Q3 2020 Citizens Financial Group Inc Earnings Call
Good morning, everyone and welcome to the citizens Financial Group third quarter 2020 earnings Conference call. My name is Greg and I'll be your operator today.
Currently all participants are in a listen only mode. Following the presentation. We will conduct a brief question and answer session. If you'd like to ask a question. Please press. One then zero as a reminder, this event is being recorded.
Now I will turn the call over to Kristen Silverberg Executive Vice President Investor Relations. Chris then you may now begin.
Thank you Greg Good morning, everyone and thank you for joining us this morning, our chairman and CEO, Bruce Van Saun <unk> CFO, John will provide an overview of third quarter results referencing a presentation, which you can find on our Investor Relations website.
After the presentation, we'll be happy to take your question Brendan Copeland head of consumer banking and Don Mccree head of commercial banking.
So he can provide additional color.
Our comments today will include forward looking statements, which are subject to risks and uncertainties that may cause our results to differ materially from expectation either.
Our lives for your overview on page two of the presentation. We also reference non-GAAP financial measures. So it's important to review our GAAP results on page three of the presentation and the reconciliation in the appendix.
I will hand over to Brian.
Chris <unk> and.
Good they do for you. It's good to have you on the team. Thank you [laughter]. Okay. Good morning, everyone and thanks for joining our call we feel.
We feel really positive about how citizens continues to rise to the occasion and makes the unprecedented challenges of 2020.
We're taking great care of customers colleagues communities, while posting strong results that demonstrate the diversification and resilience of our business model.
We are delivering record levels of pre provision profit and we're managing risks on our balance sheet well in the near term, while also preserving and making the strategic investments to position us for growth and success in the long term.
Financial performance in Q3 featured record revenue.
Income and mortgage results.
The low rate that flat yield curve environment puts pressure on NIM, what are well positioned mortgage business has performed exceptionally well capturing the refi opportunity gaining market share and providing a natural offset to low rates.
We included a page on this business and our investor deck.
In short we believe the mortgage business has room for one given the positive market environment, plus our own strong positioning and capabilities.
In addition to mortgage we saw a solid quarter in capital markets revenue, given strong advisory and underwriting performance and a nice rebound in wealth fees consumer.
Consumer piece also continued to move higher off of a tone, but.
Related locked down loans, which should continue as the economy further reopens and consumer behavior normalizes.
These factors drove non interest income growth of 11% sequential quarter and 33% year on year.
Combined with a modest decline in <unk>.
And broadly stable expenses, we delivered underlying positive operating leverage of 2.6% sequential quarter and 9% year on year.
Our pre provision net revenue grew by 22% year on year and its up 14% on a year to date basis.
Now this capital generation ranks near the top of peers, a lot has allowed us to grow loans to support customers build a profit level of credit reserves, given the uncertainty of the environment maintain an attractive dividend payout, while delivering a 9.8% CET one ratio, which is within our targeted.
Change of buying 75% to 10%.
This capital and reserve strength gives us tremendous financial flexibility going forward from a strategic and operational perspective.
Our view on the economy continues to be cautiously optimistic.
Our consumer credit book is tracking favorable to expectations, given perhaps stimulus economic reopening and forbearance on the commercial side, we're seeing some selective credit stress and industry segments that are most impacted by COVID-19, and the lifestyles.
We took a sizable charge offs two credits during the quarter as loss recognition can be a little lumpy that.
That said, we feel we are near near peak charge offs in commercial assuming the macro environment stays on the current trajectory.
Our work on top and the soap continues to make solid progress we are adding material work streams to top six largely centered on digitization and we will provide a full expense guidance on our year end call.
Yes, so we completed a student loan sale as we develop that originate to distribute model and we executed them attractive sub debt exchange that delivered both financial and regulatory capital benefits.
It's been quite a remarkable year and we feel weve handled the challenge as well and we're poised for success as the economy recovers with that.
With that let me turn it over to John for a thorough review of our financials job.
Thanks, Bruce and good morning, everyone let's.
Let's start with a brief overview of our headlines for the quarter starting on page five.
This was an outstanding quarter for citizens. Despite the ongoing challenges in the operating environment, we have.
We have generated record revenue and PPNR in the last two quarters with an excellent balance sheet position at September 30.
For the third quarter, we reported underlying net income of 338 million.
EPS of 73 cents and record revenue of 1.8 billion.
Our underlying Rafi was 9%.
Given our increased 6% linked quarter to another record level and was up 22% year over year.
We posted record fee income for the quarter by record mortgage fees and strong results in capital markets and wealth.
Also we delivered positive operating leverage of 2.6% linked quarter and 9% year over year as we continued our strong expense discipline.
Net interest income was down 2% linked quarter due to a 3% decline in loans given line draw Paydowns and a five basis point reduction in NIM due to rates and elevated cash.
This was mitigated by excellent results in interest bearing deposit costs, which fell 13 basis points linked quarter to 35 basis points.
I should note that on a normalized basis, which adjusts for PPP lungs commercial line repayments and the education loan sale completed in the quarter average loans were up slightly linked quarter.
We increased our allowance for credit losses was $2.7 billion, which translates to a prudent NPL coverage ratio of 2.29%, excluding PPP loans up from 2.09% last quarter.
Note that the reserve build during the quarter of 209 million impacted EPS by 40 cents and rocky by five percentage points.
We believe charge offs should be stable in Q4, and barring a deterioration in economic outlook, we should start to see reserve releases beginning in the fourth quarter.
Even with the significant reserve Bill we demonstrated excellent balance sheet strength, ending the quarter with a CET one ratio of 9.8% up 20 basis points linked quarter and back within our pre commit operating level of approximately 9.75% to 10%.
Liquidity ratio has also improved as we ended the quarter with an LDR of 87% and we.
And we remain in compliance with the LCR are.
Our tangible book value per share is $32.24 at quarter end up 2% compared with a year ago.
On page six I'll cover net net interest income.
Net interest income was down 2% linked quarter, given the impact of lower range and a 3% decrease in loans as lines, Roger repaid, partly offset by lower interest bearing deposit costs and improved deposit mix.
Despite the challenging rate environment net interest margin held up well down five basis points this quarter right.
Rates drove a seven basis point decrease through lower asset yields and higher cash balances were a two basis point impact. These.
These were partially offset by lower interest bearing deposit costs and outsized growth in DTA.
Moving to page seven we delivered record results again this quarter in fees, reflecting our ongoing efforts to investing and diversify our revenue streams.
Underlying non interest income was up 11% linked quarter and 33% year over year as our fee income ratio improved to 37%.
Mortgage banking delivered record results again this quarter on continued strength in originations more than offsetting a modest decline in margins compared to last quarter's all time high.
The mortgage business continues to provide an excellent natural hedge as intended against low rate pressure on NII.
The wealth business regarded nicely in the quarter with revenue is rebounding to record levels.
This was driven by a strong and trying to increase in transaction volume and a solid increase in anyway.
Service charges and card fees continued to trend back to pre coverage levels.
She consumer drivers were increases in credit card purchase volume and debit card transaction volume each.
Each of which is nearing three code activity levels.
Capital markets fees were down linked quarter, driven primarily by a recovery in trading values in the prior quarter.
Excluding this capital market fees were up 11% driven by accelerating activity in loan Syndications M&A advisory.
Turning to page eight let's take a closer look at the mortgage business.
The strong performance of the mortgage business again this quarter has really boosted our overall performance providing diversification in this low rate environment.
The business continues to demonstrate the benefits of the scale and diversity over of our origination channels off the back of our 2018 acquisition of Franklin American.
We've made significant investments in the business over the last few years upgrading our customer facing technology with our focus on innovating the customer experience.
Over 60% of retail applications are now completed through our digital.
The strength of our multi channel distribution capabilities has enabled us to meet the extraordinary increase in demand in the market with 2020, the largest year for mortgage originations in us history.
We expect volumes to remain elevated through 2021 at today's rates.
And we expect to make market share gains even as rates rise as we transition to a more purchase driven market, given our strength and execution consistency and leveraging our scale and channel diversification across our retail correspondent and wholesale channels.
Turning to page nine on expenses.
Underlying non interest expense was down slightly linked quarter, reflecting continued strong expense discipline that generated robust positive operating leverage in the quarter.
This continued expense discipline has contributed to the year over year and linked quarter improvement in the efficiency ratio now at 53%.
Salaries and employee benefits were relatively stable linked quarter and up 3% year over year due to expenses connected the strong mortgage banking production volumes.
Next on page 10 average.
Average core loans were down 3% linked quarter and up slightly after normalizing for the impact of PPP loans commercial line repayments and loan sales.
We saw growth in consumer lending in both mortgage and student.
Moving to page 11.
Average deposits were broadly stable linked quarter and up 14% year over year as consumer.
As consumers and small businesses benefited from governments in the us and clients built liquidity.
We were especially pleased with our progress on deposit costs, which declined 29% or 10 basis points to 25 basis points during the quarter.
Interest bearing deposit costs were down 13 basis points to 35 basis points.
We executed our deposit playbook to manage down deposit costs across all channels, while improving our overall funding mix.
We brought interest bearing deposit cost down significantly by leveraging data and analytics to personalized offers and optimize pricing for our affluent and mass affluent customers.
We continue to see a shift towards lower cost categories with average GDP growth of 8% on a linked quarter basis, and 40% year over year.
This continues the peer leading momentum we have demonstrated in growing low cost deposits over the last three years.
Turning to page 12 to discuss our seasonal methodology and reserves.
We have summarized the key aspects of our macroeconomic scenario, which is a foundational element of the cease of reserve estimate.
This scenarios increased slightly on that used in Q2.
Nonetheless, we used management overlays and qualitative factors to build reserves focusing on expected performance trends in specific commercial sector portfolios, most impacted by copel related not lockdowns.
Mainly retail and hospitality related creek, and casual dining as well as in selected retail products.
We feel we are well reserved at this point for extended pandemic and lockdown impacts we sectors.
Notwithstanding this sizable reserve bill our CET, one ratio improved 20 basis points to 9.8%, given our robust PPNR growth and lower our WMS.
On page 13, we provide detail on our customer forbearance programs in coming.
In commercial loans with payment deferrals declined to 1.4% of our commercial loan book down from 5.2% at June Thirtyth and this is further decreased to 1.2% as of October 13th.
For retail loans in forbearance have declined to 3.8% compared to 6% at June Thirtyth and has further declined to 3.4% as of October 30. This.
This would be approximately 2%, if we reported forbearance and being immediately after the last deferred payment.
The performance of customers that have exited forbearance is trending well with approximately 95% in current status.
Also for customers that have not taken any forbearance the delinquency status is trending favorably.
Deferrals and business banking or 8.1% and are expected to do decreased to approximately 1% by the end of October with about 40% of our customers having received CPP funds and Reopenings alleviating some of the stress.
Turning to page 14 on credit.
Non accrual loans increased 29% linked quarter given to 254 million increase in commercial which was driven by two credits to mall reach impacted by Kobin related lockdowns and as well as the $33 million increase in retail.
Note that our total already exposure is approximately 400 million with two credits now and mph status and the other performing okay.
Net charge offs were 70 basis points this quarter driven by two large credits and commercial one to a mall rate and one in metals and mining.
The increase in commercial was partially offset by an improvement in retail, reflecting the impact of forbearance and the improving economic backdrop in Q3.
We took a prudent $209 million reserve build this quarter, which increased our coverage ratio from 2.09% in Twoq you to 2.29% in Threeq you excluding PPP loans.
Despite the somewhat lumpy increase in Npls and charge offs during the quarter, we are seeing broad signs of progress in commercial credit quality as the economy recovers.
In the appendix on page 23, we provide you with an update on our view of the commercial portfolio.
In the commercial portfolio as businesses have reopened and liquidity has improved from capital raising and federal stimulus we've seen sectors begin to stabilize.
These include accommodation and food services credits, including quick service food concepts that have performed well during the pandemic.
The retail trade sector, getting our portfolio of lower risk gas stations and essential services, but.
The less price sensitive credits in the energy and related sector.
And finally, the Arts entertainment and recreation sector as 14, Cdns that has further benefited from professional sports resuming.
Given these positive trends the area, if we consider to be an elevator concern have dropped from 10% in twoq to approximately 5% of total loans.
The remaining areas of concern has been particularly hit by cobot related closures, mainly across retail related Cree and hospitality casual dining retail trade.
Occasional services and price sensitive energy.
On page 15, as I mentioned earlier, we feel well positioned to manage through the current environment with strong capital and liquidity positions.
Our CET one ratio improved to 9.8% up 20 basis points linked quarter, given our strong PPNR generation and reduction in risk weighted assets we are.
We are now back in our target range of 9.75% to 10%.
PPNR as a percentage of average assets was 3.9% year to date on a nine quarter DCF calculation basis.
Increased steadily over the last five years, reflecting the benefits of investments and increasingly diversified revenue base.
Strong deposit growth outpaced loan growth, which improved our liquidity metrics, Andrew if the spot LDR down to 87%.
During third quarter 2020, the company completed a subordinated debt exchange that will benefit total capital going forward by increasing the percentage of qualifying tier two debt.
Turning to page 16, I'll update you on top six.
We continue to execute on the transformational and traditional top program and they have clearly been instrumental in our ability to deliver positive operating leverage and drive resi improvement.
The initiatives, we launched our expected to achieve the original 2020 pre tax run rate target of $225 million and we are still on track to hit the $300 million to $325 million by year end 2021.
We are also adding significant work streams to top six largely focused on accelerating our digital capabilities to create increased efficiencies and frictionless customer experiences.
You should deliver at least $100 million run rate by the end of 2021, and we are working to increase this.
So we are also working through the cost impact of how much we'll invest or reinvest in strategic initiatives to drive future growth.
We will be updating our expense outlook, including the benefit of the expanded initiatives to upscale these programs as part of our Fourq earnings call in January.
On pages 17, 18, I want to highlight some exciting things that are happening across the company.
As we continue to strategically invest through the crisis to position us well for the medium term. We are focused not only on digitization, but also initiatives that position the franchise well for the long term.
On the consumer side, we're focused on national expansion with citizens access integrating some of our lending businesses to further develop our national value proposition.
Merchant finance, we're continuing to add new merchants to our point of sale platform launching five important new merchant finance partners, we more in the pipeline.
And we are piloting a new customer lifepoint value proposition.
In commercial we continue to expand our capital in global markets capabilities, including completing our first lead left high yield fixed income instruments.
And we're also seeing increased client adoption of our digital treasure Treasury solutions.
Now lets move to page 19 for high level commentary on the outlook for the fourth quarter.
We expect and I can be broadly stable with no expectation of PPP forgiveness benefit until next year.
NIM is expected to be down low to mid single digits.
Loan should be stable securities up modestly.
Fee income is expected to be down mid teens off the record third quarter level, reflecting lower mortgage banking fees.
While we expect to see mortgage results come down from Threeq to record levels, we do see a significant fee opportunities that should continue into fourq and well into 2021 at attractive margins, albeit lower than recent historic highs.
Non interest expense is expected to be up modestly, reflecting seasonal factors and were on track for full year operating leverage of around 4%.
We expect relatively stable net charge offs in the range of 60 to 80 basis points of average loans.
We also expect affirms our reserve release in Q4, given reserve builds taken year to date.
And we should see a decline in NPS.
On slide 20 to sum up we continue to navigate successfully through the COVID-19 crisis. The resilience of the franchises again on display with record PPNR record fee income and positive operating leverage we are.
We remain well positioned to continue to strategically invest and delivered on key initiatives.
Our ability to execute well drives our strong profitability capital and liquidity positions with that I'll hand, it over to over to Bruce.
Okay. Thank you John.
Operator, let's open it up if you're going to okay.
Okay, ladies and gentlemen, if youd like to ask a question. Please press one may zero on your telephone keypad you may withdraw your question at any time by repeating the one zero command. If you are using a speakerphone. Please pick up the handset before pressing the numbers. Once again, if you have a question. Please press one then zero at this time and one moment. Please for your first question.
Your first question comes from the line of Peter Winter from Wedbush Securities. Please go ahead.
Good morning. Thanks.
I was just curious.
What gives you the confidence.
Nonperforming assets are going to decline.
No at this point in the cycle, there still seems a lot of uncertainty that you'd be willing to release reserves next quarter.
Yes, why don't I start out and then and then you can pick 10 so.
If you look at what drove up the Npis this quarter it really was isolated to.
Just checking exposures, we had small reach.
Which you know frankly.
Frankly has been really stellar performing companies best in class, which we've had long relationships with but obviously the coated and locked in.
Change behavior.
Because some stress there so we recognize that we do.
We feel pretty careful job of forecasting.
Migration, including criticized assets and what could go NPPA.
So we think it beyond that.
We don't we don't really as I think John said in his prepared remarks, we're seeing some broad signs of optimism.
Improvement in.
The overall commercial book, So we really don't think were going to be taking a lot of new and then we'll have some charge offs. Some degree of charge offs, which will reduce the debt. So you put that all together and I think we're feeling pretty confident on the commercial side and then if you look at.
If you look at continuing as well, we've had really really healthy trends.
Yes, good evening, even surprising for the point of being surprising but.
Very solid in terms of delinquencies, so feel really good there as well.
I'd just add Doug just higher level and we have pretty good line of sight. When you think about over the next 60 to 90 days about whats going to migrate on the commercial side I mean, we've got.
You'll pay downs and charge offs that are coming through.
And your things right you know as we mentioned in our overall areas of market concern that we've we were at 10% last quarter that number has fallen to five we delineated where the puts and takes are with respect to that in our in our in our slide deck and so we've done a bottoms of cash burn analysis, which Tom can comment on.
So so we feel reasonably comfortable with that with that guy on the non accruals on the non accrual space.
And then just on the reserve levels.
Releasing reserves just I feel like there's still enough uncertainty in the economy.
Just look at the end.
The decision to release properly releases those next quarter.
Yes, I mean I'll go ahead and take that one I mean I think this comes back to the methodology as you saw in the first place I mean weve.
We've been over time, there has been significant.
Uncertainty with respect to the scenario and we saw how that trajectory played out over the first and second quarter, where we built in both quarters.
This quarter the scenario actually got a little better and I think at least from what we can see there. The the level of uncertainty has started to shake.
Shaped into something that we feel comfortable with our outlook I think the difference this quarter in terms of our build is we've been.
Spending a lot of time with individual sector reviews, and that really was the management overlays and the qualitative factors are what drove our adult this quarter.
After we've gone through all of that.
When we if the scenario barring a deterioration in the environment, we feel like after analyzing what we expect the loss content to be in these in these categories that you know that reserving require.
Requirements have been.
I've been satisfied and so therefore the loss content has been provided for.
And therefore on an on a go forward basis, the way seasonal works is that.
You would charge off against that reserves that you've already built and the net provisions will be driven by your origination.
And go forward activity so.
From our standpoint that would that would be.
Server leases, which with provisions lesson charge offs.
Great. Thanks for taking my question.
Sure.
Your next question comes from the line of Erika Materion from Bank of America. Please go ahead.
Hi, good morning Barnett Marni.
As we take a step back obviously I. Unfortunately, given the timing of where we are in the year.
I'm sure you'll get a lot of questions on 21, and I know you got the first in January for details.
We take a step back and we think about all the work that you've done either through the top program.
Building your fee income generating anything funny in a way.
Way that again.
Obviously, the interest rate challenges and the swap income roll off.
As we think about normalized retiring sort of post the spike in credit that we all expect for 21 do you think about normalized razzi for citizen.
In a post covance recovery World with no help with rates do you think that you having nothing to tell what's top or fee generation to achieve it.
10% or low double digit razzi on the other side.
Yes.
And then John you can add your perspective, but.
Yes, I think Thats certainly the case, Eric so.
If you look at what we deliver.
Just this quarter was was 9% with a huge reserve, which the bill basically cost was 5% of the Razzies. So.
You can do the math on that.
Yeah will I think going forward have lower credit costs.
We'll we'll have some NIM headwinds, but again, we consider hedges as part of the strategy.
In managing a low rate environment, but our mortgage business was also part of that strategy as well and so there seems to be a great fixation on hedging and some folks have put.
Put hedges on we I think they've done a nice job there, but some folks may have some longer duration or more hedges, but.
I don't have the size mortgage business that we have and so I think if you look at our PPNR generation through this year, we're really top of the class in terms of how we've been performing so we expect there to be linked to run in the mortgage business through next year, 60% of the households in the country that benefit.
I'd say by more than 50 basis points in terms of the massive to refinance their mortgage so there's going to be continued demand on the refinance side.
As the Mark to take back too.
Purchase market is also very well positioned we thought it would have the most diversified early.
Origination channels, which have any bank owned mortgage company with exposure to.
Exposure to retail to correspondent and wholesale.
Work really hard to digitize that business and.
In market share and be able to handle volume sufficiently shape.
Really good about that so.
I'd say, we're kind of on the floor of crude.
Crashing through double digit razzi.
I think we can get there and and certainly sustain it but it's going to take all the levers of the fee.
The fee investments that we've made gain more top and continuing to focus on driving efficiencies looking for volume in terms of loan growth and machine. We think there's going to be some opportunities. We think we are unique.
Uniquely have some niches on the consumer side that some of our peers don't have enough think also in commercial we've been able to achieve nice growth through the build out of some of our regional geographies. So.
You know what we have to do we know what the objective is and we're going to keep driving towards that.
Original medium term targets I think you probably need a little help from rates to get all the way there, but certainly double digit seems like a bar we can turtle John Yes, I think it's not too much to add other than I think it's I think that we have been a self help story in the past I think we absolutely remain so going forward in the.
In the NII space.
RBS, so actions and with interest bearing deposit costs at around 35 basis point Theres a lot of opportunity there for US. We are complete we are completely different bank than we deserve versus last and so you can expect that our interest bearing deposit costs are going to find new laws.
For for the bank.
Compared to where we were at the end of the last Sir.
On fees.
Mike It's night and day with respect to our diversification a combination of the organic organic investments that we've made and the inorganic acquisitions that we've made have been extremely powerful in the fee generation space as you're seeing in mortgage, but we shouldn't forget about wealth, which is which is hovering around record levels on its own but sometimes.
Gets overshadowed by the eye popping numbers in mortgage, but but the diversification there is great and the capital markets business has never been more diversified and then finally expenses we've had a history of our top six programs that will continue that'll be a hallmark of what we do and we have a lot more opportunity there as well. So those are the final points I think.
Thanks.
Your next question comes from the line of Scott Siefers from Piper Sandler. Please go ahead.
Morning, guys. Thank you for taking the question.
Just wanted to ask on credit broadly what is your sense for when.
Loss content will really began to materialize in I think it kind of feels like it keeps getting pushed back and the consensus you know now seems to be sort of mid to even late.
21, so just curious to hear your thoughts and then just in a very top level.
What kind of cycle I do you really think you're you're sort of setting ourselves up for it seems like with current and so most of the economy will sort of slogged through and it's just these isolated areas that we'll see the real pain. So is this something where we could really resolved most of the credit cycle next year or do we see that sort of bleeding on for for a couple of years from from here.
Sure so.
You know what I'd say on that is you have to look at commercial and you have to look at consumer.
Shimmers been extremely well behaved and rich.
Folks onshore so people rolling off forbearance have actually been current and we haven't seen any uptick in charge offs.
But I think the residual folks who own forbearance, there will be some charge offs content, there and I think that probably doesn't peak until sometime in the middle of next year, So whether that's Q2 or Q3.
See I think on the commercial side, we've got 58 to one offs this quarter.
And there's the pig is going through the Python I don't think Theres.
Significant jumps on the commercial side I think we're probably nearing the peak charge offs, but.
They'll stay elevated for a while before they they may move back down I think in the second half of the year. So.
I'd say our outlook is that.
Most of this should resolve over the course of next year setting us up for more.
More normalized charge off rates as we head towards 2022.
And they are back in July you want to comment on the consumer side at all.
Yes, let me just add a little specificity. So John quoted a few numbers in forbearance were increasingly confident that the portfolio is of high quality, particularly with some portfolios that were of high interest that hadn't gone through a cycle before our student portfolio is holding up incredibly well, so far and the merchant finance portfolio.
Really holding up incredibly well in fact that portfolio has almost almost no customers in forbearance at all and delinquency is still flat for pre cobot. So.
We're feeling really really strong above about consumer as John mentioned the customers that are firmly still in forbearance has moved from a peak.
Formats at 8% to 2%.
And our delinquency rates have been flat to down at the same time. So we're seeing a lot of gearing out of the forbearance portfolio with very minimal impact to distressed consumer behavior. So far so and we're out of the woods, but surprising.
But on the Green the Green shoots that we're seeing are quite positive Jeff maybe you want to talk about it.
I'd Echo that I do think it's kind of elevated for next year, but kind of peaking out where we are right now I think remember I'll just emphasize what Bruce said, our our view is based on a client by client liquidity analysis, where we project out current rates of cash generation versus current rates and cash burn and we're seeing really positive.
The trends, we've taken 25% of the companies that were in the high risk category out of that category based on our last analysis. We're also seeing record level of customer deposits. So they have heavy heavy levels of liquidity sitting with us and.
And what we're seeing on a customer by customer basis, we're seeing a bigger customers as everybody knows going to the public markets and grabbing any that'll liquidity that can get in the high yield the equity markets and the smaller customers. While they are having a little bit of a more difficult time, they're managing their business is in a really conservative way for cash so that kind of cut expense levels and there.
There are positioning their businesses to to survive.
Extended slowdown if there is an extended slowdown so we feel good about what customers are doing on him.
The visual basis.
That's perfect color. Thank you very much and I guess.
Sneak one in here just Bruce.
Bruce you noted the kind of.
Emerging emphasis on things like hedging programs, which you guys have benefited from I've noticed the same thing I guess, maybe John.
As you sort of think about things into into next year.
When and how do we see.
We see some of those hedges that you guys put in place roll off and and so what is this on suites. We just sort of asked our focus onto the few drivers such as mortgage and and wealthy you alluded to earlier or how do we replace those benefits as they do roll off.
Yes, I mean basically the hedges that are in place should roll.
Roll off throughout 2021 by the end of 20, Twond 2021, most of that benefit.
Is starting to to wane.
But what I do is take a step back on on NIM overall, the the levers that we're pulling and have.
Very large opportunity to get after is what I mentioned earlier with respect to interest bearing deposit costs sitting at 35 basis points, we expect those to decline significantly in 2021.
That's on the sort of funding side of things.
We also are are.
Focusing on the asset side, so we have broader be esso efforts.
Rotating.
Our capital and allocating it into better risk return.
Categories and profiles and then I know you heard from what from Bruce earlier, the mortgage business has room to run.
There are trillions of dollars of mortgages that are that have a refinance incentives.
And I think that I would say that we have.
Business is rate sensitive and has been part of our hedging story and has done incredibly well and a lot of as the NIM headwinds frankly, I guess I could say most of the headwinds all of it in 2020 and probably on a cumulative basis through 2021, most of those those rate headwinds will be will be offset by expected mortgage.
Mortgage fee elevated mortgage fee revenues. So and then of course, you heard I ever ever when you have rates falling thats, a big impact and we'll have to look at all the levers across the self help that we feel like is alive and well here and that would include expenses and top six as part of that.
The last thing I would say Scott and I know hope is not a strategy but.
If you if you consider that we could see real progress on the health front and you can get these treatments are progressing nicely vaccines are progressing you could see another stimulus bill it seems like the folks in Washington are getting closer on that.
You could actually see fairly decent rebound next year, which could result in a steepener in the curve.
Okay, great a lot of benefits and also opportunities to lay off some more hedges so anyway.
Anyway, we're keeping our eye on that.
Got you got you okay.
When you when you run your scenarios you have to consider that as a possible scenario.
That's perfect.
Your next question comes from the line of John Pancari from Evercore ISI. Please go ahead.
Good morning.
Morning.
Also on the on the credit front I know you mentioned the.
Your your closely tracking loss migration and does that influence your commentary around.
Nonperforming asset levels are likely to decline can you just give us do you have what your total criticized assets trends were for the third quarter and how that may break down in terms of the special mentioned versus classified.
Yes, I, we publish that in the Q.
I would say directionally its up and its mostly special mention so.
I will stay tuned for the details on that.
Okay, all right, Thanks, Bruce and then.
So on the credit side, the I wanted to see if you could just give us little bit of update on what you're seeing in your commercial real estate portfolio our unique.
Are you beginning to see stress there I know you mentioned the mall Reits, but just curious about.
Other properties, how that portfolio is trajecting. It looks like you added a fair amount to the reserve this quarter there yes.
Yes, I think it's I think it's really what we mentioned its retail hospitality, where we're focused if you click through the different asset classes office looks like it's holding up pretty well with rents being paid well.
Well multifamily looks like it's holding up pretty well, we've got our eye on trends. There. We don't have to gauge exposure to some of the cities. So Frank I guess hits like New York and San Francisco.
Get into industrial and healthcare and those are those are also holding up quite well. So the place for focuses on the retail and hospitality.
Hospitality side.
We've got an exposure to business travel, which is obviously slow, but we've got very diversified sponsors and we've got some support provided by the sponsors in terms of flagged chains, which have overlay guarantees on some of that so it's really.
Around the the other areas of of of retail and we feel like we're in pretty good shape with the reserves, we put up at this point I think what what we tried to do here was really look at.
If youre in an extended period of either lockdowns or consumer behavioral shifts that goes well into the 2021.
That puts more stress on these narrow sectors, let's make sure we have taken credit off the table and put up a sizable reserve there about our and the other thing I mentioned is we are working with all of the sponsors. We all we really thank the best sponsors out there and they're working with us and the restructuring of the properties that are having temporary dislocation. So.
And weve given some forbearance, but they are also putting some money into pay interest and keep the properties operate.
Okay. Thank you Thats helpful. If I could just ask one more on the efficiency that 100 million.
Yeah, just to confirm we do not yet know how much will fall to the bottom line of that $100 million.
Yes, Thats a.
That's good job. So we we conveyed to be communicated appropriately. So we are.
We are working on that launch.
Launching a number of work streams. Some of those are in Brendans area in consumer the big Digitization push.
And so far the challenge is up to at least 100 million so that.
That's that's good news and we're going to keep trying to drive that higher we also.
We also have a couple of pages in there and some of our strategic initiatives and so one of our objectives here is to really keep investing for our future. So that we come out of this.
The challenging period, and even better position, but a stronger franchise, that's position to grow and to.
We intend to do well and so we're working through a the pacing of some of those investments and which ones to prioritize so we're kind of.
Reluctant at this point to give you a full update on expense guidance until we complete that work, but I'm sure. We knew there was going to be a clamoring for what if you've got so far so we put the number out there stay tuned to January we'll give you all of that into context of our full year guidance that we gave.
Really January earnings call.
Got it all right. Thanks.
Sure.
Your next question comes from the line of Ken I was then from Jefferies. Please go ahead.
Oh, Thanks, good morning, guys.
Hey, if I could just follow up on the last question a little bit so.
Top six.
You're on track and you still have another 75 to 100 by year end and then the new hundred on top of that not looking for expense guidance, but but just can you help us understand of that 175 to 200 that you had minimal you expect to get next year. The approximate mix of like what comes through expenses of that and what comes through revenue. So that because you are.
Talking about like these new revenue opportunities as you just alluded to Bruce thanks.
Yes, I'll go ahead and take that I mean, I think in the majority of this as an expense driven program. There are some revenue opportunities that are there in the traditional top program as we have done historically, but for example, the transformation piece of this is 100% expenses for the most part and.
I would say that that's really the main driver of the program, but we also do use the program to fund.
To fund revenue.
Opportunities as well and to drive outside the on on that front I would I would hasten to add to that when you start start during the numbers you're looking at run rate target of around 220 to 25 by the end of this year that rises to as high as 325. So there is 100, there and then we also mentioned the additional 100.
Leased that Bruce mentioned as well so we want to make sure that we werent, losing track of those different hundreds yeah exam.
Exactly yes.
Okay very good and then second question just John on the on the PPP in general many banks have thought through that forgive us might start in the fourth quarter. It seems like you guys are conservative in terms of not at least putting it in your or your.
Our Eni guide, but can you just help us understand and I know, it's more of a timing question, but just what you expect and how do you expect this to all go with regardless with regard to forgiveness timing and also just how much was PPP in Threeq you.
Well thanks, guys appreciate it.
Sure I'll start off and maybe maybe Brendan will comment on it but in terms of process I mean, the forgiveness process can take up to five months Theres theres, many steps that have to be made.
Maybe Brian can talk about the invitation approach that we're taking in the fourth quarter.
But.
I think that.
Our view is given the complexity there that it would be appropriate to two.
In the outlook did not include any.
Acceleration with respect to forgiveness doesn't benefit that said, we do we do as you know the way. The accounting works is that we are incorporating the expected fees on add on.
Not real basis over the life of the 24 months of these loans and so every quarter that goes by we are recognizing Pierre now that is attributable to the PPP program.
In the third quarter.
The yield on the program is nearing hearing you somewhere.
Somewhere between.
Nearing 3% in terms of yield and and from a pre tax standpoint, if you maybe in the $25 million range.
For for the third quarter. So that gives you a sense at all of that and I call. It pre tax all of that that that's really after the expenses up a tiny bit higher.
On the Eni line, so and that number will be no forgiveness, we'll see that again in a similar number in the fourth quarter.
Given the way that the accounting works and if forgiveness really it's really a one age 2021 event as we are forecasting and I would say one thing that spruce and then I'll, let Brent and go ahead Ken.
Ken initially.
We take it out over roughly a quarter. So I think we had 140 $150 million.
Roughly to amortized on a straight line basis.
But we thought that forgiveness would occur much sooner than we had thought some of that will trickle into Q3 and Q4.
But.
Now it looks like that will largely be.
21st half 21 event.
But the spike is going to be lower since the longer. This goes towards the end of the period that you won't get the same spike as if you had a massive acceleration into say Q3.
That would have really altered the timing in a material way.
But at this point since we are steadily recognizing and then there's less time remaining to accelerate.
Spike shouldn't be as dramatic just to just make that mathematical flows.
On the on the timing the one thing I'd just add is keep in mind, the customer doesn't need to incur interest charges until October of next year, and so theres no huge pressure point for our customers to apply for forgiveness right the second and so with.
They don't have to pay they don't have to pay so so.
With the various bills going through Congress that would possibly quite positive to these customers. There is a bit of a waiting game and that's what we're hearing from most customers is that they'd rather wait and see what flexibilities afforded to them before they jump in and start with forgiveness process. So we're getting a handful trickled in and then to John's point once the customer provides all their docket.
Based on the FDA still has a three month window to stab at it and say, yes is able to be forgiven and that the recognition of that is on the SPX stance. So there's there's a bit of a tail on this we expect that as a first point in John pointed out to be.
I think some small business owners are being cautious here and just holding onto that cash to see what the forgiveness terms out of it.
I have to pay it back which is one of the reasons, we saw elevated cash balances so that it fits into their own pocket to keep the lights go on in the business and so.
We will.
I think there's just a bit of caution generally as you said.
Understood. One just quick clarification, Jon that 25 million pre tax was that the fee part of it or is that also with the eni the distance from the loan yield.
Yes.
I think part of it and the Eni, it's all it's all in and Thats consumer.
And commercial.
Okay. So thats the all in what you had from ppb. Thanks.
Your next question comes from the line of Ken Zerbe from Morgan Stanley. Please go ahead.
Great. Thanks.
So just in terms of credit it sounds like the management overlays drove most of the reserve build this quarter.
What did your C. So model if we look at Cecil by itself actually tell you to do at the reserves.
I think it's hard to parse it can actually because.
To us the Cecil model is not just a macro forecast it's a.
Process that involves many many many variables.
And management judgment as one of those variables so.
I think it's just hard to parse.
Got it Okay, and then maybe just on the same topic I guess.
I guess why apply that management overlays this quarter I am sure you had some in the earlier in the year, but it seems like maybe this quarter had more of the qualitative adjustment rather that ER.
I think I think we've had overlays or qualitative factors are part of the process every quarter I think the reason to call. These out was you had a slight divergence it looked like the macro forecast was a little better the backdrop was a little better but what we're seeing is that a concern.
Similar behavior and the effect of Lockdowns is going to be more prolonged than I think we saw when we were assessing it in the first quarter and second quarter.
We think it could be.
Well into 2021 before we get back to that life as we knew it into a normal lifestyle, which means these retail and hospitality entertainment travel all of that genre.
And still be in a difficult.
Difficult situation for longer so you wouldn't necessarily picked that up from your macro forecast I mean, that's a that's a kind of unique aspect of certain businesses are disproportionately impacted from the new normal about how we're living our lives.
So that's why we're calling it out.
All right great. Thank you.
Your next question comes from the line of Vivek Juneja from JP Morgan. Please go ahead.
Hi.
Couple of five and then just follow up on on site.
On some of the teams that have been coming up.
The release and reserves, Bruce and John that you're expecting in the fourth quarter, which loan categories do you think.
But you are expecting to see that at this.
At this point, where where's that visibility coming from.
Yes, I mean I'll go.
And take that it back it's kind of like the way the way. So work as you know I mean, we we provide for all of the loans that we believe that are outstanding at September Thirtyth for the loss content that we see after considering our macroeconomic scenario and then our qualitative factors that we review by loan category.
And if we're right and it's very hard to say that you can be there so much so much uncertainty that.
A lot of that building.
In the third quarter came through the commercial.
Folios and.
As we mentioned earlier cream retail and hospitality and we also mentioned casual dining sectors, where we've where we built reserves. So once that's done then.
Radically at least you're just going to charge off against those reserves going forward, assuming you were right about what the loss content is and what the scenarios will be there.
The rest of humor, Provisionings and would only be focused on your front book activity and growth So where we are.
Where we are going to grow going forward, let's say for example in the residential mortgage and student and merchant spaces, we would provide additional reserves for those loans as they come on as well as the cnine loans that were going to see as you get to the end of the fourth quarter. So it really is.
Just sort of look at it and those two buckets.
Waste.
Just take an assumption that the environment won't deteriorate at a meaningful way so that you don't need to add to it.
Further reserves around the back book now there could be some of that but we don't see it.
A sufficient amount of it to result in a reserve build in a nature reserve build.
Okay, and what are you thinking about the.
Student loan book because that.
For best rate has stayed pretty high it hasn't come down its higher than even resi mortgages can you comment on why that's the case.
They just not come up for.
How long is the forbearance period have they just not come up yet or have they gone on what percentage of gone in for an extension of the deferral. So.
So so we're actually starting to see it you're down a little bit in the recent in the recent weeks it was lagging a little bit principally because.
A majority of our student loan book, a student loan re Fi and a lot of those customers also have government loans, which had significant forbearance period that were cut automatically granted in some customers were triggered by the government event and they call all the private lenders and banks and raise our hands forbearance and there's sort of no no reason.
Reason for them to de link those two so.
Ben.
Aggressively working with our customers to make sure we try to understand where theyre at and the capacity to pay but if they are still on the facts we Ben.
Hi, I'm, a little bit of leeway to land on their feet, but every underlying dynamic we see in that portfolio is quite positive for call. It a super Prime portfolio. The credit is 780 plus in that.
In that portfolio and particularly in the re Fi portfolio they'll make six figure income that's the sector. That's been a least impacted by unemployment and so we feel quite strong that this is.
There is no significant underlying dynamic thats different student than any other portfolio in consumer.
Great. Thank you.
Your next question comes from the line of Saul Martinez from you BCS. Please go ahead.
Hey, good morning, guys.
Hi.
Yes.
Okay.
So so good morning.
First.
John You mentioned.
You the hedges should mostly roll off in the headwinds from the hedges rolling off should be pretty.
Most part.
Fully realized by the end of 21, and certainly 22 and I think we've estimated that the headwinds probably in the $250 million annualized.
From the hedges Rolling off can you is there any can you just give us a sense of the magnitude of the incremental headwinds as our numbers more or less right and how should we see that those incremental headwinds sort of material.
And 21, and it's one of the few.
I would be a fraction of that I, you know without really getting into the covers its not nearly that big it's not it's nowhere near that from what we can see how we how we track through 2020 I mean, you got it you got to think about.
Where where what the terms on which we which we publish and you can see with the terms are on on those those amounts I believe.
It's much much lower than that.
And and I'd say.
And I'd say to just bring it back bigger picture to you sure. Those are those are running off.
Mortgage business has been part of our hedging strategy all along the majority of the NIM headwinds on a cumulative basis are being offset.
In 2020, and 2021 by the mortgage business and we also have a very significant lever with respect to interest bearing deposit costs. This turnaround in reserve given all of the investments we've made in the analytics and product capabilities and orientation of our bank across consumer.
And commercial with respect to the relationship driven deposit gathering that we have embarked upon which takes years to do that started.
Many years ago. So we're starting to see that bear fruit those things I think about when you're when you're.
Trying to.
Consider the puts and takes for next year.
Yes, no I get that but maybe you can go mechanics offline, but is there does seem to be a sense from.
The investment community.
Headwinds are we're talking about on a static basis not factoring in some of the some of the offsets are in the hundreds of millions of dollars, but just to be clear, you're saying that that estimate just on a static basis nothing else just hedges rolling off that that number is way too high is that.
Correct.
That's correct, that's correct and we can take you through the math on that offline with with some publicly available information and we'll just make sure that you can you're seeing at the way we see it.
Okay.
One other question on an eye on.
What are you assuming for forgiveness in.
Ultimately throughout the course of the first half.
First half of next year, what percentage of loans.
So the full per se. So we're that's a 15% handle that we won't be forgiven on the back end and so the other 85% will come through mostly in one aged I felt so theres some that will come through as well.
Got it okay. Thanks a lot.
Okay.
Yeah.
Got it no one more just one more question. Okay. We'll take one more question that question comes from the line of Dave Rochester from Compass point. Please go ahead.
Hey, good morning, guys.
Hi.
On your NIM guidance I was just curious how much deposit growth, you're assuming that feeds into that if any or if you're looking for more continued favorable mix shift that you've been having there.
Moving to lower cost.
Yes, it's primarily it's primarily a mix shift story I mean, we've got we've gotten surge deposits like many other banks.
We think some of that May may stick around for quite a while and well into 2021, so theres that benefit we pay down and get everything you can pay down and were sitting around with some excess cash and so excess cash as a drag on NIM call. It about a two basis point drag or so in.
On a quarter over quarter basis in the fourth quarter, but it's.
But it's getting up to me or call. It eight to 10 basis points on an absolute basis in the fourth quarter, all that excess cash we'll see we'll have to see that pay down over time, but as it as it relates to deposits.
We're seeing great mix shift into DTA, we've had.
I think three years running now peer leading DTA growth and that's part of the next story and it's just accelerating that that trend that already whats happening with us.
That's nice to see on the deposit side.
Yeah, well you mentioned the cash that's sitting there I mean are there any lumpy maturities on the borrowing side that maybe you can take advantage of and use some of that cash to pay those down anything over the next year that we can look for that of course.
Well Jim.
Yeah, not a lot. So we are.
Our fluff funds are down to zero.
And then our senior debt, we only have very very modest and mature.
Maturities coming in on early 2020 wanting a switch it's called one issue and we did a sub debt exchange. So we're working that as much as we can but not not a huge amount of opportunity there.
Yes.
And then if you guys have any color on new loan yields on securities purchase yields that you guys are seeing today I'm just trying to get a transfer where we could ultimately be going on the average earning asset yield. If we continue to see this black curve over the next couple of years.
And so for Securities I'll take and yes.
Maybe.
But I want to talk about spreads, but I mean on the loan side, but it's it's not a great story on the security side. There was a 40 45 basis point call it negative front foot back book.
In terms of run off which comes off at around call. It 190 basis points and you've got reinvestment coming on at around 140 or 145 on the front book for Securities. So that's that's the story there I think income.
In commercial we're seeing strong sort of spreads are up but rates are down. So that's good in the consumer side of things, we're seeing some interesting positive trends there and in auto which has been quite good.
And really strong spreads there and maybe I'll, just let donovan and anything else.
I think yes auto has been very strong student loan refi has also been very strong we're seeing a significant increase in margin across basically all all the products. So.
They've also talked merchant we just.
Nice string of wins and Apple just launched there is launching our new profit our merchant business kind of has the profile of the credit card business.
Business, Apple, we're going into the new product release for them right now at the Fiveg falling somewhere.
They ask about that Microsoft all access.
As geared up for it as Big watch right now seasonally and just watch that as John pointed out earlier five new merchant partners.
Really centered in home improvement electronics and fitness similar.
Similar to our pellets on relationship of the harm so.
We're really bullish about the growth there, we're actually getting some some really decent momentum that should really help offset some of the the yield headwind from some of the other portfolios by bringing in something of that high.
And on commercial jet, we generally getting anywhere from 10 to 30 basis points better spreads on on new originations and we're also putting LIBOR floors and a lot of transactions, which are helping the overall yield at that.
That seems to be holding okay, alright, thanks for the question.
I appreciate it.
Okay, I think thats a thats.
For the Q. Thanks again for dialing in today, everyone. We appreciate your interest and support.
Have a great day and everybody stay well.
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