Fifth Third Bancorp (FITBO) 2007 Q1 法說會逐字稿

Good morning. My name is Phyllis, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fifth Third Bank first quarter 2007 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [OPERATOR INSTRUCTIONS]

I would now like to turn the call over to Mr. Jeff Richardson, Director of Investor Relations of Fifth Third Bank. Sir, you may begin your conference.

Hello, and thanks for joining us this morning. We'll be talking with you this morning about our first quarter 2007 results, as well as our outlook for the remainder of 2007. As a result, this call contains certain forward-looking statements about Fifth Third Bancorp pertaining to our financial condition, results of operations, plans and objectives. These statements involve certain risks and uncertainty. There are a number of factors that could cause results to differ materially from historical performance in these statements. Fifth Third undertakes no obligation to update these statements after the date of this call.

Now, I'm joined here in the room by Kevin Kabat, our President and CEO, and Chris Marshall, our CFO. During the question-and-answer period, please provide your name and that of your firm to the operator. And with that, I'll turn the call over to Kevin Kabat. Kevin?

Good morning. Thanks for joining us, everyone. I have a few comments and then I'll turn it over to Chris Marshall who will review our balance sheet, revenue, and expense trends, and also talk about our outlook for 2007. This is my first conference call as CEO, and it's an honor to lead this great Company. I'm excited about the team here and the things we're working on to put up the kind of results we expect of Fifth Third. These things are not going to happen overnight, but I believe they will significantly contribute to future results and we're already seeing some traction on some of these initiatives.

I'll let Chris walk through the numbers, but to sum up, I think it was a solid quarter in what is a fairly difficult operating environment, and sets us up to generate results consistent with the outlook we provided to you in January. Like most of you, I'm sure, our expectation is for a yield curve that will likely remain inverted for the remainder of 2007, if not longer, with a possible rate cut in the second half of the year, though that's not a given. Our balance sheet is fairly neutral to reasonable rate scenarios for the year, and given the size of our securities portfolio at this stage, I expect we're better positioned than most. But an inverted yield curve is not friendly to any of us. We've been seeing credit trends continue to turn, as is the industry, and we're very focused on it. We did experience some relief in the form of lower charge-offs in the first quarter as we expected on both the commercial and consumer sides. However, NPAs continue to trend upwards and we'd expect charge-offs for remaining quarters in 2007 to be more consistent with our full year outlook, in the low 50s range.

As we've said before, so far this feels like a bend in the road, not a sharp turn. We're not seeing anything to this point that would cause us to change that view. Our view of credit remains consistent with earlier in the year and we expect it to be manageable, as Chris will review in our outlook. We all know the environment is challenging, but expected it to be. Good companies do things in tough circumstances, so we're focused on a number of areas we control. We can get a lot better at keeping customers, at deepening relationships with them, and at bringing new customers in the door. It isn't sexy. It's basic execution that will create better long-term results.

We've seen some good results from our focus on improving service and customer satisfaction. In the most recent University of Michigan customer satisfaction survey, we ranked second among the large banks, and we showed the most significant improvement among those banks over the past two years. We're also seeing our attrition levels improve. In the first quarter, DDA attrition was 14.2%, down a full percentage point from a year ago. That's great progress from a peak of almost 19% in 2004. Again, more to be done, but good traction. We rolled out new retail deposits products in January that greatly simplified our product offerings. These offerings were carefully designed around the needs of customers attracted to each account type. The net result is we've seen a slight reduction in our overall deposit rates based on product design and tiering, while at the same time increasing our account sales.

Net new DDA production in particular showed strength at nearly 36,000 accounts in the first quarter. We can do better than that, but that's the result of focus and better products. And you're aware that the pricing of our interest checking account several years ago attracted a lot of rate shoppers into what should be a convenience product. While we continue to see runoff in those balances, we're seeing lower account attrition at this point and the pricing on that product is finally what I would consider more appropriate for an interest checking account. Our savings product continues to see strong growth at lower pricing from customers who otherwise would likely drift into a CD product. These results require careful product design and I feel very good about the lineup we offer our customers today. And we continue to avoid promotional pricing in line with our everyday great rates philosophy.

We're focused on execution of our sales strategies. As you know, we're putting a significant amount of focus into capitalizing on our credit card business, which has been growing nicely, but we still have less than 15% wallet penetration among our retail customers. We began piloting an automatic sales prompt for prequalified customers in January and had it fully deployed throughout our affiliates in March. Our card sales are up significantly and we expect to more than double our originations this year versus 2006.

Another significant initiative for us is healthcare, and we've got some exciting things going on here. We just announced a strategic alliance to convert our lockbox explanation of benefits images to HIPAA-compliant electronic images. This allows our clients to speed up their receivables collection. In fact, we just went live with a large university physicians group to electronically convert their paper-based EOB, and we already have a backlog of additional customers waiting for this product. We're gaining a lot of ground here, and as we progress through the year, we will have more to share in terms of the financial impact of this initiative.

All said, it's a tough environment, but I'm optimistic about some key trends in the Company. We still feel pretty good about revenue growth in 2007. But we've tempered a bit given what is not likely to be a robust revenue environment for the industry. Consequently, we're very focused on managing expense growth. This quarter, we saw 2% core expense growth sequentially and 8% year-over-year, which is higher than can be supported in the current market environment. We're going to be very focused on this and we have a number of initiatives underway to ensure that we maintain a tight reign on expenses as the revenue outlook unfolds. We still do expect to see solid results this year, but we want to be careful not to allow our investments to get ahead of revenue realization. With that, I will turn things over to Chris to talk about first quarter results and our '07 outlook. Chris?

Thanks, Kevin. Good morning, everyone. I'm going to start with the highlights of the quarter, and then go into a little bit more detail, before wrapping up with our outlook for the year. And after the highlights, my comments will generally follow the organization of our release, which you will note has changed a little bit this quarter. Hopefully you're going find this format a little easier to use and my remarks a little easier to follow.

So starting with the highlights, on the positive side, the charge-offs were significantly lower than the fourth quarter, which reflected both unusually high charge-offs last quarter as we indicated, and pretty good performance in the quarter just ended. Charge-offs declined in nearly every consumer category and in all commercial categories except commercial construction, which as you would have expected, ticked up a little bit. Fee growth was also pretty solid after accounting for the $415 million in losses associated with our fourth quarter balance sheet actions. Fees were up 2% sequentially in a quarter that's typically a pretty weak comparison for us. We saw a good bit of recovery in our retail service charges, which we were expecting. Net recovery was sufficient for us to post sequential growth in service charges this quarter, in what is typically a down quarter. And actually, I think sequential growth in all of our fee line items was a little bit better than it was in the first quarter a year ago. Obviously, 2% is nothing to write home about. But I think it's an acceptable start to the year.

Net interest margin came in at 3.44%, was up 28 basis points from the fourth quarter. It was largely driven by the full quarter realization of the benefits from our balance sheet actions. The NIM is up 45 basis points from its low point of 299 in the third quarter before we took those balance sheet actions. And that's pretty much what we were expecting. Now, net interest income came in a little bit light of our expectations. Loan growth was just not very robust and commercial deposits fell off a bit more than normal. Structurally, the incremental benefit of our balance sheet actions was about $18 million and that was largely offset by some of the items we highlighted in January. I'm going to talk a little bit more in detail when I get to NII. But those items were the leverage-leased accounting change, the IRS deposit that we made, and then the incremental funding cost of our share repurchases. We also -- first quarter also had a few -- fewer days in the quarter, and that had a slight reduction to NII, as well.

The carrying cost of the IRS deposit, as you know, is offset in our tax line, and obviously our share repurchases provide an EPS benefit. So a lot of that is geographic, but those issues roughly offset one another within NII. And then there were also some positive and negatives in the core businesses that also largely offset. And I am going to talk a little bit about those in just a minute.

Now, expenses were seasonally high reflecting a sequential increase of $17 million in FICA and unemployment expenses. Reported expenses were down 1%, but that's really due to the $39 million in financing agreement termination expenses that we had in the fourth quarter. If you set those expenses aside, as Kevin noted, expenses were up 2% sequentially and 8% versus a year ago. Now, as we told you in January, we've got a number of initiatives we're focused on that we believe are going to contribute significantly to our future growth and we intend to continue those programs. At the same time, I told you we're going to manage expense growth very carefully and that we're going to be prepared to take appropriate action if revenue growth comes in softer than we were expecting. Now right now, it's a little early in the year, but it looks like it's going to be a reasonably tough environment for putting up the kind of revenue growth that can support 8% expense growth. And so we're in the process of finalizing plans that are going to bring our expense growth down to the mid-single digits range.

Now, fortunately the timing is good for us to be making some of these decisions and we don't have to do anything drastic. But we're really not in a position to talk about the decisions we're trying to finalize in detail on this call. But we will do so to the extent necessary as we begin to implement some of our plans. I would say that we expect to see about $40 million to $50 million in expense reductions on an annual run rate basis, and we should see about half of that in the second half. Now once we finalize those plans, I'd expect that we'd see about $10 million in potential one-time costs in the second quarter.

Moving on, I mentioned that charge-offs were lower in the first quarter. However, NPAs continue to trend upward. Now we're continuing to see the most stress in the upper Midwest, particularly in Michigan, and NPA growth remains concentrated in the commercial real estate sector. We saw a large commercial real estate NPA pop up in Florida this quarter. But other than that one loan, problem assets in Florida were actually down slightly. But as a result of the overall trends in credit, we did increase our reserve to loan coverage to 1.05%. We still believe credit costs are going to be manageable this year, but we do expect to see higher credit losses over the remainder of the year, pretty much in line with the guidance we've given you.

While I've spent some time trying to highlight the significant elements of the quarter, all in all, I think the quarter was relatively clean and it should be a pretty -- a pretty easy quarter to understand. So, with that, I'm going to go ahead and spend some time walking through our results in just a little bit more detail, starting with net interest income. As we've mentioned, we had a full quarter's benefit from our November balance sheet actions, which significantly improved our net interest margin. As I said, it was up 28 basis points sequentially and about 37 basis points on a full run rate basis. Margin was 3.44%. Next quarter, we expect we're going to lose a few basis points just because of more days in the quarter. And also we're going to lose a couple of basis points related to our March hybrid issuance. Between the two of those, we're probably going to lose about 5 or 6 basis points in the second quarter. Other than that, I don't foresee anything on the near-term horizon that would drive the margin materially up or down.

As I mentioned, NII benefited by about $18 million incrementally from our balance sheet actions. This was largely offset by the three factors I mentioned earlier. Now, in order of impact, those three factors were the effect of the change in leverage lease accounting that took place on January 1st, and that accounted for about $7 million, the funding cost of the IRS deposit which was $386 million accounted for about $4 million, and then the funding cost of shares repurchased over the past two quarters totaled about $2 million in additional interest expense. Now that leaves about $5 million of benefit, and given the short quarter, we lost about $4 million to day count. Going beyond that, looking at organic activity in the balance sheet, we had somewhat stronger than expected performance from our consumer businesses, but that was largely offset by weaker than expected commercial activity. We saw a lift in the form of higher consumer deposit levels and spreads, and we had very strong credit cards and auto originations which resulted in good balance growth in both of those businesses. However, those benefits were offset by softness in commercial, where we saw lower than expected loan growth and deposit growth.

DDA balances were down, which is completely normal for the first quarter, but the drive -- the drop-off that we saw was actually more significant than we'd expected. We had a very weak first half of the quarter for deposits and that started to improve over the back half. We are going to need a strong second quarter to get back on track. I will talk more about loans in a minute. But while C&I lending remains solid, real estate demand, candidly, and our appetite for it, has resulted in slower commercial loan growth overall. I haven't touched on year-over-year trends because a lot's happened in the past year, but NII is up 3% and NIM is up 36 basis points versus the first quarter of '06. I'd also note here that our interest rate sensitivity, as Kevin said, remains pretty much neutral to any likely shifts in interest rates over the next 12 months.

All right. Let me turn to the balance sheet starting with loans. Loan growth has slowed a little bit from pretty strong levels last year, again, reflecting softening in commercial real estate demand. Companies are also being a little more diligent in terms of managing their credit lines. They're drawing down on deposit balances to pay them down. Average loans were up 1% sequentially and were up 6% versus the year-ago quarter. That would have been 7% if we excluded the runoff in consumer leases. Breaking things down, average commercial loan growth was flat sequentially and up 6% versus the first quarter. You remember that in the fourth quarter we reclassed about $450 million of C&I loans to commercial real estate. And that kind of makes the averages across product lines a little different -- a little difficult to compare. Commercial growth does look a little bit better on a [period-end] basis as we've experienced stronger results toward the end of this quarter, overall up about 5% annualized.

C&I loans were up 3% sequentially, or 13% annualized, which we feel pretty good about. Construction loans were actually down $500 million in an offset by $500 million growth in commercial mortgages, just due to loans perming out. As I mentioned, line utilization is down about 1% since September, which equates to about $500 million in lower loan demand. Average consumer loans were up 1% sequentially and 6% year-over-year. And, again, if we excluded the continued runoff in consumer leases, that annual growth would have been about 8%, which we feel pretty good about. We're seeing strong growth in auto loans. They're up about 4% sequentially. And I think you're seeing that across the industry. The spreads have been the best that we've seen in the last couple of years. Credit card growth was also very strong. It was up 12% sequentially and 33% year-over-year. So, that initiative, as Kevin said, is really off to a great start.

Now going on to deposits, average core deposits were flat sequentially, they were up 2% versus a year ago. Retail core deposit growth was pretty strong, with increases in savings and money market balances more than offsetting fairly modest declines in interest checking and retail CDs. Retail core deposit growth offset lower commercial core deposits, which were driven by seasonally-higher DDAs in the fourth quarter, and again, the paying down of lines that I just mentioned.

Now moving to the deposit captions that you see in our tables, DDAs were down 5% sequentially, driven by seasonality in commercial DDAs. DDAs were down 4% versus a year ago. Now that reflects a number of factors, including higher earnings, credit rates, the mix shift that we've talked about, and then, again, the credit line reductions. In terms of overall DDAs, we think we have got a lot more opportunity on the consumer side. And as Kevin alluded to, we're beginning to see the early signs of traction there and I think we're going to be able to build on that throughout the year. Interest checking balances declined only 1% sequentially, and that's really a good sign. Again, as Kevin said, I think we're finally starting to see that product get into the hands of appropriate account holders. IBT balances were down 12% versus a year ago, but most of that drop-off happened prior to the fourth quarter. And earlier this quarter, we reduced our rates on that product, basically down to market levels, and following that rate reduction, we haven't seen any increase in attrition.

Saving balances grew 7% sequentially and they were up 18% versus a year ago. Now we priced this product very competitively with money market rates in order to attract natural CD savers, and that strategy positions us well. Obviously, we have got more control over our savings rates and we're not going to be locked into high cost CDs if the Fed starts to reduce rates. As a result, our -- if you look at our retail CDs, they were pretty flat sequentially, but they were up 13% versus a year ago, and that was again, really high growth in those balances having occurred prior to the fourth quarter when that started to slow. Looked at as a whole, our weighted average rate paid for interest-bearing core deposits was 3.43%, which is pretty much consistent with the fourth quarter. Going forward, we will continue to monitor the competition and our position in each market, and we're really going to try to be opportunistic in terms of optimizing our overall pricing. I think we've done a pretty good job of that in the last quarter or two.

Moving on to non-interest income, fee trends, as I said, were pretty decent for a first quarter. Starting with FTPS, we had really solid results in what is always a seasonally weak quarter. Processing fees were down 3% sequentially, but they were up 15% compared to a year ago, which was right in line with what we were expecting. We're pretty pleased with that, given some slowing in consumer spending trends over the past year, given the softer economy and the higher fuel prices. Retail same-store sale forecasts have started to come down recently, and that could potentially impact us. But for now, we feel pretty good about our results and we feel pretty good about our mid-teens growth guidance.

Now when we look at FTPS and our processing business, we look at the business in three pieces. Merchant Processing revenue, which is almost half of our processing business, was down 9%, purely due to -- that's 9% sequentially, purely due to seasonality. But it was up 15% from a year ago. Now this business is really doing well and we expect that to continue. The second piece of the business is our Financial Institutions revenue. That's about 30% of the business. It was up 4% sequentially and 14% versus a year ago. As we noted in the release, this growth is a little bit better than normal. This is a business where we and everybody else has experienced some margin compression. We've talked a little bit about that in the past. And that's really a function of long-term contracts starting to renew, and there being a little bit more pressure on -- and a little more focus on debit card volume, just because it's grown so much over the last few years. Now, overall, pricing in this business is still very, very good. It's just not going to stay at the levels that it was at five and six years ago. Finally, the last piece would be card-related revenue, and that represents a little less than a quarter of the business. That was flat sequentially given holiday seasonality, and was up 14% from a year ago. Now, that's driven by interchange among our own credit and debit -- credit card and debit card customers. We'd expect to see growth there accelerate given the success of our new card initiatives.

All right, turning to deposit service charges, they were up 3% sequentially. They were flat versus a year ago. Consumer service charges were up 1% sequentially, and that was really due to the fact that we saw some recovery from the dip we experienced last quarter and that more than offset the normal seasonality. Year-over-year, consumer charges were up 2%. Commercial service charges were up 5% sequentially, but they were down 2% year-over-year. That was completely as we were expecting, and really reflected the effect of higher earnings credit rates on the balances customers maintain to pay for our cash management services.

Going on to Investment Advisory revenue, it was up 6% sequentially and 5% versus a year ago. In the private client business, which is almost 40% of our IA revenue, fees were up 12% sequentially and 15% year-over-year. That was partially driven by improved efficiency in just basically getting our customer tax returns filed. And as a result, we generated an additional $3 million benefit in this quarter, which is great, but we won't see that in the second quarter. And traditionally, that's where it would have shown up. We were pleased with recent trends in retail brokerage, as well. That's almost 30% of our IA revenue. Fees there were up 7% sequentially. We've had a lot of success there attracting more productive brokers and raising the overall individual productivity of our broker workforce. I think we're going to see some continuing benefit from a migration of some of our customers from commission-based relationships to managed relationships. And we started to see that and expect it to continue.

All right. Going on, Corporate Banking revenue was up 1% sequentially from a very strong fourth quarter. It was up 9% year-over-year. And there we're seeing just a continued strong trend in terms of institutional sales and customer derivatives, and we expect that to continue. Mortgage banking net revenue rose $10 million from the fourth quarter. About half of that was higher fees and net gains, and the rest of it was due to the absence of having an MSR write-down in the quarter. Now included in the mortgage results, we had a very small impairment of about $2 million on our [all day] warehouse. And as you know, we began originating all-day mortgages for sale in the fall of 2006. And obviously, our timing could have been a little better with this product, but our exposure is pretty small.

All of our products are designed to be salable, and they were salable until the latter part of the first quarter when market conditions, as you know, changed pretty abruptly and demand literally disappeared for certain products. As a result of that, we determined that $43 million of loans in our warehouse were not salable and that drove the impairment. And we've moved those loans into our portfolio and we don't expect them to be salable anytime in the near future. Beyond that, we've stopped originating those specific products. Now we're committed to this business, but only in originating to distribute. We have no interest in bringing all day loans into our portfolio long-term. And so we're very, very focused on staying in front of market conditions to make sure that our products remain salable. But leaving all day behind and looking at mortgage results versus a year ago, revenue was down $7 million, which largely reflected a positive year-ago MSR valuation adjustment of about $11 million. Moving on to non-interest income, the variance from last quarter was almost solely driven by the $17 million loss on derivatives taken as a part of the balance sheet actions in November.

Okay, let me turn to expenses. I covered the major part of expenses earlier. It's not worth reiterating. The one thing I would point out, though, is that year over growth of 8% was driven by higher processing expense, occupancy expense and technology expense. Now, excluding the processing revenue that is tied to our revenue growth -- I'm sorry, processing expenses tied to our revenue growth and the de novo costs, expenses were up 5%. And we think that is too high given the environment. I will talk about that a little bit more in our outlook. But we would expect processing and de novo expense growth to constitute about half of our total annual expense growth. We intend to manage the remaining expenses to a very tight level, somewhere in the 3% range. Taxes were pretty much what we expected. We came in at 29.3%, which was right in line with our guidance of 29% to 30% for the year. We don't expect that to change.

Turning to credit, results were in line with the guidance we provided in January. Again, charge-offs came in a little below our expectations, which is good. But NPAs, as I said, were a little higher than we expected. Net charge-offs were 39 basis points in the quarter, compared to 52 basis points in the fourth quarter and 42 basis points in the year-ago quarter, when, you'll remember there was a benefit from the after-effects of bankruptcy reform. Provision expense of $84 million exceeded net charge-offs by $13 million and that drove the allowance up to 105. Commercial net charge-offs were $29 million or 27 basis points versus 42 basis points in the fourth quarter. Most of that sequential decline came in the C&I category, as commercial real estate charge-offs were relatively flat. In terms of size, the largest charge-off was $2 million. And as a reminder, last quarter you will remember we had a couple of unusually large charge-offs for us, which were about $5 million each. During the quarter, we sold $39 million in NPAs, representing $5 million in losses. By comparison, in the fourth quarter we sold $13 million and we had a $1 million loss.

Consumer charge-offs were $42 million or 53 basis points, versus 64 basis points in the fourth quarter. Losses were down across the board in every consumer category. But there were really two main drivers. First, fourth quarter losses were seasonally high, reflecting our auto loan foreclosure cycle. Second, during the first quarter, we sold off charged-off consumer loans and that produced about a $10 million recovery. So, consumer charge-off ratio would have been around 60 basis points otherwise which reflects residential real estate -- I'm sorry, residential real estate markets in the Midwest and our disproportionately large auto portfolio.

Turning to NPAs, NPAs were 66 basis points alone, up from 61 basis points last quarter. NPAs increased $39 million. Commercial NPAs drove the increase, and included a $23 million growth in commercial mortgages, $3 million in commercial construction, and $10 million in C&I. Geographically, the commercial NPA growth occurred mostly in two areas. We had a $19 million NPA inflow in Florida related to a commercial real estate development relationship. Obviously, that's a collateralized relationship, so we'd expect any loss that results from it to be much less. As I mentioned, commercial NPAs were down slightly in Florida otherwise. Let's see, we also saw $17 million in increases in commercial NPAs in Michigan. And that's just a continuation of the stress situation that we've seen there for some time. Now other than the concentration in construction and CRE, we didn't see any other industry concentration in terms of commercial NPAs.

Consumer NPAs were up $3 million and that really was a reflection of [overall] growth. 90 days past due loans rose by about $243 million, and that reflects the trends we're seeing in NPAs. Growth was pretty evenly split between commercial and consumer. The commercial growth was concentrated in construction. Consumer growth was primarily in Florida and Michigan residential real estate. I will talk about credit outlook in just a second. But for now, I'd say that our view really hasn't changed from January, despite the good results this quarter. We still expect charge-offs to be higher in 2007 than in 2006. We also expect to see NPA growth continuing. And that's just given where we are in the credit cycle. As Kevin said, we'd still characterize things as a curve in the road. But we are, as all of you would expect, we're very, very focused on credit management.

Now, I'll wrap up my comments before I get to the outlook with capital. As you know, we issued $750 million of Tier One qualifying trust preferred securities in March. That supplemented regulatory capital ratios by about 75 basis points across the board, give or take a couple of basis points, depending on the ratio. Our tangible equity ratio was 7.65%. It's down 14 basis points, but obviously still very strong. That reflected share repurchases and a $96 million reduction in equity on the first of January, related to the adoption of new leverage lease accounting. And we continue to target a 7% TCE ratio at the end of 2007 and we expect to work towards that 7% over the course of the year in a relatively consistent pattern. We're going to review our capital levels as we get further into the year, and at that point we'll have more to say about capital. But I don't expect we're going to change our long-term capital target any time soon. But we will be talking to you more about it in the second half.

In terms of outlook, you will find this on page eight of the earnings release. As we noted in January, we will update our full-year outlook each quarter as the year progresses. We've underlined a couple of items that changed, where we've made adjustment to our January outlook. And I will just touch on the more important ones. Given the sluggish start of the year for loan growth and market rate expectations, we brought our NII and loan growth outlook down slightly, with the mid to high single-digits. For NII, we are assuming the forward curve in our forecast, which continues to suggest an inverted curve all year, one rate cut at the end of the year. That hasn't changed. Now, loans, consumer growth still feels good at about the 6% to 7% annual rate that we're seeing. And C&I growth feels pretty solid. We brought our overall loan growth guidance down a little bit given the lack of growth in the real estate and construction arena. We don't want to chase growth there and obviously demand has started to tail off.

The net interest margin was strong as expected, and so no change in the outlook there. First quarter NIM was probably about 5 to 6 basis points higher than I said we'd expect to see for the remainder of the year, due to the benefit of margin -- of fewer days in the first quarter, and the effect of capital management actions -- AKA, the hybrid we've taken, and other things we might do in the back half of the year.

Turning to non-interest income, overall, no change to the fee outlook, although given the mortgage environment, it might be a little tougher to deliver that growth. Credit spreads have widened, particularly in all day, so our gains will likely be smaller on what will probably be lower sales volume for us. We will know better next quarter as we see how that market is going to shape up. Processing continues to perform very well. We feel good about our mid-teens growth expectation there, as I've already said. We expect deposit service revenue growth in the mid single-digits. That's a little slower than we were thinking in January, but other fee categories feel about the same right now. Bless you, Jeff. We haven't changed our outlook for expense growth. That's mainly because we intend to manage expenses into that range. As I noted in January, about half of our expense growth will probably come from processing and card expenses and from de novos. Otherwise, expense growth should be pretty well controlled in the low single-digits. Again, the 3 percentage kind of range.

As a reminder, I want to point out that we're going to incur about $6 million in costs related to retiree eligible stock awards expense, and that's going to show up in the second quarter. And as I mentioned, we're going to have unplanned, one-time costs potentially of about $10 million, and I'd expect that all to be in the second quarter, related to some of the actions we plan to take.

All right, I already talked about loans. So, deposits, we're still looking for core deposit growth in the mid single-digits. Now that's a tough environment for growing core deposits, particularly commercial DDAs. We feel pretty good about the traction we're seeing on the retail side, as I said. And the net of those factors leads to us expect decent core deposit growth, but we'd like to see it stronger, obviously. Net charge-offs were low this quarter. So, we've reduced our full year outlook to the low end of the January guidance we've given you. So we'd expect charge-offs in the remaining quarters of the year to be in that low to mid-50s basis point area. Commercial charge-offs will probably be somewhere in the high 30s and consumer will be probably somewhere in the low 60s. We'd expect NPAs to continue to trend upwards and then maybe some movements up or down in the charge-off and NPA trends from quarter-to-quarter. But overall, this is where we expect it to be for the year.

Now other than that, there are no other changes to our outlook. So I'm going to wrap it up just by saying I think it was a solid quarter in what appears to be a reasonably tough environment for everybody. We remain very focused on executing our plan and returning Fifth Third to the levels of performance I know you all expect of us, and quite frankly, that we expect of ourselves. So thanks for your patience here. And now we'll open it up for questions.

[ OPERATOR INSTRUCTIONS ] Matthew O'Connor, UBS.

All right, you made some comments on pricing strategy of the transactions deposit, but I noticed that CD rates picked up a little bit. And I'm just wondering what the strategy is there and what we can expect going forward?

Those are -- the CD rates -- we didn't raise our rates. That's just the effect of CDs rolling over and repricing to current rates, Matt. We did talk -- so, that's the answer on CDs. IBTs were down about 10 basis points. That's really driven by the consumer side, which we don't break out. But I can tell you the 10 basis points overall really represents about a 19 basis point reduction in IBT pricing. And I just would say again, we felt really good that we did that. We studied the market very carefully, and after we executed the price reductions we didn't see any change whatsoever in attrition. So, we think that pricing is spot-on.

Okay. And then just separately, I know you're rolling out a lot of new incentive systems, both within the branches and throughout the commercial bank. Can you just remind us where we are in that process? And how it's being received so far?

By incentives, are you referring to the things we've talked about in terms of productivity measurement?

Yes. And then I think in the commercial bank, you're trying to gear some of the incentives more toward fee revenue versus just loan volumes and things like that.

Yes, I don't think those are changes in incentives. So, Kevin, I don't think we really have any -- .

Yes Matt, I think what you're referring to are two pieces to that that we talked about. One is really concentrating on focusing those incentives on the obviously higher contribution to us, but also combine that with better metrics that we've seen in the past. And those are rolled out. People are seeing those today. That goes on both sides of the house, in our commercial side of the house, as well as our retail side of the house. So, those are out and we're getting good focus on that from both sides.

Okay.

And for everybody, that is just referring to the ability to measure individual productivity down to the individual associate, with something we rolled out in January. It's now fully in place.

Okay. And then just lastly if I may, you said that you're not going to change the long-term capital targets any time soon, but that we will hear more about capital just in general in the second half of the year. Maybe give us a little hint on what that would be?

There is no hint. I mean, maybe I said that a little bit too strongly. I have said before that we were going to work through the year to a 7% capital target. We recognize that that is a strong capital level and may be a little conservative. But right now, we don't expect that to change in year. However, we will see how the Company performs through the year and we will continue to look at capital. And if we do have -- I guess what I'm saying is don't expect any news on a changing capital target in the second quarter.

Okay. All right. Great, thank you.

John McDonald, Banc of America Securities.

Chris, I was wondering if you could give some color on your consumer home equity portfolio? What trends did you see this quarter in terms of growth and credit quality on home equity?

Credit quality wasn't bad in home equity. And I know I've talked a lot about that in the past as having ticked up. There wasn't -- let me check the number here, but I don't think there was -- I don't think we saw much there, either in terms of growth or credit -- change off in credit quality at all from what we saw in the fourth quarter. I got to have -- check the number right in front of me, John, but -- .

Okay, and is that -- ?

It was sort of a steady state.

Okay. And that wasn't involved in any of the sales of loans that you did?

No.

Okay. And -- ?

I'm looking at it, and it looks like sequentially it was down 1% home equity.

Okay. And have you given any of the kind of key stats in your home equity book in terms of FICO or loan to value?

I don't know if we've shared loan to value, but we certainly can. The FICO score is pretty strong. I want to say it's in the 700ish range, maybe 7 and change. But, so I'd guess it's 700 to 710.

Okay.

And LTV, I won't quote it off the top of my head. But overall, I think credit quality in that book is pretty solid comparatively.

Okay. Just a question on reserves, too. You overprovided relative to charge-offs, but with the NPAs rising, it looks like the reserve to NPA coverage declined a little bit. Can you just comment on what your models were telling you this quarter on the reserves?

I guess I can't go any further into that right here, John, other than I think the model told us to go up a little bit based on where we saw NPAs tick up. But beyond that, I'm not sure I -- .

Okay, last thing is the implied ramp-up in the charge-off ratio from 39 you get to the low 50s for the year is pretty high. Any sense of geography? Is that a gradual ramp throughout the year, each quarter?

Yes, I would expect it to be. And I guess what I would there, John, is we didn't expect the 39 basis points this quarter. It was a little bit lower than we were expecting. And just like last year, I was telling you I didn't want to draw a trend from any one quarter. I don't want to draw a trend off of the first quarter here. So, we would -- right now I would say it would be steady growth, in that 50s. But if there's a fluctuation quarter-to-quarter, I'm not going to be surprised by that.

Okay. Thanks.

Mike Mayo, Deutsche Bank.

Can you talk about the trade-off between investing long-term with the de novos and showing positive operating leverage today? The expenses are going higher, largely due to de novos, or at least partly, at the same time, you're guiding for less loan growth, I guess deposit service charges might be under a little pressure, et cetera.

Yes, first of all, Mike, congratulations on your new job. I would say that we are very focused on operating leverage. But the de novos that we're investing in are performing very well. And to the extent they continue to perform well, we are going to continue to invest in them. We look to make expense cuts in other areas so that we can make those investments. So, sort of an indirect answer to your question, but the de novo performance is good and we don't want to cut back there.

Well, specifically, what's the retail deposit growth, linked quarter, if you strip out the commercial deposits?

Hang on one second.

And I guess related question, deposit service charges, what are seeing there, too? Because that's somehow related to the branches, right?

Yes, retail deposit growth would be 2% to 3%. Deposit service charges -- first of all, commercial, I think we -- you're really talking about consumer retail in service charges?

Well I'm talking about branch-related revenues generally. And it's not broken out that way in the release, but when you look at total deposit, it doesn't look good. And you're saying the retail specifically is better.

Our -- I would say our retail service charges, while they came back a little bit in first quarter, we actually think should be better. And it has nothing to do with de novos. It has to do with some other issues that we're working on. I actually think retail service charges should improve through the year.

Okay. And then lastly, at what point would you say, hey, we need to cut back on the branches or even accelerate it?

Well, as I think you'll remember, we did say we are accelerating now, given the returns we're seeing. I think we're going to -- we look at that very, very closely. And to the extent that we see a slowdown, either in our performance or in any region, we might pull back and slow down. But where we're making our investments, we don't see that on the horizon right now. So I wouldn't expect to see any -- I don't see anything out there that's going to slow down our de novo growth right now.

Thank you.

Chris Mutascio, Stifel Nicolaus.

Congratulations to you on your new job, too.

I appreciate it. Hey Chris, can you give me a view of the secondary market for the problem loans that were sold? If I did the math correctly, you sold $39 million, took about a $5 million loss, that's about $0.87 on the dollar. How does that compare with past quarters?

Past quarters impairment on Alt-A-- you're trying to compare -- oh, on NPA sales.

I'm sorry, the NPA sales in terms of -- ?

Pretty much the same. I mean that changes quarter-to-quarter. We look at that very opportunistically. I'd say if the pricing we saw on those sales were to fall off significantly, we probably would not be making the sale. So, we look at the economics of each sale, and this quarter looked a little bit better. And that's why we sold a little bit more.

Great, thank you.

When I say a little bit better, that's not necessarily quarter-over-quarter, just in general to what we normally see the trends. It was actually a tiny bit softer than it was last quarter.

Ed Najarian, Merrill Lynch.

Two questions. First, with respect to the net interest margin, you talked about maybe 5 or 6 basis points of pressure coming in the second quarter. But then seemed to imply a pretty stable outlook after that. Given that you expect the yield curve to remain inverted for the balance of the year, obviously we talk a lot about competitive pricing in the Midwest on loans and deposits, what gives you confidence that you can keep that relatively stable margin subsequent to the second quarter?

The inverted curve, we've planned on that. So, that was in our forecast. It's a good question on competition. If we go back a couple of quarters, that was a big question mark for us, Ed. And as the year is starting to unfold, while we see it's tough -- demand is tough, we don't see the irrational pricing that we were concerned we might see. And so, if things stay the same -- I mean it's a very competitive market, but we don't see a change in that, good or bad. So, based on what we're seeing out there, what we saw in the first quarter, I think stability is probably to be expected in the margin.

As you're layering on new volume to the balance sheet, are you getting spreads that are close to your existing margin?

Yes. Yes. There's not a big -- there's not big change. Obviously, there's different markets, we may see a little bit more softness than others. But overall, there's not a significant change in spreads predicted or nor have we seen them.

Okay, thanks. And then second question, with respect to the capital management issue and driving towards a 7% tangible E-to-A by the end of the year, how committed are you to getting to that level predominantly through stock buybacks? Or will there be a number of other means to get there, including say, smaller acquisitions or a significant dividend increase, or other things? Just trying to look for sort of a little indication on terms of how you'll get to that lower level.

The 7% is planned to be achieved through stock buybacks. No special dividend. It doesn't include any acquisition that might happen. But we obviously look at our overall capital targets, should we do something. But right now, you should assume that that's purely stock buyback. I guess I'd go back on one other thing, just make one last comment, Ed, on spreads. If spreads start to deteriorate significantly, you should look for us to slow down our loan growth. What we don't want to do is start chasing credit where we're not going to get paid for it. So, right now, things are holding, and we expect them to. But we -- you should expect us to act prudently if spreads start to disappear in certain categories or certain markets.

Okay, thanks.

Kevin St. Pierre, Sanford Bernstein.

My questions have been answered, thank you.

At this time, there are no further questions. Are there any closing remarks?

No, we just thank you. As we mentioned, we feel it's a fairly solid quarter in a tough environment, and we continue focused on the things that we think will make a difference to us as we go forward. So, thanks for your attention this morning, guys, and talk to you soon.

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