Fifth Third Bancorp (FITB) Q3 2021 Earnings Call Transcript

Fifth Third Bancorp (FITB -0.22%)
Q3 2021 Earnings Call
Oct 19, 2021, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Fifth Third Bancorp third-quarter 2021 earnings conference call. [Operator instructions] Please be advised that today's conference is being recorded. [Operator instructions]. I would now like to turn the conference over to your speaker today, Chris Doll, director of investor relations.

Please go ahead, sir.

Chris Doll -- Director of Investor Relations

Thank you, operator. Good morning, and thank you for joining us. Today, we'll be discussing our financial results for the third quarter of 2021. Please review the cautionary statements on our 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 update any such forward-looking statements after the date of this call. This morning, I'm joined by our CEO, Greg Carmichael; CFO, Jamie Leonard; president, Tim Spence; and chief credit officer, Richard Stein. Following prepared remarks by Greg and Jamie, we will open the call up for questions.

Let me turn the call over now to Greg for his comments.

Greg Carmichael -- Chief Executive Officer

Thanks, Chris, and thank all of you for joining us this morning. Earlier today, we reported a third-quarter net income of $704 million or $0.97 per share. On a core basis, we earned $0.94 per share. Once again, we delivered strong and steady financial results while fully supporting our customers, communities, and employees.

During the quarter, we generated an adjusted ROTCE of nearly 19%, which represents the fifth straight quarter exceeding 18%. We generated period-end C&I loan growth of 4% compared to the prior quarter, excluding the impact of PPP. Commercial loan production increased 5% from last quarter, representing the strongest quarter since the fourth quarter of 2019. We generated strong consumer household growth of 3% compared to last year, with growth in every region in our footprint, reflecting the continued success of our branch and digital initiatives.

And as expected, we generated positive operating leverage on a year-over-year basis. Our performance this quarter reflected strong business outcomes across our franchise, resulting in improved and diversified revenues. This was combined with disciplined balance sheet management, expense management, we had another quarter of benign credit results. We closed the Provide acquisition and the sale of HSA deposits in the quarter to improve long-term growth and profitability.

Provide, a leading fintech company serving healthcare practices will further accelerate profitable relationship growth. The seller HSA deposits is part of our multiyear strategy to simplify the organization and prioritize investments in order to generate differentiated outcomes for our customers and shareholders. Despite continued pressure from low-interest rates, adjusted PPNR increased 4% compared to the year-ago quarter highlighting the strong results from our fee-based businesses in retail, mortgage, commercial, and wealth and asset management. Excluding the impact of PPP, average total loans increased 1% compared to last quarter.

Reflecting strong commercial loan production as well as strength in our indirect auto through residential mortgage portfolios. Commercial loan production increased 5% sequentially with record quarters in corporate banking and middle market. Despite some of the challenges we have been hearing from our customers, including supply chain constraints and labor shortages, the strong production was led by our healthcare, renewable energy, and retail verticals and was well diversified geographically. Our commercial lending production trends, pipelines, and retention of the client relationship all support continued loan growth.

As it relates to Provide, we are very pleased with the progress we have seen so far. We are even more excited about the opportunities for continued growth. As we have previously mentioned, we expect strong origination volumes in 2022, reflecting a robust pipeline, and of product capabilities and key talent hires, provides supports our relationship approach with approximately two-thirds of customers having either a deposit account or a payments relationship with Fifth Third. During the quarter, we recorded a net benefit to credit losses as well as historically low net charge-offs of eight basis points, reflecting continued improvement in both our commercial and consumer portfolios.

In addition to historical low credit losses, we experienced another quarter of improvement in criticized assets and NPAs. Our criticized assets declined nearly 20%. Our NPA ratio declined nine basis points sequentially. Our NPA to NPL ratios this quarter have reverted back to pre-pandemic levels.

Our strong craft performance reflects disciplined client selection, conservative underwriting, and continued support from fiscal and monetary government times programs. Our balance sheet and earnings power remained very strong. As we've said before, we remain focused on deploying capital into organic growth opportunities, evaluating strategic nonbank opportunities, paying a strong dividend, and share repurchases. Bank acquisitions remain a lower priority.

I'd like to once again thank our employees. I very much appreciate the way you have continually risen to the occasion for our customers, communities, and each other. I'm very proud that in addition to producing strong financial results, we have also continued to take delivered options to improve the lives of our customers and the well-being of our communities. For our customers, we are excited to roll out Genie, our new AI-driven digital system in the fourth quarter.

This will drive targeted marketing capabilities, digital engagement, and improved customer retention. For our communities, we made a $15 million contribution to our foundation this quarter as part of our $2.8 billion commitment to accelerate racial equity, equality, and inclusion in our communities. In total, we have contributed $40 million in philanthropic support since the end of last year. We continue to make targeted investments to accelerate economic revitalization as you may have seen in last week's announcement, a Fifth Third Neighborhood Investment Program.

This innovative initiative further demonstrates our commitment to being an ESG leader in addition to other recent proof points, including charting over $6 billion toward our $8 billion renewable energy goal to be achieved by 2025, announcing a new position about climate risk to focus on identifying, measuring, and managing the physical and transition risk of our clients and a robust transparent and peer-leading ESG disclosure. In summary, we believe our balancing strength, diversified revenues, and continued focus on disciplined management throughout the company will serve us well into 2022 and beyond. We expect to generate positive operating leverage on a year-over-year basis in the fourth quarter and also for the full year in 2021. We remain committed to generate sustainable long-term value and consistently producing through-the-cycle top quartile results.

With that, I'll turn it over to Jim to discuss our third-quarter results and our current outlook.

Jamie Leonard -- Chief Financial Officer

Thank you, Greg, and thank all of you for joining us today. We're very pleased with our financial results this quarter, reflecting focused execution throughout the bank. Our quarterly results included solid revenue growth and continued discipline on both expenses and credit. The reported earnings included a $21 million after-tax benefit or $0.03 per share from the three items noted on Page 2 of the release.

Our strong business performance throughout the bank is reflected in our return metrics. We produced an adjusted ROA of 1.32% and an adjusted ROTCE excluding AOCI of 18.7%. Improvements in our loan portfolio credit quality resulted in a $63 million release to our credit reserves and an ACL ratio of 200 basis points, compared to 206 last quarter. Combined with our historically low net charge-offs, we had a $42 million net benefit to the provision for credit losses.

Moving to the income statement. Net interest income of approximately $1.2 billion increased 2% compared to the year-ago quarter, reflecting the benefits of our balance sheet positioning, continuing benefits from PPP income, and income from our Ginnie Mae forbearance loan purchases. Our NII results relative to the second quarter included a $6 million reduction in PPP income, a $4 million decline in prepayment penalties in our investment portfolio, and the impact of lower-earning asset yields, partially offset by a higher day count and a reduction in long-term debt. Our allocation to bullet and locked-out structures is currently 60% of the total investment portfolio which is expected to continue to provide ongoing NII protection in this low rate environment.

On the liability side, we reduced our interest-bearing core deposit costs another basis point this quarter to four basis points. With a highly asset-sensitive balance sheet and over $30 billion of excess liquidity, we continue to be well-positioned to benefit when interest rates rise while also remaining well hedged if rates remain low, given our securities portfolio and derivatives. Total reported noninterest income increased 13% sequentially, impacted by a $60 million gain associated with the disposition of HSA deposits as previously communicated. Adjusted noninterest income increased 3%, driven by strong mortgage banking, treasury management, leasing, and wealth and asset management revenues.

Commercial banking revenue, which achieved record results for the past two quarters remained solid as strength in M&A advisory fees, particularly in our healthcare vertical was more than offset by lower corporate bond fees. Compared to the year-ago quarter, adjusted noninterest income increased 13% with improvement in every single caption, reflecting both the underlying strength in our lines of business as well as the robust economic rebound over the past year. Our total noninterest revenue was 41% of total revenue in the third quarter. Reported noninterest expense increased 2% compared to the second quarter, primarily due to the $15 million foundation contribution.

Adjusted expenses were flat sequentially as an increase in marketing expense associated with Momentum Banking and increased T&E expense were offset by a decrease in compensation and benefits expense. Compared to the year-ago quarter, adjusted noninterest expense increased 2%, primarily driven by an increase in performance-based compensation, reflecting strong business results, servicing expenses associated with Ginnie Mae loan purchases, and the impact of the Provide acquisition. These items were partially offset by lower card and processing expenses due to contract renegotiation and lower net occupancy expenses. On a year-over-year basis, total adjusted fees have increased 13%, compared to just 2% expense growth.

Moving to the balance sheet. Total average portfolio loans and leases declined half of 8% sequentially, including the headwind from PPP loans. Excluding PPP, average loans, and leases increased 1%, with period-end loans up 1.5%, pointing to positive momentum as we head into the fourth quarter. Average total consumer portfolio loans increased 2% as continued strength in the auto portfolio and growth in residential mortgage balances were partially offset by declines in home equity and credit card balances.

While we did not retain incremental conforming mortgage originations in the third quarter, we have elected to retain approximately 400 million of our retail mortgage production for the balance sheet in the fourth quarter and we'll continue to evaluate the economic trade-offs given our balance sheet capacity in this environment. Average commercial loans declined 2% compared to the prior quarter due entirely to PPP forgiveness. Excluding PPP, average commercial loans increased around half of 8% with C&I loans up 2%. Production was robust across the board, up 5% compared to the prior quarter, with both corporate and middle-market banking generating record production, which was well diversified geographically.

As a result, period-end C&I loans, excluding PPP, increased 4%. Revolver utilization of 31% was stable compared to the prior quarter. However, it is worth noting that total commitments have increased approximately $5 billion since the end of last year, driven by new client acquisition and an increase in demand from existing clients in anticipation of future business growth. Average CRE loans were down 3% sequentially with lower balances in mortgage and construction driven by elevated payoffs in areas most impacted by the pandemic, reflecting our cautious approach to those sectors.

Our securities portfolio was stable sequentially. We continue to reinvest portfolio cash flows but will remain patient on deploying the excess liquidity. Assuming no meaningful changes to our economic outlook, we would expect to begin our excess cash deployment when investment yields move north of the 200 basis point level. We remain optimistic that continued GDP growth in the Fed's eventual tapering of bond purchases will present more attractive risk-return opportunities in the future.

Average other short-term investments, which includes interest-bearing cash, remain elevated, reflecting growth in core deposits since the onset of the pandemic, which are up 6% year over year. Moving to credit. Our strong credit performance this quarter once again reflects our disciplined client selection, conservative underwriting, prudent balance sheet management, and the continued benefit of fiscal and monetary stimulus programs and improvement in the broader economy. As Greg mentioned, the third quarter net charge-off ratio of eight basis points was historically low and improved 8 basis points sequentially.

Nonperforming assets declined 15% with the NPA ratio declining nine basis points sequentially to 52 basis points. The decline in criticized assets reflected significant improvements in retail nonessential and leisure, consistent with the reopening of the economy and higher activity in those sectors as well as improvements in our energy and leveraged loan portfolios. We continue to focus on segments of nonowner-occupied commercial real estate particularly central business district hotels as activity has not yet returned to pre-pandemic levels. Moving to the ACL.

Our base case macroeconomic scenario is relatively similar to last quarter, which assumes the labor market continues to improve, and job growth continues to strengthen, with unemployment reaching 4% in the first quarter of 2022 and ending our three-year reasonable and supportable period at around 3.5%. We did not change our scenario weights of 60% to the base and 20% to the upside and downside scenarios. However, our ACL release was lower this quarter as the improvement in the underlying economic forecast decelerated from the second quarter. Additionally, the ACL requirement in the downside scenario worsened compared to the second quarter due to a forecasted slower pace of recovery and a larger increase in unemployment.

If the ACL were based 100% on the downside scenario, the ACL would be $788 million higher. If the ACL were 100% weighted to the baseline scenario, the reserve would be $176 million lower. While the favorable economic backdrop and our base case expectations point to further improvement in the economy, there are several key risks factored into our downside scenario, which could play out given the uncertain environment. In addition to COVID, we continue to monitor the economic and lending implications of the supply chain and labor market constraints that currently exist.

Our September 30th allowance incorporates our best estimate to the economic environment with lower unemployment and continued improvement in credit quality. Moving to capital. Our capital levels remained strong in the third quarter. Our CET1 ratio ended the quarter at 9.8%.

During the quarter, we completed $550 million in share repurchases, which reduced our share count by 14.5 million shares compared to the second quarter. We also raised our common dividend $0.03 or 11% to $0.30 per share. Our capital plan supports approximately $300 million of share repurchases in the fourth quarter of 2021 and we continue to target a 9.5% CET1 by June 2022. Moving to our fourth-quarter outlook.

We expect average total loan balances to increase 2% sequentially, excluding the PPP headwind. Including the PPP impact, we expect average total loans to increase approximately 1%. Our outlook reflects 0.5 points of improvement from commercial revolving line utilization, continued strength in commercial production given our record pipeline, and continued stabilization in paydowns based on activity that we are seeing so far in October. We expect average C&I growth of four to 5%, excluding PPP in the fourth quarter, and CRE balances to decline around 1% or so, primarily due to construction constraints.

As a result, we anticipate total average commercial loan growth of around 3% sequentially, excluding PPP. We expect average total consumer loan balances to increase around 1% sequentially, including the impacts of Ginnie Mae forbearance pool purchases in our held-for-sale portfolio. We purchased 300 million during the third quarter, an additional 700 million in early October. Given our loan outlook, we expect NII to be down 1% sequentially in the fourth quarter, assuming stable securities balances and a $17 million reduction in PPP income.

Excluding PPP, we expect fourth-quarter NII to be up slightly relative to the third quarter. Our guidance indicates full-year 2021 NII declines less than 1% compared to full-year 2020 despite no meaningful growth in investment securities balances throughout the year and an average decline in one-month LIBOR of approximately 40 basis points. We expect NIM to decline three to four basis points in the fourth quarter, primarily due to loan yield compression. We expect fourth-quarter fees to increase around 6% compared to the third quarter and to be up around 8% on a year-over-year basis, excluding the impacts of the TRA.

This results in full-year 2021 fee growth, excluding the impacts of the TRA of approximately 10% compared to 2020. Our outlook assumes a continued healthy economy, resulting in a record full-year commercial banking revenue led by 20% growth in capital markets fees, record wealth and asset management revenue up double digits, and double-digit growth in card and processing revenue. We expect private equity income to be in the $40 million area in the fourth quarter. Our outlook assumes a sequential decline in top-line mortgage revenue of approximately 40%, with roughly half of that decline due to seasonally lower fourth-quarter volumes and declining spreads and half to our decision to retain 400 million in retail production that I mentioned earlier.

We expect fourth-quarter expenses to be stable to up 1% compared to the third quarter, reflecting continued growth in technology investments, servicing expenses associated with the Ginnie Mae loan purchases, and continued marketing support related to our rollout of momentum, offset by disciplined expense management throughout the company and initial savings beginning from our process automation program. As a result, our full-year 2021 total core revenue growth is expected to exceed the growth in core expenses despite the rate environment. We will have achieved positive operating leverage in a year in which the vast majority of the industry will likely experience an erosion inefficiency. We expect total net charge-offs in the fourth quarter to be in the 10 to 15 basis points range, which would result in full-year 2021 charge-offs of 15 basis points or so.

In summary, our third-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. We will continue to remain the same principles of disciplined client selection, conservative underwriting, and a focus on a long-term performance horizon, which has served us well during this environment. With that, let me turn it over to Chris to open the call up for Q&A.

Chris Doll -- Director of Investor Relations

Thanks, Jamie. [Operator instructions] Operator, please open the call for questions.

Questions & Answers:

Operator

[Operator instructions] Your first question comes from the line of Scott Siefers with Piper Sandler.

Scott Siefers -- PIper Sandler -- Analyst

Morning, guys.

Greg Carmichael -- Chief Executive Officer

Good morning.

Scott Siefers -- PIper Sandler -- Analyst

Hey. I just wanted to ask a couple of questions on loan growth, which looks like it's coming back nicely. First, I was hoping you could talk about any differences you're seeing in demand between your larger and smaller customers. Jamie, I think you had mentioned that production sounded pretty strong in both corporate and middle market.

So any additional color there? And then second, I was just wondering if you could speak to the dynamics you're seeing in terms of both pricing and structure, just in other words, changes to the competitive environment.

Greg Carmichael -- Chief Executive Officer

Yes. This is Greg. Let me start off, and then I'll flip it over to Tim, and maybe Jamie. First off, we're very encouraged what we're seeing from a production perspective.

We've got commercial production in the third quarter. '21 was strong at 5.4 billion. That was up from 5.1 billion in the second quarter and 5.2 billion in the third-quarter 2019. We expect that production to continue to be stable going into the fourth quarter, so that's encouraging.

We expect average loans up 1% with PPP and 2% up without PPP assets. So that's some strength there. We're also seeing line utilization tick up a little bit more in our core middle market, which is nice to see that for change. So when you think about our geographies, what we're seeing right now from a geography perspective, North Carolina, Texas, Cincinnati, Columbus were our top four markets from commercial loan growth in Q3, which is encouraging.

If you look at six regions that had all-time highs, which we're very encouraged with Chicago, Green Rapids, Columbus, Kentucky, North Carolina, and Texas. So that felt really good, and we're starting to see once again, some good momentum out there. Net new relationships, something we watch very carefully brought in 419 new commercial relationships year to date. Most of that was in core middle market and some of that in March quarter.

But net-net, we're seeing good progress out there, good performance. Encouraged by what we're seeing to date as we go into the fourth quarter and then into 2022.

Tim Spence -- President

Yes. Just to add a few points to what Greg mentioned. So I had the chance to be out in eight of our 14 regions this past quarter. I think you get really excellent color when you have an opportunity to sit with clients and with bankers.

I mean they're all feeling the shortages as it relates to labor and supply chain. We have hotel operators who are now only cleaning rooms when people leave. As an example, I visited an electronics client out West and asked to see their demo room, and there was nothing but holes in the walls where is the equipment and they had sold all the inventory because they are struggling to get the parts in to be able to fill orders. So all those issues are still real.

I think the good news is we are seeing M&A as a catalyst. We're seeing capex now as a catalyst, in particular, for businesses that are able to substitute equipment and automation for manual processes. And then bluntly, as Greg mentioned, I think we feel pretty confident that a lot of the improvement we're seeing is just coming from taking share. I mean the relationship count Greg mentioned be higher than where we were at prior to the pandemic.

So we'll have taken more new relationships on board this year through nine months than we had in all of 2018 or 2019 just as an example. So the good general pickup there. It would be great to continue to see a little bit more activity as it relates to utilization as folks try to build inventories and otherwise, it's just -- that's going to be the wildcard for us.

Greg Carmichael -- Chief Executive Officer

Jim to add one more thing. Scott, also, if you look at our verticals, which I should have mentioned is, our largest production in the areas we're seeing a larger strengthen right now is technology, media, telecom, our retailers, financial institutions are all going well. So we're seeing some good momentum in those spaces.

Jamie Leonard -- Chief Financial Officer

And then, Scott, to answer the second part of your question, in terms of the segments, I think Greg and Tim did a nice summary there. What we're seeing from a line utilization perspective is that the middle market line utilization is up almost 1%, whereas corporate banking continues to trend down. So quarter over quarter, that utilization was stable. And if we want to go into the decimals, it was 31.3 at the end of June, and it's 31.1 as we sit here on September 30th, but we are starting to see more borrowing demand and pickup in the middle market space as opposed to the corporate banking.

And then in terms of pricing, while NIM came in as expected in line with our July guide, we do have the headwind in the C&I yield portfolio because it is very competitive out there. I think, for the most part, banks are competing on price and nonbanks are competing on structure. So for us, the price headwind comes in just a little bit tighter spread, but also some of the reduction in the LIBOR floor. So you lose some of that excess earnings in this environment, but you can perhaps recapture the yield benefit as the Fed starts to move on the front end of the curve, hopefully in the next year to 18 months.

So as expected, but certainly, a headwind when it comes to pricing.

Scott Siefers -- PIper Sandler -- Analyst

Yup. OK, good. Thank you very much for all the color

Operator

Your next question comes from the line of Peter Winter with Wedbush Securities.

Peter Winter -- Wedbush Securities -- Analyst

Good morning. You guys have done a phenomenal job on the securities yield with the rate locks on the cash flows in the bullets. I'm wondering is this type of securities yield sustainable into next year with the rate locks continuing?

Jamie Leonard -- Chief Financial Officer

Yeah. I would say, Peter, it's -- we're inoculated from the rate environment, but we're not immune to it. So it's -- as you saw in the numbers this quarter and as we look out even next quarter, it is a steady grind down as we reinvest the cash flows. So that hurts the yield a bit, 10, 15 basis points or so.

If you look out on the bullets themselves, they're at a 265 yield with cash flows, I think we're projecting about 7 billion of cash flows in that portfolio over the next five years. So there will be a step down should rates stay where they are today. Reinvestment yields right now, I think, are in the 170 to 180 range. So barring a curve steepened, it will be a slow, but definitely downward trend on the portfolio yield.

The good news for us is we're very well-positioned, and it is pretty insulated from the environment relative to how the peers have positioned their portfolio.

Peter Winter -- Wedbush Securities -- Analyst

OK. And if I could just follow up on expenses. You've had the benefit of those expense initiatives this year, which clearly benefited when looking at the fee income growth relative to the expense growth. Can you just talk about some of the expense saves opportunities going forward as we go into next year? Or has a lot of the low-hanging fruit been realized? And if you could also talk about any inflation pressures looking into next year?

Jamie Leonard -- Chief Financial Officer

Sure. Thanks for the question. The one update we have on expense savings in our program for 2022 is that we are targeting $125 million in savings for 2022, and that's a combination of the lean process automation, intelligent operations, the branch closures. We have 42 branches closing in the first quarter of 2022 and then some smaller vendor savings bundled together.

So we've tightened the range on that bundle of savings from 100 to 150 million to 125. And then obviously, we're not getting into expense guide for 2022 because we'll continue to evaluate how much of those savings will be reinvested into sales force expansion on commercial as well as the wealth and asset management. But we feel good about the progress we're making on the LPA program. In fact, if you look in the press release, buried, I think, at the bottom of Page 14 is an FTE count, and we're down a couple of hundred FTE even with adding about 100 from the Provide acquisition, and that's starting to show the benefit of that LPA savings.

So we've made progress. We've had some success. There's about 6 million of savings in our fourth-quarter forecast tied into that program, but then the 125 million for next year.

Tim Spence -- President

The headcount there doesn't even reflect the benefit from the offshore, right? The automation savings on offshore processes that were completed by JV partners, where we're, I think, north of 20% at this point of the processes that we're offshore now fully automated.

Jamie Leonard -- Chief Financial Officer

And from the other part of your question on inflation, in terms of wage inflation and other things, we've been able to manage through the environment from an employee and cost structure and still deliver fairly stable expenses this quarter. We continue to see opportunity to do the same while there is the wage inflation and other pressure. We do have those other opportunities ahead of us. And so perhaps some of the $125 million would be absorbed by some inflationary pressure.

But ultimately, a moderate amount of inflation would ultimately be very positive for the bank in terms of PPNR and interest income capabilities.

Peter Winter -- Wedbush Securities -- Analyst

That's great. Thanks, Jamie.

Operator

Your next question comes from the line of Gerard Cassidy with RBC.

Gerard Cassidy -- RBC Capital Markets -- Analyst

Good morning, everyone.

Greg Carmichael -- Chief Executive Officer

Good morning, Gerard.

Jamie Leonard -- Chief Financial Officer

Good morning.

Gerard Cassidy -- RBC Capital Markets -- Analyst

Greg, when you look at your CET1 ratio, you're targeted to bring it down to 9.5% in June of next year. It looks like if I recall correctly, your required number is 7% by Feds. What would it take for you guys to bring it down from 9.5% to something lower? Or is it now the 9.5% in down and you're just not going to budge off on that?

Greg Carmichael -- Chief Executive Officer

Well, there's nothing set in stone, Gerard. But at the end of the day, we think that's a prudent place to be. It's multifaceted as we think about that level. We -- obviously, we believe we could run the bank at a much lower level but also we watch where the market is going, the environment we're operating in, I think that's a proven target point to shoot for at this point.

Gerard Cassidy -- RBC Capital Markets -- Analyst

Very good. And then maybe, Richard, we could talk about credit quality. Obviously, your numbers similar to some of your peers are quite strong, particularly in the net charge-off area. And I suspect that this is unusually good and it's not sustainable just due to normal seasoning in portfolios.

How long do you think you guys could see net charge-offs stay at this extremely low level? And when do you think that they start creeping up to a more normal level? I know normal is hard to define but when do they start to creep up?

Richard Stein -- Chief Credit Officer

Yes. Gerard, thanks for the question. Clearly, we're pleased with the eight basis points this quarter. And like you said, we don't think that's going to repeat.

But given the economic outlook, we do expect charge-offs to be better than our through-the-cycle average and probably certainly into '22 and into '23 for a couple of reasons. One, it's going to be simply the amount of liquidity that's out there. Two, inflation, collateral values continue to be strong. And when we run our mid-cycle stress test, we're seeing 25 to 35 basis points as a charge-off range for the bank through '22 and '23.

Now that -- as I said, it's a little bit lower than what we think the long-term average is. If you recall, we think through-the-cycle average is somewhere between 35 and 45 basis points. But given our approach, given the way we manage the balance sheet, the way we think about client selection and underwriting, we think it's a grind through '22 and '23 back to something that feels a little bit more normal.

Gerard Cassidy -- RBC Capital Markets -- Analyst

Great. Appreciate it. Thank you.

Operator

Your next question comes from the line of Ken Usdin with Jefferies..

Ken Usdin -- Jefferies -- Analyst

Hi. Thanks. Good morning. Hey, Jim, I just wondering if you could elaborate a little bit more on the portfolio structure.

So when you talk about the 7 billion that's kind of going to run off over the next several years, how high are the on that part of the book? And when you're reinvesting the cash flows to keep the book flat, are you also buying back some new type of bullet structures? Or are you just more investing in kind of plain vanilla today?

Jamie Leonard -- Chief Financial Officer

So we've been buying a little bit of everything when we're reinvesting. The portfolio of cash flows have been running about 1.5 billion a quarter, second quarter, third quarter. So depending on the day, we've added some Level ones, we've added some Level twos. But in total, the mix hasn't really changed a whole lot.

And then in terms of the bullets, over the next couple of years, it's a very small number in terms of total cash flow, maybe a couple of hundred million. And then over years three, four, five, then you start to have cash flow portfolio. But right now, the total book -- bullets as well as the cash flowing securities, we're in a 275 yield, give or take. And then for the fourth quarter, yield should be a little bit better than that with a little bit of seasonal mutual fund dividends in the plus a little bit of prepayment penalties that have occurred thus far in October.

Ken Usdin -- Jefferies -- Analyst

OK. Got it. Thank you. And just a follow-up.

You guys have been really taking down the long-term debt footprint, which is still even a size the majority of your interest-bearing liability costs. Just wonder where is the level of bucking that you need to keep it at? And what's the trade-off versus the deposit base, the mix of deposits, and how much more could you potentially return -- reduce that footprint? Thanks.

Jamie Leonard -- Chief Financial Officer

Yes. We're probably at the low point in terms of the long-term Fed outstanding. We had a maturity in September, 850 million that we'll perhaps look to replenish in the next quarter or two. But I think we're at a good spot and we're well-positioned.

We've been able to utilize the excess liquidity and take advantage of the environment to deliver some savings from a cost standpoint, both from long-term debt as well as running off some of the CD book that certainly behaves more like wholesale funding than the core deposit book. So I think we're in a good spot, and we've probably reached the end of the line on the long-term debt but probably have a little bit more room on the CD book to run it down a little bit more.

Ken Usdin -- Jefferies -- Analyst

OK. Got it. Thank you.

Operator

Your next question comes from the line of John Pancari with Evercore.

John Pancari -- Evercore ISI -- Analyst

Good morning.

Greg Carmichael -- Chief Executive Officer

Good morning.

John Pancari -- Evercore ISI -- Analyst

Greg, you mentioned some key talent hires that should help drive loan production into 2022. Can you provide a little bit of color on the areas where you're hiring, particularly within the lending areas? And if that hiring is continuing? Thanks.

Greg Carmichael -- Chief Executive Officer

Absolutely. Thanks for the question. Obviously, the Southeast markets, we've been adding to our management bankers in that market with a lot of success there. So we're really putting the production we're seeing in that market.

So we'll continue to add in that market. There's great opportunities. We run a good franchise down there, and that's obviously a focal point for our expansion. In addition to that, I would say Texas, the West Coast, California, the talent we've been able to acquire in those markets, the bankers that we brought on significant increases in bankers in those markets over the last two, three years, and we're seeing great progress from a production perspective, outstanding perspective.

So like those are the strategies. We watch them very carefully. We invest where we see opportunities in those areas continue to be great opportunities for us. More to come.

So let me just start over to Tim to see if he has any color he wants to add to that.

Tim Spence -- President

Yeah. I think a couple of other Greg hit the geographic points. We also are in the process of building out a mortgage warehouse vertical. That's a good business for us.

It's a business we've been in historically, but it hasn't been a point of focus, and we saw an opportunity there with some talent to go out and take some market share. So I think that's an area we continue to add to the renewables theme and are focused on how we expand what is already, I think, a pretty strong capability there and a good track record. And then we were pleased to be able to land some really important talent in to Provide post the Provide acquisition and now have now formally launched the Vet vertical there for veterinarians, which I think it's going to be a really good source of growth to complement the strength we already had in medical dental in that business line.

John Pancari -- Evercore ISI -- Analyst

Got it. All right. Thank you. And then secondly, if you could just update us on where you stand on core system upgrade? Can you maybe remind us of the timing of the project and the cost that you see tied to it? And then separately, do you see any risk to the cost that you had budgeted for the upgrade given the wage inflation dynamics? Thanks.

Greg Carmichael -- Chief Executive Officer

First off, our tech budget, just me take that first, is about $700 million. That's been growing about 10% per year for the last five years. When you think about our core platforms, we talked about the modernization effort that's been going on for a couple of years. You saw that with our mortgage loan origination system, the resiliency platforms we put in place, the data architecture strategy that we rolled out, next coming up is obviously FIS core deposits.

We're in a midst right now turning on Ensino. That's going extremely well and something we're very pleased with. So this is an ongoing effort. If you ask me if it was a baseball analogy, we're probably in mid-innings here.

But it's a long game, and we'll continue to invest prudently. In addition to that, when you think about our tech spend, a lot of that tech spend is focused on being able to take cost out. So lean process, automation has been a great focus of our business in an area where we've made a lot of progress in. So we'll continue to invest for those opportunities.

We'll continue to stay focused on core platform replacement. Our partnership with FIS, the fact that we're the largest processing customer. If you think about how we think about that business and the integration what we've done with our core platforms, we'll be able to manage costs very efficiently and effectively through that exercise. So we're very comfortable with what we think the new operating environment will look like from a cost perspective.

But if you think about our tech spend, how we think about our business, it's really 50% of keeping the business running so to speak, 35% of advancing the business, and then 15% protecting the business.

Tim Spence -- President

Yes, John. It's Tim. One just small point to add to that, and it came up earlier. There was a question about inflation and wages.

Jamie said earlier, we were immune but not inoculated on a different point -- I'm sorry, inoculated but not immune on a different point. And here again, we raised our minimum wage to $18 an hour in 2019. I think we were the first to the regional banks, certainly of our peer group to have made that move. And the byproduct of that is we are watching as I'm sure you are, the announcements coming out of many of our peers that they're raising their minimum wage, but they're getting to $18 an hour in nearly all cases, which is where Fifth Third is already at.

The byproduct to that is a lot of that near-term impact is kind of in our run rate.

John Pancari -- Evercore ISI -- Analyst

Got it. All right. Thanks for taking my question.

Operator

Your next question comes from the line of Bill Carcache with Wolfe Research.

Bill Carcache -- Wolfe Research -- Analyst

Thanks. Good morning. I wanted to follow up on your net charge-off rate commentary. As you think about the normalization of your NCO rates off these low levels to the 25, 35 basis points in '22, '23 that you mentioned, is the level of your reserve rate currently high enough such that the trajectory is also likely to be flat to down even as NCO rates normalize higher? Any color that you can give on that dynamic would be helpful.

Jamie Leonard -- Chief Financial Officer

Yeah. I think it's a little tough to take a life of loan expected loss rate of the ACL and compare it to short-term forecast because the loan maturities certainly are a swing factor in that. So obviously, we're comfortable with our ACL at 200 basis points. It's 204 basis points excluding PPP.

So yes, I'm comfortable that the ACL is adequate to cover the expected losses over the life of the loans. And then when Richard is talking about those periodic charge-off levels for a point in time and with a fairly shorter duration portfolio throwing off some of those losses in the consumer side, card, and auto, I think we're in a good spot.

Bill Carcache -- Wolfe Research -- Analyst

Very helpful. Thank you. And then following up on the utilization commentary, to the extent that supply chain problems were to extend further into next year, how much do you think that weighs on -- just given the makeup of your client base, how much would that sort of weigh on the normalization of utilization rates versus the potential for those utilization rates to continue to improve even if those supply chain problems were it takes tend a bit longer?

Jamie Leonard -- Chief Financial Officer

Yeah. I think we're seeing stable line utilization because of those supply chain constraints. So hopefully, the worst-case scenario would be stable. As we talked about in our guide, we expect a little bit of an uptick, both from a seasonal and year-end positioning with our customers of about 0.5%.

So we've reduced our outlook on utilization because of the supply chain and labor constraints. From a next year perspective, hopefully, they get resolved and we'll start to see inventory builds and that should provide a little bit of a tailwind to our loan growth expectations.

Bill Carcache -- Wolfe Research -- Analyst

Got it. Thank you for taking my questions.

Operator

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

Matt O'Connor -- Deutsche Bank -- Analyst

Good morning.

Greg Carmichael -- Chief Executive Officer

Good morning.

Matt O'Connor -- Deutsche Bank -- Analyst

I was wondering if you could dig a little bit more into some of the loan yield pressure that you were talking about earlier? And if you kind of just hold rates constant, when does that eventually flatten out?

Jamie Leonard -- Chief Financial Officer

Yeah, Matt, it's -- for our quarter, if you look in the tables and you look at the gross yield decline 2Q to 3Q, it's really driven by three factors. One, 2Q had elevated prepayment loan fees that get recorded in the NII. So 2Q was high. So that was a portion you have regular repricing front book, back book phenomenon, and that's -- I would characterize it as three basis points or so of NIM from that.

And I expect that should continue into the fourth quarter. And then the other phenomenon on the LIBOR floor is more a consequence of getting through renewal season and some of the other things happening out of the second quarter. So that should dissipate, but that was call it, third half of that yield compression you see in the tables in the earnings release. So as we look ahead, I would expect a couple of -- two to three bps headwind from C&I loan yield compression for all of those factors into the fourth quarter, and that's why we're guiding the reported NIM down as well.

the fourth quarter, similar to what we saw in the third quarter.

Matt O'Connor -- Deutsche Bank -- Analyst

And then I guess beyond 4Q, I mean, is there still a salmon pricing between the back book and the front book and all that, or are you getting close to -- sorry, go ahead.

Jamie Leonard -- Chief Financial Officer

No. Thanks for the question. I think from a front book, back book perspective, it's -- the tailwind of the curve steepening we've seen in the third quarter, and should that continue, we'll hit that intersection. But in until we get a little more left, you do have the repricing effect continuing where new loans are coming on at lower yields than the runoff and pay downs in the back book.

I think on top of that, we have done a nice job managing NII and the balance sheet through this environment. And we certainly have dry powder, whether it's through the asset sensitivity or the 33 billion of excess cash that we could choose to deploy to mitigate those effects if need be. But for now, we still think patient is still the way to go. And therefore, if there's a little bit of NIM compression along the way, that's fine.

Our focus is more on the long term and delivering the best performance we can over the next five years.

Matt O'Connor -- Deutsche Bank -- Analyst

OK. Thank you.

Operator

Your next question comes from the line of Mike Mayo with Wells Fargo.

Mike Mayo -- Wells Fargo Securities -- Analyst

Hi. Well, you mentioned positive operating leverage in 2021 even while we spent 10% more on tech and that you're in kind of the fourth or fifth inning of your tech transformation. So I guess the question is, do you intend to continue to spend around 10% more on tech each year? And how is that changing, especially as you move off-premise as much as you are, is there going to be a period where you have to run somewhat parallel systems, and then you'll get the benefit in a few years out? And more generally, how do you think about the number of tech partners that you have? And if you can quantify the number, I'll take that, too.

Greg Carmichael -- Chief Executive Officer

Yeah. And Mike, this is Greg. Listen, I think 10% is probably the right number for us, not cast in stone. As you mentioned, operating leverage -- positive operating leverage, that's something we're very focused on.

We delivered -- we'll deliver in 2021 as we go into our planning process for 2022, our focus is on positive operating leverage. So as I mentioned earlier, a lot of that -- some of that tech spend is going right to process efficiencies. We were able to take out the 200-plus additional people and so forth, branch closes some of the things that we're working on right now. And on the other expense side of the house supports that positive operating leverage.

And we continue to grow fees at a really robust rate, close to 10% CAGR over the last couple of years. So net-net, positive operating leverage is something we're very focused on. We believe we can continue to deliver on. In addition to that, the tech spend will roughly run around 10-plus percent.

When you think about the core platform modernization, we talked about the fourth or fifth inning. I think of it more as a cricket test batch. It's been going on. It's going to continue to go on for quite some time.

We're going to have to deal with that. But at the end of the day, I think as we put these new platforms in, we're able to do in a very systematic way with respect to how we turn these platforms on. So it's not the big bang approach. We're able to turn it on by geography, by product line.

So we're very insulated for having to do a big bang impact. With that said, you have some dual system platforms that are going to run simultaneously until we get all markets, all products converted over in the case of some of our major implementations coming up like our core deposit platform. So that's going to take a little bit of time. But at the end of the day, we should be a lot more efficient.

We should be able to bring further -- more enhancements at a different case forward to our business. We should be able to continue to take out costs through our lean process automation and our investments in AI technology. So net-net, tech is going to be a source of spend for us in that range that I mentioned before as we go forward. But then nothing we're getting paid very well for it.

Our objective is to go head-to-head with the fintech players, the large bank competitors that we have to deal with, and be very successful. And we've been able to do that and demonstrate that. When you think about the fintech players that are out there, we've got the same capabilities. We've got our products like Momentum, but we also got 53,000 free ATMs, 1,100 banking centers, and 10,000 service personnel that they don't have, and we got the core relationships.

So net-net, we'll continue to stay focused, but that's kind of the range of what we're going to operate in.

Mike Mayo -- Wells Fargo Securities -- Analyst

That's helpful. Just one more follow-up. Just one simple thought. I mean there's a debate of how much banks should keep on-premise versus off-premise.

Clearly, you're going more in the off-premise direction, and it seems like you're accelerating that. What was the tipping point? What was the biggest factor to say, "You know what, we want to have more of the open architecture of the off-premise even though some other banks are saying we want to keep a lot of foreign profits."

Greg Carmichael -- Chief Executive Officer

I think we intend to transition basically just had 90% on-premise. And you think about that for the next five years as we look at this, but it's going to shift. As you mentioned before, so 90% on-premise is going to shift to roughly 90% off-premise. And 70% of that will be hosted in a private cloud.

When you think about platforms like FIS and [Inaudible] going to be private clouds, and the public cloud, AWS, about 20%. So you think about the shift, 90% will be an off-premise model, and roughly 70% private, 20% public.

Mike Mayo -- Wells Fargo Securities -- Analyst

All right. Thank you.

Operator

Your next question comes from the line of David Konrad with KBW.

David Konrad -- KBW -- Analyst

Hey. I was hoping you could help us out with if there's any constraint limitations on the balance sheet? Meaning as we look at our earnings models over the next couple of years and redeploy a lot of the excess liquidity. Just wondering, some of your peers has mentioned, maybe 30% of our assets would be the limit of securities regardless of rate. So just wondering if you thought about a constraint on the securities book? And then also embedded in the securities book, the CMBS portfolio has kind of crept up.

Now it's just under 60% of the available for sale. Didn't know if there -- it's all agency or predominantly agency, but didn't know if there's a concentration limit that you have on that portfolio as well. Thank you.

Jamie Leonard -- Chief Financial Officer

Yeah. Thanks for the question, David. The short answer is that when we look at the excess liquidity, call it, 30 billion, we expect a third of it to go into the securities portfolio, a third of it into loans, a third of it, we think, while deposits in the banking system may not decline, we do expect those deposits to find a more productive home, perhaps money market funds, or other investment vehicles. So for us, we're running at 18% or so in the securities book as a percent of total assets.

So if we take, call it, 10 billion of the excess liquidity and put it into the book, we're at 23, 24%. That's where I'd like to operate at somewhere 23 to 25% of total assets, but it's not a capacity constraint, it's more, I think, given the environment, that's a more productive place to be. In terms of the CMBS, I think the heart of your question is asked what is the non-agency CMBS portion of the portfolio, and that's 3.8 billion or so. And again, for us, it's super senior tranches.

We feel very good about the credit enhancement, 30-plus percent there. So not a large credit risk position to have, whereas the rest of the CMBS, that book would be agency guaranteed.

David Konrad -- KBW -- Analyst

OK. Thank you.

Operator

At this time, there are no further questions. I would like to turn the floor back to management for any additional or closing remarks.

Chris Doll -- Director of Investor Relations

Thank you, Angie, and thank you all for your interest in Fifth Third. Please contact the Investor Relations department if you have any further questions.

Operator

[Operator signoff]

Duration: 57 minutes

Call participants:

Chris Doll -- Director of Investor Relations

Greg Carmichael -- Chief Executive Officer

Jamie Leonard -- Chief Financial Officer

Scott Siefers -- PIper Sandler -- Analyst

Tim Spence -- President

Peter Winter -- Wedbush Securities -- Analyst

Gerard Cassidy -- RBC Capital Markets -- Analyst

Richard Stein -- Chief Credit Officer

Ken Usdin -- Jefferies -- Analyst

John Pancari -- Evercore ISI -- Analyst

Bill Carcache -- Wolfe Research -- Analyst

Matt O'Connor -- Deutsche Bank -- Analyst

Mike Mayo -- Wells Fargo Securities -- Analyst

David Konrad -- KBW -- Analyst

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