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. We are pleased with our third-quarter results. We generated strong loan growth in both commercial and consumer categories and generated record adjusted revenue.
NII was positively impacted by higher market rates. Fee income was resilient despite the market-related headwinds and expenses were well controlled, while we continued to reinvest in our businesses. Consequently, we achieved a 53% adjusted efficiency ratio. Also excluding net securities losses related to two legacy venture capital investments, we generated core PPNR growth of 13% compared to last quarter and 27% compared to last year.
Net interest income was approximately $1.5 billion, a record quarter, and increased 12% sequentially and 26% year-over-year, primarily attributable to the benefit of higher market rates, growth in commercial loan balances and the full-quarter benefit of securities purchased in the second quarter. Our NIM expanded 30 basis points during the quarter while interest-bearing core deposit costs increased 32 basis points to 41 basis points in total this quarter. This equates to a cycle to date deposit beta of 16% thus far on the first 225 basis points of rate hikes.
Total reported non-interest income decreased just 1% sequentially. We generated improved mortgage banking and leasing business fee income, which was offset by softer results in market-sensitive businesses, including capital markets and the impact of higher earnings credit rates in treasury management.
Non-interest expense increased 5% compared to the prior quarter, driven by an increase in compensation and benefits expense, including the impact of the July minimal wage increase to $20 per hour, higher technology and communications expense reflecting our focus on technology modernization initiatives and the full-quarter impact of the Dividend Finance acquisition.
Expenses in the quarter included a $7 million benefit related to the mark-to-market impact of non-qualified deferred compensation with a corresponding offset in securities losses. This compares to a $27 million benefit in the prior quarter.
Excluding the NQDC impacts from both periods, total non-interest expense increased $35 million or 3%. Noninterest expense was flat compared to the year-ago quarter despite the impacts of our fintech lending acquisitions of both Dividend and Provide.
Moving to the balance sheet. Total average portfolio loans and leases increased 2% sequentially. Including held for sale loans, total average loans increased 1% compared to the prior quarter. Average total commercial portfolio loans and leases increased 2% compared to the prior quarter. With muted payoff and a stable revolver utilization rate of 37%, period-end commercial loans increased 1% sequentially and 14% compared to the year-ago quarter. Average total consumer portfolio loans and leases increased 1% compared to the prior quarter driven by Dividend Finance, which, as a reminder, is recorded in other consumer loans as well As growth in residential mortgage. This growth was partially offset by a decline in indirect secured consumer loans. At quarter-end Dividend loan balances were approximately $1.4 billion. Average core deposits decreased 3% compared to both the year-ago quarter and the prior quarter, impacted by the intentional run-off of excess and higher-cost commercial deposits in the second quarter and lower consumer interest checking balances in the third quarter.
Compared to the year-ago quarter average commercial transaction deposits decreased 10% while average consumer transaction deposits increased 5%, reflecting our continued success growing consumer households. We grew our securities portfolio approximately $1 billion during the third quarter compared to $6 billion in the prior quarter. We currently expect security portfolio balances to remain generally stable through the rest of the year. We have continued to focus on maintaining structure in the investment portfolio to provide stable and predictable cash flows. Our overall allocation to bullet and locked-out structures at quarter-end remained at 67% and our duration declined to 5.5 in the current quarter compared to 5.8 in the prior quarter.
Moving to credit. As Tim mentioned credit trends remained healthy and our key credit metrics remain well below normalized levels. The NPA ratio of 46 basis points was down 1 basis points sequentially. Our commercial NPA ratio has now declined for eight consecutive quarters. The net charge-off ratio was flat sequentially at 21 basis points. The ratio of early-stage loan delinquencies, 30 to 89 days past-due remained relatively stable sequentially and the amount of loans 90 days past due was approximately 2/3 of what it was a year-ago. We continue to closely monitor Central Business District Hotels, non-profit healthcare, including senior living and offer CRE. We are also monitoring exposures where inflation and higher rates may cause stress, including the impact of changing consumer discretionary spending patterns as well as the ongoing monitoring of the leveraged loan portfolio.
From a balance sheet management perspective, we have continually improved the granularity and diversification of our loan portfolio with a focus on high-quality commercial relationships and on homeowners, which are 85% of our consumer portfolio. We maintain the lowest overall portfolio concentrations in both commercial real-estate and in non-prime borrowers among our peers. Through the Dividend and Provide acquisitions, we added granular fixed-rate loan origination platforms. We have also focused on positioning our balance sheet to deliver strong stable NII through-the-cycle. Our strong deposit franchise securities and cash-flow hedge portfolios as well as the additions of Dividend and Provide's lending capabilities should continue to position us to drive strong outcomes.
In the cash-flow hedge portfolio we have added an incremental $5 billion since the end of the second quarter bringing the total cash flow hedges added this year to $15 billion. The combined securities and cash flow hedge positions will support NII through the end-of-the decade.
Moving to the ACL. Our ACL build this quarter was $96 million, primarily reflecting loan growth as well as a slightly worsening economic outlook relative to June. Dividend Finance loan growth contributed $63 million to this ACL build. Relative to the second quarter, the Moody's GDP growth forecasts are slightly stronger while the unemployment in home price forecast have weekend in both the baseline and downside scenarios.
Given our expected period-end loan growth, including stronger production from Dividend Finance, we currently expect a fourth-quarter bill to the ACL of approximately $100 million, assuming no changes in the underlying economic scenarios. The impact of the expected dividend loan originations to the ACL should be in the $80 million to $90 million range due to our improved loan growth expectations.
Our economic scenarios incorporate several key risks that could exacerbate existing inflationary pressures and further strain supply chains, including continued aggressive rate hikes and quantitative tightening and labor supply constraints becoming more binding than originally anticipated.
Our September 30th allowance incorporates our best estimate of the economic environment. Future baseline unemployment estimates may begin to be increasingly impacted by the Fed's aggressive monetary policies.
Moving to capital. Our CET1 ratio ended the quarter at 9.1% compared to 9% in the quarter. The increase in capital was primarily due to our strong earnings capacity, partially offset by RWA growth, reflecting robust organic business opportunities. Moving to our current outlook. For the fourth quarter of 2022, we expect average total loan balances to be stable to up 1% sequentially. We expect commercial loans to grow 1%, reflecting strong pipelines in middle-market and corporate banking and assuming commercial revolver utilization rates remains stable at 37%.
We expect consumer balances to be stable, down 1%, reflecting our decision to lower auto loan production to enhance our returns on capital and lower residential mortgage balances partially offset by dividend loan originations of around $1 billion in the fourth quarter.
From a funding perspective, we expect average core deposits to increase 1% to 2% sequentially. However, we do expect some continued migration from DDA into interest-bearing products. Wholesale funding balances should be stable given expected core deposit growth relative to our earning asset base.
Shifting to the income statement. We expect fourth quarter adjusted revenue growth of 6% compared to the third quarter excluding the third quarter security losses associated with legacy venture equity investments. We expect NII to be up approximately 5% sequentially, assuming a 75 basis-point hike in November and another 50 basis points in December. We expect a cumulative deposit beta of around 30% by year-end. This should result in interest-bearing core deposit costs rising from 41 basis points in the third quarter to the mid to-high 90 basis point area for the fourth quarter.
We expect fourth quarter adjusted non-interest income to be up 6% to 7% compared to the 3rd-quarter or stable excluding the impacts of the TRA. We have a strong M&A advisory pipeline and expect to continue generating strong financial risk management revenue which we expect will be offset by earnings credits and softer topline. Mortgage banking revenue given the rate environment. We expect total adjusted non-interest expenses to be up 3% to 40% compared to the third quarter, reflecting continued investments in talent, technology and our Southeast branch expansion. Our guidance assumes we open 17 new branches, 16 of which will be in our high-growth Southeast markets. Our fourth quarter guide implies stable expenses for 2022 on a full-year basis compared to 2021 and 8% adjusted revenue growth excluding securities losses resulting in PPNR growth in the high-teens. This will result in a mid 50%s efficiency ratio for the full year, a four-point improvement from 2021 and a fourth quarter efficiency ratio in the 51% to 52% range.
We expect fourth quarter net charge-offs to be in the 20 basis point to 25 basis point range which will result in full year net charge-offs of approximately 20 basis points. In summary, with our PPNR growth engine, disciplined credit risk management and commitment to delivering strong performance through the cycle, we believe we are well positioned to continue to generate long-term sustainable value for customers, communities, employees and shareholders.
With that, let me turn it over to Chris to open the call up for Q&A.
