Q1 2021 Citizens Financial Group Inc Earnings Call
Okay.
Good morning, everyone and welcome to the citizens financial group first quarter, 2021 and earnings conference call.
My name is Ellen and I'll be your operator today.
Currently all participants are in a listen only mode. Following the presentation and we will conduct a brief question and answer session.
As a reminder of this event is being recorded.
Now I'll turn the call over to Kristen Silverberg Executive Vice President of Investor Relations Christian you may begin.
Thank you Alan good morning, everyone and thank you for joining us that's.
This morning, our chairman and CEO, Bruce Van Zone, and CFO, John Woods will provide an overview of first reported results referencing a presentation, which you can find on our Investor Relations website. After the presentation, we'll be happy to take questions. Brendan Coughlin head of consumer banking is also here to provide additional color John.
Mccree head of commercial banking, who usually joins us and the personal conflict today and.
As of today will include forward looking statements, which are subject to risks and uncertainties that may cause our results to differ materially from expectations. These are outlines the 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.
We actually in the appendix with that I will hand over to Bruce. Thanks, Christian Good morning, everyone and thanks for joining our call today.
We're pleased to get off to a good start to 2021 is our business model continues to demonstrate the strength diversification and resilience notwithstanding continuing impacts from the pandemic.
We continue to focus on taking good care of customers highlighted by $1 8 billion of PPP loans and the latest round of the program.
We've kept our colleagues safe and productive and we continue to drive benefits to our communities through various grants and strong levels of volunteerism.
Our strategic initiatives remain on track and will lead to increasing differentiation and growth and franchise value versus peers overtime.
Our financial headlines are terrific.
And we're flattered by a large reserve release, given the improved economic outlook, we delivered underlying Q1 EPS of $1 41, and Aro TCE of 17, 6%, while our CET one ratio grew to $10 one per cent and our liquidity remains elevated with and 81%.
Warner and volume to deposit ratio.
The first half of the year can be thought of as the transition period for us in terms of P. PNR as the rack.
And levels of mortgage revenue normalized.
While we are still seeing strong levels of originations, both refi and purchase elevated margins have been returning to historical levels as the industry capacity has expanded and competition has intensified.
We currently expect mortgage revenues broadly to bottom in Q2, and then stabilized and the second half.
During the first quarter, we saw strength and capital markets and wealth fees, which partially offset the drop in mortgage fees. This should continue into Q2, and we should start to see loan growth pick up as well, which provides a further offset.
The outlook for the second half P. P and our is strengthening as we expect loan growth plus the stabilized NIM given the steeper curve to help deliver top line growth.
This combined with strong pull through of our top benefits and overall expense discipline should result in healthy levels of positive operating leverage in Q3, Q4, and the second half along with returned to solid PPA and our growth.
The outlook for credit also continues to brighten with the negative provision of 140 million and the first quarter. Our ACL ratio ex PPP loans is now two point or three per cent.
This compares with our day, one ACL upon and seasonal adoption of 147%, so theres likely still more to go and reserve releasing assuming the economic outlook continues to affirm and clarify.
All of our credit trends continue to be favorable both on the consumer and commercial side, we've moved our charge off guidance for full year, 2021% to 35% to 45 basis points from the initial guidance of 50 to 65 basis points.
So to sum up and we feel we're off to a great start the economic outlook continues to improve and we are executing well on the initiatives that will position us over time as the top performing bank.
With that I'll turn it over to John.
Thanks, Bruce and good morning, everyone.
Let me start with the headlines for the quarter.
We reported underlying net income of 626 million and EPS of $1 41.
Our underlying royalty from the quarter was 17, 6%, which includes the impact of a sizable reserve release.
Revenue of $1 7 billion was broadly stable year over year strong fee income offsetting the impact of the low rate environment on NII.
Highlights include continued strength and capital markets record results and wealth and well controlled expenses.
We recorded a negative provision for credit losses of $140 million, which reflects strong credit performance with lower charge offs and improving loan portfolio of profile.
And and improving macroeconomic outlook with our ACL ratio now at 2.0% to 3% excluding PPP loans.
And finally, we are and a very strong capital position with one of 10, 1% after returning $262 million to shareholders and dividends and share repurchases during the quarter.
We also continued to grow our tangible book value per share, which was $32 79 at quarter end of 3% compared with a year ago.
Next I'll refer to a few of the slides and give you some key takeaways for the first quarter of.
And then the outline of our outlook for the second quarter and provide some comments on 2020 one.
Net interest income on slide six was down 1% linked quarter, given lower day count.
And balances were broadly stable and net interest margin was up slightly.
The net interest margin improvement reflects the steepening yield curve and continued discipline on deposit pricing.
Interest bearing deposit costs are down seven basis points to 20 basis points, which more than offset the impact of lower asset yields.
We expect that elevated deposit levels from recent stimulus and will continue to impact margin and the near term.
We will continue to be proactive and pricing down deposits and pursuing attractive loan growth opportunities in areas like point of sale of finance and education as well as an attractive commercial segments.
The steepening of the current provided us with the opportunity to begin and adding to our hedge positions to moderate our asset sensitivity.
We added $7 billion of five year received fixed cash flow swaps and terminated some pay fix swaps during the course of the quarter.
Those actions combined with expected balance sheet changes reduced our asset sensitivity to about eight 5% from 10, 8% at the end of the year.
The Florida, referring to slide seven we delivered solid fee results again, this quarter, reflecting our ongoing efforts to invest in and diversify our revenue streams and.
As expected mortgage fees were down approximately 15% this quarter. Despite the strong volumes has heightened competition and increased industry capacity pressured gain on sale margins.
Nonetheless mortgage fees were still strong compared to a year ago, and we expect the continued strong level of originations across all channels over 2021, as the market shifts to being more balanced between refi and purchase activities.
2021 is expected to be the strongest home purchase market and history only restrained by housing inventories.
Wealth fees were a record of 12% linked quarter, reflecting an increase in AUM from net inflows and strong market levels with record sales.
Capital markets fees remained robust.
We're down 8% from a record level and the fourth quarter with lower M&A advisory fees, partly offset by increased underwriting revenue.
Foreign exchange and interest rate products revenue decreased $7 million linked quarter, given the reduced client hedging as a result of less lending activity and lower volatility.
Expenses on slide eight were well controlled up 3% linked quarter, driven by seasonality and salaries and employee benefits were.
We're continuing to focus on both the transformation transformational and business as usual aspects of our top six program and we are on track to deliver total pre tax run rate benefit of $400 million to $425 million by the end of 2021.
Average loans on slide nine were broadly stable linked quarter as commercial payoffs and slightly lower loan yield line utilization of about 32% compared to the historical average of roughly 37%.
It was partially offset by growth and our education mortgage and point of sale finance portfolios.
Looking at year over year trends average loans were up approximately 1% to the PPP education and mortgage.
We executed the PPP lending program very smoothly with $1 8 billion of loans secured as part of Brown to taking the total PPP loans to $5 1 billion of period end.
We expect that about 85 per cent of the round one loans will be forgiven by the end of the year and for round two of which our five year loans about 20% can be forgiven by the end of 'twenty, one and about 70% forgiven after two years.
Overall, the PPP program will help stabilize NII and the first half of the year, while the benefit will taper off a little and the second half.
On slide 10 deposit flows benefited from the recent consumer oriented the stimulus, especially and low cost categories and our liquidity ratio has remained strong.
Average deposits were up 1% linked quarter, and 16% year over year as consumers and small businesses benefited from government stimulus and commercial clients built liquidity.
We are very pleased with our progress on deposit repricing with total deposit costs down five basis points to 14 basis points and.
And interest bearing deposit costs down seven basis points to 20 basis points during the quarter.
We continue to drive the shift towards lower cost categories. The PTA now of about 30% of average deposits compared with only 23% of year ago.
The strength of our deposit franchise is becoming very clear given all of the investments we've made including the launch of our digital bank enhanced data analytics and introducing new cash management tools for our commercial clients.
At the end of the last low rate cycle, and 2015, our interest bearing deposit costs bottomed at about 34 basis points.
This cycle and we're already at 20 basis points and we expect these costs to decrease to the low teens by the end of the year as we execute our deposit playbook.
Moving on to credit on slide slides 11, and 12, we saw strong credit results this quarter net.
Net charge offs were down nine basis points to 52 basis points linked quarter.
This is at the lower end of our guidance for the first quarter and driven by a reduction and commercial.
First quarter commercial net charge offs included charge offs and areas of market concern, including pre retail casual dining and one large charge off related to the financial sponsor.
Non accrual loans decreased $11 million linked quarter with of $76 million increase and commercial driven by charge offs loans sales activity and repayments.
Retail non accrual loans increased by $65 million linked quarter, driven by mortgage loans coming off of forbearance. However, given the strength of the housing market with inventories at historical lows and strong Ltvs and our book, we expect little to note the loss content and these mortgages.
In addition, our commercial criticized loans continued to trend down this quarter decreasing by $495 million of 11%.
Given the improvement and the macroeconomic outlook and performance of the portfolio, our reserves decreased but remain robust ending the quarter at $2 two of 3%, excluding PPP loans compared with $2 two 4% of the ended and the fourth quarter.
And this is still significantly higher than our 147% day, one and seasonal implementation coverage.
We anticipate there likely will be further reserve releases, assuming the macroeconomic outlook continues to strengthen and solidify.
We have some detailed credit slides and the appendix for your reference one on slide 22 current commercial credit.
Since the start of the COVID-19 crisis, we have been highlighting the commercial areas most impacted by the lockdown.
As we continue to see improvements and the operating environment. These areas of concern have and have decreased to two 3% of the total CFC loan portfolio down from four 6% and <unk> 'twenty and approximately 11% of <unk> 'twenty.
The remaining areas of concern and <unk>.
<unk>, <unk> retail and hospitality casual dining and Arts entertainment and recreation.
And accordingly, we are maintaining prudent reserve allocations, where the reserve coverage of about 10% of these areas.
We remained and maintained excellent balance sheet strength as shown on slide 13, and increasing our set one ratio from 10% and <unk> to 10, 1% at the end of the first quarter, which is slightly above our target operating range after returning $262 million and capital to shareholders and the quarter.
Before I move onto our <unk> outlook, let me highlight some exciting things that are happening across the company on slide 14.
On the left side of the page we were very pleased to be able to provide about $1 8 billion of new PPP loans through the latest SBA program, providing critical funding to over 30000 of our small business customers.
On the consumer side, we recently announced the expansion of our national point of sale offering from merchants through our citizens pay offering.
We are continuing to add new merchants to our point of sale platform, such as Bj's wholesale club with more and the pipeline and the portfolio was up 8% year over year.
In addition, we continue to make great strides and our digital transformation with our digital sales of 48% year over year.
Clearly our customers are demanding of different distribution models from us one that allows for more efficient digital transactions, and and and and advice oriented focus and our branches.
We launched our new mobile App on iOS and January which is receiving great reviews with an average of four six stars and the App store.
And commercial we have built out of robust corporate finance advisory model, which is supporting our geographic expansion efforts, our capital markets business delivered its second best quarter ever and the first quarter demonstrating.
Demonstrating the benefits of the investments we've made over the last few years.
On the right side of the page you can see a high level view of our strategic priorities all of which remain on track.
And now for some high level commentary on the outlook for the second quarter on slide 15.
We expect NII to be up to two two and 5% with NIM up modestly more broadly stable excluding elevated cash.
We expect loan growth of one 5% to 2% and the second quarter, followed by an acceleration and the back of the year.
Earning assets are expected to be broadly stable and the second quarter.
Fee income is expected to be down high single digits, reflecting lower mortgage banking fees as gain on sale margins declined further towards more normal levels, partially offset by strength across many of the remaining fee categories.
Noninterest expense is expected to be down slightly.
We expect net charge offs will be and the range of 30 to 40 basis points of the average loans with a meaningful reserve release through provision.
Before I wrap up I'd like to provide some comments on this transition period towards economic recovery and our 2021 full year outlook.
First we remain confident and our 2021 and our outlook with NII higher and fee slightly lower than our original guidance let.
Let me give you some further color on the puts and takes.
We're expecting loan growth to really pick up and to age 21, driven by student and point of sale auto and mortgage as well as commercial utilization starting to rise from historical lows as the economy volume stable footing and companies begin to invest for growth.
Coupled with the steep building the steeper yield curve this encourage our NII outlook.
Our outlook for fees of slightly lower driven by mortgage as we expect additional pressure on gain on sale margins as they begin to migrate lower.
And the curve Steepens, we should see a transition to greater contributions from purchase of our originations and servicing.
We have included some additional detail and the mortgage landscape and the appendix on slide 20.
We expect other fee categories, namely capital and global markets and wealth to continue to be strong as we leverage our investments and the economy rebounds.
And other categories like car Ts and service charges and fees should also benefit as consumer confidence and spending picks up.
Given these dynamics, we expect PPE and hard to bottom and the second quarter, and then rebound to levels higher than the first quarter for the remainder of the year given strength in NII and fees as well as well control of expenses.
We also expect to the close to neutral operating leverage in <unk> compared to <unk>, followed by meaningful positive operating leverage and the second half.
We are also expecting a substantially better credit outlook for the full year GAAP.
Given the strong performance of the loan portfolio and improvement and the macroeconomic forecast, we're reducing our full year charge off guidance range to 35% to 45 basis points and with this improvement. We can also see our ACL ratio declined meaningfully from the current and $2 three of 3% 2.0 of 3% ex PPP.
To wrap up this was a strong start to 2021 for citizens as we begin to transition away from the effects of the pandemic to an improving outlook for interest rates and economic growth.
And while staying focused on executing across our strategic initiatives with that I'll hand, it back over to Bruce.
Alright, Thanks John.
Operator, let's open it up to the Q&A.
Okay.
And thank you.
Ladies and gentlemen.
And we will now begin the the Q&A portion of the conference call if you'd like to ask a question. Please press one and then zero on your Touchtone phone, you'll hear and indication you've been placed in the queue and you may remove yourself from two by repeating the one the zero command.
And if youre using the speaker phone, we ask you to please pick up your handset and makes it and your phone is on mute it before pressing any buttons.
Again for questions Bruce One then zero at this time.
Our first question will come from the line of Matt O'connor with Deutsche Bank go ahead.
Hi, Good morning, your outlook for loan growth is a bit better than what we've heard so far from other folks and with just wondering if you could elaborate on the drivers of both in the near term.
And then how robust you think loan growth can be kind of when the thing fully reopen and I'll call. It later this year and into next year.
And so I'll start off of that Matt and others may weigh in here, but and the near term I think that the strength that we're seeing is really attributable to our diversified consumer lending and retail businesses. When you see what we've been able to do and the mortgage portfolio auto and education I think those are areas that have been areas of.
And the vast and will continue to be and the second quarter.
And I also believe that debt when we get into the second quarter youre going to start to see although across the industry, we've seen utilization levels.
Down a bit and the first quarter I think we believe that that will start to moderate and stabilize and possibly start to head back up off of historic lows historic low levels. So you can see commercial contributing as well and the second quarter and and as you said.
And <unk>.
And I will create the.
The staging ground if you will for what we see and the second half.
And where the.
The continuing expectations for reopening.
Economic activity accelerating on the commercial side inventories building.
Capex expenditure starting to.
Recover and increase so those are the those are the forces that we see in terms of loan growth.
Throughout the year.
Yes on the consumer side of thanks, Sean.
And I'd offer a couple of thoughts.
And across all the asset categories.
Excuse me unwound and.
Credit tightening and we did through Covid and so we haven't changed and our risk appetite, but the temporary tightenings that we did those are now broadly unwound and so we should see originations pick up across all categories. We've also turned on marketing that we had artificially suppressed last year as well.
Asset by asset.
At the guys mentioned last quarter, we had sort of put auto and a flat ish trend intentionally the the market always allowed for us to grow but we were optimizing our balance sheet with all of the excess deposits. We have now and the short duration and we're finding incredibly high returns and the auto business. So you should expect that to continue to moderately grow assuming of the environment allows.
As for outsized returns, which we're not seeing a slowdown.
And the student side, we have.
A record quarter, and Earl and our costs and we'll refinance product that over 900 million and originations that could moderate a tiny bit of its still at record levels, giving high rates and if the as the federal portfolio of student loans come off their forbearance and September that will provide another opportunity for growth and then seasonally are in school of business. We're in.
Speaking of very big year of a lot of students took the year off given COVID-19 of big freshman class coming in and just seasonal growth and the summer and the fall and lastly.
And of point of sale is an area that we've spent a lot of time and investment and we've got great traction we're up to about 15 partners. So we're in the build phase there, whereas these partners ramp of your naturally getting sort of outsized outsized growth from the law of small numbers as the portfolio gets to scale. So I've got a lot of confidence and the <unk>.
Look and consumer growth and underpinning that is obviously improvement and consumer confidence.
Just to add it's Bruce Matt just one last proof point on the commercial side. In addition to line utilization, which is seeing activity start to build so our pipelines are much stronger at this point than they were early in the first quarter. So.
So that's a good sign of both economic activity backlogs and the M&A.
Phil pretty high so are we.
And we see line utilization kicking and plus just the fresh deals and.
We continue to add bankers and grow our market share.
And as most of the.
The men and building commercial related to deals.
As he just referenced or is there also kind of.
From early signs of increased call it organic investment among our commercial borrowers I think there's I think there's some of both of that quite honestly so.
Right now you can see the economic stats are fantastic and so people are positioning to try to capture that demand and so that base increasing supply.
Requires some capital investment and then also lay.
Labor, bringing people back to work, which frankly, when we talk to many of our corporate customers has been a gating factor, it's hard to actually fill out their their needs and we.
We're trying to be helpful on that with some initiatives around workforce development, but.
The animal spirits are starting to.
Kick in here.
Okay. Thank you.
We will move the next to the line of Erika Najarian with Bank of America go ahead. Please.
Hi, good morning.
A follow up to Matts question, because I want to make sure of the market really understands this and a lot of your larger peers and where are the consumer exposure is more credit card related.
Really talk to us over the past couple of days about how deleveraging with going to negatively impact demand and perhaps.
And maybe give us a little bit more detail about why your consumer products are not necessarily going to be impacted the same as credit card.
Yes, Erika and thanks, It's Brendan I'll, just say of credit card book is significantly.
Smaller than our peers on a average basis to our overall loan book and so we are seeing a little bit of those dynamics and our credit card portfolio, we're not calling for growth and a credit card, but that delevering of our card book with all the extra stimulus is a much more muted impact for us on our overall consumer lending portfolio than others, just given the relative under <unk>.
The nature of our card book so.
We found opportunities to grow and more niche places like point of sale, which is.
And the demand is generated by purchase activity and as the economy rebounds consumer confidence comes back folks are out there buying bigger ticket items again, and the point of sale business was there to help and.
Very naturally lined up against the recovery of consumer spending on how we think about modern and financing for consumers and <unk>.
The rates are going up they are still very very low and sort of looking at student loan refinancing as I mentioned before is something that's still going to be very very strong because of lot of customers that are and the money and thats the product that our peers generally speaking don't have and so that's generating outsized growth for us and similarly and students in school business as I mentioned before seasonally.
And just naturally that we're going to have some growth just by being in that business and the back half of the year, which most of most of our peers don't have.
And although again not to be too redundant, but we had intentionally sign line on it so we're back and in growth mode, there and a moderate level. So when you add all of that up I think we've got a lot of confidence that we're going to buck the trends that youre hearing from others.
And and we're proving that the numbers show in Los Angeles of quarters that were already delivering and even through the COVID-19 period.
Add to that diversification is important and so we have from.
The more portfolios and some well targeted portfolios and niches.
Should continue to still grow so thats I think while it will we will kind of books of tied a little bit.
Overall in the I would just add also the outlook for.
Of the so-called buy now pay later of installment financing kind of.
Tailoring products to people of point of sale is very very positive I think the industry forecast for that is 20% growth over the next five years and part it's much much lower first you have to get the rebound of upon I think the low single digit in terms of the growth outlook. There. So I think we've made a bet that this is going to be a burgeoning attractive area.
And we're well positioned to catch someone here.
Okay and my second question is on the margin outlook for the second quarter, and and perhaps a little bit beyond and thank you for giving us and update on how you're expecting PPP to unfold for the rest of the year I'm wondering and the same up modestly guide how much forgiveness, Inc.
I assume for the second quarter.
And and also maybe give an outlook on how you're how you're thinking about redeploying the excess cash for the rest of the year.
Yes, I'll try and take that Erika and I think just to focus on the second quarter I think that the rate environment is favorable to us and others, but I think that we're seeing nice tailwind from the rate of long long and rise.
And I'd also referenced the fact that.
We've added to our hedge portfolio and the first quarter and that's that's contributing and.
And we'll get a full quarter effect of that and the second quarter and just our overall mix.
And.
On both of the asset and deposit side zone, so greater GVA and GTA.
And the first quarter and that's that's flowing into the second quarter and don't forget some of the comments I made earlier about about our deposit costs and that's that's a lever that continues to contribute and those are some of the important I think drivers into the into two Q with more room to run there.
And the 20 basis points coming down to sort of.
Into the teens ended the second quarter and into the low teens as you get to the end of the year. So those are some of the forces PPP is less of a less of a contributor and it's pretty as we mentioned it stabilizes overall NII.
And in terms of in terms of NIM.
No real.
Meaningful difference between.
Forgiveness last quarter versus this quarter or next quarter. So it's really not a driver over the over the last quarter or next.
Got it just to clarify so the forces that are driving and higher and the second quarter all of our sort of core business trends.
They are rates rates balance sheet balance sheet mix deposit pricing.
And and and loan growth because of the things that we're really really driving us.
The further word on PPP and then John all of it right, but that's been pretty stable through the back half of last year through the first half of this year.
And you look at the yields on those loans with forgiveness baked in and it's not a big winner for the.
For the bank so.
What we had anticipated was that we'd start to see some falloff of a given the new program that was added.
Slide down and the second half of the years much less severe.
And so.
Don't think of the PPP.
This year will be a huge factor compared to last year on any sequential quarter of that that we would have to call out.
Got it thank you so much.
Yes.
We will go next to the line of John Penn Curry with Evercore ISI. Your line is open.
Good morning.
Good morning.
Regarding your commentary on the operating leverage expectation for improvement and for I think.
Incidents and.
Healthy level of operating leverage any way you can help us think about the magnitude in terms of sizing that up what type of <unk>.
Level of operating leverage and peak is achievable and in the back half and then what that could possibly mean for 2022 as you look out.
Yeah. So.
The.
And historically, if you look at.
What we were able to deliver since the IPO, we've probably been in the 300 basis points of of operating leverage.
The mode and.
EBITDA was six or 7%.
Revenue growth and then three of 4%.
<unk> growth of just kind of scaled with what the revenue environment is we tend to compress the expenses to try to maintain something like that and so.
And clearly that would be our objective over time and as.
John indicated we're kind of working through of transitory phase where the mortgage revenue has the reset it was a huge boon for last year. We did 400 basis points of operating leverage for all of last year, which was fueled by more of the so and the first half of the year as that normalizes that makes it hard to deliver the positive operating leverage although we did.
State and our guidance that we should come pretty close to neutral and and.
The second quarter and notwithstanding that set of last.
Led to drop on mortgage revenues before it stabilizes once we can get back to kind of having debt mortgage bottom out and we're seeing nice growth and our fees, we're seeing a balance sheet growth, we're seeing good performance on NIM.
And then we should get back to having a nice top line and you can count on us to continue to strength the constrained the expense growth.
We've done I think of really good job with the top program of <unk>.
Repositioning citizens to Pete.
The much.
More equipped for the future in terms of our technology. So we have of Nextgen technology element to that project, we have huge going digital and go into a digital first business model of going to that.
So it does require investment, but our mindset all along has been the self fund to try to find the inefficiencies and how we're running the place ring those out and then and term go reinvest those and I think we've demonstrated over time that we're quite good at that so.
We're managing the expense base tightly, but we're certainly keeping up with the investments that we need to position us for future growth.
Great. Thanks, Bruce and that's helpful and then separately on the consumer side on the merchant partner.
The side of the kind of a two parter first just wanted to see if you can give us a little bit of color around the risk adjusted returns youre able to get and that business in terms of maybe the ammonia yields that youre seeing on your partnerships.
Partnerships as well as the loss of assumptions and then separately I know you mentioned buy now pay later and Bruce.
And if you.
And if you believe you need more scale there to take advantage of the opportunity or if you need.
More capabilities on the digital front, and therefore would you be open to a.
And acquisition to give you greater scale or do you think the momentum you have already in the and the area is.
Sufficient thanks.
Yeah. Thanks Brendan.
I would say into the risk adjusted returns on the point of sale business. The way you should think about it is its equivalent to a credit card profile the geographies of little different the yields are a little bit lower and the losses are meaningfully lower.
But the returns are equivalent to what you'd expect on a prime card portfolio, which is why we sort of disclose the mall in the same bucket of other other retail so.
And which is great because of you think about that if youre getting equivalent credit card returns, but lower losses that are going to perform even better through the cycle. That's a very very attractive place to play and as I've shared in the past when you look at the credit performance of point of sales.
Through Covid forbearance was basically nonexistent and delinquencies were down from pre COVID-19 levels. So that portfolio is operating.
And if there was no recession or lockdown going on around us and so we're incredibly excited about that dynamic and we don't think of it was artificially created the <unk>.
Customer experience of so slick and integrated into consumers' top of wallet payment debt really were kind of getting the top payment position and that product. So.
We're very excited about that relative to acquisition and look we're really bullish on our capabilities. We think it's very distinct from what others offer in the space because of the old school traditional buy now pay later players and even relative to some of the Fintech, where we are we've got a unique niche that we've also of our balance sheet. We don't have the upload these loans and allows for a lot more creativity and.
The innovation and how we structure of the product.
And as an example, like the Apple product, where it's a revolving purchase where the customer gets the new phone every year, that's hard to do if you're reliant on capital markets to fund your business model. So we're excited about the business model. If there was an acquisition that could help us accelerate at the right price of course, we would look at it but I don't think we need one to get scale.
Great. Thank you I appreciate you taking the questions.
We will go next to Peter Winter with Wedbush Securities Go ahead.
Good morning, everyone and I wanted to ask about the average securities yield noticed it held steady quarter to quarter and I'm just wondering what the the new reinvestment rate is on the securities and <unk>.
If you are extending duration.
On that portfolio.
Yes, I mean I'll take the last question first I mean, I think the as you know most of our portfolio is and a mortgage backed security agencies.
<unk> space and so really that's the range driven outcome and pretty typical that you and as you would see.
As rates rise prepayments slow and some of those mortgage backs will extend the duration and so that's really what's going on there we didn't the actual lease of our purchase activity and endeavor to extend the duration that was just and impact of of the macro on the securities that we have.
And I think the way that and look at it.
The Securities book, It's it's basically.
A few weeks ago I might have said that our reinvestment yields could have been in the neighborhood of 175 to 180 and might have been close to where the runoff yields would be but over the last couple of weeks as you've seen the rally and rates.
Or sort of and the.
And I'll call it $1 60 range and so it'll it'll be a.
A negative front book back book.
Properly and the early part of the second quarter, but as you get into the end of the third quarter based upon what we see you can start to see securities portfolio of being the first.
The term book that starts to get to neutral on front book back book and begins to become a positive contributor into the second half and so.
And and I'd say more broadly those of the client that's the kind of dynamic youll see.
And with other loan categories as.
One by one you will see.
Improvements on that front the other thing again back to this as a broader NII.
And NIM story, but.
If we believe where rates are headed and the forces all indicate that we will get a higher long term rates as you get to the end of the year, we will continue to.
Layer in.
And our swaps.
And our swap hedging program as well, which will also contribute to NII and can have the faster the impact when you start to see the curve steepen exactly play of through swaps. So front of backlog converts from the headwinds.
Sort of the tailwind as you get to the end to end to end of the second half and then you can see our our playbook on right management of all contributing to NII and NIM.
Got it. Thank you and then just on the the allowance for credit losses, and I'm, just wondering with the improvement in credit.
How quickly do you think you can get back to that day seasonal day, one level and does that level changed just because of the composition of the portfolio of changing with more and more of the growth of more growth from consumer.
Yes, I'll go ahead and take that I mean, you've seen us.
Are come down relatively meaningfully this quarter of the way the way of seasonal works if you had perfect non.
Knowledge about where the macro is head and all of that good news and all of that expected outcome with all of the what I'll be built into our our results this quarter.
But do you also have to take into consideration the uncertainty around those expectations and the uncertainty as we're turning towards much more positive macro that uncertainty and the range of potential outcomes is still very very wide and as a result, we have a number of overlays that arent judgmental and nature that.
Sort of worked together with our model outputs to give you what you wont give you what our results are so net net the balance would be that we haven't paid per lease is happening now.
If in fact, the uncertainty around the base case begins to narrow you can see our coverage getting closer to day, one as you get into the second half and towards the end of the year.
Great. Thanks.
Okay.
We'll go next to the line of Ken Zerbe with Morgan Stanley.
Alright, great Thanks, and good morning.
I guess the first the first question just in terms of the swaps. The you put on and can you just talk about the duration of those and I understand where you're sort of in the low rate environment, but at some point of rates will rise and I'm just kind of curious how the timing of those swaps play out of your expectation for Fed fund hikes at some point.
Yes, I mean, the duration of five years on the swaps that we put onto the with the $7 billion.
And and that's relatively typical I mean, you sort of look at this on a dollar cost averaging basis. When you see the five year is really where a lot of this hedging happens and when you saw the five year growth from 40 basis points to 90 basis points and a very short period of time that said, that's a signal to trigger the first.
Sort of tranche of hedging that you will do over time and really were not what Youre doing is you are you are reducing your downside when you start to layer hedges and and so our first tranche was triggered it's contributing and a positive way it takes away and.
And reduces the risk to lower rates.
Over time, but we basically are in the RF you pause after that first sort of.
Category of hedging and you wait for the next sort of range of rates before you get into the next the next tranche and so of $7 billion is a fraction of what our overall hedging will be as you get.
And you'll get to the end of the cycle and so rather than waiting to pick the perfect spot.
And maybe a year from now and do all of our hedging all of that once you tend to do it over time and total just leg into it it's akin to the dollar cost averaging and cash level for you guys sooner and investing in your portfolios.
Yes.
The last yes.
Of the last tranche that you would do.
And if if and when the five year hits its peak and then if you have a big rally and rates those that will widen out the first tranche that you do as you get towards the towards the end of the five years. If in fact rates rates continue to rise and rise and rise. Then you have you have those those turn negative but those are more than offset.
By all of the positives of the hedging that you do as rates continue to rise.
And it makes perfect sense and then just my second question in terms of capital, obviously very strong see tier one of the 10, 1% can you just talk about your plans or expectations of how does that eventually get absorbed and now you can buy back stock, but it sounds like you're also kind of have stronger balance sheet growth.
And I think.
And I think we've said this before and our program here and our.
Our number one capital objectives are.
To support the dividend and to support organic growth and putting capital to work and support of our customers and clients. So that's really our first objective and.
And if we can do that and a way that is additive and at returns that exceed our cost of capital. We think that's the right thing to do for the franchise and so that's our focus.
As we mentioned earlier, we do have the transition to.
Loan growth beginning in the second quarter, the average loan growth, one 5% to 2%, but spot loan growth from the second quarter will be higher than that as things begin to accelerate and you could see 3% or better spot growth from the second quarter alone and seeing those numbers go higher still if the environment unfolds. The way we expect so that's our focus to the extent.
We have excess capital even after supporting all of those things and then that's when you get into.
We look at that debt returning it to shareholders through the form of of buybacks and thinking and parallel about bolt ons and <unk> acquisitions.
Alright, thank you.
Our next question will be from the Scott <unk> with Piper Sandler go ahead.
Good morning, guys. Thanks for taking the question.
The first question and sort of a follow up on the capital.
And one from the prior question.
And just given the credit concerns of kind of melting away and is there any opportunity to maybe revisit your internal.
The capital targets, a little lower the.
A little higher than some of your peers and then and of course some of that I'm sure is just due to the complexion of the balance sheet, but nonetheless, the with the risk profile, improving just would be curious to hear of any thoughts there.
Yeah, It's Bruce.
We've as you are aware of inch down overtime. So I think initially we had a 10 and a quarter target as our set one ratio and and we want to.
And then to 10 and a quarter and now were $9 75 to 10 so.
I think initially coming out of the IPO is a relatively new company without a long term track record, having a little higher.
The <unk> targets than peers made sense, you've seen through the CCAR work that.
Credit losses stress and.
The median or better slightly better than median.
And so there's really not such a significant need any longer to carry the little extra push and although I do like to sleep well at night and sort of testing.
Our strong capital ratio of helps with that.
But.
Over time, we'll see where the peer group does and if the peer group continues to inch down given the positive outlook for the foreseeable.
Foreseeable future. There is no reason that we couldn't do that as well, but at this point.
And we're locked in for this year with the 975 to 10 range and the fact.
That gives us plenty of firepower given the capital we're generating potential for future reserve releases to per.
Sue our agenda of the significant loan growth and potentially some fee based acquisitions and also giving some back to our shareholders.
Perfect Alright. Thank you and then maybe John just sort of a follow up on some of the actions you took the regarding rate sensitivity in the first quarter and I think I can sort of sort of back into some of the based on kind of what you said about duration of and things like that but I think you guys have said in the past year.
Great sensitivity of sort of $55 45 short and versus long and.
It was there and is there any meaningful change in.
And how that looks now following some of those first quarter actions.
Yes, and how much of a difference I would maybe call. It 60 40, but basically that's about where we are 60 short 40 long in terms of the complexion.
Okay perfect Alright, Thank you very much guys sure.
Next we'll go to Ken Usain with Jefferies. Your line is open.
Hey, guys. This is the Amanda Larsen on for Ken.
And I guess on the loan growth outlook from our one on one 5% and 2%.
And you did talk about the buckets, but if you can kind of just talk about the mix you would expect of gist.
Commercial versus consumer.
And <unk> that would be helpful.
Yes, and I think that.
It's kind of retail I would describe it as it's really going to be leading the way.
And the second quarter.
<unk> commercial.
Maybe a true.
It begins its march and and as the recovery really contributes to higher and higher utilization and as far as loan pipelines that you heard from Bruce earlier begin to sort of realize themselves. So I'd say and the second quarter, its probably I don't know and something in the neighborhood of two thirds, one third of the majority coming from from.
And from retail, but commercial clearly contributing and beginning to began to be a bigger contributor as you get into the second half of the year.
I think you've got some from for average loans purposes.
Got to work through some of the dynamics of the first quarter.
But what we're pretty excited about is on a spot basis, we see.
Significant growth.
And the second quarter.
Which will set us up well for the <unk>.
Growth and the second half of the year. So the the goal really and the second quarter is to really layer and that nice spot level of growth that will fully manifest itself and the average numbers. So therefore, we're at the one and a half the two.
But it does if we achieve it set us up extremely well for the third quarter.
Okay Super and then John can you just frame of the conversation on swaps with how much you earned on cash flow hedges and the first quarter and then maybe what's expected for <unk> and beyond and assuming LIBOR, it's flat from here.
Yes, I mean, the way the we've talked about that and the past is really on a year over year basis, given that the portfolio is contractual and and you can sort of see it we've talked.
Last year based upon the portfolio of that was in place at that time of day.
Debt at year from 2021 would be about a call it $75 million to $80 million decline and contribution from the swap portfolio of versus 2020 and of just with the the 7 billion that we put on and the first quarter and thats been cut in half and so the.
The the headwind from swaps is really declining if rates continue to rise from here. It's that number will continue to decline off of off of that level I think the broader point, though is you can't really look at it and isolation you've got to look at overall as.
As we indicated net interest margin being.
Broadly stable, excluding excess cash and frankly rising if you consider what's going on with the deployment of cash and what's happening with our expectations on loan growth and adequate and another reminder, on our deposit.
Our costs.
Ever that's unique to us.
We may have come down a little slower than others and and because we had a lot further to come.
And so of 20 basis points headed to sort of call. It mid teens and the second quarter headed to low teens to the end of the year. That's another driver so the big picture, including all of the swap.
Dynamics net interest and net interest margin.
And as appears to be.
And then stabilizing and will.
And as an improving picture going forward.
It's Tony.
What was the gap versus peers would serve slightly higher deposit costs and turns into the lever two of assets.
And curious environments of many of the fears of already reached levels that it is hard to improve upon and the interest bearing deposit costs, where you still have some of them to run.
And all cyclical alright, thank you so much.
We'll go next to the line of Bill card cash with Wolfe Research go ahead.
Thank you good morning, I wanted to follow up on some of your earlier comments you guys have a unique view given your mix of consumer versus commercial lending can you give a bit more color on how you see pent up demand dynamics playing out across both groups as we make further progress into the reopening it sounds like you think there'll be a bit more gearing.
Initially on the consumer risk of commercial side, but I was hoping you could just expand on that thought process and how does the excess liquidity that both groups have available play into into that.
And that thinking.
Yes, I can start on the consumer side I think.
The growth the growth that we're projecting is.
Is sort of happening underlying right now and then.
And we'll get a bit of of a tailwind from the reopening and consumer confidence growing but the structure of our products are so diversified and naturally set up to give us outsize growth I had mentioned earlier student loan refinancing you should think about that a lot like mortgage when rates are low and even though they are ticking up a little bit they are still at historically low and that creates a boom.
And of Dominion and it's almost like stimulus and other form of the stimulus for customers and that we're providing through.
Restructuring and their payments down and so that just is naturally demanded now independent of the reopening.
Similarly with point of sale.
And as the economy reopens the customers are starting to do big ticket purchases again, we're seeing our debit transaction and average ticket go up pretty significantly those transactions and now up year over year very clear consumers are starting to spend again, which means point of sale of financing is well positioned.
For growth with the economy reopening, we're seeing that anyway, even independent of another tick up of the economy reopening and auto has been a hot market.
Auto industry sales and a really really high and the market is still bearing outsized returns and so.
And while the Eaton is good and we're going to continue and we've got a diversified auto business number one J D power and the country and auto we're very well positioned to grow that business and a well controlled way with double digit ROE, which you don't typically see with auto so yes, I think as the economy reopens that should provide a bit of another <unk>.
And but.
Even even at a moderately slow place pace of the economy of reopening I still feel pretty good given the diversification of our business that will get we will get the growth that we're calling for and consumer.
Yes, and I would say, we still would expect to see some elevated cash levels and.
A lot of times that's.
And of geared to folks who worked in the service industries and.
Loss of employment and or still kind of holding onto the precautionary cash levels given given the circumstances. So.
That will I think run down fairly gradually but these other factors that Brendan mentioned.
Somewhat.
Separate from that they're not as impacted by kind of the stimulus money that's been paid out.
And then I think on the commercial side, it's really just the question of.
And how fast.
The folks take a positive view about the need to meet demand if they see demand rising.
And then they can start.
The investing and then how do they financed that they can use some of the big liquidity levels that day.
And we're able to two of mass but.
And I think you'll see that our.
Corporate cash start to drop some but then going back and borrowing on lines.
As a kind of of the next phase that you would expect to see and then some special purpose facilities to build of new plant or things like that or just the deals that continue to happen and the financing that goes with the those acquisitions. So.
We would expect.
The to see we're already starting to see that some of the cash is getting put to work and it really just depends on how fast the view.
About the current economic improvement solidifies.
That's helpful. Thank you if I could follow up on <unk>.
Do you think that the elevated payment rates that we've been seeing really and the consumer side of the.
Broadly.
Had peaked based on what you guys are seeing or.
Particularly we know what the effects of the latest stimulus checks or the.
<unk> potentially remain elevated for a bit longer here before we start to see them come down and I guess contribute a bit more to some of that improvement and balances that youre expecting.
Yeah, so that the.
Elevated the stimulus on prepayment rates is mostly felt on credit card.
We are and our guidance still calling for credit card to shrink slightly healthy purchase activity, but theres a lot of cash out and the environment as you pointed out.
Some of the prepay rates that we're seeing on other products are not necessarily stimulus driven like mortgage with a lot of churn and refinancing where we're originating taking share but the portfolio is growing but.
There's a lot of underlying prepay risk and that will start to slow as.
As the interest rates go up.
Of moderately although we still think volume and demand is going to be very very heavy but it has kind of turned towards purchase versus refi. So we should see and natural slowing of of prepay on the mortgage portfolio and also say on home equity. We don't talk about that very often it's a very big business for us and it's been slowly shrinking.
And shrinking faster and the industry, you've got a lot of the big banks that are sitting on the sidelines at the moment that have really curtailed or even shut down their home equity originations platforms. So we're enjoying.
Sure that's almost double what we naturally get which naturally get really high market share and this and this industry. So.
And I expect us to out of minimum b or <unk>.
Lower decline and others on home equity for prepay speeds, given the size and pace of our originations capacity.
And there is some optimism and potentially that we could start to see home equity flatten and.
And might be the headwind anymore for us. So there's a lot of dynamics that they could play there, but really your question around stimulus would be most filter and credit card and that is called for and our underlying guidance and more than offset by those sort of dynamics.
Understood. That's very helpful. Thank you for taking my questions.
Sure.
We'll go next to the line of Saul Martinez with UBS go ahead. Please.
Mr. Martinez Your line is open go ahead.
Sorry, sorry about that of the mute.
Hey, Thanks for taking my question.
You indicated that most of the expected decline and noninterest income is coming from lower mortgage banking fees, but that it should sort of hit a floor and the second quarter I guess I just want to understand the logic, there a little bit better what would what gives you confidence of that.
We will see a floor and we will start to see in.
<unk> Q and we won't see further and further compression in margins beyond that the pressures. The the overall fee line and then and then secondly, I'll just ask my second question now on the swaps.
Yes.
And what receive rate or are you getting on those and because I guess I understand the logic of of averaging in and leg into it but.
Maybe to I guess, the flip side of that is it does seem a little bit out of step.
On the surface to me with the view that Youre that.
And that you expect rates.
To continue to rise with it seems like maybe.
You can argue that it's a bit premature to leg into it already so you just the flesh.
Flesh that out for us a little bit.
Sure.
On mortgage.
And what we've seen happen.
Kind of starting in May.
Late third quarter into the fourth quarter was the.
And the industry gearing up Inc.
In terms of capacity, adding capacity too.
And really capture of the whole refi opportunity and.
And then you had some of these big nonbank players going public and.
And being pretty aggressive around market share so.
The the very high gain on sale margins.
We're kind of of frankly of.
Amazing and unsustainable patch and Q3.
And started to normalize back to historical levels based on those factors those forces and.
So we kind of see that playing out through the second quarter and then Rick.
Restore and kind of getting restored to levels that we've seen historically.
And the current view is unlikely to go meaningfully below that so.
That's the assumption that we're making.
The flip side to that is that there's there's also.
Our strong and our outlook for originations were looking at over three trillion and should be.
Next to.
2020 of another record year in terms of originations and we're probably seeing a shift from refi to a little bit more purchase and the mix and we're very well positioned and our retail chain of the channel the capture that.
Still looking at a strong level of origination so theres really no headwinds there at all and then.
And the size of our servicing book and the.
The MSR assets all of that should.
The offer is somewhat of an offset to the to the fall and margins. So.
So.
And we'll see so I think we've been pretty good at it.
The forecast and meets dynamics, but.
The market is the market and we'll see how it plays out but I think of <unk>.
Pretty hard about the factors and trying to project those out and so.
And we feel pretty confident that debt.
And the likely scenario for Q2, and then for the rest of the year.
So I'll stop there unless unless you want to add anything growth.
Well set of would be the ones. The one and maybe data point I would add to that and just to kind of accentuate the rebound and purchase offsetting some of the refi decline is that over the last 45 days, we've seen about a 30% growth rate and purchase volume coming through our retail channel. So.
It's not just hopes and dreams, we're seeing it actually and.
And real momentum for the business. So we feel pretty good about the volume outlook to Bruce's point.
The margins bottoming at 2019 levels is really the key assumptions and it doesn't go any deeper than historical levels, and we're seeing and starting to stabilize right now so yeah. So it will slow the flip the second question over to John Yeah, Yeah.
Yes, so the.
So I think the point here is.
We saw a pretty rapid rise and and the five year.
Over the last several months as I mentioned and I think at the end of last year was around 40 basis points it had gotten.
And frankly, north of 90, but and I think it is settling in around 80 right now.
That is really emblematic of the first sort of.
And risk triggers that we think about and.
Basically this is an interest rate risk hedging program and that hedging program.
<unk> requires us to consider where our asset sensitivity is and what the downside of exposures are and so from that perspective, we have several.
Sort of triggers and tranches of of hedging that will do over time. This is.
The first one and I think there would be another one and if it hasnt and if rates continue to rise. Although it is our expectation of the ratio continued to rise and the last sort of couple of weeks is a reminder that debt.
Things can deviate from your base case, and so we're just being prudent risk managers and taking our asset sensitivity from around 11% to something thats in the very high single digits and as we get to the top of the rate cycle, and we will get back down to something Thats, you know and the lower single and single digit similar to where we've been in the past and Thats. It.
Very prudent and sort of approach versus waiting around from the perfect time to begin to hedge and the.
And the other question you asked was what what the receive rate was <unk>.
During that range of 40 to 80 basis points and the five year range and most of that hedging towards the upper end of that range.
And that will give you the answer and a good.
Alright, Thanks, I think I think there's no more questions and the Q. So.
Again, I want to thank everybody for dialing in today, we certainly appreciate your interest and support.
Have a great day and everybody stay well thank you.
Ladies and gentlemen that concludes today's conference call. Thank you for your participation you may now disconnect.
Okay.
And I did try to bring and the speakers.
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