending, which we expect will increase future loan and revenue growth.

Average consumer loans were down 1% from last quarter and down 2% year-over-year. Excluding auto, average consumer loans were up 4% year-over-year. Auto loans were down 14% year-over-year. The reduction in auto balances continues to reflect our decision to curtail indirect originations and redeploy capital elsewhere.

Residential mortgage loans grew by 1% sequentially and 10% year-over-year as we continue to retain jumbo mortgages, ARMs, as well as certain 10- and 15-year fixed rate mortgages on our balance sheet during the quarter.

Our home equity loan originations were 17% higher this quarter sequentially, and up 7% year-over-year. As loan paydowns in our legacy book continue to exceed strong origination volumes, portfolio outstandings decreased 3% sequentially and 8% year-over-year.

Our credit card portfolio was down 3% from the first quarter, although end-of-period balances were up 2% sequentially. We are seeing stronger growth related to the new card rollout that we executed at the end of last year, with purchase active accounts up both sequentially and year-over-year. We expect that our simplified and more competitive card offerings, along with our enhanced analytical capabilities, will allow us to drive faster growth in the second half of this year and into 2018.

Excluding the deliberate reduction of indirect auto loan balances, we are expecting to grow our consumer and mortgage loans by a low- to mid-single-digits rate in 2017. The outlook reflects our current expectation that HELOC paydowns on older vintages will continue to outpace production in the near term. Consistent with our strategy, the redeployment of capital from indirect auto lending to other parts of our consumer lending franchise should provide further support for higher ROTCE and ROA levels.

Our investment portfolio balances remained relatively stable in the second quarter, as we had expected. We continue to expect to maintain our investment portfolio at roughly the same level.

Average core deposits were down 1% sequentially as growth in the consumer portfolio was offset by declines in the commercial portfolio. A sequential decline in money market and interest checking accounts was offset by increases in savings balances.

We feel good about our deposit balances as we continue to make rational decisions between pricing them appropriately for profitability and maintaining and growing relationship-based, LCR-friendly deposits. The market, especially in large commercial accounts, is becoming more competitive, which we expected all along. And our margin and NII outlook already reflect the market dynamics as we observe them today.

Our modified liquidity coverage ratio continued to be very strong, at 122% at the end of the quarter. Net interest income of $945 million was up $18 million, or 2%, from the previous quarter's adjusted NII, and is up $37 million or 4% from last year. Our strong underlying NII performance reflects the positive impact of higher short-term rates.

Growth in NII came both from the consumer and commercial portfolios, reflecting higher interest rates, partially offset by the impact of higher wholesale borrowings. Over the last year, expansion in earning asset yields significantly outpaced the increase in our cost of funds.

The adjusted NIM increased 3 basis points from the first quarter to 3.01%, exceeding our previous guidance. Excluding the prior-quarter's card remediation impact, our total loan yield was up 11 basis points sequentially, with commercial yield up 13 basis points.

As we look ahead, third-quarter NIM should be a couple of basis points wider than the second-quarter NIM. With the assumption of a rate increase at the very end of the year, we currently expect the full-year NIM to be roughly in line with our margin in the second quarter.

Overall, deposit betas so far have remained low and are in the mid-teens, with commercial betas in the 30% range. Our guidance assumes that on a blended basis, consumer and commercial deposit betas will increase to the 40% range in the coming months for the most recent move in June. For subsequent rate hikes, we expect deposit betas to be in the 50% range. If we see betas at lower ranges, our margin could exceed our guidance.

We expect our third-quarter net interest income to be up by about 2% sequentially. For the full year, we expect NII growth of approximately 5%.

Excluding the impact of the Visa swap, noninterest income in the second quarter was $571 million compared to $536 million in the first quarter, which included a $31 million lease remarketing impairment. Mortgage backing net revenue of $55 million was up $3 million sequentially.

Originations were 17% higher than the first quarter, and our gain on sale margin improved to 209 basis points compared with 198 basis points. Origination fees were up 28% sequentially, in line with our guidance.

During the quarter, our origination mix was heavily weighted towards purchase volumes, as refinance activity remained muted despite the lower rate environment. Approximately two-thirds of the originations continued to be sourced from the retail and direct channels, and the remainder were originated through the correspondent channel.

This quarter, we executed on the purchase of servicing rights of nearly $4 billion worth of mortgages, in addition to the $6 billion we discussed with you last quarter. $2.4 billion of the nearly $10 billion has been onboarded thus far, with the rest scheduled for the third quarter.

Corporate banking fees of $101 million were up $27 million or 36% sequentially, reflecting the impact of the $31 million lease remarketing impairment last quarter. Corporate banking revenues this quarter reflected a broader decline in trading activity across the industry. We expect that this line item will exhibit some quarterly variability, given the nature of the capital markets business.

We currently expect corporate banking fees to increase 6% to 8% in the third quarter sequentially. We have a strong pipeline that we look to execute during the second half of the year.

Deposit service charges were relatively stable, up $1 million from the first quarter of 2017 and the second quarter of 2016. Card and processing revenue increased 7% sequentially. The sequential performance was driven by an increase in customer transactions and spend volume compared to the seasonally lower first quarter.

Total wealth and asset management revenue of $103 million was down 5% sequentially due to seasonally higher tax-related private client services revenue in the first quarter, partially offset by higher personal asset management revenue.

Revenues increased 2% relative to the second quarter of 2016, mainly due to higher personal asset management and brokerage revenue. Recurring revenues in this business have increased to 80% of fees from 75% in the second quarter of 2016, and 72% in the second quarter of 2015, as we have continued to shift our product and service offerings toward more recurring revenue streams to limit our reliance on transactional activity.

Excluding mortgage banking revenue and non-core items shown on slide 14 of the presentation, we expect noninterest income to grow by 2% in 2017. The change from our previous guidance of 3% is primarily due to the second quarter's lower capital markets activity which we expect to pick up in the second half of the year. For the third quarter, on the same basis, we expect fee growth of approximately 2% over the second-quarter levels.

We remain focused on disciplined expense management while still investing for future revenue growth. Noninterest expenses were down 3% both sequentially and year-over-year, which was better than our guidance and was broad-based across nearly all of our expense lines.

Since the beginning of 2016, we have been able to report improving expense results almost every quarter. Excluding the impact of the amortization of low-income-housing-related investments, which nearly all of our peers show in their tax line, our efficiency ratio is approaching 60%. We will maintain our expense discipline to help partially fund the wide array of investments that Greg discussed.

We plan to invest a portion of our savings this year to drive near-term growth momentum. A good example of this is our investment in direct marketing. We believe with significantly improved direct marketing analytics capabilities, which we have been enhancing over the last year, we will be able to impact future retail household growth to support both loan and deposit production.

As a result of our improved outlook, we will grow our direct marketing expenses in the third quarter. Similarly, our investments in technology continue to support many revenue growth and expense-saving opportunities across our Company. Our teller automation project is nearing completion. The mortgage project is in progress. And our teams are working on the initiatives to enable easy access to direct personal credit offers.

Despite all that investment activity, we now expect expenses in 2017 to be roughly flat compared to 2016, including incremental expenses associated with new initiatives under Project North Star. This improves upon our guidance last quarter that called for expenses to be up 1%. Any increase relative to this guidance would be related to higher-than-anticipated growth in business activity.

In the absence of North Star-related expenses, this guidance implicitly points to a decline by about 1.5% in 2017. Given the expectation of a ramp-up in some North Star investments and the marketing spend that I just mentioned, we currently expect third-quarter expenses to be up about 1% from reported expenses in the third quarter of 2016.

Our guidance today clearly reflects our commitment to achieving positive operating leverage in 2017. We are making substantive progress in lowering our efficiency ratio towards our long-term target of sub-60%.

Turning to credit results on slide 9. We are very pleased with our second-quarter credit results. Total quarterly net charge-offs were the lowest in nearly 17 years. Net charge-offs were $64 million or 28 basis points, an improvement from $89 million and 40 basis points in the first quarter of 2017, and from $87 million or 37 basis points in the second quarter, a year ago.

The sequential improvement was driven by an $18 million decrease in C&I net charge-offs. C&I net charge-offs were positively impacted by higher-than-normal recovery levels. Consumer charge-offs were down $7 million sequentially, and stable year-over-year.

Total portfolio nonperforming loans were $614 million, down $43 million from the previous quarter, resulting in an NPL ratio of 67 basis points. The largest concentration is in energy, with roughly one-third of the balances related to the 2016 downgrades. New transfers to the NPL portfolio were at their lowest levels since the second quarter of 2015. Total NPAs were down 8% from last quarter, with sequential improvement in nearly all loan categories.

The criticized asset ratio has decreased to 5.5% from 5.8% of commercial loans at the end of the first quarter, and is at a 10-plus-year low. Our loss provision was $22 million lower than last quarter, reflecting the positive trends in our loan portfolio.

With the resulting reserve coverage as a percent of loans and leases of 1.34%, only 1 basis point lower than last quarter, our allowance coverage of NPLs increased to 200% from 188% last quarter. Our previous guidance that net charge-offs will be range bound with some quarterly variability remains unchanged, and we continue to believe that our provision expense will be primarily reflective of loan growth.

Our capital levels remained very strong during the second quarter. Our Common Equity Tier 1 ratio was 10.6%, reflecting a decrease of 12 basis points quarter over quarter, and an increase of 70 basis points year-over-year.

The sequential decline in capital was driven by a $342 million share buyback initiated during the quarter. Our tangible common equity, excluding unrealized gains and losses, decreased 13 basis points sequentially, but increased 38 basis points year-over-year.

The results of this year's CCAR exercise were very strong. The combination of our strong current capital levels, the continuing improvement in the risk profile of our balance sheet, and our strong earnings have resulted in a consensus payout ratio which is near the top of our peer group. We expect to increase both dividends and buybacks strongly over the next four quarters, subject to economic conditions and the ultimate approval of our Board of Directors.

Going forward, we intend to be balanced between dividend increases and share buybacks. As you know, any future reduction in our Vantiv ownership gives us additional capacity for further share buybacks.

We also think that our current capital levels are higher than what we need to run our Company from a through-the-cycle safety and soundness perspective, given the significant improvement in the risk profile of our organization. As we continue to execute our strategy in this evolving regulatory environment, it is likely that we may see further decreases in our overall capital levels.

At the end of the second quarter, common shares outstanding were down 11 million shares or 2% compared to the first quarter of 2017, and down 17 million shares or 4% compared to last year's second quarter. Book value and tangible value were both up 1% from the last quarter.

With respect to taxes, we expect our third-quarter tax rate to be roughly around 25.5%, and the full-year 2017 tax rate to be in the 24.5% to 25.5% range. Our guidance reflects the benefits from our recent actions and provides support for the initiatives under North Star.

Slide 12 provides an updated outlook, for your reference. As we discussed with you, some of the initiatives are already impacting our performance, especially on the expense side. The implied decline in our base expenses, excluding our North Star-related expenses, is indicative of the ongoing impact of the expense initiatives.

Our North Star performance expectations were clearly stated last year: end-of-2019 run rate ROTCE between 12% and 14%; ROA between 1.1% and 1.3%; and efficiency ratio, sub-60%, without any meaningful help from the environment. We have also projected that 2018 would be the first year of step up towards these targets.

During last quarter's earnings call, we guided to a 1.1% ROA and 11%-plus ROTCE in 2018, assuming two more rate increases this year, and two more next year. We had one of the rate increases in June, and we have one more projected in December of this year. If we see two more in 2018, our expectations should still hold.

Our revenue growth outlook, our ability to achieve positive operating leverage without changing our risk appetite, and strong balance sheet and our strategic positioning give us confidence in our ability to create additional shareholder value.

To that end, we are pleased to announce that we will be hosting our first-ever Investor Day on December 7 in New York. Our executive team will share additional details about their businesses and the progress we are making towards our strategic objectives.

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 the time we have this morning. During the question-and-answer period, please provide your name and that of your firm to the operator.

TaShawn, please open the call up for questions.

(Operator Instructions). Scott Siefers, Sandler O'Neill & Partners.

Tayfun, I was hoping you could just -- obviously a lot of guidance. I appreciate the transparency. As you look into the back half of the year, you suggested the rebound in corporate banking revenues off the softer 2Q due to capital markets.

I'm wondering if you can maybe walk through some of your expectations for some of the other drivers that you see that get you to the updated guidance for the full year, just in fee income specifically.

I'll make some overall comments, and then Lars probably can provide some color on corporate banking. In general, our expectation -- when you look at the main parts of our fee revenues -- mortgage, I think it's going to be a fairly stable quarter in the third quarter. So we are expecting the current environment to continue, so there's nothing out of the extraordinary in terms of our expectations for mortgage.

Wealth and asset management has been very -- so it's stable and nicely growing for us. The deposit fees there, we are seeing payments income growing into the second half of the year, similarly.

I don't have any out-of-the-ordinary expectations with respect to any of the other fee income items. I just want to remind you that we obviously -- the way, as we always do, we have the fourth-quarter TRA payment that we are expecting from Vantiv.

Turning over to the corporate banking side, clearly we have a look at our pipeline, and maybe Lars can provide some color on what we're seeing there.

First of all, when you look at the overall corporate banking piece, I would point out you may see in the appendix there that the core business lending fees were actually up nicely on a linked-quarter basis. And Scott, that was reflective of the record production that we've had this quarter, the highest level that we've seen in over a year.

Beyond that, obviously a lot of headwinds in the sales and trading and FICC business, which you, of course, have seen across the industry. That's going to be largely driven by the yield curve, a volatility in the overall marketplace, and what we see on some of our FRM businesses. So that will impact that.

The good news for us is that, as you know, we've continued to strategically position ourselves to build out our advisory businesses, in particular in investment banking, M&A. And that's become a much bigger part of our overall corporate banking fee mix.

So that's a real positive; because as I look towards the second half of the year, we're seeing activity levels start to pick up, Scott, both at the larger transactional level and in our core middle-market that looked fairly promising. And I think that help us to deliver some pretty attractive fee incomes.

We're also continuing to add expertise and resources that align with a number of our industry verticals. Which that, too, will be incremental, I think, to the growth of some of our corporate banking fees for the second half of the year and beyond.

Okay, perfect. That's good color and I appreciate it. And then finally, just one ticky-tack question, either for you, Tayfun, or maybe Jamie. I think in the past you guys have talked about a securities yield in like the 3.05%, 3.10% range for the full year. Any update on how you guys are thinking about that?

Yes, I still believe that we will be right in that range. We think the portfolio is well-positioned and we're pleased with the results.

Okay. All right, perfect. Thank you, guys, very much.

Geoffrey Elliott, Autonomous Research.

Maybe starting with Vantiv, clearly there's potential for them to undertake or produce a significant transaction. I wondered if you could give some thoughts on how a big transaction by Vantiv would change, first, your thoughts around continued ownership; and then second, any accounting impact from your percentage ownership dropping down.

Geoffrey, thanks for the question. This is Greg. At this point right now, since they are just in early stage due diligence with WorldPay, we are not in a position to make any comments about that transaction or the impact, our how we feel about that transaction at Fifth Third. So, more to come on that on our next earnings call, once that transaction materializes or they decide to do something different. At this point, we have no comment on that transaction.

And on the equity method of accounting that you are alluding to, Geoff, there is a pretty low threshold for that. I think the ownership percentage would have to decline to low single digits before that accounting methodology would change.

Thank you. And then another one on (technical difficulty) income. Taking a step back, if you look at the lines that made that up year-on-year, service charges is up 1%, wealth and asset management is up 2%, but pretty much everything else looks like it's down year-on-year. So how should we think about understanding that in the context of the growth initiatives that you're talking about?

I think the one comment that I would make, because it is such a large item, our corporate banking fees are a significant line item. And there is fee income associated obviously with the nearly $4.5 billion of loans that we have exited over the last 18 months. So we need to take that into account when analyzing the year-over-year change in corporate banking.

As we move forward and reach the end of the year, with those exits coming to an end, I would expect the momentum in corporate banking to actually move up. And also in capital markets on page 11, we are listing a number of initiatives that directly impact fee income growth in addition to other areas such as wholesale payments, insurance, self.

As we look forward into 2018 and 2019, there are some significant pickups in all of these areas with respect to our fee income growth expectations.

Thank you.

Gerard Cassidy, RBC.

Greg, when you look at what the Treasury proposed about a month ago in changes for the banking industry, both legislatively and regulatorily, if you had to pick one or two that you think would best benefit Fifth Third, what would those choices be of some of the proposals they made?

First of all, I think it was very well done, and 149 pages focused on depository institutions and some of the things that they are looking at, and were all basically put together by input from the banks. And I think LCR would be one that we'd want them to look at, that they're looking at that we could some improvement on how that is calculated and how that is viewed. I think that would be very positive.

In addition to that, I think overall on the capital management, I mean as we just talked about, we are strong from a capital perspective. Our ability to deploy that capital and making it easier for us to do business, especially in the area of small business lending, and some of the changes that the guidance would suggest, I think it would make it easier for us to serve that sector. So I think those are the two areas that we'd like to see some progress made.

And then obviously on -- from a regulatory perspective overall, some of the activity with the inter-agency dependency between the Fed and the CFPB and the OCC, trying to get that a little more fluid and a little less complex and some of that redundancy that creates -- the cost it creates for banks would be another step forward, I think, in allowing us to better serve our customers.

Very good. And I apologize if you guys mentioned this in the call, and I missed it, but when we look out -- as you mentioned, you're in a strong capital position, you did well in CCAR. What's the long-term dividend payout ratio you guys think you will get comfortable with? Obviously the Fed seems to have lifted that line in the sand at the 30% mark, where you guys can go higher. How do you guys think about it?

First off, it really gets down to how we view our forward earnings opportunities and the amount of capital we have to deploy. As the CCAR data suggests, we've asked for an increase to our dividend of $0.02 this quarter, another $0.02 in the nine months from now. So that's very strong.

I would see that north of 30%. But with respect to putting a number on it right now, I don't want to do that. But I think if you look at the next nine, 12 months, I think we feel really good about our ability to increase our dividend and deploy capital to that line.

Great. Thank you.

Ken Usdin, Jefferies.

Thanks again for that revenue slide on North Star. I wanted to ask you -- it mentions that you're not including the baseline in the expense initiatives. So just given the fact that you guys can -- are willing to articulate the revenue side of North Star, can you help us understand what was originally -- I think you guys said $150 million to come from the cost side; and how you'd expect that to project and manage the overall growth rate of expenses. Thanks.

Hey, Ken. So when we started to lay out our expectations last year, we mentioned that about 45% of the improvement would come from an uplift in our base performance. And we still believe that is the case, and we clearly have a very strong business composition. And we look to see better performance over the next two years.

In terms of -- you were correct. In terms of the expenses, our expectation is roughly 20% of that money -- of that amount that we identified. Obviously we have started some of those initiatives. And the ongoing improvements in our actual expenses and expense guidance reflects the results. Whether it's related to vendor renegotiations, any workspace management savings, or even on just headcount efficiencies, I think we are moving on with some of those initiatives.

As we look forward -- and we discussed this in some meetings throughout last quarter with investors -- we expect our base expenses, excluding North Star-related investments, to remain well-managed. We will be entering our planning period here shortly in the next 90 days. And our guidance to our businesses will be to maintain their expense base, the core expense base into next year. But we will see what the outcome will be, and we will update all of you during the Investor Day. But we clearly expect ongoing efficiencies coming out of our businesses as we look forward.

Okay, so we'll look forward to that update. Then just one follow-up on the NIM. You clarified before you are 3.05%, 3.10% on the securities book and what you're expecting for the full year on NIM. But can you just talk about just progression from here, and the puts and takes, given the June hike? And then just the balancing act between deposit betas and asset repricing? Thanks.

Sure. This is Jamie. As you look ahead on the third-quarter NIM, we do expect, as Tayfun mentioned, a 2 basis point expansion from the second quarter, 3.01% into the third quarter. And that's really driven by 3 basis points' improvement from the June Fed move, net of the deposit betas, which is a 40% assumption.

And then 2 basis points of improvement from continued loan pricing discipline and the favorable loan mix shift you're seeing on the balance sheet. And that's offset by 1 basis point erosion from day counts, and 2 basis points of a detriment from our funding actions, which you saw in part was the June holding company issuance.

And so, in our outlook, we do assume a December Fed move. However, as we sit here today that's looking less likely. The good news is it doesn't have that big an impact on our projections.

Thanks for the color. Thank you.

Erika Najarian, Bank of America.

Just a follow-up question on fees. I just want to make sure we're understanding the fee guidance correctly. The base upon which we're growing full-year fees, adjusted on a 2% basis ex-mortgage, is that 2016 base $2.1 billion?

Yes. That's correct.

Okay. And so if I think about the progression -- my peers had asked about this, but the progression is pretty significant on an implied basis. So if 500 -- if the adjusted fees in the first quarter was $484 million, and the second quarter is this $516 million, and then you gave us guidance for 3Q that implies $526 million -- that means that fourth-quarter fees, ex-mortgage, would have to be over $600 million. And I'm wondering what I'm missing there. Or if I'm not missing anything, what's driving that significant progression upward.

So Erika, just another reminder that in the fourth quarter, as we have had for many years now, we have a $40 million plus payment related to the Vantiv TRA agreement. So that's clearly one item that moves the fourth quarter fee income up.

In addition to that, there are a couple of obviously pipeline-related expectations in corporate banking. The timing of that is -- we cannot necessarily plan for the timing. We're laying it out for the second quarter, and that's providing a lift.

And also relative to the first quarter, which was -- or which was weaker in corporate banking, I think the third- and fourth-quarter numbers look better. That's what's driving the increase as we approach the end of this year.

Got it. And just as a follow-up question, just switching gears: as you pointed out during the call, the CET1 ratio of 10.7 seems very robust for your size and risk profile. And I'm wondering what your thoughts are, over time, what an appropriate sustainable level of CET1 would be for your company.

I think that, given the risk profile of our Company, in the long-term, the Company can be operated with a capital ratio of 8.5% to 9%. But I think it's very early for us to guide to that. But if the regulatory environment continues to evolve in the direction it has been, we can see our capital ratio starting to move to a 9 handle.

And whether or not we can take it down below that would be a reach, at this point; but somewhere around 9.5% is clearly a very good number that we can achieve without the significant change.

Our CCAR filing has a 10% number as we exit the current CCAR period. So there is some room for us for improve our leverage ratio from the current level.

And just squeezing one more in, since Greg mentioned LCR as a binding constraint that you would like to go away -- given your robust LCR today, how much in free liquidity could be deployed if LCR is not applicable to a bank your size?

This is Jamie. A couple of benefits from the -- if the LCR were to be eliminated, there are benefits besides the ability to deploy those excess securities into loans or other things, including the flexibility to rotate out of the lower-yielding level 1 securities into level 2s. That help would be 20, 25 basis points of yield enhancement. Right now, we have about $10 billion of level 1s, and then that also generates a better convexity profile going forward. So, the benefits aren't just the ability to deploy the excess capital -- or the excess liquidity; it's also what we currently hold could generate higher returns.

Right now in our LCR calculation, at 122% at the end of the quarter, within that number we have about $2.9 billion of level 2As above the cap. So at a minimum, that could be deployed.

And then the final benefit that we see from an LCR revision standpoint is that certain classes of deposits would certainly become more bankable and more valuable, such as financial sector deposits that have the 100% outflow assumption. And we believe that could alleviate some of the pricing pressure that we're seeing on commercial deposits today.

Got it. Thank you.

Ken Zerbe, Morgan Stanley.

The first question, just in terms of slide 11 you have in terms of North Star, specifically the personal lending line -- it's obviously the biggest contributor to the $299 million.

But can you just remind us, maybe break it out a little bit more, how much of that $74 million comes from tech enhancements versus higher net interest income from unsecured lending? Which I would imagine would come at a bit more risk than the rest of your portfolio. Thanks.

First of all, let me just answer the first part of your question. That's a combination of our own credit card growth -- so pure net interest income -- and our GreenSky partnership, where we continue to grow the portfolio. In addition to that, we also have expectations of an expanded offer for our own personal unsecured lines.

In terms of the risk profile, Ken, is we -- first of all, the GreenSky portion of that growth is coming at a super prime level. We're talking about 750, 760 type FICO scores. We're monitoring that, and it's behaving within our expectations.

So we don't see a significantly increased risk profile, even in under stress conditions. Similarly, in our credit card portfolio, the focus is in footprint. And this is retail customers who have a very positive credit risk profile. And the same approach would be used in our own personal unsecured lending. So our expectation is this growth is not going to alter the risk profile of our consumer lending.

Got it, okay. And just a related credit question. On slide 19, you talk about your retail exposure. So thanks for the additional information there. But you do mention the $3.1 billion as being, quote, higher risk retail. And I just kind of make sure we clarify. How much of that is truly, truly higher risk? Are you seeing deterioration in -- and I see you have anchor malls -- or mall anchors, regional malls, et cetera. And how do you differentiate the risk within that retail portfolio?

Hey, this is Frank. Good question. I would call it core retail. Higher risk is probably not the right terminology. So think about it this way: as the slide shows, we've got just over $3.1 billion all-in in retail exposure core that we manage. We manage the vast majority of that, two-thirds of that, through our vertical very closely; 3% of our total loan book, so it's not substantial.

When you look at the $1.9 billion on the slide, most of that is specialty retail. The remainder of that would be general retail. The vast majority of that is not to the clothing sector or to the electronic store sector that's been this volatile. 3% of it is the mall anchors.

But really what's more important to your question is that 98% of the specialty and general retail that you see there, the $1.9 billion, they are pass rated credits. There's only 2% of that portfolio that's criticized, so we're not seeing deterioration. It's performing better than our overall C&I book at this point.

When you look at the balance, there's less than $1 billion in CRA, which gets a lot of attention -- $769 million. Only one-third of that is to regional malls. And of that, over 80% are to A/B properties. So we feel very good overall, and the REIT book is primarily very high grade exposure. We feel very good about the overall exposure we have to retail.

So higher risk is really not the right term; but the vast majority of this portfolio is pass rated and performing to our expectations.

Okay, great. Thank you very much.

John Pancari, Evercore.

On the commercial loan growth front for the second quarter, aside from the exits that you flagged, it still appears that the underlying commercial growth trends were somewhat weaker. And I know part of that could be some of the -- on the real estate side, some of the permanent financing market impact. But what other areas did you see any softness in the quarter? And is it indicative of any demand factors on the commercial side? Thanks.

Speaking specifically, I think, John, to this quarter, we saw a pickup in activity, frankly, and it was across nearly all of our verticals with the exception of healthcare, which we've been managing very carefully over the last couple of years, is there's obviously a lot of uncertainty there to client selection. And working carefully with that vertical has been a high priority for us. But we've seen nice growth in a number of our verticals that I mentioned previously.

Commercial real estate has really -- that's actually been a source of some growth for us. I would not see that as a headwind. A lot of the growth that we've seen more recently over the past two quarters, to our earlier point, is later-stage, the maturity of our construction portfolio. But we would expect that the growth rate of that would begin to reduce over a period of time. In fact, if you looked at it -- commercial real estate on a year-over-year versus linked quarter, you would see that already beginning to play out.

If you looked across our core middle-market franchise, we saw a pickup in activity level. In fact, we saw the highest production in our core middle-market also this past quarter in over a year. Indiana, Florida, Tennessee; North Carolina is a perennial leader in the clubhouse there. So I'm feeling more optimistic about our ability to grow that core middle-market franchise in commercial -- overall commercial portfolio. But it will certainly be influenced by the overall economic environment as we head into the second half of the year.

Our pipelines look promising. We're investing resources into it. We're expanding our capabilities. And, frankly, I think that we are well positioned to grow that for a number of quarters to come.

John, I wouldn't describe our second-quarter activity as weaker. We had -- it was our strongest origination quarter since the first or second quarter of 2016.

The other thing I would add, John, is if you excluded the strategic exits of $600 million and look at what we've done this year, we would be up 3% year-over-year on the commercial growth. And that's the focus of the organization, is on the opportunities that we're looking for, the type of relationships we want to bank.

I think we're doing a pretty good job, especially in a very muted environment. We're doing a pretty good job of building those relationships. We're growing our commercial relationships. We're growing our consumer households. That's what this bank is focused on: the quality, the return profile of our balance sheet. And that's been evidenced in the numbers we discussed today.

Okay. So that decline -- the modest decline in end-of-period commercial balances on a linked quarter basis, and the 3% year-over-year decline in commercial balances, that's mainly all the -- for the quarter, that's mainly all the exits, then?

Yes.

Yes, yes. Like I said, 2% is for the full -- where we're at right now on the strategic exits. But that comes to an end, John, at the end of this year. Those strategic exits are done. We have accelerated those type of exits. I think the outcomes with respect to yield, with respect to the credit quality that we've got, demonstrate that was the right decision.

Our thought around the indirect auto lending and what we're seeing with used car prices and the volumes out there, we were a year ahead of everybody else. We like what we're doing in that sector. Once again, it's about quality and being good through the cycle.

So we feel really good about production and where we're at for the remainder of this year, given the environment we're operating in and the competitive nature for the quality relationships that we got to go after. So I'm very encouraged what the team's producing.

And one last thing, John, that I would just kind of give as evidence of the growth of our quality portfolio with two very careful client selection is we continue to take market share in the investment banking space for regional banks. We've done that throughout 2016 and this year. That's a key part of our relationship building: fine strategy, aligning that with where we want to grow. Right risk appetite, right risk profile, right return profile.

Okay, thank you.

Saul Martinez, UBS.

Wanted to ask about capital allocation strategy. You obviously have a ton of excess capital, especially in light of, Tayfun, your commentary about where you can operate ultimately. And so -- and obviously you have Vantiv in your back pocket.

But how do you think about capital allocation in the context of your M&A strategy? And once you get off of any sort of regulatory or CRA restrictions, how would you be thinking about potentially doing something from a -- not only just fee generation businesses, but would depository institutions also be part -- or could they be part of the strategy?

So right now our focus is building a strong bank. With all the objectives that we've already stated as Project North Star, that's job one for this business right now that we're focused on. We've been very, very thoughtful about how we deploy capital for strategic opportunities in the non-depository sector, non-banking sector, such as our investments in the fintech space, wealth and asset management, insurance space.

We will continue to do that and deploy capital smartly in those opportunities because they create fee opportunities for us that enhance our value proposition to our customers. That makes sense.

With respect to doing a brick-and-mortar bank type of deal, that is, right now, not in front of us. It's not what we're focused on. And the regulatory environment will play itself out in the environment at some point. We'll probably be more conducive to doing those type of deals, but right now it's not what we're focused on.

Okay, got it. Just switching gears. Very helpful color on Project North Star, the revenue growth plans. Can you just give us a sense, though, as to how much of the growth in the -- or the revenue figures for 2018 and 2019 are fee-based opportunities, and how much of it is more balance-sheet-driven or NII? Could you give us a sense of sort of the parameters around that?

John, I'll give it to Tayfun in a second. But we've communicated, it's really one-third, one-third, one-third of our North Star $800 million: one-third of it, expense; one-third of it, balance sheet optimization; and one-third from fees. So in general, that's how you should think about the numbers you we're putting forth and how we will achieve that $800 million improvement.

I think, Saul, the one area in terms of balance sheet growth, one area we have given some direction with respect to GreenSky loans and that can move the balance sheet. The other balance sheet items are likely to come towards the end of 2018 and into 2019. And when we get together in December at the Investor Day meeting, we will give you a better breakdown of fee versus net interest income.

Right. So if I think about the 112 and the 299, respectively, it sounds like it's really more fee generation that -- at least initially. Then it is sort of balance sheet and NII --

The goal is -- yes. I think at the beginning, you will see a higher fee income growth. And NII growth will probably catch up to a certain extent in 2019.

And final just related question, in terms of -- there's obviously a big swing, $13 million to $112 million. Just the glide path. Should we be thinking that's later 2018 or earlier 2018? Or any sense of just the glide path in terms of when that really starts to kick in and move the needle on your revenue growth?

Yes, many of these projects are longer-term projects that start to provide bottom-line support. So it is going to be more back-ended than front-ended.

Got it. Thanks a lot.

Christopher Marinac, FIG Partners.

I just wanted to go back to the improvements in the portfolio and the quality of relationships, et cetera. Should we be seeing some loan pricing improvements the next couple quarters? Or should we -- again, going back to the North Star improvements that you outlined in terms of where to capture that.

First of all, I would tell you we were pleased to see loan spreads actually widen on new production this quarter. We continue to stay very disciplined in terms of our pricing strategy and overall relationship strategy.

I'm not sure that I would count on that type of expansion on a linked-quarter basis throughout the balance of the year. But I do think it evidences our overall salesforce's commitment to building out relationships with a very disciplined credit pricing, but overall commitment to relationship pricing.

Yes I think, Chris, two factors that play a role there. One is these exit obviously -- exits, especially the credit related exits, carry a higher coupon. So from an overall portfolio yield perspective, we were very pleased that we achieved what we achieved, even after that. And then the other one is the market continues to be very competitive. It's difficult to be predictive about the widening of spreads.

Yes. So, back to John's question about loan growth in those first two quarters, if you think about that $900 million that came out, there was a large portion of that that we would define as leverage, higher coupon. And yet in spite of that, we were able to execute in verticals and in areas where, frankly, we'd been able to largely offset that.

Great, guys. Thank you for the color. Appreciate it.

Matt O'Connor, Deutsche Bank.

The expenses came in a lot lower than I think you were guiding to a few months ago. I think it's about maybe $25 million; which obviously, annualized, is a big number.

And I'm just wondering, is that -- realization of some of the efficiency savings a little bit sooner? Is some of the fee revenues coming a little bit weaker? Kind of general lumpiness? Just help reconcile the expenses being much lower than what you thought a few months ago.

This is Greg, Matt. I think, first off, we've done a nice job of managing our personnel expenses, and really focused on that. Also the other areas, the nondiscretionary line items, we've been very myopic at really going after where we see those opportunities. We've put the pedal down, so to speak, on continuing to focus on vendor management, information technology, those areas.

So we feel that most of that improvement really didn't come from a production perspective; came really from our focus on improvement in expenses. And the organization is well designed to go after these opportunities, and we put a lot of focus on it.

And quite frankly, some of it just matured quicker than we anticipated, which is encouraging, because it's about execution and about our credibility to execute on these plays. So we're very positive with what we're seeing right now, but it's mostly on just execution on the initiatives.

Okay, thank you.

And there are no further questions over the phone at this time.

I'll turn the call back over to Sameer Gokhale for closing remarks.

Thank you, TaShawn, 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.