Q3 2023 Fifth Third Bancorp Earnings Call
Participants
Bryan Preston; Senior VP & Treasurer; Fifth Third Bancorp
Christopher Doll; Director of IR; Fifth Third Bancorp
Greg Schroeck
James C. Leonard; Executive VP & CFO; Fifth Third Bancorp
Timothy N. Spence; CEO, President & Director; Fifth Third Bancorp
Christopher William Marinac; Director of Research and Banks & Thrifts Analyst; Janney Montgomery Scott LLC, Research Division
Ebrahim Huseini Poonawala; MD of United States Equity Research & Head of North American Banks Research; BofA Securities, Research Division
Erika Najarian; Analyst; UBS Investment Bank, Research Division
Gerard Sean Cassidy; MD, Head of U.S. Bank Equity Strategy & Large Cap Bank Analyst; RBC Capital Markets, Research Division
John G. Pancari; Senior MD & Senior Equity Research Analyst; Evercore ISI Institutional Equities, Research Division
Kenneth Michael Usdin; MD and Senior Equity Research Analyst; Jefferies LLC, Research Division
Manan Gosalia; Equity Analyst; Morgan Stanley, Research Division
Michael Lawrence Mayo; MD, Head of U.S. Large-Cap Bank Research & Senior bank Analyst; Wells Fargo Securities, LLC, Research Division
Robert Scott Siefers; MD & Senior Research Analyst; Piper Sandler & Co., Research Division
Presentation
Operator
Good morning. My name is Rob, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Fifth Third Bancorp Third Quarter 2023 Earnings Conference Call. (Operator Instructions)
Chris Doll, Head of Investor Relations. You may begin your conference.
Christopher Doll
Good morning, everyone. Welcome to Fifth Third's Third Quarter 2023 Earnings Call. This morning, our President and CEO, Tim Spence; and CFO, Jamie Leonard, will provide an overview of our third quarter results and outlook. Our Treasurer, Bryan Preston and Chief Credit Officer, Greg Schroeck, also joined us for the Q&A portion of the call. Please review the cautionary statements on our materials, which can be found in our earnings release and presentation. These materials contain information regarding the use of non-GAAP measures and reconciliations to the GAAP results as well as forward-looking statements about Fifth Third's performance. These statements speak only as of October 19, 2023 and Fifth Third undertakes no obligation to update them. Following the prepared remarks by Tim and Jamie, we will open the call up for questions. With that, let me turn it over to Tim.
Timothy N. Spence
Thanks, Chris, and good morning, everyone. We believe that great banks distinguish themselves, not by how they perform in benign environments or rather by how they navigate challenging ones. That is why we focus on stability, profitability and growth in that order. It's also why I am so pleased that our key return and profitability metrics remain resilient despite the market-related headwinds that all banks are facing.
Earlier today, we reported earnings per share of $0.91 or $0.92 excluding a $0.01 impact from our Visa swap, reflecting strong PPNR results and favorable credit outcomes. We generated an adjusted return on tangible common equity ex AOCI of nearly 16%, which increased 50 basis points sequentially and a return on assets of 1.26%. We generated strong fee growth compared to the year ago quarter, supported by a more diverse range of fee income streams than peers and our investments in treasury management, capital markets and wealth management.
Our third quarter total noninterest expense increased less than 2% compared to the year ago quarter, and we generated an adjusted efficiency ratio below 55%. In the last 4 years, we have managed expenses to the lowest growth rate among peers despite also investing in growth by building more new branches, raising our minimum wage, modernizing our technology platforms and acquiring 4 fintech companies. Expense management at Fifth Third is a continuous process and not a program. Since March of this year, full-time equivalent employee head count is down 3.5%.
Turning to the balance sheet. We generated 4% average deposit growth compared to the year ago quarter versus a 5% decline for the industry. New relationship growth remains strong. Consumer households grew more than 2%, led by 6% growth in the Southeast, a continuation of our multiyear growth base. New middle market relationships added year-to-date remain 25% ahead of last year's record base. Thanks to the release of the annual FDIC summary of deposits, the third quarter provides a unique opportunity to understand market share gains and losses on a metro area by metro area basis. This year, Fifth Third maintained or improved our market rank in every single one of our 40 largest MSAs.
In the Midwest, we maintained our #2 overall position behind JPMorgan Chase. In the Southeast, where we are just 4 years removed for opening our first next-gen branch, we have reached or are approaching target locational share in 8 of our original 11 focused markets. We intend to continue to open approximately 35 branches per year through 2028, at which time nearly 50% of our branches will be in Southeast markets. These market share gains are the byproduct of multiyear strategies that are not easily replicable by competitors. They include innovative operational deposit-oriented products like Momentum Banking, AI-driven customer acquisition strategies and the top quartile customer service model in addition to our investments in new branches.
Our key credit metrics remained strong during the quarter. Charge-offs were in line with our July expectations in both early-stage delinquencies and nonperforming assets improved sequentially. The ACL increased 3 basis points given slight changes to Moody's macroeconomic forecast.
Turning to liquidity and capital. We made significant progress against our goal to adapt early to expected changes in the regulatory framework. Our focused efforts throughout the bank enabled us to end the quarter with $103 billion in total liquidity sources and to achieve full Category 1 LCR compliance at the end of both August and September. During the quarter, we also made significant progress on our RWA optimization initiative. Total RWA declined 1% compared to the prior quarter. Our exercise should be complete by the end of the fourth quarter, so we can return to growing loans next year.
We created over 30 basis points of CET1 capital during the quarter, reflecting our strong earnings power while we also raised our quarterly dividend by 6%. With respect to the economy, while aggregate figures on spending and employment remains strong and market sentiment has shifted more in favor of a soft landing. We continue to be more cautious given concerning signals disguised beneath the aggregates. For example, while the most recent headline payroll numbers were strong, most, if not all, the job growth is a byproduct of more people working part-time jobs. Real average weekly earnings slipped every month during the quarter and the lower end of the consumer spectrum now maintains deposit balances below pre-COVID levels. Anecdotally, the last time Google searches for soft landing was this high was in May of 2008.
Before I turn it over, I want to say thank you to our employees for everything you do to take care of our customers, strengthen our communities and support one another. Your efforts are why Time Magazine recently recognized Fifth Third as one of the world's best companies, and why I am as confident as ever in Fifth Third's ability to outperform through the cycle and to deliver innovations that improve lives for all our stakeholders.
With that, Jamie will provide more details on our third quarter financial results and outlook.
James C. Leonard
Thank you, Tim, and thanks all of you for joining us today. Our third quarter results were once again strong despite the market headwinds. We continue to strengthen our capital and liquidity levels ahead of pending regulations while also managing our business very efficiently. We achieved an adjusted efficiency ratio below 55%, reflecting ongoing expense discipline throughout the bank and the continued diversification and resilience of our fee revenue streams.
Net interest income of approximately $1.45 billion decreased 1% sequentially. Our NII and NIM results reflect our proactive and continued defensive positioning given the uncertain economic and regulatory environments. Our short-term investments, which primarily represent our cash held at the Fed increased $5 billion on an average basis and increased $8 billion on an end-of-period basis to $19 billion. This increased level of cash was the primary driver of our 12 basis point NIM decline.
Adjusted noninterest income increased 1% compared to the year ago quarter, driven by growth in capital markets and deposit service charge revenue, partially offset by a decrease in mortgage revenue driven primarily by lower origination volumes. Our ability to produce strong capital markets revenue in a volatile market has become a key distinction for Fifth Third compared to many peers.
Adjusted noninterest expense increased just 2% compared to the year ago quarter, reflecting growth in compensation and benefits, occupancy and technology expenses partially offset by continued expense discipline across the company.
Moving to the balance sheet. Total average portfolio loans and leases decreased 1% sequentially due to softening customer demand and our RWA optimization efforts. Average C&I balances decreased 2% sequentially. As Tim mentioned, clients remain cautious with respect to their growth plans. Consequently, production was muted in corporate banking. Also, average CRE balances decreased 1% compared to the prior quarter. The period-end commercial revolver utilization rate of 36% increased 1% compared to last quarter, partially due to our exit of certain lower returning unused commercial commitments.
On a sequential basis, total corporate banking commitments and unused commitments decreased 3% and 4%, respectively, while total middle market commitments and unused commitments increased 5% and 7%, respectively. This trend highlights our capital optimization efforts while we continue to grow share in the middle market. Average total consumer portfolio loan and lease balances decreased 1% sequentially due to our intentional decline in indirect auto and the overall slowdown in residential mortgage originations, given the rate environment, partially offset by growth from dividend finance.
Our card balances increased just 1% this quarter, reflecting our conservative risk culture and focus on transactors. Balances have increased 3% relative to the year ago quarter compared to 11% for the industry. Average total deposits increased 3% sequentially as increases in CDs and interest checking balances were partially offset by a decline in demand deposits given the mix shift we have seen for several quarters. DDAs as a percent of core deposits were 28% for the quarter compared to 30% in the prior quarter. The 2-point decline was primarily due to the strong deposit growth in the denominator that Tim highlighted from our net new relationship growth in both Consumer and Commercial, which are obviously skewed to interest-bearing products in this environment.
As a result, we added more than $4 billion in core deposits during the quarter, the most since the fourth quarter of 2021. Additionally, the DDA migration continued to show signs of deceleration this quarter and marked the smallest dollar decline in DDA balances since the onset of the rate hiking cycle. By segment, average consumer deposits increased 2% sequentially, and commercial deposits increased 4%, while wealth and asset management deposits declined 2% reflecting clients' alternative investment options.
As a result of our balance sheet positioning and success adding new deposits, we achieved a loan to core deposit ratio of 74% at quarter end, which should be one of the best, if not the best, compared to our regional peers. We also achieved full Category 1 LCR compliance at 118% at quarter end.
Moving to credit. As Tim mentioned, credit has remained resilient. The net charge-off ratio of 41 basis points increased 12 basis points compared to the prior quarter as we expected, reflecting 2 credits, which had been fully reserved. Early stage delinquencies decreased 7% compared to the prior quarter, while loans 90 days past due, of just 2 basis points or a record low for Fifth Third.
Nonperforming loans decreased 9%. This quarter marked the lowest inflows of commercial NPLs since the second quarter of 2022. From an overall credit management perspective, we have continually improved the granularity and diversification of our loan portfolios through a focus on generating and maintaining high-quality relationships. As many of you know, we tightened underwriting standards during COVID, which limited our growth but improved the stability of our balance sheet.
In Consumer, we have focused on lending to homeowners, which is a segment less impacted by inflationary pressures and have maintained conservative underwriting policies. In Commercial, we have maintained the lowest overall CRE concentration as a percent of total loans relative to peers for many years. Our criticized nonperforming and delinquent CRE loans have all improved sequentially and remain very well behaved.
And within that, the same is true for our office exposures. For instance, criticized office loans represented just 5.4% of total office CRE, which improved 180 basis points sequentially. Additionally, we have 0 delinquencies and 0 charge-offs. We also decreased loan balances by 8% in the office book without any loan sales. These credit quality metrics are significantly better than peers who have reported their office exposure so far this quarter. While credit quality in the office portfolio has remained very strong, and we continue to believe the overall impact on Fifth Third will be limited. We nevertheless continue to watch it closely given the environment.
Our shared national credit portfolio also remains very strong from a credit quality perspective, with criticized assets, nonperforming loans and net charge-offs consistently lower than the overall commercial portfolio across a multiyear period. Our credit resilience highlights our proactive risk culture. We continue to closely monitor all exposures where inflation and higher rates may cause stress throughout the entire portfolio as well as the fallout from the ongoing labor strike in the auto manufacturing sector, where we think our exposures are very manageable.
Moving to the ACL. Our reserves decreased $5 million, but the coverage ratio increased 3 basis points sequentially to 2.11% as the impact of lower period end loans was offset by a slightly worse overall base case economic outlook. As you know, we incorporate Moody's macroeconomic scenarios when evaluating our allowance. Both the Moody's base scenario and the downside scenario used for the third quarter ACL assume a slightly worse average unemployment rate compared to the prior quarter. We maintained our scenario weightings of 80% to the base and 10% to each the upside and downside scenarios.
Moving to capital. Our CET1 ratio increased 31 basis points sequentially ending the quarter at 9.8%. Our capital position reflects our ability to build capital quickly through our strong earnings generation, combined with the impact of our RWA diet. Our tangible book value per share, excluding AOCI, increased 10% compared to the year ago quarter. We continue to expect improvement in our unrealized securities losses resulting in approximately 35% of our current loss position accreting back into equity by the end of 2025 and approximately 2/3 by 2028, assuming the forward curve plays out.
Looking forward, we expect to build capital at an accelerated pace given our RWA optimization initiative and our continued deferment of share buybacks. We anticipate accreting capital such that our CET1 ratio ends this year above 10%.
Moving to our current outlook. We expect fourth quarter average total loan balances to decline 2% to 3% sequentially with consumer loans down 2% and commercial loans down 3%. The reflects our overall cautious economic outlook combined with one more quarter of our RWA diet as we are responding quickly to higher risk-adjusted return thresholds throughout the bank considering the economic and regulatory environments. We expect average deposits to be up slightly on a sequential basis. Within that, we expect core deposits to increase 1% due to our multiyear investments in the franchise to add households and primary commercial relationships, along with the benefit from seasonality. While we continue to expect modest migration from DDA into interest-bearing products in a higher for longer interest rate environment, specifically for the fourth quarter, we expect the mix of DDA to core deposits to remain relatively stable given those seasonal benefits.
Shifting to the income statement. We expect fourth quarter NII to be down approximately 1% to 2% sequentially due to the continued impacts of the balance sheet dynamics I mentioned. Our NII guidance assumes no additional rate hikes and a cumulative beta, which includes CDs and excludes DDAs of 55% by the fourth quarter. Excluding brokered deposits that we have been using as a replacement for other wholesale funding, given the pricing considerations, our cumulative beta expectation continues to be 53%. This outlook translates to total interest-bearing deposit costs increasing 15 to 20 basis points in the fourth quarter.
Our guidance assumes that our securities portfolio balances remain relatively stable through year-end. As a byproduct of our strong deposit growth, combined with our loan outlook and stable securities balances, we expect to hold closer to $20 billion in cash and cash equivalents by year-end. Given these balance trends, we expect our loan to core deposit ratio to continue to move lower through the end of the year, which will keep Fifth Third in a strong liquidity position in anticipation of more stringent regulatory requirements, including remaining compliant with the full Category 1 LCR.
We expect fourth quarter adjusted noninterest income to increase 1% to 2% compared to the third quarter. We expect revenues to remain resilient across most captions driven by our multiyear focus on growing a diverse portfolio of fee businesses that should perform well in different economic environments. We expect fourth quarter TRA revenue of $22 million compared to $46 million in the fourth quarter of 2022. We expect fourth quarter adjusted noninterest expenses to be stable to up 1% compared to the third quarter. Our guidance excludes the pending FDIC special assessment, which we currently estimate at $208 million for Fifth Third.
With respect to credit quality, we expect fourth quarter net charge-offs to be 30 to 35 basis points. We do expect to gradually normalize from here. We continue to believe that our through the cycle annual charge-offs will be in the 35 to 45 basis point range given the credit risk profile of the bank. Given our reduced loan outlook, we expect the change in the ACL for the fourth quarter to be stable to up $25 million, assuming no significant changes in the underlying Moody's economic scenarios. This considers production from dividend finance of around $700 million in the fourth quarter, which as you know, carries a higher reserve level of around 9%.
In summary, with our proactive balance sheet management, disciplined credit risk management and commitment to delivering strong performance through the cycle, we believe we are well positioned to meet the proposed regulatory requirements while continuing to generate long-term value for our shareholders.
With that, let me turn it over to Chris to open the call up for Q&A.
Christopher Doll
Thanks, Jamie. Before we start Q&A, given the time we have this morning, we ask that you limit yourself to one question and a follow-up and then return to the queue if you have additional questions. Operator, please open the call up for Q&A.
Question and Answer Session
Operator
(Operator Instructions) And your first question comes from the line of Scott Siefers from Piper Sandler.
Robert Scott Siefers
Jamie, I was hoping maybe you could expand even a little more on your thoughts on bringing in so many deposits in the third quarter. I know you're trying to get your liquidity to a certain very high level and you achieved it. But it was just a kind of astonishing number. So just curious as to what the thinking throughout the quarter was. I guess additional forward look though you provided some of the deposit commentary or expectations in there. But just any additional thoughts would be helpful, please.
James C. Leonard
Thanks, Scott, for the question. We were certainly bringing the Victory bell on deposits this quarter. Really, when you take a look back, coming out of March, [man], that's one of the biggest drivers of our deposit success in the second quarter and the third quarter was really transitioning our customer recommendation engine from household growth to deposit growth. And while that sacrificed a little bit on the household growth numbers instead of our typical up 3% or up 4%, we were 2% on households, but that translated to very strong consumer deposit growth. And so within the deposit growth we did have during the quarter of almost $4.8 billion, about 60% was Commercial, 40% was Consumer. And within Consumer, 70% of that growth was in the Southeast markets, while 30% of that growth was in the Midwest. So again, the retail franchise at Fifth Third is just performing at an extremely high level.
And on the Commercial side, the growth was surprisingly high given the corporate banking book growth within the commercial deposit growth. About 80% of the growth was in corporate banking. So at the time, we were targeting, let's get LCR, full LCR north of 100%. We actually came in at 118%. So definitely did better than we initially expected than what we were dissecting the quarter end results. It really makes sense that the corporate banking book did better. And as one of sort of hidden benefits of the RWA diet is that we are getting better share of wallet within that corporate banking book, and that also helped drive the deposit growth. So overall, a very strong quarter. Again, for us on the deposit side, we expect continued growth in the fourth quarter, albeit at a little bit lower growth rate but still up a bit in the fourth quarter.
Robert Scott Siefers
Perfect. That's very helpful. And then if I could switch gears for just a second. The securities portfolio remarks, I guess you all might come out looking a little heavier than some others. But by the same token, you guys have been more hesitant to use the HCM classification as well. I guess just any updated thoughts on sort of how you're thinking about that. It's at least optically, would help out levels, if not in terms of real world. But just curious to hear your updated thoughts.
James C. Leonard
Yes, if you break it down between real world and regulatory world, that's really how we are looking at this in the real world with really the economic risk. Whenever you have a fixed rate asset, whether that's in AFS, HTM or in the loan portfolio, you have that economic risk to higher rates. We have elected to hold our securities in AFS, and we'll continue to do so, given that it gives us better flexibility and opportunity to reposition as the environment changes. But when you are in the real world managing the balance sheet, how we approach balance sheet management is in totality. And you can look at our strong NII results, our interest-bearing liability results, any of the measures relative to peers, the total balance sheet is performing very well. We're going to grow NII this year, 3% to 5%. Others are shrinking. So our philosophy is paying off in the real world.
The challenge simply comes from the fair value of a single line item and putting that into capital. We're not insensitive to how that looks on the face of the balance sheet and the tangible book value per share. But we still believe it is prudent to have that flexibility because flexibility has value. In terms of the regulatory risk, perhaps one of the details that we continue to evaluate as something we've not really communicated to all of you externally, is that given the burn down that you have in the presentation and the significant, whether it's static rate, forward rate, you're looking at 60%, 65% of the AOCI burn down during the transition into the new capital regimes, assuming the rules play out as currently written, and that burn down is going to happen on our portfolio because our portfolio has structured. We have defined maturities unlike those portfolios that are in residential mortgage-backed, instruments with convexity and extension risk, we know our portfolio is going to pay down.
And we know that this is going to be very manageable from a regulatory capital perspective. When we model the capital impact at a fully phased-in level on AOCI, the impact on CET1 is about 125 basis points when you reach the third quarter of 2028 and that's why we continue to accrete CET1 is to be able to have sufficient regulatory capital for that world. And in fact, should rates get north of 8%, we would still be maintaining a CET1 well above regulatory (inaudible) would be over 8% CET1 in that environment.
So we feel good about how we're positioned, how we will roll down the curve and ultimately, the regulatory capital. It's just one of the challenges in this environment with everything in AFS is that you have that mark on the tangible book value per share, that erosion. But at the same time, should rates fall. I think all of you would be very pleased with how much tangible book value accretion, we would report in that environment.
Timothy N. Spence
And Scott, if I just put a point on the last thing. Jamie said, I mean, we believe investors want us to do what is best for managing the business and for recognizing the fact that options have value but if you believe that the AOCI mark is weighing on the stock, then the other way to look at it is the burn down is 25% accretion intangible book value per share in the next 2 years just given the current outlook on rates, which is a pretty unique buying opportunity, the other way to look at it.
Operator
And your next question comes from the line of Erika Najarian from UBS.
Erika Najarian
Jamie, this first one is for you. Not to belabor the earlier point, but all the PPNR metrics and balance sheet metrics look great and so did the forward look. And I guess, if you could just explain what happened in the quarter, I think given that your portfolio -- your securities portfolio is 61% CMBS. I think investors that know you well, expected not as much negative convexity. Was there something unique that happened in this quarter in the portfolio that -- where the AOCI was that much wider?
James C. Leonard
Not really. It was a pretty vanilla quarter for us where we had cash flows in the quarter of about $500 million. We put about $700 million to work of the excess cash in short duration Level 1 treasury floaters. When you look at the AOCI walk that happened in the quarter, the securities portfolio because everything is in AFS, worsened about $1.2 billion and if you look at how the 5-year move increased about 45 basis points, the 10-year move to about 75% and then spreads widen 5 bps on the CMBS and about 15 bps in mortgage. So when you add it all up with the DV01 of about $25 million, that gets you to the AOCI movement for the quarter on the investment portfolio. And so it was in line at least with our expectations with how rates were moving during the quarter.
Erika Najarian
Got it. And my follow-up question was for you, Tim. I think it was a very powerful statement you said in the beginning of the call in terms of confidence that you could return to loan growth next year. I think several of your peers that have similar CET1 ratios and similar AOCI marks are still talking about dieting. Could you give us a sense of, first of all, if you could confirm what the AOCI was in basis points, Jamie. And second, Tim, how are you balancing on one hand, the market wants you to continue to build capital as we approach that transitional date on CET1? And on the other, we're still hearing low demand from corporates for financing.
Timothy N. Spence
So there's a lot in there, but that's the right question, Erika. So a few things here. One, I think -- we have tried to be consistent in how we confront change or a need for change and how we operate the company. And the underlying principle here is that if you have to make a change, it's better to do it quickly so that you can get it behind you and return to normal mode of operations. So we have been aggressive in building liquidity. Jamie talked about the fact that we were Cat-1 LCR compliant in both August and September this year. And I think equivalently, we have tried to be very proactive about how we manage through the RWA diet.
So we have one additional quarter to go of dieting to hit our RWA target, which was about a 2% reduction. If you just look at what we're expecting in the fourth quarter. And from there, we'll have achieved what we think we need to achieve in order to be able to refocus on growing the balance sheet. Prudently, I should say, growing the loan portfolio prudently sequentially over the course of the next year. We have the benefit of a very high level of profitability right now, right? We obviously don't have all of the peer reports at this point. But if you look at the core profitability measures here, they're excellent. We're generating 30-plus basis points of CET1 a quarter, which is quite helpful as it relates to being able to both build capital and fund loan growth.
And then while demand is tepid, across the sector. We have some idiosyncratic benefits here that probably have been a little bit lost behind the diet in the form of both dividend and provide, which continue to perform very well and generate growth. And the sustained multiyear investment we've made in expanding our middle market coverage in the Southeast markets, the middle-market relationships in terms of the new relationships we've added in the company year-to-date, are 25% ahead of our all-time record pace.
And we still have bankers who are seasoning in, in terms of building their portfolios that we have been fortunate to hire over the course of the past few years. So that -- those are the things that really provide the catalyst in an environment where demand in aggregate is a little bit more tepid and then the raw capacity in the form of capital generation to be able to support that statement that we can return to growth next year.
James C. Leonard
And then, Erika, on your other components of the question, CET1 for us finished the quarter at 9.8%. Excluding the investment portfolio, AOCI, that number would be 6.3%. And then the RWA bloat from the pending rules would be about 2% to 3% of RWA, which is about 20 basis points. So we would look to be at a 6.1% level. But as we talked about, then the earnings power of the company is very strong. We continue to defer the buybacks. We'll continue to accrete capital and with the passage of time, given the structure in the investment portfolio, the burn down of that AOCI will be 65% or so by the time we reach the fully phased-in level. So we feel that this is a very manageable time line for the company. In fact, have a lot of cushion should rates even go higher.
Operator
And your next question comes from the line of Gerard Cassidy from RBC.
Gerard Sean Cassidy
Tim, coming back to your opening comments about your corporate and commercial customers being cautious and you yourself seeing some of the economic cross winds or cross currents being cautious. I noticed yesterday that the real GDP number that the Atlanta Fed puts out for the third quarter, is calling for a 5.4% real GDP growth in the third quarter. It's probably too high. But the point is there are a lot of cross currents. Can you share with us when you talk to your customers, what do you think is going to take them to become more optimistic and most cautious? Is it a Fed halting and increasing short-term interest rates? Is it better inflation numbers? What do you think they're waiting for before they really start committing to borrowing more money and growing their businesses?
Timothy N. Spence
Yes, that's a great question, Gerard. I think, honestly, it's less uncertainty, right? So to your point. So you have a lot of variables underway here. You have the Fed and rates, as you mentioned, you have an immense amount of government spending right now, which is propping up economic growth in certain sectors of the economy that otherwise wouldn't be there. You have sort of unusual times in the housing market, where we have both high rates and still stable or even in some markets, slightly growing home prices, even the home affordability is at an all-time low.
And it's just, I think, more than anything else, we need to see some of those variables get fixed, right, in terms of what happens. So if the Fed stops raising rates and then introduces a cut, I think that would be helpful. I think that we have to see the last of the stimulus dollars come out of consumer accounts and see what the floor looks like in terms of consumer spending. And then I think we have to have a better sense for what the underlying economic activity looks like in areas where the government spending the $2 trillion that are coming out of the various government programs are not driving a lot of the economic activity for people to get a little bit more focused. Because again, what I hear and I went out to have the opportunity to get feedback from about 3 dozen clients shortly before the call here, is they're seeing a gradual slowdown that is essentially disposable income.
They're seeing disparities on the consumer side between either the businesses or take hotels, hotel properties that either cater to retired people or to high-end consumers in high-end destinations continue to do well, whereas the mass market properties are starting to soften. We hear them on the B2B side being much more guarded as it relates to liquidity and monitoring cash and adjusting staffing levels and just delaying the larger CapEx investments here.
And I think an interesting data point, as I had the chance to spend a little bit of time with the head of economic development for one of the large states in our footprint and I was asking about the new project pipeline. So yes, pipeline is still robust. There's a lot of discussion going on, but the time to decision from when they're initially contacted about a potential opportunity for either a new plant or a headquarter relocation or otherwise to the award in a given state has moved from 200 days as recently as 18 months ago to over 500 days. So you can just see the grind down here of economic activity as people sit on the sidelines and wait to get a better sense for what direction we're headed on the economy.
Gerard Sean Cassidy
Very insightful. And then on credit, tying into maybe the economic comments that you just made, and I don't know if this is for Greg and Jamie, but can you share with us -- Jamie, you showed some very strong credit numbers prepared remarks. And can you tell us, is it better underwriting, if you look back to the financial crisis, through the cycle, net charge-off ratio, I guess it's quite a bit higher than what you're thinking today?
And then second, is it also your customers, because of the pandemic and what they went through, are they just better managed today from a balance sheet perspective than was the case pre-financial crisis?
Greg Schroeck
Yes, it's Greg. It's a great question. I think it's all of the above, right? I think we have been very disciplined, very fundamental about our through-the-cycle underwriting for the past several years. We've been very disciplined around our concentration geographically or by product, right? So we have a very well-diversified portfolio. As a result, we're not seeing trending one way or the other. So we've just been disciplined around that. We've been disciplined around ongoing portfolio management, right? So we are proactive. We're getting out ahead of issues when they arise. We are stress testing 200 basis points ahead of the yield curve -- forward-looking yield curve. And we've seen throughout the cycles. To the extent we get out ahead of this and we identified issues earlier, we minimize. We also have the ability then to bring solutions to our clients, right, to help them through some of these cycles.
And so we're seeing all of that across the board, be it in our commercial real estate portfolio, very diverse. We weren't as aggressive in that portfolio as some other banks were when rates were 550 basis points lower and the same thing through our C&I book. So it's fundamental, sticking to those fundamentals, staying disciplined, both on the front-end underwriting, client selection and then staying on top of the portfolio.
Operator
Your next question comes from the line of Ebrahim Poonawala from Bank of America.
Ebrahim Huseini Poonawala
I guess maybe just following up on Gerard's question around the macro and credit. Tim, just if you can add to your comments, there's still some concern that we could hit a recession first half of next year could drive significant deterioration in credit quality. One, how much of a visibility do you have into credit change over the next few quarters where you can safely say that's unlikely. And maybe, Jamie, just talk to us about the ability of the CECL model to capture that kind of deterioration ahead of time.
Timothy N. Spence
So good morning Ebrahim, it's good to chat. I think a couple of comments. So narrowly to your point, I think we have fairly good visibility into what the first half of the year is going to look like. And we're not seeing anything at the moment that would suggest that we're headed toward credit deterioration in the first half, right? We talked about it in the script delinquency formation that delinquency rates are actually down on the early-stage basis. NPAs are down sequentially, and we have a roll forward for you in the appendix. The slides, which would indicate that, that trend is likely to continue through the fourth quarter. And on the Consumer side, just as an example, the nice thing about the way that we manage delinquencies is it's like an assembly line. So you can see in the 0 to 29 and then the 30-plus buckets what you're going to be dealing with or early next year, and there just isn't anything in there to be worried about.
With that said, the base case we're using as we think about the management of the company, strategic investments, how we manage expenses and otherwise, continues to assume that maybe the market is a little bit too bullish on the idea of a soft landing here. I mean, again, you just look at the payroll numbers, so -- and apply a human lens to it. So jobs are up, but job participation is flat. Labor force participation is flat. And average hours worked are down and unemployment is stable. What that means is you have more people working 2 jobs because they're not getting enough hours or earning enough money at the job that they were working -- the base job that they were working to be able to cover their expenses.
So when you then look at declining real incomes, the only thing that really would be standing between somebody who is having to work 2 jobs and is still suffering from a declining real income and credit delinquency is the fact that there was the stimulus buffer that built up because people had forbearance on loan portfolios and stimulus dollars. Well, the student loans are back now. Housing inflation is still very high at 7.2%, I think, in the most recent prints. And those are just early indicators that there are people across the country that are struggling a lot more than the headline numbers would suggest.
So I feel good because the 2 areas, I would say, the market is most worried about right now are subprime consumers and renters where we have very little in the way of exposure on virtually no subprime, I think the lowest level there of any of our peers who provide information on that front and 85% of the consumer exposure is to homeowners. And then in commercial real estate, where, again, our exposure relative to total capital is lower than anybody else's. And because we weren't trying to grow that portfolio materially, we're able to be much more selective, which is reflected in superior credit metrics right now when you look at our commercial real estate book relative to others. So it's both smaller and better performing.
James C. Leonard
And in terms of how the consumer is doing and what we see in our data, the average consumer balance is still -- deposit balance is still 15% above pre-COVID levels. But to Tim's point, renters are back to pre-COVID levels and sub-660 FICOs are actually below pre-COVID level. So the averages can be a little bit misleading in terms of what credit outcomes may bring in 2024. But as Tim said, we're certainly well positioned from a credit perspective on our balance sheet.
And from an ACL perspective on the second part of your question, the scenarios we use from Moody's have GDP contracting almost near 0. So the modeling certainly picks up erosion in the forecast. In this quarter, you had a slight erosion both in GDP and unemployment as well as with corporate profits and that was part of the reason or the primary reason why our ACL coverage increased from 208 basis points to 211 basis points. It's just we had the benefits of the loan balance reduction and the unused commitment reductions from RWA optimization efforts that offset that.
Ebrahim Huseini Poonawala
Got it. That's helpful. And just as a separate question. In terms of deposit pricing, as we look through next year and if rates don't get cut in higher for longer, are you observing any differences within your geographies, Midwest versus Southeast? Clearly, you're opening a lot of branches in the Southeast. So you have a different strategy there, I assume relative to the home market. Just give us a sense of pricing competition, any differences? And in your view, is deposit pricing now essentially national in nature? Or is it still localized where certain markets could meaningfully outperform or lag in -- on the pricing side?
James C. Leonard
Yes, excellent question. I'll start and then turn it over to Bryan. In terms of total deposit cost and deposit pricing, the quarter played out as expected with our beta ticking up from total deposits, excluding brokered to 50%. We expect that to hit the 53% beta we talked about a quarter or two ago. So the pricing is playing out as we had expected. And I think most of the bank's beta guides are coming up to where we've been at this hire for longer scenario. But in terms of each geography, Bryan, do you want to touch on that?
Bryan Preston
Yes, absolutely. Thanks, Jamie. In general, I think what we're seeing is that it's a combination of -- it is local and a national impact right now. And what you're seeing is that you may have periods of time where the dominant players or the bigger players in specific markets may just have a lower liquidity need. And so that gives you a little bit of an opportunity to be a little bit more aggressive and do well from a share perspective. But what we've seen since March is that tends to rotate around a little bit.
And ultimately, as people start to realize as deposit competition is moving in the market, you're just seeing people then start to react. Your most rate-sensitive customers are absolutely focused on the national markets. They tend to be the ones that are most willing to use a nontraditional provider, and so you definitely see some of that. But in general, it tends to -- you still tend to have some opportunity to take advantage of some geographic differences, but those geographic differences can rotate over time.
Operator
And your next question comes from the line of Ken Usdin from Jefferies.
Kenneth Michael Usdin
I think you guys said in the conference season that the fourth quarter would likely be the bottom for NIM and the first quarter of next year will be the bottom for NII dollars. Just wondering, given the guide you gave today, if that still foots to that and anything we should be thinking about in terms of like getting to that NII bottoming?
James C. Leonard
The first quarter, the day count is what will drive that NII trough. The NIM, whether it's the fourth quarter or the first quarter is going to be driven solely by how much excess cash we have from the strong deposit performance. So we'll see, but it's going to be one of those 2 quarters.
Kenneth Michael Usdin
Okay, got it. And then as you think forward, how do we understand the benefit that you'll get once rates get to a peak about fixed rate loan repricing. I think it's clear to understand how the securities book moves. But on the loan side, can you walk us through just how much benefit you might be able to see as we get into next year from that side being able to offset any lagging deposit pricing?
James C. Leonard
Yes, the consumer book, in particular, is where most of the fixed rate repricing benefit resides. If you look at 2024, we'll have about $8 billion of consumer loan payoffs as how we model it. And front book rates are 200 to 300 basis points higher than back book rates. And so if you take that, coupled with, call it, $4 billion in security maturities and cash flows, you end up with about $300 million tailwind on an annualized basis. Obviously, that will happen during the course of 2024, so take half of that for the in-year effect. But you're looking at $300 million type of run rate benefit just from 1 year's repricing.
Kenneth Michael Usdin
Got it, okay. If I could just ask one last one. The swap slide you have just talks about the '25 -- 2025 versus '23 update. Is there anything different or any thought process different about some other banks who have been adding securities based swaps to protect capital and add a little variable rate juice? Have you done anything like that incrementally? Or is that slide looks pretty intact in terms of how you're approaching swap portfolios of both loans and securities?
Bryan Preston
Yes, we've done nothing incremental at this point. Obviously, we're paying attention to the market and evaluating opportunities. I think more than anything, as Jamie mentioned, the bullet/locked-out structure of our portfolio ultimately is our hedge to higher rates right now because we now have those defined maturities that are going to come in, and we think that keeps us relatively well positioned. But we're constantly keeping an eye on the market and figuring out if there are opportunities for us to continue to improve our positioning.
Operator
Your next question comes from the line of Mike Mayo from Wells Fargo Securities.
Michael Lawrence Mayo
I guess this goes in the category of no good deed goes unpunished. Your efficiency ratio of 55%. Do you think that can improve next year, which is another way of saying is there any shot at getting positive operating leverage? And when I give the positives and negatives, and correct me, it looks like from the negatives, the RWA diet certainly helps capital, but has a cost to NII. And I think you mentioned NII not bottoming maybe until first, second quarter. You have the cumulative beta going up to 53%. It's in line, but still going higher. You're opening 35 new branches a year.
On the other hand, your RWA diet will end and maybe you can lean into the balance sheet more. You mentioned the deposits, the smallest DDA increase since March, the excess cash, which you could choose to put to work, so really part of the tailwind is the asset beta relative to the deposit beta. So does your efficiency improve next year? Can you get positive operating leverage? Is that too much of a stretch? How do you think about that?
James C. Leonard
Yes, I think it will be environment dependent, which I'm sure is not the answer you want. But I think you hit on all the right points, Mike, which is the RWA diet makes positive operating leverage difficult in 2024. With that said, we will do everything in our power to deliver as good a results as we can, but I think it will be a challenge in 2024.
Timothy N. Spence
The old saying is Cincinnati invented hustle, so we're going to work as hard as we possibly can on that front.
Michael Lawrence Mayo
And just clarification on the credit side. Did I hear you correctly, you have 0 office delinquencies, 0 office charge-offs. Commercial, you have the lowest inflows to NPA since 2Q '22. You reiterated 35 to 45 basis points through the cycle. Is that correct? And I know it's been asked already, but you're saying the economy is grinding lower doesn't look good. So you just say your credit is economically insensitive at this point? I mean that's like -- don't you think you could maybe be wrong if things don't go so well?
Timothy N. Spence
Until you got to the last part there, I was going to say in a word, yes. But then you made the question a little more complicated. If you want to...
James C. Leonard
Yes, all of those facts are correct, and we feel very good about all of the work we've done on the credit portfolio over the last 15 years. In terms of it being economically insensitive, no, but within any industry, there are going to be winners and losers, and that's where it comes down to that client selection that Greg referenced. We just believe we are very well positioned, and we've been very diligent and part of the benefit that we're getting right now is the fact that we were not stretching for loan growth over the past several years and we probably had the lowest loan growth guides over the past several years running. And so back to our priorities of stability and profitability ahead of growth.
Operator
Your next question comes from the line of John Pancari from Evercore ISI.
John G. Pancari
Just on the credit side. I know you mentioned that the new NPA inflows were the lowest since the second quarter of '22, excluding the large charged-off items, I guess, could you maybe talk about the sustainability of that? What are you seeing in terms of risk migration and some of your internal risk ratings and everything that -- do you think the inflows are likely to remain that low at this point? And what's the driver of the pressure? Is it the areas everybody suspects in terms of CRE or is it more on the C&I side?
Greg Schroeck
Not on the CRE side, great question. Not on the CRE side, we're not seeing. It doesn't mean we're out of the woods yet. We're watching that portfolio. Clearly, there's stress in that portfolio, but we have so little of it, that's not driving. And as I said earlier, we don't have any geographic or product trends. There's not an industry that's driving our NPA numbers as we sit here today. We have very little from a delinquency standpoint.
And so again, it gets back to how diverse the portfolio is. Yes, I still think we've got some pressure on the 550 basis point rate increase that will flow through to our clients. But we're on top of the portfolio. It's why we're stressing 200 basis points ahead of the yield curve. So we get out ahead of that stuff. And so could it go up a little bit given all the cross-currents, sure, but I think we're in a great spot. Our client selection has been outstanding. Our through the cycle, very disciplined fundamental underwriting I think gets us through this cycle. And so I feel good about where we are today. And even if it goes up a little bit, it's very controllable.
John G. Pancari
And then secondly, kind of a 2-parter. Do you have -- I know you mentioned the criticized loans are down in total this quarter versus last. You have the magnitude of that decline? And then on the Shared National Credit side, the portfolio of 29% of loans, I think over the past year that maybe is down a touch. I mean, do you expect that you're going to reduce the size of the Shared National Credit book? And also what is the criticized ratio for that portfolio?
Greg Schroeck
Yes, so we reduced the -- it is about 29%, you're right. We reduced that portfolio by about 7% year-to-date, given the diving that Jamie talked about earlier, I would expect that number to probably continue to decline between now and year-end. Our portfolio that SNC portfolio performs better on every metric than the rest of the portfolio. So it's under 6% from a criticized asset standpoint. Delinquencies are less than we see in the rest of the book. NPAs are less. So it is some of our strongest performing of the portfolio -- commercial portfolio.
James C. Leonard
John, it's Jamie. The crit office loans were what I referenced that declined 180 basis points. Crits overall, were up just a little bit.
Operator
And your next question comes from the line of Manan Gosalia from Morgan Stanley.
Manan Gosalia
I wanted to follow up on the RWA diet and the trajectory of rates. I guess does that move into 10-year impact how you manage that. So from here, we get the 10-year moving up 1% or down 1%. Does that impact how you will manage loans and as we look into next year, what would cause you to maybe lean into loan growth? And what would cause you to peel back? Is it just the outlook on credit, what you're seeing there? Or could the rate outlook impact that as well?
Bryan Preston
Yes, it's Bryan. I would tell you that the outlook on rates has a modest impact on how we think of loans, but it's more about just composition and more in consumer where we may see some additional opportunity or -- and relative asset classes, you might feel a little bit better about some of the spreads in auto. You're going to see almost no mortgage production in a higher rate environment, obviously. And that's probably the biggest implication just given that our commercial portfolio is primarily floating rate, doesn't really have a big impact from a floating rate portfolio perspective. And it really for us comes down to overall macro, how we feel about what the credit outlook is going to be and whether or not we're earning adequate returns on the capital we're deploying.
Manan Gosalia
Got it. And then just from a cash perspective, it seems like the build was a little bit more than you guided to before? I think you had said about $15 billion or so in cash is what you were targeting before. I think your target has now moved to $20 billion. What's driving the change? Is it the volatility in rates? Is it just preparation for LCR? Or is it also just that you can get 5.5% on cash, then makes more sense to hold cash over securities?
James C. Leonard
It was mostly the fact that deposit growth outpaced expectations. And in this environment, we want to hold excess cash as opposed to doing anything, adding it to the investment portfolio. We certainly view cash as an asset allocation at these rates, as you referenced.
Manan Gosalia
So it sounds like at some point, you'd be able to bring that $20 billion down. It might not be in the next 6 months or so. But as rate volatility improves, you might be able to bring that down?
James C. Leonard
Yes, I would say that our balance sheet is elevated due to a couple of reasons. One, the unrealized losses, whether you have an AFS or HTM, you do have to fund those losses in your liquidity buffers. And so should those losses come down, that certainly frees up cash to shrink the sheet or over time as our non-HQLA allocation matures, we will reinvest that in shorter duration level 1s and also allow us to maintain an LCR above 100%, while also shrinking the sheet. It's just -- both of those things are going to be measured more in years than in quarters in terms of the cash coming down.
Manan Gosalia
So just as a clarification then, does that make you more asset sensitive, all things equal now versus, say, last year?
James C. Leonard
We're pretty neutral right now, how that lines up versus last year, probably a little asset sensitive a year ago, whereas today, we're neutral to at least in the disclosure showing liability sensitive.
Operator
And your last question comes from the line of Christopher Marinac from Janney Montgomery Scott.
Christopher William Marinac
I know you mentioned a little bit about credit in previous questions. But generally speaking, is the criticized and classified number is going to be within a certain band in the next several quarters? Or do you see them rising more than that?
Greg Schroeck
Yes, I would say steady based on what we're seeing now from the delinquency and NPA, all the above and our ongoing portfolio, in the last 12 months, we have re-rated 95-plus percent of the portfolio. So based on all of that underwriting or re-underwriting, if you will, I'm expecting steady.
Christopher William Marinac
And if it went higher than you think that would obviously drive more provisions and obviously more reserve build next year, just all things being equal. Is that fair?
James C. Leonard
Sure. Yes.
Greg Schroeck
Sure.
Operator
And we have reached the end of our question-and-answer session. I will now turn the call back over to Chris Doll for some final closing remarks.
Christopher Doll
Thanks, Rob, and thanks, everyone else, for your interest in Fifth Third. Please contact the IR department if you have any follow-up questions. Rob, you can now disconnect the line.
Operator
This concludes today's conference call. Thank you for your participation. You may now disconnect.
