James C. Leonard
Executive Vice President and Chief Financial Officer at Fifth Third Bancorp
Thank you, Tim, and thank all of you for joining us today. Our second quarter results were solid. We generated strong loan growth in both commercial and consumer categories, deployed excess liquidity into securities at attractive entry points and remain disciplined in managing our deposit costs. Expenses were once again well controlled even though we continue to reinvest in our businesses.
Fees did underperform our April expectations due to the market volatility, but even with that softness, we generated core PPNR growth of 11% on a year-over-year basis. As a result, we achieved a sub-55% efficiency ratio and generated 7 points of positive operating leverage from the second quarter of 2021. The ACL ratio increased 5 basis points sequentially to 1.85%, which includes a 4 basis point impact from the Dividend Finance acquisition. Combined with $62 million in net charge-offs, we recorded a $179 million total provision for credit losses.
Moving to the income statement. Net interest income of approximately $1.3 billion increased 12% sequentially and 11% year-over-year. As Tim mentioned, the underlying NII growth was around 15% compared to last quarter, of which approximately half of the growth was attributable to higher market rates and half from the combination of investment portfolio growth and loan growth, primarily in C&I.
Our interest-bearing core deposit costs were well controlled at just 9 basis points this quarter, up just 5 basis points sequentially and helped drive the 33 basis points of NIM expansion during the quarter. Total reported noninterest income decreased 1% sequentially and increased 3% on an adjusted basis.
Compared to the prior quarter, we generated improved financial risk management, card and processing gross treasury management fees and private equity income, which was partially offset by weaker performance from our market-sensitive businesses, including commercial capital markets and mortgage and the impact of higher treasury management earnings credit rates.
Noninterest expense decreased 9% compared to the prior quarter, driven by a decline in compensation and benefits expense from the seasonal peak in the first quarter, lower incentive-based comp in the current quarter due to market dynamics that impacted fees and overall continued expense discipline throughout the company. Expenses in the quarter included a $27 million benefit related to the mark-to-market impact of nonqualified deferred compensation, which has a corresponding offset in security losses. This compares to a $12 million benefit in the prior quarter. Excluding the nonqualified deferred compensation impacts from both periods, total noninterest expense decreased $95 million or 8%. Non-interest expense decreased 4% compared to the year ago quarter.
Moving to the balance sheet. Total average portfolio loans and leases increased 4% sequentially. Including held-for-sale loans, total average loans increased 3% compared to the prior quarter. Average total commercial portfolio loans and leases increased 4% compared to the prior quarter, primarily reflecting growth in C&I loans. Commercial loan production remained robust throughout the franchise, outperforming our original expectations.
Our production and pipelines are the result of our strategic investments in talent as we continue to see strength in new quality relationship generation during the second quarter. With muted payoffs and a 1% increase in the revolver utilization rate to 37%, period-end commercial loans increased 3% sequentially and 12% compared to the year ago quarter.
Average total consumer portfolio loans and leases increased 3% compared to the prior quarter, driven by residential mortgage and the dividend acquisition, which are recorded in other consumer loans. This growth was partially offset by a decline in home equity. At quarter end, total dividend loan balances were $650 million, reflecting our decision to hold some loans for dividend would have otherwise sold combined with their post-close production volume.
Average core deposits were stable compared to the year ago quarter and decreased 4% compared to the prior quarter, including the impact of the intentional runoff of excess and higher cost commercial deposits. This runoff was in line with our expectations and reflects our pricing discipline from our strong overall liquidity position.
Compared to the year-ago quarter, average commercial transaction deposits decreased 8% and average consumer transaction deposits increased 1%, reflecting our continued success growing consumer households. Given the improved entry points during the first and second quarters, we deployed cash into the securities portfolio, which resulted in second quarter average securities balance growth of approximately $12 billion. We completed net purchases of $6 billion in securities during the second quarter compared to $13 billion in the prior quarter. The higher than previously expected security purchases in the second quarter were the result of accelerating planned second half of 2022 purchases given the attractive entry points in late May and June. We currently expect security portfolio balances to remain generally stable through the rest of the year.
We have continued to focus on adding duration and structure to the investment portfolio to provide stable and predictable cash flows. Consequently, our overall allocation to bullet and locked-out structures increased from 64% to 67% at quarter end, and our duration increased from 5.4% to 5.7%.
Moving to credit. As Tim mentioned, credit remained healthy and in line with our previous expectations. The NPA ratio of 47 basis points improved 2 basis points sequentially, with net charge-offs of just 21 basis points. The ratio of early-stage delinquencies, 30 to 89 days past due relative to loans was stable in the second quarter and the amount of loans 90 days past due is less than half of what it was a year ago.
We continue to closely monitor the same areas we have previously discussed, such as Central Business District hotels, Senior Living and Office CRE. We are also monitoring exposures where inflation and higher rates may cost stress, including the impact of changing consumer discretionary spending patterns as well as the ongoing monitoring of the leveraged loan portfolio.
Our ACL build this quarter was $117 million, of which approximately 75% was from strong loan growth, including the $53 million ACL impact from the dividend acquisition, and the remaining 25% was attributable to worsening economic projections relative to March, net of reductions in certain pandemic-related qualitative adjustments.
Given the incremental clarity on the economy's ability to withstand geopolitical tensions and the pandemic fallout with vaccine efficacy and other measures, we elected to return to our standard approach for scenario weights of 80% to the baseline and 10% due to the downside and upside scenarios. We believe our models are better suited to appropriately evaluate economic scenarios and outcomes from monetary tightening on our loan portfolio than on humanitarian crises such as pandemics and wars.
Despite the scenario weight change, we increased our reserves in specific portfolios such as CRE, where we continue to believe there are elevated risks. Our baseline scenario assumes the labor market remains relatively stable with unemployment ending our three-year reasonable and supportable period at around 3.8%, which is slightly weaker than our previous estimate. Additionally, GDP growth and home price forecasts have weakened relative to our March forecast in both our baseline and downside scenarios.
Our expectations incorporate several key risks that could exacerbate existing inflationary pressures and further strained supply chains, including aggressive rate hikes and quantitative tightening and labor supply constraints becoming more binding than originally anticipated. Our June 30 allowance incorporates our best estimate of the economic environment.
Moving to capital. Our CET1 ratio ended the quarter at 9% compared to 9.3% in the prior quarter. The decline in capital was primarily due to strong RWA growth, reflecting robust organic business opportunities and the impact of the Dividend Finance acquisition. We expect to accrete capital to the 9.25% area by year-end given our strong earnings capacity, and we will evaluate resuming buybacks after that time.
Moving to our current outlook. For the full year 2022, we continue to expect average total loan growth between 5% and 6% compared to 2021 or around 10%, excluding PPP and Ginnie Mae impacts, reflecting strong pipelines and stable commercial revolver utilization rates over the remainder of the year.
Dividend Finance is generating strong origination volumes. We expect loan originations of around $1.3 billion in the second half of 2022, which is 30% more than our original estimates. Similarly, Provide loan production remained strong as we expect over $1 billion in total production in 2022. Dividend and Provide together are expected to contribute a little more than 1% of the total average loan growth for the year. We expect average commercial loan growth of 9% to 10% or 14% to 15%, excluding PPP. We expect total average consumer loans to be stable in 2022, reflecting our decision to lower auto loan production to enhance our returns on capital.
We expect around $7 billion in auto and specialty production for the full year, which will still result in double-digit growth in average indirect consumer secured balances in 2022. Our outlook also assumes growth of approximately 15% in other consumer loans, reflecting the benefits of Dividend Finance.
Shifting to the income statement. We continue to expect full year adjusted revenue growth of 7% to 8%, which will be a record year of revenue for Fifth Third. Given our outlook for earning asset growth, combined with the implied forward curve as of July 1, which assumes a Fed funds rate of 3.25% by year-end, we expect full year NII to increase 17% to 18%. Our outlook incorporates the impacts from runoff of the PPP and Ginnie Mae portfolios. Excluding those portfolios, NII growth would be around 20%.
Our current outlook assumes average deposit balances decline a couple of billion dollars in the third quarter, reflecting the full quarter impact of the second quarter runoff of excess and higher cost commercial deposits and seasonality and then return to growth in the fourth quarter.
Since the onset of the rate hikes, our deposit betas have been muted at low single digits for the cycle to date. We expect increases to our interest-bearing core deposit costs to accelerate over the next two quarters due to the timing, impact of deposit repricing lags from earlier hikes and continued aggressive rate hikes from the Fed. We continue to expect a 25% deposit beta on the first 225 basis points of rate hikes and a marginal beta of around 45% to 50% on the next 75 basis points of rate hikes.
The ultimate impact to NII of incremental rate hikes will be dependent on the timing and magnitude of interest rate movements, balance sheet management strategies, including securities growth and hedging transactions and realized deposit betas. We expect full year adjusted noninterest income to be down 7% to 8% in 2022, reflecting softer second quarter performance, combined with the high probability of continued market volatility, reflecting a more aggressive rate outlook, including lower wealth and asset management, mortgage and capital markets revenue as well as higher earnings credit rates offsetting strong gross treasury management fee growth.
Despite the expected decline in capital markets revenue, we expect full year capital markets revenue to be up nearly 50% from the pre-pandemic 2019 levels, which highlights the success we've had over the past few years in growing a diversified capital markets business.
We expect full year adjusted noninterest expense, including the impacts of Dividend Finance to be stable to down 1% compared to 2021, an improvement from our previous guide of up 1% to 2%. We continue to strategically invest in our franchise, which should result in low double-digit growth in both technology and marketing expenses. Our outlook also assumes we had 20 to 25 new branches, primarily in our high-growth Southeast markets in 2022. Our guidance also incorporates the minimum wage increase to $20 per hour that went into effect on July 4.
We expect these investments in our people, platforms and franchise to be offset by the savings from our process automation initiatives, reduced servicing expenses associated with the Ginnie Mae portfolio, a decline in leasing expense given our LaSalle solution sale and our continued overall expense discipline throughout the company. As a result, our full year 2022 total adjusted revenue growth, combined with our expense outlook, should generate 4 points of improvement in the efficiency ratio and positive operating leverage of around 8%.
Full year adjusted PPNR growth is expected to be 17% to 19%, which is an improvement to the range compared to our April estimate, reflecting the strong NII and expense outcomes, partially offset by the market-related fee headwinds. Our outlook for significantly delivering on our positive operating leverage commitment reflects the benefits of our ability to grow our customer base, combined with our strong balance sheet management and expense discipline.
For the third quarter of 2022, we expect average total loan balances to increase 1% sequentially, reflecting 1% to 2% growth in commercial and stable consumer balances. We expect our average securities portfolio to increase $2 billion to $3 billion, reflecting the full quarter impact of purchases made during the second quarter.
Shifting to the income statement. We expect third quarter adjusted revenue growth of 8% to 9% compared with the second quarter. We expect NII to be up 11% to 12% sequentially, reflecting strong loan growth, the impact of securities purchases and the benefits of our balance sheet positioning. We expect adjusted noninterest income to be down 3% to 4% compared to the second quarter. We expect total adjusted noninterest expenses to be up 4% to 5% compared to the second quarter or up 2% compared to the year ago quarter due to the acquisitions of Provide and Dividend Finance.
Excluding the second quarter, NQDC benefits on expenses, we expect noninterest expenses to increase around 2% sequentially. We continue to expect third quarter and full year 2022 net charge-offs to be in the 20 to 25 basis point range.
In summary, with our balance sheet positioning, PPNR growth engine and discipline credit risk management, we believe we are well positioned to continue to deliver strong performance in this type of environment.
With that, let me turn it over to Chris to open the call up for Q&A.
