Fifth Third Bancorp (FITBI) 2019 Q2 法說會逐字稿

Good day. My name is Jay, and I'll be your conference operator for today. At this time, I would like to welcome everyone to the Fifth Third Bancorp Second Quarter 2019 Earnings Conference Call. (Operator Instructions) It is now my pleasure to turn today's program over to Mr. Chris Doll, Director of Investors Relations. Sir, the floor is yours.

Thank you, Jay. Good morning, and thank you all for joining us. Today, we'll be discussing our financial results for the second quarter of 2019. Please review the cautionary statements on materials, which can be found in our earnings release and presentation. These materials contain reconciliations to non-GAAP measures along with information pertaining to the use of non-GAAP measures as well as forward-looking statements about Fifth Third's performance. We undertake no obligation to and would not expect to update any such forward-looking statements after the date of this call.

This morning, I'm joined 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, Chris, and thank all of you for joining us this morning. Earlier today, we reported second quarter 2019 net income available to common shareholders of $427 million or $0.57 per share. Our reported EPS included negative $0.14 impact from the item shown on Page 2 of our release, mostly due to merger-related expenses associated with MB Financial. Excluding these items, our adjusted second quarter earnings were $0.71 per share.

Our financial results were very strong, exceed our previous guidance and reflect the progress we are making on our 4 strategic priorities to: the Leverage technology to accelerate digital transformation; invest to drive organic growth and profitability; expand market share in key geographies; and maintain credit, expense and capital discipline. Strong performance also reflects our continued focus on driving profitable revenue growth, improving managing our expenses and the improved profitability resulting from MB Financial.

During the quarter, we completed the MB Financial customer conversion, which represents a significant milestone. We remain very optimistic about our post-acquisition growth prospects, both in our retail and commercial franchises.

Additionally, net interest income, fee income and expenses all performed better than our April expectations. As a result, our adjusted efficiency ratio improved more than 250 basis points from a year ago quarter to 58.5%. Our net interest margin, which include the expected positive impact from MB Financial, expanded 9 basis points and was in line with our previous guidance despite the challenging interest rate environment.

Net charge-offs were 29 basis points, improved sequentially and year-over-year, reflecting the ongoing benign credit environment and previous balance sheet actions. Our adjusted ROTCE, excluding the impact of AOCI due to the significant unrealized investment portfolio and cash flow hedge gains, was 15.8% in the second quarter.

Before providing an update on the progress related to MB Financial and our key strategic priorities, I'd like to make a few observations about the macroeconomic environment. As I mentioned at a recent investor conference, we continue to see a generally healthy economic backdrop. Consumers continue to benefit from a combination of a strong labor market and limited inflationary pressures resulting in strong wage growth. In commercial, banks are being more cautious and have expressed concerns about both current and potentially more punitive future tariffs affecting their growth plans.

Due to the higher end-of-quarter paydowns, our loan origination volume was somewhat tempered relative to our previous expectations. However, we continue to have a robust pipeline particularly in middle-market lending, which position us well for the second half of the year. However, we will not chase loan growth for the sake of growing.

We'll be remaining disciplined in our approach to client selection by focusing on the balance between credit quality and profitability. For instance, we continue to reduce our exposure to nonrelationship commercial leases and are maintaining a cautious approach to commercial real estate lending at this point in the cycle. Our balance sheet management philosophy of focusing on improved performance through the full economy cycle positions us well for the future. For the rest of 2019, we continue to expect generally stable credit quality with potentially poor fluctuations, given the current low absolute levels of charge-offs.

Now an update on MB Financial acquisition. In early May, we completed the MB customer conversion. We successfully converted the majority of systems less than 2 months after closing the merger. As with any conversion, we continue to follow-up with customers and employees to ensure a smooth transition. We have already completed 46 of the Chicago area branch closures, which consisted of a mix of Fifth Third and MB locations. We will close the last branch related to the transaction by the end of this month.

Our best-of-breed approach throughout the acquisition has been the key to the successful outcomes we have achieved so far. As a result, we have experienced no material employee attrition. 91% legacy MB employees who were offered position with Fifth Third are still here today. We have also not experienced a material customer or client attrition. In fact, the commercial client attrition rates since the conversion has been lowered than the MB legacy attrition rate during the past 24 months leading up to the acquisition and has continued to improve over the past 2 months.

During the second quarter, we generated end-of-period loan growth in the Chicago region of more than $100 million and deposit growth of more than $200 million, both increasing approximately 1% from the prior quarter.

We continue to receive positive overall feedback from our new MB retail customers. They now have access to nearly 200 branches, the third largest network in the Chicago area, in addition to advanced digital capabilities, sophisticated wealth client solutions and access to our expanded network of over 50,000 fee-free ATMs.

We are focused on maintaining the positive momentum in the Chicago market. We recently unveiled a new Chicago marketing campaign that pays homage to both MB's legacy and our dedication to serving our commercial clients. It has been very well received. In addition, we have begun utilizing our next-generation branch design in select Chicago locations. We believe we can offer greater convenience and even better customer experience that's more efficient and more automated.

We remain very pleased with our progress we have made and are confident in our ability to deliver the financial synergies as previously communicated. We continue to expect to realize the $255 million in annual expense synergies by the end of the first quarter of 2020 and have already completed many of the key expense actions. We will achieve approximately 80% of the run rate savings by year-end.

We also continue to expect to generate meaningful revenue synergies from the acquisition. We have been pleased with the initial success, turning additional revenue opportunities since the customer conversion. In our national asset-based lending business, we have already generated robust pipeline of new client relationships to accelerate future growth. Furthermore, we have seen early signs of success leveraging MB's leasing capabilities, provide value-added client solutions across our markets. We continue to expect revenue synergies to generate approximately $60 million to $75 million in annual pretax income net of expenses by 2022.

In addition to the combined power of our enhanced ABL leasing capabilities, we also expect synergies to come from the complementary focus on middle-market lending and from deploying Fifth Third's capital markets, digital banking and treasury management solutions capabilities. We believe that Fifth Third Chicago is now in a significant position of strength that will allow us to generate stronger deposits, household and revenue growth going forward.

While we have devoted a significant amount of energy on the MB acquisition to deliver for our clients, employees and shareholders, we also remain focused on executing on our key strategic priorities to produce strong financial results. First, we continue to leverage technology such as our data analytics capabilities to accelerate our digital transformation while continuing to monetize our systems and infrastructure. We are prioritizing investments that improve the customer experience, grow households and drive further operational efficiencies. We've also made considerable investments over the past several years to modernize, simplify and rationalize our infrastructure. This allows for faster and more data-driven insights. We're also investing in advanced fraud and cybersecurity technologies. As a top area of concern, our investments include providing alerts and real-time monitoring to detect and respond to threats quickly. These investments have resulted in a year-over-year decline in fraud losses.

Second, we continue to invest in our business to drive profitable organic growth. We have made several recent investments in technology and talent to support our growth plans, including key additions to our sales teams and strategic areas of the company. For instance, in middle market banking, we have added key talent in our new geographies, including California and Texas.

Also in our corporate (inaudible) positive outcomes from our ongoing investments in both our sales force and technology and expect [similar] growth in our commercial fee-based businesses going forward. In wealth and asset management, we are focused on leveraging partnerships across other lines of business as well as in-market RIA and town acquisitions to maximize revenue opportunities. We have been very successful generating new business and have experienced positive AUM inflows for 6 consecutive quarters.

In retail, we are successfully leveraging our target of marketing campaigns in our preferred banking program to grow households in the mass affluent segment. As a result of our strategic investments across our retail franchise, we have generated total customer deposit growth of more than 6% over the past year, excluding the benefits from MB, which is significantly greater than almost all of our peers. We leveraged our one bank operating model to collaborate across all of our businesses in order to provide holistic client solutions, we will continue to invest in our businesses to diversify revenue and accelerate growth.

Our third priority is to expand our market share in key existing markets. I know we have the necessary scale in the Chicago market. We'll continue to optimize our branch network in our legacy footprint in order to support our faster-growing Southeast markets. By the end of this year, we will have completed approximately 2/3 of the planned 100 legacy branch consolidations and open 25% of the 100 planned openings in the Southeast markets.

Lastly, we are focused on maintaining our disciplined approach to credit, expense and capital management throughout the company. As I mentioned earlier, credit discipline remains as important now as ever. We're focused on maximizing through the cycle returns rather than generating lower-quality loan growth. We have demonstrated our ability to diligently manage our expenses while investing in areas of strategic importance. We remain focused on continuing to generate positive operating leverage.

We also continue to allocate and manage our capital prudently. We deploy capital based on what we believe will generate the highest long-term return for our shareholders. Tayfun will share more details regarding our current capital return expectations. Our clear defined set of strategic priorities are designed to enhance revenue growth as well as generating expense efficiencies in order to meet our financial and strategic objectives.

I'd like to once again thank all of our employees for their hard work, dedication and for always keeping the customer at the center. It's because of our employees that we were honored to be named Best Regional Bank by Kiplinger for the second year in a row. They also recognize our next-generation branch design, knowing that it creates a more modern and friendly atmosphere.

I was pleased we were again able to deliver strong financial results. We remain very confident in our ability to outperform through the cycle and create significant value for our shareholders.

With that, I'll turn it over to Tayfun to discuss our second quarter results in more detail and our current outlook.

Thank you, Greg. Good morning, and thank you for joining us today.

Let's move to the financial highlights on Slide 4 of the earnings presentation. Reported results for the quarter were negatively impacted by 2 notable items, an $84 million after-tax impact from MB merger-related charges and a $17 million after-tax negative mark related to the Visa total return swap. Excluding these items and other items from prior period as shown in our reconciliation tables, including MB-related merger charges and prior period Worldpay gains, pre-provision net revenue increased 29% on a year-over-year basis and increased 24% from the prior quarter. Our financial performance also reflected the full quarter benefits associated with the acquisition of MB.

Our adjusted results for the second quarter were very strong with net interest income, noninterest income and expenses all performing better than our April guidance. The area where we are significantly outpacing the peer group is our NII and NIM performance. We have been very deliberate and comprehensive in our actions over the past 12 months and longer in managing our interest rate risk, including our strategies in managing the investment portfolio, our preference not to grow our Residential Mortgage portfolio and the timing of the hedge transactions that we have executed ahead of the rate downturn. These were well-thought out and well-executed decisions with a longer horizon view that put our performance ahead of others. Looking at the disclosed information prior to today, our net interest margin, excluding purchase accounting accretion, is above the median of the peer group acts.

Our adjusted return metrics were also strong during the second quarter with an adjusted ROA of 1.33%, an increase of 12 basis points from last quarter. Also we achieved a return on tangible common equity of 15.1%. It is important to note that given the current rate environment and our prior actions to shield the portfolio from higher prepayment speeds, the unrealized investment portfolio gain as well as the hedge portfolio gain have increased significantly. Consequently, our ROTCE was impacted by elevated AOCI levels. Given the interest rate outlook, we expect these items to continue to affect our recorded return on tangible capital. In the second quarter, our AOCI as a percent of total shareholders' equity was 5.7%. By comparison, the median for the peer banks that announced prior to today was a negative 1.5%, which makes a very meaningful difference when comparing return metrics. Therefore, we are providing you with our ROTCE excluding AOCI of 15.8% in the second quarter.

During the quarter, we successfully completed the MB customer conversion. Therefore, our future reported growth rate should provide a clearer depiction of our firm-wide core growth performance. Our second quarter results also indicate that we are tracking slightly ahead of our expense savings pace associated with MB Financial. In line with our previous guidance, we expect to achieve approximately 80% of the run rate expense savings by year-end and realize our annual expense goal of $255 million beginning the second quarter of 2020.

Our second quarter credit performance continue to reflect the benign macroeconomic environment. The net charge-off ratio of 29 basis points decreased 12 basis points from last year and decreased 3 basis points from last quarter. Commercial losses remained near historically low levels and the consumer loss rate improved 9 basis points sequentially. We remain focused on maintaining credit discipline at this point in the economic cycle.

Moving to Slide 5. All of our balance sheet captions were impacted by the MB Financial acquisition on a year-over-year and sequential basis. In our commercial business, the growth patterns in portfolios we are prioritizing look very encouraging. In the second quarter, we have seen good growth in our middle-market banking business. National large corporate loans in our verticals also grew, albeit at a slower pace, and we have seen declining balances in commercial real estate reflective of the cycle and risk environment as well as in large ticket indirect leasing where we hold new originations in early 2018.

End-of-period commercial real estate loans were flat from last quarter. Our balances as a percentage of total risk-based capital remain very low at less than 80%, which keeps our commercial real estate exposure relative to capital near the bottom of our peer group. Average commercial loans and leases increased 25% from the year ago quarter and 16% from the prior quarter. Commercial loan production increased 3% sequentially driven by strong middle market lending originations. Second quarter middle market loan production outpaced the previous quarter in 8 of our 13 markets. In our Chicago region, total end-of-period loans increased more than 1% sequentially. Payouts and paydowns at the very end of the quarter had a larger impact on our national corporate banking portfolio. Total commercial line utilization decreased 1% sequentially but increased 2% year-over-year.

Our pipelines throughout the business remain solid. With a good start to the quarter, we expect to generate strong C&I loan growth in the second quarter partially offset by declines in CRE and commercial lease businesses. Average total commercial loans should be stable on a sequential basis in the third quarter compared to the second quarter. We are mindful of the risks associated with the current environment and believe that we need to continue our prudent client selection and underwriting process as loans with aggressive pricing and structures at this point in the cycle may not necessarily be in the best interest of our shareholders. Having said that, we are confident that we will continue to prudently grow our portfolio within our current risk and profitability profile. Excluding the positive impact of MB, on a year-over-year basis, we have grown our C&I loans at 7.1% above the peer median. For the full year, we continue to expect average total commercial loans to increase approximately 20% compared to 2018, again impacted by the MB acquisition.

Average consumer loans grew 9% from the same quarter last year. Apart from MB, our core growth rate was strong driven by auto loan production of a $1.4 billion during the quarter. We are seeing continued decline in home equities, growth in line with the industry and credit card, growth in indirect auto and a flat Residential Mortgage portfolio in line with our view of the current rate cycle. In the third quarter, we expect total average consumer loan balances to increase approximately 2% sequentially. For the full year, we expect average total consumer loans to increase approximately 8% compared to 2018. Combining the commercial and consumer portfolios, we currently expect full year 2019 average total loans to increase approximately 15% to 16% compared to 2018, which is unchanged compared to our previous guidance.

Moving on to Slide 6. Compared to the prior quarter, NII increased $164 million or 15%. Adjusting for purchase accounting accretion from the non-PCI MB loan portfolio, NII increased $149 million sequentially or 14%. Our second quarter NII benefited from a $16 million of PAA or 5 basis points of NIM. The adjusted second quarter NIM of 3.32% increased 4 basis points from the first quarter, consistent with our April guidance.

As I mentioned before, we are very pleased with the outcomes from the actions that we have taken with respect to our prudent and long-term-oriented interest rate risk management. With these actions, we have been able to protect our rate exposure to lower short-term rates and particularly with our investment portfolio positioning to a flatter long end of the curve. We have not executed any new hedges in the second quarter, and a portion of the swaps that we executed last year have effective date this quarter and the first quarter of 2020 with 5-year terms and had an average fixed rate of 3.14%. In addition, the 2.25% 1-month LIBOR floors that we executed in late 2018 become effective December of this year, again with a 5-year term. We have included additional information related to our interest rate risk profile and investment portfolio positioning in the presentation appendix.

Interest-bearing core deposit costs increased 4 basis points sequentially, which was below the peer average and was consistent with our previous guidance. Our performance reflects our success in generating stable consumer deposit growth. Our overall interest-bearing liability costs continue to be very well maintained, up only 1 basis points during the quarter. Our outlook assumes 3 25-basis-point rate cuts throughout the remainder of 2019, in July, September and December. In that environment, we assume that deposit betas will be in the high 30s to 40 range.

As a result of these assumptions, we currently expect our third quarter NII, excluding PAA, to be up approximately 1% sequentially, reflecting the benefits of our larger earning asset base and day counts partially offset by continued market pressures from lower rates. Our third quarter NIM, also excluding PAA, should be down approximately 3 basis points compared to the adjusted second quarter NIM of 3.32% due to the impact of lower short-term rates. We expect the third quarter benefit from PAA to decline to 4 basis points. As a result of the expected 3 basis points decline in core NIM and a 1 basis point drag from lower accretion, reported NIM should decline approximately 4 basis points compared to the reported second quarter NIM of 3.37%. We have provided more detailed information in our presentation appendix related to our expectations for purchase accounting accretion, excluding the potential impact from prepayments as well as expected core deposit intangible amortization expense.

We expect full year 2019 NII growth of approximately 15% to 16% compared to 2018, excluding PAA and including the impacts from lower rates. Should the Fed cut rate 75 basis points in the second half of 2019, we expect the NIM excluding PAA on a full year basis to expand approximately 7 basis points in 2019 compared to our prior guidance of 10 basis points, which assumes static interest rates.

Moving on to Slide 7. Corporate banking fees were up 14% compared to the year ago quarter and up 22% from the prior quarter, reflecting the impact of leasing revenue from MB Financial as well as solid core performance. In capital markets, we experienced a less favorable environment during the quarter, which pressured revenues and debt capital markets and loan syndications. For the third quarter, we currently expect our corporate banking revenue to increase approximately 7% compared to the second quarter, reflecting both the larger client base post-MB and improved performance from the initiatives we have previously discussed.

Card and processing revenue was up 10% compared to the year-ago quarter and increased 16% compared to the prior quarter primarily reflecting increases in credit and debit transaction volumes partially offset by higher rewards. Wealth and asset management revenue was up 13% from the year ago quarter and 9% from the prior quarter due to higher personal asset management revenue and institutional trust fees. The sequential increase was partially offset by seasonally strong tax-related private client service revenue in the prior quarter. We are very optimistic about the AUM growth in the second half of the year, which also bodes well for growth in 2020.

Mortgage banking revenue was up 19% year-over-year and 13% sequentially. Origination volume of $2.9 billion was up 76% from the last quarter and 36% from the same quarter last year. The gain-on-sale margin from our retail channel increased from 235 basis points in the first quarter to 244 basis points in the second quarter. Our total gain-on-sale margin of 166 basis points was down 10 basis points sequentially due to channel mix and was flat from the year ago quarter.

Deposit service charges increased 4% compared to the year ago quarter and increased 9% compared to the prior quarter. Performance from both the year-ago quarter and prior quarter reflected higher commercial deposit fees driven by the benefit of the MB client base along with continued client acquisition at core Fifth Third franchise. The growth in commercial deposit fees was partially offset by lower consumer deposit fees as we continue to focus by improving our product and service offerings. For the third quarter, we expect total noninterest income to increase approximately 2% from the adjusted second quarter of 2019. And for the full year, we expect total noninterest income to increase 15% to 16% from the adjusted 2018 noninterest income.

Moving on to Slide 8. Second quarter reported expenses included merger-related items from the MB transaction of $109 million as well as intangible amortization expense of $14 million. Noninterest expense adjusted for these items and prior period items shown in our materials increased $102 million or 10% from the year ago quarter. The expense growth for the quarter came in below the low end of our previous guidance, demonstrating our continued commitments to maintaining expense discipline and achieving positive operating leverage. Excluding the previously mentioned merger-related items, the year-over-year increase in expenses reflected higher compensation expenses and continued investments in technology. The growth in expenses was partially offset press by lower incentive-based payments and the elimination of the FDIC surcharge.

We currently expect third quarter expenses to be flat sequentially from the adjusted second quarter 2019. Also we expect full year 2019 expense growth of approximately 13% from an adjusted 2018 expense base of $3.865 billion. All expense projections exclude merger-related expenses and the impact of intangible amortization. Our NII fee and expense outlook for the third quarter should continue to lower our efficiency ratio by another 50 basis points or so. We are cognizant of potential challenges to the overall revenue growth expectations in light of the rate environment and recognize expense management as a tool to counter the impact of a weaker growth outlook.

We remain on track to deliver on the previously provided outlook for MB-related expense savings. We continue to expect to achieve $255 million in savings by the end of the first quarter 2020. Our second quarter results reflect approximately 40% of the total run rate expense savings target. Based on our current expectations, at the end of the year, we are on target to capture 80% of the savings on a run rate basis. Additionally, we continue to expect our total after-tax merger charges, inclusive of the merger-related charges recognized in current and past periods as well as future projected charges, to be approximately $250 million after-tax.

Turning to credit results on Slide 9. Second quarter results -- second quarter credit results continue to reflect the generally benign environment. Our key credit metrics have remained stable and remain at or near historical lows. The second quarter net charge-off ratio of 29 basis points decreased 12 basis points from the year ago quarter and 3 basis points from last quarter. The commercial charge-off ratio of 13 basis points increased slightly compared to last quarter and decreased 21 basis points from last year while the consumer net charge-off ratio of 59 basis points decreased 9 basis points compared to last quarter. The NPA ratio of 51 basis points declined one basis point compared to last year. The ALLL ratio was flat sequentially at 1.02% with provision expense offsetting net charge-offs due to slightly lower end-of-period loan balances. Again, I would like to remind you that the current economic backdrop continues to support a relatively stable credit outlook with potential quarterly fluctuations, given the current low absolute levels of charge-offs.

Turning to Slide 10. Capital levels remained very strong during the second quarter. Our common equity Tier 1 ratio was estimated at 9.6%, and our tangible common equity ratio excluding unrealized gains and losses was 8.27%. Our tangible book value per share was $20.03 this quarter, up 11% year-over-year and 7% from the first quarter.

During the quarter, we initiated and settled $200 million in buybacks, which reduced common shares outstanding by approximately 7.2 million shares. Additionally, at the end of the quarter, we settled the $913 million share repurchase initiated in the first quarter of 2019, which lowered share count another 2 million shares. We also raised our common dividend $0.02 in June to $0.24 per share. Through the first half of the year, we returned nearly 120% of earnings to shareholders through buybacks and common dividends.

At the end of June, we announced our capital distribution capacity of approximately $2 billion for the period of July 1 '19 through June 30, 2020. This includes the ability to execute share repurchases as well as increased common stock dividends and exclude potential repurchases related to the remaining after-tax gains from the previous sale of Worldpay stock. As always, our capital actions are subject to Board approval and market conditions.

We continue to remain focused on disciplined capital management. We will continue to calibrate our capital ratios to the risk profile of our balance sheet and business composition, which points to a lower level of capital than we currently have. As always, we will continue to take into account the prevailing microeconomic conditions and peer group capital levels in our overall capital management approach. Our medium-term CET1 target is 9% to 9.5%.

Slide 11 provides a summary of our current outlook. Based on our third quarter and full year 2019 outlook, you can see we currently expect a strong finish to 2019. The combination of our strong performance in the second quarter and a stable outlook in this challenging rate environment is encouraging even under probably the most conservative rate outlook one can apply.

Reflecting the market expectation that the Fed will most likely lower rates by 75 basis points by the end of 2019, we expect to generate a core ROTCE of approximately 16.5% in the fourth quarter of 2019, excluding the impact of AOCI. Furthermore, we expect our fourth quarter ROA to be in the 1.35% range with an efficiency ratio below 57%. This is consistent with our previous guidance for the fourth quarter of 2019 with the exception of the impact of lower rates than what we previously expected. We plan to provide more information regarding our revised 2020 return targets later this year as the future path of interest rates hopefully becomes clear.

In summary, I would like to reiterate a few items. Our second quarter results were strong and continue to demonstrate the progress we have made over the past few years toward achieving our goal of outperformance through the cycle. Our execution on the MB acquisition is on track to meet our targets and guidance on both expense and revenue synergies. Also we are on track to reposition our branch network to improve our market share in the Southeast. As always, we remain intently focused on successfully executing against our strategic priorities and remain confident in our ability to achieve our financial targets.

With that, let me turn it over to Chris to open the call up for M&A -- Q&A.

Thanks, Tayfun. (Operator Instructions) Jay, please open the call for questions.

(Operator Instructions) Our first question comes from the line of Scott Siefers of Sandler O'Neill.

Tayfun, I just want to make sure I understand the guidance correctly. I appreciate all the granularity. Just as I look specifically at the fee guidance for the full year, just given that we have half the year in the bag and then we've got the third quarter guide, it looks like the fourth quarter ramp would be just very, very strong. I want to make sure I understand what all the puts and takes are as you see them, I guess. Both for the third quarter, it sounds like corporate banking is going to be pretty strong. But then into the fourth quarter, what would drive that really big ramp?

Yes. So Scott, the underlying third quarter to fourth quarter growth is truly in corporate banking and a combination of overall capital market as well as treasury management. As we look at our corporate treasury management pipelines and the expected onboarding of some of those client revenues as well as in general our expectations with respect to just corporate banking fee activity, that builds the basis for our outlook.

Okay. So it should indeed be well above the $700 million, I guess, in fees in the fourth quarter if I'm reading it...

Yes. Mathematically, that should be over $700 million. That's correct.

Our next question comes from the line of Ken Zerbe of Morgan Stanley.

Just a question. In terms of the margin, I know the MB does -- obviously helps you guys out a fair amount. Is there any way to separate out the benefit that you got on a core NIM basis, so ex the PAA from MB versus what Fifth Third would have done this quarter ex MB?

Yes. Ken, it's Jamie. I would look at it -- as we left the first quarter, our guide was we're going to grow from 3.28% core NIM to a 3.32% core NIM, which is actually what we posted. When you decompose the NIM benefits, I think we said on the last call, we would expect the MB loan and deposit portfolios to be additive to NIM. And the challenge with unmixing the paint this quarter on the benefit is that we made a lot of investment portfolio and funding actions in advance of the MB acquisition.

But in total, I would decompose the NIM that a combination of the balance sheet positioning, funding action, investment portfolio plus MB's loan and deposit portfolio benefit was 8 basis points. And then our core deposit growth on a core basis, so Fifth Third, was up 2%, and that added a basis point. So we had 9 basis points of benefit. And then that benefit was partially offset by a basis point from headwind from day count, a basis point impact from the $1.3 billion on-balance sheet audit securitization we did in April and then 3 basis point erosion from market rates, which, as we've talked about in the past, is primarily related to the 1 month LIBOR to Fed funds spread, which cost us a little over $1 million per quarter per basis point, and that contracted to 6 basis points during the quarter. So when you take all of that together, that posted a core NIM of 4 bps. But it is getting harder and harder to break out what MB did exclusive of the other actions we took on the balance sheet.

Yes. This may be one last time that we're doing this, but it's going to be very difficult going forward from hereon.

Got you, and understood. Now that actually -- that answer was actually very helpful. And then just a really quick follow-up. Are you guys -- in terms of the hedging strategy, I know you've been adding more hedges this quarter. Are you guys now fully done, comfortable where you're at with the hedging -- with your hedging portfolio?

So we're definitely please with what we were able to execute. I would tell you in the fourth quarter of 2018, we did the $11 billion of total hedges, $3 billion in floors, $8 billion in received fixed swaps. As Tayfun mentioned, $3 billion of those received fix swaps were forward starting, $1 billion began in June and another $1 billion will begin in the third quarter and the final $1 billion leg of that is in January. I would love to do more but not at these entry points.

So what we did this quarter and actually over the last 6 months as opposed to adding more hedges because we didn't like the entry points, we effectively repositioned the investment portfolio to the equivalent interest rate protection of about $10 billion in notional swaps. So we included an extra page in the slide deck. It's Page 20. It's just to highlight the additional positioning we've done with the investment portfolio, to highlight the protection that it will provide. And so that obviously helped during the second quarter and helps protect the outlook as we go forward.

So a long answer to a simple question. But at the end of the day, there are a lot of tools we have at our disposal. And we've been, I think, very effective at utilizing them, whether it's swaps, investment portfolio, the fact that our CD portfolio is -- 76% of it matures in under 12 months so that should reprice fairly fast, the fact that we put on additional fixed rate auto so the auto production was $1.4 billion for the quarter and should be about $5.8 billion for the year. So we've done a lot behind the scenes to help protect to the low rates, and that's starting to shine through in the results.

Our next question comes from the line of Matt O'Connor of Deutsche Bank.

You mentioned the 4Q '19 targets assuming CET1 migrating down to about 9% compared to 9.6% that you're at right now. Is that implying some fund ending of the buybacks, of the $2 billion that you're targeting for next 4 quarters?

No. We should be -- I mean we will be -- we're not necessarily providing how we're going to execute those. But more or less, I think it's going to be even -- we also as you know, have a portion of the Worldpay gains still waiting to be converted to buybacks potentially.

Okay. All right. And then just separately, on the early-stage delinquencies, they were up both Q2 and then especially year-over-year. Is that being distorted at all from the MB deal?

Matt, there's a little bit of noise there. Some of those are matured facilities that were in the process of getting through the pike. They're small facilities overall. We expect that to subside over the next quarter. So there's nothing there that portends a deterioration in credit leading to losses or anything like that. It's just working through some of the backlog we need with the adjustments primarily on MB and, again, not delinquent but more so matured facilities that we've got a plan in place to work through. We've made a lot of progress. So you'll see that come down in the next couple of quarters.

Our next question comes from the line of Ken Usdin of Jefferies.

One question on just the loan growth commentary, Greg, you made in your intro. So that caution, I guess, on the commercial side, is that just talking points? Or is that something that you're seeing? You mentioned still the strong pipelines in the back half. So can you talk about whether that's anecdotal or actually coming through in terms of a change in the amount of pipeline that you guys are seeing?

Ken, we haven't finished opening our pipelines yet, and actually, we feel very confident about our ability to deliver on the commitments we just made on asset growth for the second half of the year. But the conversations are less optimistic. Obviously with the noise that's out there right now, potential slowing economy, the rate environment, what's happening with the tariffs and so forth, it's just that cautionary discussion. We're picking that up, but -- once you get that kind of ebbs and flows. But right now, we have nothing to show up in our pipelines. Actually, production held up very well in the second quarter as we talked about, and we expect that to materialize again and continue forward in the third and to fourth quarter this year.

Okay. Got it. And my second question, just on the deposit cost side. Tough to see kind of the underlying core. Jamie, you mentioned a little bit in terms of the MBFI effect. But you had 4 basis points interest-bearing cost increase below peers probably because in part of the averaging. Just how do you think about the trajectory of that interest-bearing deposit cost from here in terms of the ability to start controlling that, if not showing a rate of decline at some point?

So the deposit cost in the quarter, MB's book at the end of the year, and you can look at their fourth quarter release, their deposit cost were roughly in line with our deposit cost, not far off at all. So our up 4 was -- as we guided to last quarter, we thought we'd be up 4. We were up 4, and that's really the Fifth Third book. So we think it's been -- rate costs have been well maintained on the deposit side.

For our forecast, if we were to not have a Fed cut at the end of July, I think our -- a normal amount of deposit rate increase for us would be up 1 bp or 2, just given mix and promotional rates and new acquisitions because we continue to have good deposit growth. But given that we have a July cut and a September cut in the forecast, those numbers, I think, will be down 1 bp or 2 from the levels that you seen in the second quarter.

Next question comes from the line of Mike Mayo of Wells Fargo Security.

This question might go in the category of no good deed goes unpunished. But why not guide for lower expenses in the third quarter versus the second? I mean it's not like you're done with the merger savings. And also at what point would you increase the expected savings from the merger?

Well, Mike, we still continue to invest in our company. We are very much interested in maintaining a healthy revenue growth. We are interested in making all the necessary technology investments that we need to make. So as much as we like the way we manage expenses, we also want to make sure that we continue to support the franchise.

In terms of the overall expense savings, I mean we will share those with you. But I think we've proven over the past 2, 3 years that we are good stewards of expense, and we will continue to execute on those cuts.

And just a separate question. In terms of the hedges that you put on last October and November, I mean that was ahead of the industry. What are you doing now? And what caused you to put on those hedges before so many others?

Mike, Jamie gave a good discussion on the way we are managing the investment portfolio. I think lately since -- sort of the end of last year into this year, we've executed a few actions to position the investments -- the investment portfolio. We thought that was a better choice between executing through the transactions and moving the portfolio.

And we look at the environment and the market expectations every day. And as certain windows open, we may choose to add more direct hedge protection. But at this point, we have been favoring moves on the investment portfolio to protect the downside. But that may change. It's a very fluid process, and we are very careful.

And I think over the years -- we have a great team. They have provided a great perspective on economic growth as well as central bank actions, and it's that same team will continue to monitor the situation as closely as they have over the years.

Next question comes from the line of Gerard Cassidy of RBC.

Can you guys share with us, maybe Greg, the outlook when you look out over the next 12 months? Certainly, the MB Financial transaction from the numbers that we're hearing today seems to have started out very well. I know at the time of the announcement your stock suffered because of the deal, some of the metrics that were included in the deal. But what is your view going forward on consolidation and acquisitions?

First of all, we're extremely pleased with the MB acquisition, the partnership, and I do want to thank all the MB employees for their great leadership to this transition. So we're very pleased with that.

We're very pleased also with quality of that business. And our foregoing expectations to achieve our expense synergies and revenue synergies, we feel very, very confident. And as Tayfun mentioned in his comments, we're still ahead of the expense side of the house, and we're very bullish on the revenue side of the house as we start to look at some of those pipelines starting to come together.

It all starts with the people. We've got great people at MB, in partnership with the Fifth Third team in Chicago to serve that market. With that said, job one is to get this done right and deliver on the commitments that we made, whether it be: the 400 basis points of improvement on our efficiency ratio, which we're on our way to do that; the 200 basis points improvement ROTCE; the 12 basis points of ROA; the improvement we want to deliver on those commitments as we said we would to our investors. And that's going to be job one. We want to get that done right and demonstrate that going forward. So our focus is on that.

Our focus is on continuing to build and expand our businesses organically, whether we'd be growing in new markets like California, Texas, our investments in the Southeast, products, services and people, and we're going to continue to do that. And that's really the focus is, MB and then organic growth. There's nothing out there on the horizon right now that we'll focus on beyond that.

Very good. And then Tayfun, maybe can you give us an update on CECL, what you think the day 1 impact might be come first quarter of next year?

Gerard, we're not quite ready yet to share. Obviously, there's a lot of work that's still going on. There's still a lot of work ahead of us between now and year-end. We are in the middle of these parallel runs. My expectation is the earliest we will probably potentially give an update will be our third quarter earnings, but we're working very diligently to finish all the work.

Next question comes from the line of Saul Martinez of UBS.

So -- I'm sorry if this is a really simple question. I just want to make sure I understand the fourth quarter financial target, the -- and how to read that. So you note that the 75 basis point of cuts have a 70 basis point impact on ROTCE, 5 basis points on ROA yet you basically maintain your full year guidance for all of the items, including net interest income. So I mean should we basically assume that your run -- your expected run rate for NII may be a little bit lower than what you had previously but the full year number doesn't really change in part because you basically outperformed in the second quarter? So I just want to make sure I understand what the fourth quarter targets imply for run rates.

Yes. I think in general, Saul, if you remember the guidance that we provided back in April, these numbers do line up very well, including the impact of lower interest rate. Now on ROTCE, the additional impact is coming through the AOCI, and that's why we wanted to exclude that and gave you the 16.5% excluding the AOCI. Overall, if you take our NII guidance, up about 1% from the adjusted Q2, you will see that we're not necessarily expecting a growth into the Q4 based on that third rate cut assumption. And -- I mean it's not like a big fall or anything like that, but you're not going to expect another 1% growth over that.

In terms of fee income, I answered one of the earlier questions, we are expecting a good amount of growth from the third quarter into the fourth quarter in terms of fee income.

And in terms of the expense outlook, it's not different. These numbers are a large percentage just because of the MB comparisons, and therefore, you're not seeing the underlying movements. But our expectation is that we had great performance in the second quarter with respect to NII. We still expect very good performance in light of a lower rate environment. And we just kept our overall return targets pretty much intact despite the weaker rate environment and because we just outperformed quite a bit in the second quarter. I mean that's really -- that has also a lot to do with our ability to maintain our overall return target.

Okay. Got it. That makes sense. Just to follow up then on the deposit cost and the deposit beta assumptions. I think you mentioned that we could expect, with your rate assumptions, a couple of basis points decline in the third quarter. You also mentioned that deposit betas you're assuming are high 30s. I think high 30s or low 40s, if I recall. How does -- that high 30, low 40s, over what time period does that lay out? So you're assuming 50 basis points in cuts, for example, in the third quarter. Should we assume that deposit cost then in the fourth quarter will reflect that beta assumption? Or does that deposit beta lay out over a multi-quarter type of time horizon?

Yes. It's a very good question. And unfortunately, the answer is somewhat complicated because you have about 12% of our deposit book is indexed to Fed funds. So when the Fed moves, 12% is going to reprice immediately at a 100% beta. But then we have various offers that are out there that those deposit rates will come down over time. So it's really a blend that will deliver it. And as Tayfun mentioned, over the 3 rate movements, we're modeling the 38% beta, which is exactly what our cycle-to-date beta was on the 225 basis points of Fed funds increases.

Okay. And if I could have maybe one final one on that. Those index deposits, where are they baked in? Are those in the other time deposits?

It's across-the-board. Yes, I'd say it's fairly evenly distributed.

It's probably less in other deposits...

In more savings and IBT.

Correct.

Sorry, what was that?

It's more in savings and IBT as opposed to other.

Got it. And are they mainly commercial deposits? Or...

Yes. Yes.

Next question comes from the line of Marty Mosby of Vining Sparks.

First, let me maybe give you a little more credence than you give yourself because I listen to a lot of different calls every quarter and your approach to net interest income of being neutral, when everybody else was still enamored with being asset-sensitive, gives you the flexibility to take advantage of those events when you saw them because your goal at the end is trying to be as neutral as you can what you see on the interest rate sensitivity numbers. So I think that perspective gives you a lot of flexibility versus trying to play what's happening even if it seems like the momentum is going to continue in the right direction. So always like listening to your calls, Tayfun and Jamie, you all have done a great job of getting ahead by keeping that perspective.

In that vein, one of the things that you've done, I think, is being able to keep these cash flow securities out. In a sense of as you're kind of moving from mortgage-backed into these locked-out type of securities, your premium amortization this quarter was pretty minimal. So I just wanted to -- when you mentioned your margin, you didn't mention any premium amortization or mortgage-backed securities. So is it true that this quarter, underneath all these numbers, that would be a pretty minimal impact as you've been shifting the portfolio?

Yes. And I didn't give that data point. But that's exactly what the repositioning accomplished. I think we ran last year net premium amortization of $6 million a quarter. I think this quarter, we were around $2 million. So that benefit definitely showed up in the quarter.

And when you compare that to other banks that went from like a 6 last year to probably 4x that this quarter with all the prepayment speeds accelerating, that was a big kicker in the sense of how you outperformed so dramatically on your NII because it took that risk out of the equation.

The other thing that I wanted was just, Tayfun, very easy question, to wrap it up here. If you look at operating leases, you mentioned that in the income statement and the expenses, can you give us a little feel for what it was this quarter and what it's been in prior quarters?

So the approximate on -- I'll give you the number on the revenue side. Increase is probably about $20 million-ish quarter-over-quarter, Q1 to Q2.

And what's the base this quarter? How much was it in total?

I -- about $40 million, $45 million, Marty.

Our last question comes from the line of Kevin St. Pierre of KSP Research.

Tayfun, you mentioned that -- one thing that has benefited the NIM and your NII performance was the decision not to grow the first mortgage portfolio. You did guide to third quarter increase in consumer loans of about 2%. As you're thinking -- with the prospect of lower rates, as you're thinking change there? Or are you expecting growth in other loan categories?

Yes. We're not -- our -- the -- our outlook, at least for the second half of this year, sort of matches the production patterns with respect to the refi environment. I don't think that by the time we get to year-end, our residential portfolio outstandings will be much different from where we are today.

Got you. Got you. And maybe one final. Notice pretty stable demand deposits period end quarter-to-quarter on a linked quarter. Could you speak to deposit attrition at MB and how things are going there?

Yes. The deposit attrition at MB is going fine. It's slightly less than the attrition they experienced for the 28 months leading up to the acquisitions. So it's right in line to slightly better.

There are no further question at this time. Chris, you may continue.

Thank you, Jay, and thank you all for your interest in Fifth Third Bank. If you have any follow-up questions, please contact the IR department and we will be happy to assist you.

This concludes today's conference call. You may now disconnect. Have a great day.