Q3 2022 Citizens Financial Group Inc Earnings Call
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Good morning, everyone and welcome to the citizens financial group third quarter 2022 earnings conference call.
My name is Alan 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.
As a reminder, 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 Ellen good morning, everyone and thank you for joining us.
Morning, Chairman and CEO , Bruce Van <unk>, and CFO , John Woods will provide an overview of our third quarter results Brendan Coughlin head of consumer banking and Don Mccree head of commercial banking are also argue to provide additional color we will be referencing our third quarter earnings presentation located on our Investor Relations website after the.
The presentation, we will be happy to take questions. Our comments 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 outlined for your review on page two of the presentation. We also reference non-GAAP financial measures. So it's important to review our GAAP results on page <unk>.
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<unk> and the reconciliations in the appendix with that I will hand over to various okay. Thanks, Chris and good morning, everyone. Thanks for joining our call today.
We delivered another very strong quarterly result in Q3.
Well I think rates positively impacted our net interest income and net interest margin fees.
Fees and expenses were broadly stable and credit performance remains excellent.
We grew average loans, 2% and deposits, 1% as our liquidity and funding position remained strong and our set one ratio of nine 8% is above the midpoint of our nine 5% to 10% target range.
Our TCE to total asset ratio sits at six 1%.
Performance metrics include a net interest margin of three in a quarter and that's up 21 basis points, we had positive sequential operating leverage of 6%.
We hit our efficiency ratio below 55% at our return on tangible common equity was around 18%.
Built our credit reserves by $49 million with our ACL at 141% and Thats above the one 3% day, one seasonal reserve adjusted for the investors acquisition.
Beyond these impressive financial results, we've continued to make good progress in executing our strategic initiatives.
Consumer we launched citizens private client, which will help drive wealth opportunities we migrated our national digital bank to a modern cloud based platform. We continue to grow share with citizens pay and we're executing well on our expansion into New York City Metro region.
In commercial we have successfully integrated recent acquisitions like J M. P. M T H capital into our coverage and product model. Our M&A pipelines are at record levels, and our geographic and industry vertical build out is delivering strong results in terms of market share gains.
Enterprise wide, we're successfully wrapping up our top seven program, while building out top eight stay tuned on that our next Gen. Tech program has really been the standout initiative that has been a game changer for us.
These programs demonstrate our mindset of continuous improvement finding ways to run the bank more efficiently. So we can deliver positive operating leverage and self fund investments for our future.
We're also doing some interesting things in PSG, such as developing a carbon offset program for clients as well as investing in a virtual power agreement that delivers clean energy and we have more interesting innovation in the pipeline.
As we look forward to Q4 in 'twenty 'twenty three we feel that we are well positioned to deliver strong results and to keep growing and enhancing our franchise value.
We are well prepared for challenges that may materialize in the macro environment with a really strong balance sheet position and highly prudent credit risk appetite, but we also plan to keep playing disciplined offence with continuing investments in our growth initiatives.
Current environment gives us a great opportunity to prove our mettle and deliver responsible sustainable growth.
One aspect that we emphasized in today's presentation as our confidence in the quality of our deposit base.
<unk> been able to transform over time.
We've had good deposit stability over the past couple of quarters as some peers are seeing outflows in our deposit betas are back in line with the pack.
We're seeing very strong loan betas and expect these to remain above deposit betas through 2024, assuming the current forward curve.
As a result, our NIM will continue to rise more gradually as time goes on.
We've also layered in sizable net interest rate hedges to protect NIM at <unk> through 2024, if the fed reverses and brings down short term rates.
Moving off the zero bound for short rates has unlocked the value of our deposit franchise and significantly benefited our Aro TCE.
With a clearer macro outlook and less market volatility, we feel the value of our commercial bank build out will also manifest benefiting further R. R O T C E.
So very exciting time for citizens and with that I'll stop and turn it over to John to cover the financials in more detail John Thanks, Bruce and good morning, everyone first I'll start with our headlines for the quarter referencing slide five.
We reported underlying net income of 669 million and EPS of $1 30 SaaS.
Our underlying ROTC for the quarter was 17, 9%.
Net interest income was up 11% linked quarter, driven by a 21 basis point improvement in margin to 325%.
And 2% growth in average interest earning assets.
Average loans are up 2% linked quarter with 3% growth in commercial.
Fees were fairly stable down 2% linked quarter as our client hedging business returned to more historical levels. Following an exceptional first half of the year at mortgage results softened a bit.
Capital markets fees and service charges were stable.
We remain highly disciplined on expenses, which are up 1% linked quarter.
Overall, we delivered underlying positive operating leverage at 6% linked quarter and our underlying efficiency ratio improved to 54, 9%.
We recorded a provision for credit losses of $122 million.
And a reserve build of $49 million this quarter, which reflects an increased risk of recession.
We offset by improvement in portfolio mix.
Our ACL ratio stands at 141% up from 137% at the end of the second quarter and compares with a pro forma tier one seasonal reserve of approximately one 3%.
Our tangible book value per share is down eight 6% linked quarter driven by the impact of higher long term rates on the OCI.
We continue to have a very strong capital position with our set one ratio at nine 8% just above the midpoint of our target range.
Next I'll provide further details related to third quarter results.
On slide six net interest income was up 11% given higher net interest margin and 2% growth in interest earning assets.
The net interest margin was three 5% up 21 basis points.
As you can see on the NIM walk in the bottom left hand side of the slide.
The increase in asset yields outpaced funding costs, reflecting the asset sensitivity of our balance sheet.
Moving to slide seven with.
With the current expectation for the fed to raise rates. Further we are confident that we will continue to realize meaningful benefits from rising rates as the forward curve plays out.
Our asset sensitivity has driven a significant improvement in NII year to date and those benefits will continue to accumulate into the fourth quarter and compound into 2023.
Our overall asset sensitivity increased to approximately three 3% at the end of the third quarter up from two 6% for the second quarter, primarily driven by the impacts of variable rate loan originations.
Our asset sensitivity will allow us to have further upside of the forward curve continues to move up.
We expect the cumulative loan beta is to exceed deposit betas through the rate cycle.
Our interest bearing deposit beta is tracking well within our expectations and the ultimate outcome will depend upon the pace and level of fed rate hikes from here.
So far this cycle with fed funds, increasing 225 basis points since <unk> 21, or two months of interest bearing deposit beta as well control at 18% through the end of the third quarter.
On a sequential basis, our deposit beta was 26%.
We began in the rate cycle with a strong liquidity and funding profile, including significant improvements through our deposit mix and capabilities.
We will continue to optimize our deposit base and to invest in our capabilities to attract durable customer deposits.
We continue to execute our hedging strategy to managing a more predictable and stable outlook for NII as we benefit from the higher rate environment.
Youll find a summary of our hedge position in the appendix on slide 23.
In the third quarter, we did an additional $10 billion of hedges with a focus on extending our protection out through 2024 and beyond primarily through forward starting swaps.
We expect our NIM to rise to three 5% or better by the end of 2023 and for our overall hedge position to provide a NIM floor of about three 5% through the fourth quarter of 2024, if we see rates come down by 200 basis points across the foreign curve.
Before it could move higher with further hedge actions.
Moving on to slide eight we posted good fee results despite headwinds from continued market volatility and higher rates.
These were fairly stable down 2% linked quarter as our client hedging business returned to more historical levels. Following an exceptional first half of the year.
Card fees were strong again this quarter, while capital markets service charges for stable.
Focusing on capital markets market volatility continued to impact the bond and equity markets M&A advisory fees picked up nicely, but this was offset by lower loan syndication revenue amid increased economic uncertainty and market volatility.
We continue to see good strength in our M&A pipeline continue to build strong pitch activity and a growing backlog.
While current market volatility may constrain the ability for deals to close capital market fees should see some seasonal improvement in the fourth quarter, particularly in M&A advisory and even more broadly if market settled out.
Mortgage fees were softer as a higher rate environment weighed on production volumes, which more than offset the fact that production margins improved modestly this quarter, but still remain below historical levels.
We are seeing signs of the industry, reducing capacity, which should benefit margins overtime and.
And servicing operating fees were stable.
While fees are $5 million lower linked quarter, given the impact of lower market levels on a U N.
And in other income we saw a seasonal benefit from our tax advantaged investments and an increase in leasing revenue.
On slide nine expenses were well controlled up 1% linked quarter. Our top set an efficiency program is continuing to make good progress and is on track to deliver over $115 million of pretax run rate benefits by the end of the year.
Average loans on slide 10 are up 2% linked quarter, driven by 3% growth in commercial with growth in C&I and CRE, given modestly higher line utilization and slower paydowns.
Retail loans increased 1% with growth in mortgage and home equity offsetting planned runoff in auto.
Period end loans were broadly stable linked corner given higher than usual end of quarter C&I line pay downs, which were generally redrawn after quarter end.
On slide 11 average deposits were up $1 3 billion or 1% linked quarter with growth coming from retail term deposits from citizens access savings and commercial banking deposits were broadly stable.
Deposit costs remained well controlled our interest bearing deposit costs were up 38 basis points, which translates to an 18% cumulative beta.
We feel good about how we are optimizing deposit costs in this rate environment and our performance to date is reflective of the investments made to strengthen our deposit franchise since the IPO.
Overall liquidity improved as we've reduced our <unk> advances by $2 3 billion and increased our cash position at quarter end.
Moving on to slide 12.
Saw good credit results again, this quarter across the retail and commercial portfolios net.
Net charge offs were 19 basis points up six basis points linked quarter, but still very low.
Relative to historical levels.
Nonperforming loans were broadly stable at 55 basis points of total loans.
Given the higher risk of recession, we are watching our loan portfolio very carefully for early strong signs of stress in particular Cree office.
Leverage loans and selected nonprofit sectors.
At this point, we aren't seeing significant issues emerge.
Also the leading indicators for consumer continued to be stable and favorable to pre pandemic levels.
Personal disposable income has declined from stimulus driven highs, but for many remains above the pre pandemic 2019 average.
Spending for travel and restaurants remained steady and above pre pandemic levels.
While credit card and home equity line utilization and are still well below pre pandemic levels.
And retail delinquencies continue to remain favorable to historical levels.
Turning to slide 13, I'll walk through the drivers of the allowance this quarter.
We continue to see very good credit performance across our retail and commercial portfolios.
While we arent seeing stress in the portfolio at this point, we increased our allowance by $49 million to take into account an increased risk of recession, partly offset by improvement in portfolio mix.
Our overall coverage ratio stands at 141%, which is a modest increase from the second quarter.
If you recall when we adopted <unk> at the beginning of 2020, our coverage ratio was 147%.
However, given the investors acquisition and some shifts in the portfolio mix, we estimate our pro forma day, one seasonal allowance to be approximately one 3%.
The current reserve level contemplates a shallow recession and incorporates the risk of added stress on certain portfolios, including those subject to higher risk from inflation supply chain issues and return to office trends.
Moving to slide 14, we maintained excellent balance sheet strength.
Our set one ratio increased to nine 8%, which is slightly above the midpoint of our target range.
This combined with our strong earnings outlook puts us in a position to resume share repurchases in the fourth quarter.
Tangible book value per share and the tangible common equity ratios were both reduced by the impact of higher long term rates on OCI.
We have increased our held to maturity portfolio for about 30% of total loans at quarter end, which has helped to mitigate the impact of rising rates.
Our fundamental priorities for deploying capital have not changed and you can expect us to remain extremely disciplined in how we manage capital allocation.
Shifting gears a bit on slides 15, and 16, you'll see some examples of the progress we've made against our key strategic initiatives and what's on tap for our businesses in the near term.
Essentially closed the investors acquisition in April we've been executing against a phased approach to the integration.
In the second quarter, we began originating mortgages on our systems and since then we have completed the conversion of mortgage servicing.
We also successfully completed the conversion of more than 10000 investors wealth clients, representing about $1 $6 billion in assets to our platform.
Got a lot more to do but I'm pleased to say that we are on track to complete the deposit and branch conversions in mid first quarter 2023.
We have included a high level integration timeline in the appendix on slide 22 importantly, we remain on target to achieve our planned $130 million and run rate net expense synergies by the end of 2023.
Approximately 70% will be achieved by the end of 2022.
We also continue to expect that the integration costs will come in below our initial estimates.
In the last few years, we have launched a collection of new banking products and features that make it easier to bank with us.
Last week, we announced the next step in that evolution with citizens and plus which provides financial rewards banking features and tailored advice that grows with customers from everyday banking to personalized wealth management.
This includes citizens private client, our new expanded wealth management, offering which will launch by the end of the year.
We are fully committed to driving momentum in our wealth business and as part of our launch we are hiring more than 200, new financial advisers and relationship managers.
We continue to make meaningful strides forward with our national digital strategy in Tech modernization.
Earlier this year, we migrated citizens access to a fully cloud enabled platform and we launched a national storefront, adding mortgage and education refi to the portal.
Over the next year or so we plan to expand our national storefront, adding card and checking first and then wealth and citizens bank.
As we add products to the platform, we have an exciting opportunity to build relationships across a growing national consortium customer base.
Our vision is to migrate our core branch deposits to this modern platform over time, which will be a sea change in efficiency and flexibility in terms of implementing upgrades and enhancements.
We are also growing our innovative citizens pay offering which is currently at about 160 merchant partners and expanding across targeted verticals.
Over the next year, we are working to launch a new mobile app and a unique customer direct experience.
Moving to the commercial business on slide 16.
Over the past eight years, we've invested heavily in talent and product capabilities in M&A, corporate finance bond and equity underwriting FX and commodities and so on.
Despite the challenging environment, we remain near the top of the league tables consistently ranking in the top 10 is a middle market and sponsor book runner.
And helping corporates and private equity sponsors access capital through the public markets.
We have also integrated our cash management in global market solution as well with our coverage.
We are excited about the potential synergies from our recent acquisition as we target growth in key verticals.
M B at the JMP acquisition gets us much deeper into the growing health care technology and financial services sectors expands our equity underwriting and ads research capabilities and.
And DH capital expands our capabilities in the Internet infrastructure Communications sector's software and next generation It services.
These businesses are exceptionally well positioned for when markets reopen.
Moving to slide 17, I'll walk through the outlook for the fourth quarter.
We expect NII to be up roughly 3% driven by the benefit of higher rates with a margin rising to the 3.3% to 335% range.
Average loans are expected to be stable to up modestly as commercial growth is partially offset by auto rundown.
Fees are expected to be stable to up modestly.
Noninterest expense is expected to be stable.
Net charge offs are expected to be approximately 20 to 22 basis points.
We expect our set one ratio to land near the upper end of our target range of nine 5% to 10%.
And our tax rate should come in at approximately 22%.
With respect to the full year, we continue to track well and expect to beat our full year 2020 guidance across key P&L categories and performance measures, we expect to deliver positive operating leverage for full year 2020 to an excess of 5% with fourth quarter sequential positive operating leverage of about 3%.
We also expect to deliver our full year efficiency ratio of about 57% with the fourth quarter coming in under 54%.
And we expect to deliver a full year ROTC in excess of 16% with the fourth quarter, well above both Q3, and our medium term target range of 14% to 16%.
To sum up on slide 18, we delivered a strong quarter amid a dynamic environment and we are optimistic about the outlook for the fourth quarter and into 2023.
We expect to continue to see significant benefits in our net interest income from the higher rate environment.
Our diverse fee business is driving solid results and our capital March of markets business in particular is well positioned for when markets stabilize.
And our commitment to operating efficiency remains a hallmark.
We are well prepared for a slowdown in the environment with a strong capital liquidity and funding position and we are being prudent with respect to our credit risk appetite and loan growth.
At the same time, we are playing some offense executing well on our strategic initiatives in each of our businesses that will deliver medium term growth and outperformance with that I'll hand, it back over to Bruce Okay. Thank you John Alan why don't we open it up for some Q&A.
Okay.
Thank you Mr. Van Sean we're now ready for the Q&A portion of the call.
If you'd like to ask a question. Please press one then zero on your telephone keypad, you'll hear an indication had been placed into queue and you may remove yourself from the queue by repeating the one that is zero command.
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Again, if you have a question press one zero at this time.
Your first question comes from Scott <unk> with Piper Sandler go ahead. Please.
Good morning, everyone. Thanks for taking the question.
Hum you could expand a little on your thoughts regarding NII dynamics into next year, you know I thought the $3 50 year end 'twenty three our margin expectation.
That was definitely a highlight and I think just generally your comments about loan betas overwhelming deposit betas cumulatively those suggest some confidence that NII should continue to grow after the fed stops tightening, but just would love to hear your thoughts on the puts and takes on the additional color you might be willing to add.
Yes, sure. So I just break it down into two overall categories. You've got the net interest margin dynamic, which is a big driver in where we're messaging that we expect our net interest margin to continue to rise.
I think loan betas in the last cycle for us were up near 60% or so this.
This cycle, we're doing some more hedging so you can see our loan betas dropping a little bit the nice part about that is that it provides us downside protection, so youre going to see loan betas in the mid to.
Low to mid fifties, you compare that to a deposit beta that we previously message would be around 35% or so.
<unk> been up 100 basis points. Since then I mean, you can see our deposit betas, maybe getting into the upper thirty's.
Or thereabouts, given given humana, certainly given what's going on with rates.
And the last.
In the recent couple of months. So you take that dynamic can see cumulative loan betas.
And you know exceeding deposit betas in that drives NIM is higher.
We're also remixing on the loan side into more variable youre seeing the strength of the multiyear investments on the deposit side, playing out and then let's not forget the other aspects of the balance sheet, where you've got securities book.
And that Securities book is funded primarily by by DDA and some wholesale and so you can see the front book back book dynamics really really taking hold where you've got you know you've got the securities yields on the front book in the fourth quarter.
Somewhere between $4 50 and 5%.
And with a 2% runoff and so thats pretty powerful when you've got essentially a strong DDA underpinning.
What's going on there in the in the Securities book. So those are the those are some of the net interest margin dynamics. If you flip over to the other side of things, where you see our opportunity for continued loan growth.
Where you are seeing us rotate into more of a variable rate approach solid opportunities in home equity and other aspects in the retail side, but commercial is and were feeling optimistic on the commercial side and and that's going to drive loan growth into 'twenty three.
It'll be economic environment dependent and but nevertheless, the underpinning of rising Nims I think is really what gives us the confidence to continue to see that NII improving engine into 'twenty three.
Alright, that's perfect color. Thank you very much for that and I guess just.
You know with rates, having moved so much just curious about your thoughts on sort of the citizens access products.
What kind of trends are you observing about sort of the stickiness of those customers. How much is loyal how much are sort of shopping for rates and are your tactics at all changing with regards to that product.
And why don't you take that one yeah. Thanks.
We're seeing some decent growth in citizens access and the digital native customer still exists out there and is waking up a little bit as rates have gone up so where it's been a very very effective strategy for us. The customers are loyal to citizens were seeing good augmentation from those customers are very real brand engage customers.
And the customer base is growing so our balanced growth is coming.
From both sides, new customer acquisition and existing customers, bringing us more as we brought rates up.
But most importantly, it serves to sort of a.
How 'bout isolated deposit raising strategies to protect the core bank.
From needing to bring in.
<unk> sensitive customers into the bank or really relationship focused in our core franchise.
The combination of the health of our deposit franchise improvement led by DDA and privacy of our customers.
It has been really showing up well so our deposit betas and consumer are dramatically different than they were in the last cycle and it's really for both of those points of the turnaround and the health of the customer franchise and the core bank and then the effective strategy of using access both to drive national growth, but also to have a much more targeted and isolated way to grow interest bearing.
Does it it doesn't make us reprice, our whole book. So we're really pleased with how it's playing out in citizens access is right, where we thought it would be and it should be executed really well and the net debt.
The strategic aspects of citizens access that over time is just a whole another benefit of that of that platform correct I think thats, what obviously, we've messaged that on these calls before but the the integration of our citizens access deposit platform of all of our national lending businesses to make our national platform much more integrated and customer strategic John mentioned, the launch of our new <unk>.
But our cloud based migration, we are making really sizable progress on bringing together all of our national capabilities to deepen those relationships as well as just sort of the deposit angle that we launched with a couple of years back.
Perfect.
Thank you very much.
Yes.
Your next question comes from the line of Erika Najarian with UBS. Your line is open.
Hi, good morning, and thank you so much for being Craftsman impactful messaging from this morning.
Sure. My first question is for you Bruce.
You have teased that you're you know top eight is underway and you know as we think about how much you've improved the bank.
And John has certainly helped balance sheet and Brendan and Dawn has helped balance sheet positioning.
How what is your vision for what top aide can accomplish.
You know, we're looking at a bank clearly outperforming the market today outperforming expectations.
Feels like a lot of the big rates of change have been accomplished in the previous you know seven plans so and that's that's sort of the Genesis of the question what do you envision top eight to accomplish.
Well.
Erika I think when we.
Ended up hitting our top two in top three we were getting questions as to how much re architecture and reengineering of how Youre running the bank has left us to our you know picking the fruit that's really high in the tree.
Yeah, It was getting higher in the tree, but I think what we've been able to do as exhibit this mindset of continuous improvement that we're not gonna be satisfied with how we're running the bank.
We're going to look at all aspects in terms of how were staffed and organized and R.
Our vendor relationships and other.
Other kind of efficiency, new technology deployment to deliver more efficiencies and so over time, that's just become part of our DNA here.
And so we're not going to rest and say well. We just had another successful result with top seven.
Let's take a breather.
You really can't take a breather, because we have investments that we want to fund in.
In our future.
Business initiatives that we list on our COO.
Couple of the slides in consumer and commercial.
And that requires net investment in Capex and Opex.
And in order to fund those things, having these top programs and finding efficiencies.
To self finance those investments and keep the overall rate of expense growth.
Modest.
There's the equation that we've used to drive ROTC from the 5% when we started at the IPO to 18% levels. Today. So so I think youre going to continue to see us.
Pursue that mindset of continuous improvement and don't be surprised when we have a successful announcements and execution of top eight that there might be even more top programs down the road after that.
Got it.
And just a few clean up questions.
So much for giving us a lot of color on the ACL.
I'm wondering you know what the weighted average unemployment rate that you assume in the $1 41, ACL today and just John a quick cleanup question to Scott's line of questioning how do we think about the NII dynamics into next year, what are you assuming about deposit growth and deposit mix shift.
Yeah I'll just take the first one is we are.
Using some fairly conservative assumptions when we set the ACL, so I would characterize it as a moderate recession, rather than a short recession in the unemployment levels get up.
Over 6%.
<unk> is kind of where we've modeled it so.
We think we're being fairly conservative.
But we reassessed at each quarter.
So John I'll hand the.
Deposit question over to you, yes, sure I mean, I think the some of the trends that you'll likely see into.
Into the fourth quarter continue into 'twenty, three but I'd say the couple.
Couple of items I'd highlight are.
Starting with the customer value proposition that you're seeing us continue to invest in its been multi years to build this deposit platform and in both consumer and commercial those investments are coming to fruition and demonstrating themselves, but we're continuing to invest so so you're seeing just core deposit growth coming from.
From that and you heard your Brendan.
Let's talk about citizens plus as an example of the core growth that we think can give us some unique ability to take some share into 'twenty three.
Citizens access and and.
The retail CD.
Arena is a place where we we.
<unk> taken that down close to zero and so that will come back a bit in that in that in that category.
It's not forget New York Metro, We've entered New York Metro and we're starting to see really nice uptake once we converted HSBC, we're going to convert SBC in the first quarter of 'twenty three so we suspect that we're going to start.
You start to see some some lift coming out of that and then just broadly in commercial but the product and coverage investments that we've been making over the years and continue to make.
And that will offset what we're building in.
All of the all of what I, just described will offset our expectation we're going to have some DTA migration as rates rise. So that's built into our outlook and built into the NIM guide that we're going to have some realistic expectations of migration. So those are some of the areas I would highlight.
Thanks, so much.
Your next question will come from Matt O'connor with Deutsche Bank. Your line is open.
Hi, Good morning, I'm really good detail on credit back in the Appendix page 24 for retail and 20 pallets on commercial.
And obviously you guys have improved the mix in both areas over the last few years, but are there any signs of weakness within certain kind of customer groups that you could point to and then like what leading indicators might you suggest.
That we want that you pay attention to.
Well I'll start and then maybe.
Turn it over to my colleagues for some additional color, but Matt.
Matt I think what.
<unk> continues to be very positive is that.
The expectation that things will normalize back to pre COVID-19 levels continues.
<unk> continues to be deferred and so we're only seeing.
Very slow migration in terms of.
Consumer.
Charge offs, and Npls and delinquencies, it's still kind of better than pre pandemic period.
I would highlight there.
Our focus on a very high quality borrowers in these portfolios Super Prime and high Prime those folks are still doing pretty well through the current environment have a lot of liquidity.
And so so we feel really good about where things sit in consumer.
Similarly in commercial over time, we've migrated to lend to a bigger company. So mid corporate space companies with an excess of 500 in revenues and.
And they tend to be more diversified and better credits and so we also see a very solid performance metrics across all the things.
P as in charge offs et cetera.
On that side, you've got to go to the usual suspects if you think the economies weakening.
And that would be commercial real estate leveraged lending and then.
Maybe certain sectors and nonprofit.
Which we've heightened our monitoring in those areas, but we don't we don't see any smoked at this point.
So maybe with that let me turn it to Dan for additional color on them.
I think I think you hit it where are we.
We've actually activated our downturn playbook, which involves a lot of incremental stressing a lot of incremental portfolio management and a lot of incremental conversations with clients I think there's a couple of pieces of good news.
Supporting the lack of deterioration in credit one is we think management teams culling through the pandemic got incredibly focused on efficiency in their business and they cut costs and the automated it and they built liquidity and they repaired balance sheets than they hedged and they did a lot of things that we're prudent from a risk standpoint, so there's a little bit of a buffer we think.
The portfolio against what could be deterioration, if we go into a deep recession.
The thing we're most focused on is the real estate office portfolio given back to work. We've got fully leased office buildings in those leases are running for a couple of years in the future, but we've got a lease rolls that were focused on and whether they're going to renew or not.
I think just personally I was I was in New York City yesterday people are back in the office.
The other thing is that high percentage of our office properties a caliber yes, yes, and then a lot of it suburban.
It's in the right places a lot of it's in places, which are in the southern southern tier and things like that so we don't have a lot of San Francisco for example, where are they going to there's going to be a lot of.
A lot of distress. So msas are important in the real estate business and I think the I think the leverage book as you know that's you always look at the leverage the sponsor leveraged book you know our strategy, there, which is high levels of diversification of our average hold as kind of $10 million to $12 million. So we do a lot of leveraged finance, but we distribute 95 to 97.
Percent of it so and we're not really seeing any kind of severe stress in the leverage book. So we feel pretty good and then all the early stats the quick class ratios nonperforming loans watch assets, which we have very significant possibly around all seem to be in pretty good shape right now, but we're not we're not necessarily the other thing I'll mention.
And John touched on this we are being incredibly disciplined on new originations, we're really not taking on any new clients right now.
Getting it.
We're getting very focused on returns, we're actually commanding a higher level of pricing given the current market environment. So we're watching our front book very carefully also Jeff how about you Brendan Yeah I'd.
I'd say that the health of the consumer is still very very resilient, having said that we're doing a lot of the similar things that Don is mentioning kind of putting in a proactive approach to a potential downturn, so making investments in collections being ready for an inevitable tick in the wrong direction.
Tightening some credit on the margins will be incredibly disciplined on where we're lending right now to make sure that the returns are right and we got deep real customer relationships and it's within the risk profile.
That is within our risk appetite.
Having said all of that with what we're seeing kind of out the window today.
The consumer is still 20% plus excess liquidity and deposits as a general statement and charge offs are still.
50% to 60% of the rates that they were pre COVID-19 and we're not seeing any meaningful signs of that reinflate in if you look at the.
The overall U S <unk>.
Bottom decile are two of the country you are starting to see that excess deposits burn off and they're living more paycheck to paycheck, which is where they were pre COVID-19. We don't over index on that segment and so we.
We we index much higher and so we're not seeing a lot of the pain that is potentially happening at the very bottom of the segment in the U S flowing through anything in our book.
Look we're seeing some very very early signs that are potentially we are at the early days of a normalization.
Janet cart.
Customers that paid in full each month.
It was about 32% of our portfolio pre COVID-19 it is.
Now at 41% it peaked at 42% so it's down a tiny bit, but it's still significantly better than where it was before COVID-19. So we're starting to see small signs of potentially customers getting to normal, but I wouldn't say, it's accelerating at all it's still very resilient and significantly healthier than where it was pre COVID-19.
Great.
Alright, Thank you very much guys wanted though.
Alrighty.
Your next question will come from the line of Ebrahim <unk> with Bank of America. Your line is open.
Good morning.
Just wanted to follow up one on credit I think if I heard you correctly the killer.
<unk> AC and assumes a 6% unemployment rate.
It just means they think she still has still to be new I'm trying to understand absent that unemployment rate expectations going materially higher just if you could give us the thought process around drivers of additional reserve build over the coming quarters. If the CRT market is at home prices.
Because what I'm trying to get to is unemployment is at three and a half 6% seems a long ways away if that doesn't go much higher what else would guide those materially higher does it ended up to well maybe ended the quarter.
Yeah I'll go ahead and start there I mean, I think that first I'd like to just make sure. We're reminded so we've got 141 basis points against the portfolio right now when when you pro forma adjust that for investors and some other things you get our day one of about 130, so were 11 basis points over day, one so that covers a lot.
<unk>.
And so we're covering environ.
The environment that Bruce Bruce described earlier I think you also mentioned a few pockets of of.
Areas that we're watching very closely so we're watching the core office space and we're watching a few sectors on the C&I side, just reminding that we're not seeing any when you look at where our delinquencies are we're not seeing any any early signs of any deterioration here, but but that could change and that could change quickly. So we're keeping keeping a close eye on it.
But.
And as things turn.
Have those areas of concern that we that we were focused on in the pandemic, which most of which got cleaned out and has been improved proved over time, but those are that's the playbook will go back to we'll go we'll go back to those areas of concern and take it away.
I'll just add that.
I think we're feeling pretty good if you if you.
Look at the <unk>.
Scenario that says we get to a moderate recession, then it doesn't get any worse than the need to actually keep building.
May lessen from from what it was this quarter I think there was a reassessment that the fed is going to have to stay.
At higher rates, which probably increases the probability of recession, a little bit and that was reflected in growing up before.
Basis points.
So you'd have to see a or even greater conviction that we're likely to hit a recession or the fed is going to go higher with rates, which is going to have more collateral damage for the need to build on the macro outlook.
Of course, the other things that contribute to a higher provision as loan growth. So if we have.
Loan growth and then I think also as John indicated if we have a kind of changing view uncertain sector risks, we already have overlays for example for the things we mentioned we have.
The kind of reserve built for commercial real estate office.
Think thats sufficient, but our view on that could change over time so.
So I think we're kind of sitting at a pretty good spot now.
Have to wait and see what happens with the macro forecasts in certain sectors.
The amount of loan growth that comes through those things would determine whether we have to keep building the reserve and how much.
I would say that.
I think the concerns that we're going to be building the way we did during the pandemic and Oh My gosh. These numbers can be kind of a runaway freight train.
Don't see that at all at this point, so I think those fears are overblown.
Probably one of the reasons such cast a pall over stock valuations.
But at this point.
We don't see that.
Well, that's good color and just one guy.
Bruce on the on the New York strategy. So once you complete investors integration first quarter next year give us a sense of like should.
Should we expect like are you, adding new bankers what are the capabilities you are adding to the franchise just given how huge that market can be in terms of just market share gains not just <unk>, but for the next few years, yeah. Yeah sure. So I'll start and then maybe I'll ask Don and Brendan to talk about their businesses, but.
I think the theory has been that.
We bring a.
Thoughtful approach to how we think these markets, we really understand neighborhoods, we understand individuals and we really tailored advice to situations, where somebody is on their life journey.
Where are they.
Reside et cetera.
<unk>.
On the corporate side, we also want to be that thought leadership position, where we are the trusted adviser to accompany us negotiate anything its many challenges and trying to achieve growth.
And we've been able to stake out that ground.
<unk> fully in the major cities that we compete in we do as well in Boston, we do it well and Philadelphia Pittsburgh some of our other big cities.
So notwithstanding the fact that New York is a relatively crowded and competitive marketplace.
Think that our style can be successful in New York.
Take a little time, we bought some good foundational assets.
We need to bring our additional kind of culture and approach and bring our broader product set. So we can do more for our customers and give them more advice and.
Better capabilities better customer experience, but we think we will be successful in that over time. So in effect. This is a bet on ourselves and.
And so far everything is tracking exactly the way, we had expected with little signs of green shoots.
We were kind of onto something pretty good.
With that let me maybe go to Brendan first and talk about.
The consumer and small.
Small business side, and kind of where you're making investments.
So I know that our view of the future.
We're incredibly pleased with the start in New York City post the HSBC acquisition and as John mentioned, two we've already started some integration with investors on mortgage and wealth.
New Jersey, and some of the boroughs in New York.
We're hiring so we're hiring up.
<unk> financial advisers mortgage loan officers and business bankers.
We're also restocking the retail organization and it's using talent across the board.
And so far it has really paid dividends.
The New York market and from our branch network standpoint is the most productive market out of any of our markets. So far early days, which is an incredibly good early signs and we're getting a lot of customers coming back to us from some of the big banks.
Including HSBC customers enjoyed that we didn't buy but enjoyed the location of the people and we're really starting to see some growth typically when you do a branch deposit deal you see some.
Deposit run off to the tune of 10% to 20% in the first year, we're actually seeing the opposite the underlying.
Retail deposit base is actually net growing in New York right away and we didn't have any attrition post legal day, one so theres a long long way for us to continue to build share in its early signs, but we're very bullish on what we're seeing so far and in the investors franchise, they kind of lean into business banking more than consumer and.
And we're excited about that we think the investors capabilities there.
Their distribution can help us accelerate our business banking strategy overall across the franchise and then when we put our consumer playbook on the Investor franchise. We're seeing this big benefit already at HSBC and they were principally a retail franchise. When we put that on the investors franchise that didn't have a meaningful retail presence.
Difference from what we bought and what we can build over time as even more substantial so we're very excited about it there's still a lot to do.
But early signs are very positive.
I would point at three things one is the.
The ability as you said Bruce to to deliver a much broader product set into the existing investors franchise. So great greatly expanded treasury services capabilities. For example, the ability to hedge directly for clients and that's well underway and we pick up a lot of very good bankers from the investor side, So our workforce quadruples overnight just with the ACA.
<unk> second thing is we're going to benefit on the commercial side from all the branding that Brendan is doing so the visibility in New York City of branches that advertising and the like is the name recognition is helpful. So we don't have to explain who citizens as to potential new clients and we're also hiring we announced yesterday, a new market had for New York City.
Trop, which came from Jpmorgan. So we've got a new leader in place in New York, and we're off to the races right.
That's great color. Thank you so much sure.
Your next question will come from Gerard Cassidy with RBC. Your line is open Mooney.
Good morning, Bruce Good morning, John .
Sure.
First kudos for a very good slide presentation, you guys gave quite a bit of detail. It's one of the best out there. So thank you.
John talking about your hedges that you put into place slide 23 gives us a good breakout of what you have in place.
Can you share with US obviously is protecting you should rates start to go down I would assume in late 'twenty and into 'twenty four.
What kind of rate environment work against what you just put into place or what you've had in place and you put more into place this quarter, what kind of rate outlook with.
This would not really work that well with.
Yeah, I mean, well let me let me just start off with I think that the point of getting those hedges on in the third quarter was to allow.
Ourselves to continue to participate in 2023 with rates rising and so that.
The intent of all of that was to look past. This next year into 'twenty, four and 'twenty five and say you know.
If in fact, we ended up with a.
Our lower regime in those years, but let's try to find ourselves into a floor that would help maintain the level of ROTC is that we're trying to achieve and so we are stabilizing.
Stabilizing revenues and stabilizing our.
Returns by doing this now of course, there's a tradeoff that tradeoff is if rates.
Instead of beginning to come down in 'twenty four they were to remain high or go even higher.
That would be an opportunity cost, but nevertheless on an absolute basis, we got very attractive returns being locked in through this strategy and I think that that's really what we're trying to achieve that's gerard.
Gerard it's tricky and you're trying to find a sweet spot and you're looking at the forward curve and talking to economists looking at economic forecasts.
Leaving yourself enough.
Upside participation for high rates, but then also recognizing that theyre not going to stay up forever trying to floor out your downside and so.
Time will tell.
Hindsight's always 2020, if you went through earlier.
You missed the window. If you had held off another six months could you have gotten better.
<unk> levels, but right now we feel we've done a pretty good job of as you can see from the results today, we're still asset sensitive we're still benefiting as rates go up and now we can sleep at night that were not going to see ROTC slide down the poll if rates turned around and go back down.
Very good and is it safe to assume all of the Counterparties are the major global investment banks and these.
Yeah.
Yes, exactly okay personal side on that front.
Okay. Thank you and then just a second quick follow up question.
Obviously, you're not an advanced approach bank and therefore, the OCI is not an issue with your CET one ratio, which is the binding constraint for most banks are all banks.
When do you when do you think people start to get a little concerned about the tangible common equity ratio yours is still very healthy but is there do you guys I know its an accounting issue, we we all get that but.
Do you think there will be a concern if it gets too low and do you have any idea of what that rate might be and then second John when you accrete the Aoc I back into capital as the bonds pay off do you knew about how much we will start coming in starting maybe next year in terms of the OCI and coming back into capital.
Yeah, maybe I'll just start to say that you know.
We did put the TCE to ta ratio into our presentation deck today, because we do think it's worth keeping an eye on that end.
Some.
Folks in the peer group of.
Either a bigger securities portfolio or didn't put as much in H T M. In the TCE to ta ratio as sliding.
Quite a bit ours is sliding a little bit, but still appears pretty healthy.
You could argue that if that's not a regulatory ratio.
It's not really something to worry about significantly because it will turn around over time. It's just effectively you've got these securities that are going to be earning you less than if you were able to take the cash and reinvest and at today's levels.
So anyway, I think we feel good where above 6%.
And historical times Thats kind of been a marker and I think we can sustain that there we have about 30%.
Of the.
The overall portfolio and held to maturity.
And we'll have to see where rates go but if they go up a little bit from here, we're going to continue to generate.
The capital we think we can keep it at pretty healthy levels.
John I'll turn it over for you for trying to the turnaround in the rest of the answer yes, great and just a supplementary earlier on I mean, sorry, and we got our ultimate journey.
Around 30% right now and sort of balances are down a little bit from a to that to that point as well as it relates to the how the Aoc I will come back and if yes, if rates kind of.
I'll move around on US just the way to think about it at September 30, we have about $4 5 billion after tax sitting in that number and that'll come in over about five years. So.
It gives you an ability to work through that hopefully.
Great No that's.
Very helpful. Thank you guys.
Sure.
Your next question comes from the line of Betsy <unk> with Morgan Stanley . Your line is open.
Hi, Good morning. This is Brian Wilson on for Betsy I was wondering if you could talk a little bit about the expectation to resume buybacks in <unk> and just some of the puts and takes there you were just talking about capital a moment ago. Obviously your Reg capital position is quite strong today.
But at the same time, the macro backdrop is still a bit challenging. So it was just wondering what makes you comfortable at.
Resuming buybacks at this stage. Thanks sure. So you know.
We are kind of at the north end of our 9.5% to 10%.
Range and we indicated we would expect to land there at the end of the year. So I think if you look at our target range relative to peers, we've been a little on the conservative side, which I think has served us well and particularly going into <unk> and.
An environment with a significant amount of uncertainty.
That's the position we want to be in.
Having said that you can see the level of profitability. We have now is very significant.
So we're generating a huge amount of tangible.
Equity each quarter this quarter next quarter.
And so we can certainly blow past, 10%, if we went back in the market buying our stock.
So I think there's opportunity for us to even improve that ratio a little further and be in the market buying our stock.
Wildcards.
Often as you know.
The amount of balance sheet growth and the.
The amount of are there any acquisitions are likely in the near term.
And I think on that score we've given you the guidance for what we'd see for loan growth. So that's factored in.
And then I'd say on the acquisitions, we've really only done.
On very small acquisitions, so far this year, we've really been 100% focus on making sure. We're integrating the ones. We did last year, we had a pretty banner year last year with the New York Metro play and then J M P.
N D H capital and so if we focus on integrating we feel really good about where those are and so nothing big likely before the end of the year, even just in terms of the fee based deals that we do.
So I think we have the wherewithal to go out and build the ratio a bit further plus get in the market and buy back some stock.
Okay. Thanks.
Your next question will come from Ken Houston with Jefferies.
Your line is open.
Thanks, I know I know, we're getting over an hour here. So just a quick one follow up on <unk> question.
So.
How how through the hedging program do you feel like you are at this point given what you show us on that great Slide 23.
Have you kind of done what you need to do if not how much more you think you need to still add to get that asset sensitivity to the position you really wanted to live in.
I think you know that this world there are many many things that we consider when we when we worked through that so we think about the evolution of the balance sheet, where we think rates are going to go et cetera, but that if you look at our three 3% most of that's on the short end. If you were to say, okay. We know that the fed is not going to raise rates anymore and you want.
To take that down to neutral that would mean about 10 or $15 billion of additional hedging that would be necessary.
So what we're gonna be careful and methodical about that and update our balance sheet outlook update our asset sensitivity, but there's still a significant amount of hedging left to do.
You know before we would we would say that we're done with this cycle.
Okay, and then just a quick follow so John that point you made in the deck about <unk> 24, NIM floor of $3 25 and are down 200, if the fed does hang high do you have any do you have an idea of what that NIM. It looks like in a down 100 scenario.
Yeah, I mean, it's somewhere between the two right I mean I think okay.
Somewhere between the two I mean, I would say that that would be a better outcome for us and.
You could you could expect that that'll be somewhere between the two and three to $3 25, and $3 50 forecast that we gave.
Okay. That's fair all right do you want to make sure. There was it was pretty symmetric. Thank you yeah.
Your next question will come from the line of John <unk> with Evercore. Your line is open.
Good morning.
Good morning.
On the call.
Capital markets.
Side of the business I know you indicated that you expected seasonal increase in the fourth quarter. If you can help us.
Sorry is that up or how do you think about the magnitude there based upon your pipeline.
Yeah, John we had a little trouble hearing you.
I think I got it yeah. So so John we've got we've got pipeline is bigger than we've ever had on our capital market side I think it's important to kind of realize that the place. We play is middle market and capital markets. So that most troubled spots to generate revenue in capital markets. As these very large M&A deals which require very long.
Financing. So those are what are what are struggling with the market. So we were really pleased that we were able to hold cap markets kind of flat quarter on quarter, given all the volatility in the market.
And we think most of the action is going to come in M&A, We've got a very big M&A pipeline, a lot of which does not require financing and it looks like it's moving along quite nicely. So it's not going to double but we think it could go up 10 to 20 million Bucks in the fourth quarter, but we'll just have to see as we go through the quarter, how much volatility and what the backdrop is but we're assuming pretty big disk.
<unk> to the pipeline in terms of what we're forecasting right now so we're we're pretty comfortable that we're going to have a good quarter and then we do think we'll get a little we will do a little better now that the currency and interest rate volatility has calmed down a little bit that hurt us in the third quarter, because people werent really willing to step into the market and hedge we think we'll do a little bit better and better on the markets business also in the fourth.
Yes, and I would I would just add so we don't get carried away with Don sanguine outlook on commercial fees.
In Q4.
When we looked at our total fees.
Top of the house will probably still see a little leakage on mortgage production are the good news here is that servicing has held up.
Very strong and so our diversification has paid an lent stability to mortgage, but there's probably a slight.
Additional step to take in Q4, and then we did make some changes in our policies regarding overdrafts, where we've oh.
Done away with NSF fees.
So that would flip the service charges line a little bit so.
You'd probably see some strength in commercial offset a bit with a little fall in the consumer side, but overall, we're guiding to the net of that should still be stable to up modestly and we'll just have to see how much of the capital markets pipeline as Don said actually gets printed.
Got it okay. Thanks, hopefully you can hear me a little bit better one last question.
Have you sized up the size of the shared national credit portfolio.
And then also what percentage of that.
Portfolio, where are you in the lead position.
Yeah, I think the shared national credit portfolio.
Is.
A pretty.
Decent size as we've moved up market.
But.
I'd point out a couple of things there is the kind of when you're in shared national credits in general those are bigger companies that have multi bank facilities.
And they tend to be better credits.
The second thing is that we continue to migrate towards trying to aim for the left lead position and no shared national credits.
Or be one of the book runners or admin agents, so become a meaningful bank to those overall.
Our customers and so that's just been part of our strategy.
And we're making good traction on that strategy I think a lot of times investors will think that.
The shared national credits is a particular point of risk.
Our view is that actually.
As part of our strategy and those are actually good credits and if you get to be in the driver's seat of leading the deals.
That's the place you want to be.
I think that's right and it's all about.
Return against assets against deployment, so underlying the BSS strategy on the commercial side that we talked about the quarters.
We're exiting $1 billion to $2 billion a quarter of under returning assets a lot of those are shared national credits, which just haven't.
Panned out once we've been a relationship for a couple of years, so that portfolio churns quite aggressively also and our ability to monetize through the product capabilities that we've built over the last five years is significantly different than it was five years ago. We just got many many more opportunities to engage and become that lead bank with those funds.
That helps a lot alright, thanks for taking my questions. Okay sure.
That's the end of the queue on the questions. So really appreciate everybody's interest and support have a great day.
Yeah.
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