Q4 2022 Citizens Financial Group Inc Earnings Call
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Speaker 5: Good morning everyone and welcome to the Citizens Financial Group fourth quarter and full year 2022 earnings conference call. My name is Keely 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.
Speaker 6: As a reminder, this event is being recorded. Now I'll turn the call over to Kristin Silberberg, Executive Vice President Investor Relations. Kristin, you may begin. Thank you, Kelli. Good morning, everyone, and thank you for joining us. First this morning, our Chairman and CEO , Bruce Van Sorn, and CFO John Woods will provide an overview of the event.
Speaker 7: After 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 2 of the presentation.
Speaker 8: We are also referencing non-GAAP financial measures, so it's important to review our GAAP results on page three of the presentation and the reconciliations in the appendix. With that, I will hand over to you, Bruce. Okay, thanks, Kristen, and good morning, everyone. Thanks for joining our call today.
Speaker 9: We are pleased with the financial performance we delivered for the fourth quarter and the full year, and we feel well positioned to navigate through an uncertain environment in 2023.
Speaker 10: We are playing strong defense with a robust balance sheet position and highly prudent credit risk appetite.
Speaker 11: At the same time, we continue to play disciplined offense with continuing investments in our growth initiatives. We are focused on building out a prudent, sustainable growth trajectory over the medium term.
Speaker 12: I'll comment briefly on the financial headlines and let John take you through the details. For the quarter, our underlying EPS was $1.32, our return on tangible common equity was 19.4%, and the efficiency ratio was 54%.
Speaker 13: sequential operating leverage was 1% and sequential PP&R growth was 2.6%.
Speaker 14: Leading our performance was 2% sequential NII growth, reflecting NIM expansion of 5 basis points to 3.3%, and relatively stable loans given the impact of a $900 million reduction in our auto portfolio. Growth was 1% excess impact.
Speaker 15: Deposits were solid with 1% sequential growth, and our LDR remained stable at 87%.
Speaker 16: Our fee businesses showed resilience and diversity given a challenging environment down about 1% sequentially.
Speaker 17: The number of M&A fees pushed into Q1, and mortgage results were softer than expected.
Speaker 18: We maintain stable expenses in the quarter and credit metrics remain good.
Speaker 19: We boosted our allowance for credit losses to 1.43% of loans, which compares with pro forma day one CECL levels of 1.30%.
Speaker 20: We restarted our share repurchase activity in Q4, buying $150 million of stock, and we ended the year with a set 1 ratio of 10% at the top of our targeted range.
Speaker 21: For full year 2022, we delivered underlying EPS of $4.84 and ROTCE of 16.4% as we captured the benefit of rising rates in our strengthened deposit base.
Speaker 22: The results handily exceeded our beginning of year guide, which we included in the appendix of the presentation.
Speaker 23: With respect to our guidance for 2023, we assume a slowdown in economic growth to 1% for the year.
Speaker 24: two early Fed rate hikes and a Q4 cut, and inflation getting below 3% by Q4.
Speaker 25: We project moderate loan growth, partially offset by continued runoff in our auto book of close to $3 billion.
Speaker 26: Overall, we see solid NI growth as NIM gradually rises to 3.4% over the year, a roughly 8% growth in fees, giving a rebound in capital markets fees over the course of the year.
Speaker 27: solid expense discipline with core expense growth, X acquisition and FDIC impacts of 3.5 to 4%.
Speaker 28: We announced today our top eight program which targets 100 million in run rate benefits and about 80% of that is expensive in fact.
Speaker 29: Credit should be manageable with net charge-offs in the 30 to 35 basis point range, and we expect to build our ACL to 1.45 to 1.5% of loans.
Speaker 30: We expect to repurchase a meaningful amount of stock given strong profitability, modest loan growth, and limited expectation for acquisitions, with our set one ratio forecast near the high end of our 9.5-10% range.
Speaker 31: Capital return to shareholders should approach 100% and yield to investors of our dividends plus capital return via repurchase could top 12%.
Speaker 32: So all in all, a very strong year of execution and delivery for all stakeholders by citizens in 2022. And we feel we are well positioned in 2023 to continue our journey towards becoming a top performing bank.
We continue to make good progress in executing on our strategic initiatives across consumer, commercial and the enterprise.
We've transformed our deposit base and are reaping the benefits.
We've adjusted our interest hedging to protect against lower rates through 2025.
Given the improvement in our ROTCE over time, we are raising our medium-term target to 16-18% from 14-16%.
We've stayed focused on positive operating leverage, we've captured the benefit of moving to a more normal rate environment, and we still have plenty of upside in our feed businesses as market conditions improve.
exciting times for citizens.
I'd like to end my remarks by thanking our colleagues for rising to the occasion and delivering a great effort in 2022.
We know we can count on you again in the new year.
And with that, I'll turn it over to John .
Thanks, Bruce, and good morning, everyone.
Big picture 2022 is a strong year for citizens with significant delivery of strategic initiatives against the backdrop of uncertainty and volatility in the macro environment.
Most notably, we closed our acquisitions of HSBC and ISBC.
We captured the benefit of higher rates with strong NII and NIM.
And our balance sheet and interest rate position were well managed.
While fee revenues were impacted by the environment, we are very well positioned across our businesses to capitalize on the upside potential when markets normalize, particularly in capital markets.
Mortgage margins, margins and volumes should recover over time and we are excited for the growth prospects arising from our wealth investments.
We are actively managing our loan portfolio, focusing on allocating capital where we can drive deeper relationship business into 2023 and beyond.
We continue to maintain good expense discipline, delivering in excess of $115 million of pre-tax run rate benefit through Top 7, generating 4.7% underlying positive operating leverage for the year and 16.4% full year RODC.
Let me give you the headlines for the financial results referencing slide five.
For the fourth quarter, we reported underlying net income of $685 million and EPS of $1.32.
Our underlying route fee for the quarter was 19.4%.
Net interest income was up 2% linked quarter with five basis points of margin expansion to 3.3% and relatively stable loans given a planned reduction in our auto portfolio.
Period end and average loans are broadly stable in each quarter, up to 1%, excluding auto runoff.
We drew deposits of 1% linked quarter and our LDR was stable at 87%.
Fees should some resilience amid a challenging environment, down 1% next quarter.
We saw a modest improvement in capital market fees driven by underwriting and M&A, but this was more than offset by a drop in mortgage fees and a CDA DBA impact in our FX and IRP business.
Expenses were broadly stable each quarter.
Overall, we delivered underlying positive operating leverage of 1% linked-quarter, and our underlying efficiency ratio improved to 54.4%.
Our credit metrics were good with NCOs of 22 basis points of 3 basis points linked quarter.
We recorded a provision for credit losses of $132 million and a reserve bill of $44 million this quarter. For more information, visit www.fema.gov
Our ACL ratio stands at 1.43%, up from 1.41% at the end of the third quarter, and approximately 13 basis points above our proforma day 1 seasonal adoption coverage ratio.
Our tangible book value per share is up 5% in each quarter.
Next, I'll provide further details related to the fourth quarter results.
On slide six, net interest income was up 2% given higher net interest margin.
The net interest margin of 3.3% was up 5 basis points.
As you can see on the NIMWOC on the bottom left-hand side of the slide, a healthy increase in asset yields continues to outpace funding costs, reflecting the asset sensitivity of our balance sheet.
With Fed funds increasing 425 basis points since the end of 2021, our cumulative interest bearing deposit data has been well controlled at 29% through the end of the fourth quarter.
Moving on to slide seven, we posted solid feed results despite headwinds from continued market volatility and higher rates.
These were fairly stable, down 1% linked quarter with lower mortgage and FX and derivatives severe weather seasons.
partly offset by an improvement in capital market fees.
Focusing on capital markets, market volatility continued through the quarter. However, underwriting and M&A advisory fees picked up.
We continue to see good strength in our M&A pipelines, including several deals that were pushed into Q1.
Mortgage fees were softer as the higher rate environment continued to weigh on production volumes
We are seeing pressure on volumes moderating and signs of the industry reducing capacity, which should benefit margins over time.
Servicing operating fees were stable.
Card and wealth fees posted solid results for the quarter.
On slide 8, expenses were well controlled.
Broadly stable in quarter.
Our top seven efficiency program delivered over $115 million of pre-tax run rate benefits by the end of the year.
We are excited to announce the launch of our new TOP8 program, and I'll cover that in a few slides.
On slide nine, average and period end loans were broadly stable in quarter, but up 1% ex-auto runoff with 1% growth in commercial reflecting demand and asset-backed financing and growth in CRE, primarily reflecting line draws and slower pay-dots.
We have seen commercial utilization moderate a bit over the quarter as inflation and supply chain pressures continue easing and clients are adjusting inventory to reflect this, as well as lower CapEx in anticipation of a softer economy.
Average retail loans are down slightly but up 1% ex planned runoff and auto, given growth in mortgage and home equity, which bring an opportunity for deeper relationships and better risk adjusted returns.
On slide 10, average deposits were up $1.4 billion, or 1% linked quarter, with growth primarily coming from term deposits, money market accounts, and citizens access savings.
Overall, commercial banking deposits were up 2.4% and consumer banking deposits were broadly stable.
We feel good about how we are optimizing deposit costs in this rate environment.
Our interest-bearing deposit costs were up 67 basis points, which translates to a 29% cumulative beta, broadly consistent with our expectations.
We began the rate cycle with a strong liquidity and funding profile, including significant improvements to our deposit mix and capabilities.
We achieved overall deposit growth this quarter and will continue to optimize our deposit base and to invest in our capabilities to attract durable customer deposits.
Overall liquidity remains strong as we reduce our flood advances by 1.3 billion and increase our cash position at quarter-end.
Our period end LDR improved slightly to 86.7%.
Moving on to slide 11, we saw good credit results again this quarter across the retail and commercial portfolios.
Net charge offs were 22 basis points of 3 basis points linked quarter, which is still low relative to historical levels.
Now performing loans are 60 basis points of total loans, up 5 basis points from the third quarter, given an increase in commercial largely in Crete.
Retail delinquencies continue to remain favorable to historical levels, but we continue to closely monitor leading indicators to gauge how the consumer is faring.
Although personal disposable income remains strong, debt service as a percentage of disposable income has essentially returned to pre-pandemic levels, while consumer confidence has stabilized as inflation has eased.
Turning to slide 12, I'll walk through the drivers of the allowance for score.
While our current credit metrics are good, we increased our allowance by $44 million to take into account the growing risk of an economic slowdown.
Our overall coverage ratio stands at 1.43%, which is a modest increase from the third quarter.
The current reserve level contemplates a moderate recession and incorporates expectations of lower asset prices.
and the risk of added stress on certain portfolios, including those subject to higher risk of inflation, supply chain issues, higher interest rates, and return to office trends.
Given these pressures, we are watching our loan portfolio very carefully for early signs of stress, in particular, pre-office.
Back on slide 32 in the appendix, we have provided some additional information about the CREATE portfolio. We have provided some additional information about the CREATE portfolio.
Our total create allowance coverage of 1.86% includes elevated coverage for the office portfolio, while the multifamily portfolio has a much lower reserve requirement.
The $6.3 billion office portfolio includes $2.2 billion of credit tenant and life sciences properties which are not as exposed to adverse back-to-office trends.
The remaining $4 billion relates to the general office segment, for which we are holding a roughly 5% allowance coverage.
About 95% of the general office portfolio is income producing and about 70% is located in suburban areas.
Moving to slide 13, we maintained excellent balance sheet strength. Our Set 1 ratio increased to 10%, which is at the top end of our range.
Tangible book value per share was up 5% in the quarter and the tangible common equity ratios improved to 6.3%.
We returned a total of $350 million to shareholders through share repurchases and dividends.
Our strong capital position combined with our earnings outlook puts us in a position to continue to return capital to shareholders through additional share repurchases.
Shifting gears a bit, starting with slide 14, we'll cover some of the unique opportunities we have to drive out performance over the next few years.
We have tried to be very disciplined in prioritizing the areas that we think have big potential and where we have a right to win.
So in consumer, we've got four big opportunities
First is our push into New York Metro. We are investing in brand marketing, doing well in the technology conversions, and putting our best people against the market opportunity.
We are encouraged by our early success with some recent client wins in commercial and the HSBC branches driving some of the highest customer acquisition and sales rates in our network.
The full ISDC conversion is just around the corner on President's Weekend, and we look forward to making further strides as we leverage the full power of our product lineup and customer-focused retail and small business model across the New York market.
You will see more details on slide 28 and 29 of the appendix.
Importantly, we achieved about 70% in run rate of our planned $130 million of investors' net expense energies as of the end of the year, and we expect to capture the rest by the middle of the year.
We also continue to expect that the integration costs will come in below our initial estimates.
Moving to wealth, we've launched a number of exciting initiatives with Citizens Private Client and Citizens Plus as we orient the business towards financial planning led advice.
These should really help us penetrate the opportunity with our existing customer base.
On slide 15, our national expansion is another area where we have a great opportunity to build on our digital platform that has been focused on deposits for the last few years.
We've moved that to a cloud-based platform, and we are adding our other product capabilities so that we can offer a complete digital bank experience to serve customers nationwide with a focus on the young mass affluent mark segment.
Where we might have only had a lending or deposit relationship before, our vision is to build a national platform that allows us to serve our customers in a comprehensive way.
And we have also been very innovative in creating distinctive ways to serve customers.
Citizens pay, for example, is an area where we have significant running room.
We've attracted many new partners, up about 150 versus a year ago, which should really ramp the business.
And we built an industry leading home equity business powered by our innovative fast line process, which is enabled by advanced analytics and digital innovations that have drastically reduced origination time.
Moving to the commercial back on slides 16 and 17.
We filled in all the product apps.
acquisitions brought us M&A and other advisory capabilities, and we built out debt capital markets capabilities organically.
We've hired some great coverage bankers and we are focused on high growth regions around the country and the right industry verticals to serve larger companies.
We also have a very strong sponsor coverage and are well positioned to support private equity capital.
Bottom line, we've aligned ourselves with the attractive opportunities with a full product set to drive significant market share and fee revenues.
Moving to slide 18, we are excited to announce the launch of our latest COP program.
Even as we push forward on offense with our strategic initiatives and acquisitions, it is important to remember that a key to citizen success since our IPO has been our continuous effort to find new revenue pools and realize efficiencies.
and then reinvest those benefits back into our businesses so we can serve customers better.
We've effectively executed up our top seven program, achieving a pre-tax run rate benefit of approximately $115 million at the end of 2022.
And we've launched top eight with a goal of an exit run rate of about $100 million in pre-tax benefits by the end of 2023, with that split about 80-20 between efficiency and revenue-oriented initiatives.
Moving to slide 19, I'll walk through the outlook for the full year, which contemplates an economic slowdown and the end of December forward curve view of two 25 basis point bedhikes before an expected 25 basis point cut in the fourth quarter.
We expect solid NII growth of 11 to 14 percent and we project our NIM to gradually rise towards approximately 3.4 percent for the fourth quarter of 2023.
Our overall hedge position is expected to provide an implore of about 3.2% through the 4th quarter of 2024 and a gradual 200 basis point decline across the curve commencing in Q4 2023.
In the fourth quarter, we took actions to transition $3 billion of active swaps from 2023 to forward-starting positions in 2024.
And we've done even more so far in January to rebalance the distribution of down rate protection.
You'll find a summary of our hedge position in the appendix on slide 30.
We expect moderate loan growth with average loans up about 4 to 5%. We are targeting about $3 billion of spot auto runoff as we shift the portfolio towards products with more attractive risk-adjusted returns.
We expect total average earning assets to be up 3 to 4%.
On the deposit side, we see 3% average deposit growth and a 2-3% spot deposit decline with cumulative deposit betas at year end reaching the high 30s.
Fees are expected to be up 7 to 9 percent with the capital markets rebound building over the course of the year.
Non-interest expense is expected to be up roughly 7% or about 3.5 to 4% if you adjust to the full year effect of the HSBC and investors acquisitions and the FDIC premium increase.
If the year unfolds as we expect, we should be able to drive about 400 to 500 basis points of positive operating leverage.
Given current macro trends and portfolio originations, we expect that our ACL ratio will rise to the 1.45 to 1.5 percent level depending upon how the economy fares.
We expect our Set 1 ratio to land at the upper end of our target range of 9.5 to 10%, even with our target payout ratio approaching 100%.
All of this translates into our ROTC in the high teens for 2023.
On slide 20, we provide the guide for Q1.
Note that Q1 is seasonally weak for us with a day count impact and seasonality impacting revenues and taxes on compensation payouts impacting expenses.
Moving to slide 21, as Bruce mentioned, we have completely transformed the franchise since the IPO, executing well against our priorities and achieving our desired performance targets. We are ready to raise the bar, lifting our ROTC target to 16 to 18 percent.
The key to the further ROSI improvement is continuing to deliver positive operating leverage.
As we look out over the medium term, we should see a recovery in loan and deposit growth, and we will continue to balance, continue our balance sheet optimization efforts to focus on deep relationship lending to maximize risk adjusted returns.
We are well positioned to grow fees meaningfully, and even if rates come down a bit, we expect NAI to benefit from the protection we have put on through the SWOT portfolio.
You should expect us to stay disciplined on expenses.
Credit is projected to be stable as the economy strengthens.
And we continue to focus on returning a meaningful amount of capital to our shareholders through our repurchase program and targeting a dividend payout of 35-40%.
Over this timeframe, we would expect our Set 1 ratio to remain within our target range of 9.5 to 10%.
To sum up, slide 22.
We delivered a strong quarter against the backdrop of a dynamic environment and we have a positive outlook for 2023.
We are ready for the uncertainty of an economic slowdown in 2023 with a strong capital liquidity and funding position.
We've taken actions to protect our NIMS and we are being prudent with respect to our credit risk appetite and long-term.
At the same time, we are moving forward, executing against our strategy, and making important investments in our business that we believe will deliver sustainable growth and outperformance over the medium term. With that, I'll hand it back over to Bruce.
Okay, thank you John and operator why don't we open it up for Q&A.
Thank you, Mr. Van Zon. We are now ready for the Q&A portion of the call. Ladies and gentlemen, if you wish to ask a question, please press 1, then 0 on your touchtone phone. You'll hear an acknowledgement that you've been placed into queue, and you can remove yourself from queue at any time by repeating that 1-0 command. If you're on a speakerphone, please pick up your phone.
Sounds like you you guys rebalanced some of the hedges in the fourth quarter and are continuing to do so year to date so far was hoping you might please just expand upon how you're thinking on Alco has changed since last quarter and sort of sort of how you intend to position yourself
Yeah, I'll go ahead and start off. I mean, I mean, big picture, we, um, as a sensitivity last quarter was around 3%. We're a little bit below that this quarter. Um, just giving away the outlook for the balance sheet, um, you know, appears to be playing out in 2023. So as we're, as you've seen over time, we've taken our asset sensitivity down.
We are, you know, most of that asset sensitivity is really driven by the short end of the curve, which we expect to remain elevated throughout 2023. And as a result, we're looking at some of the downside, down rate protection that we had in place in 2023 and just repositioning that out of
Spot starting active swaps into forward starting stops into 2020 forward starting swaps into 2024 and beyond so we're looking to you know, you know looking to basically push that out and and basically Get that down rate protection, you know smoothed out into the 24 and 25 periods
rather than holding on to all of that down rate protection here in 23. That's the main objective and what we were doing in fourth quarter, and we've done a little bit more of that in early 1Q. And then more broadly, we're looking at that interest margin, that corridor, if you will, we're trying to protect that corridor with
at the low end if rates were to fall by 200 basis points out in 2024, you'll see a floor of around 320. So you see that 320 to 340 corridor being something that over time is more narrow than you would have seen from us maybe in past cycles. So that's the main objective. And I would just add to that Scott.
I mean, our view in the macro is that the Fed likely moves maybe once or twice the forward curve says they'll move up 25 basis points a couple of times and then stop. And then typically they would pause for six or seven months before they would cut.
And so if there's a cut happening, it likely happens very late in the year, and maybe it could be early next year. So guided by that view, that's kind of why we're pushing out that downside protection a bit.
Terrific. Thank you very much. And then just a separate question. It looks like fees will need to rebound fairly meaningfully following the first quarter to hit the guide. I know, Bruce, you had mentioned an expectation for improved capital markets through the year. Maybe just a thought or two on how you see the main drivers of that fee guide as the year progresses, please. Okay, let's let it
had really strong pipelines this year, but because of the volatility, because of the fact that the Fed is still moving higher, that's created uncertainty and just an inability to actually get the money to work from private equity or some of the deals done because the financing.
hasn't been there the way it's been in the past. And so I think as you, going back to that macro forecast, as the Fed is likely nearing kind of the destination in terms of peak rates, I think that starts to loosen up the markets, the financing markets. You'll see less volatility. And so I think as you, going back to that macro forecast, as the Fed is likely nearing kind of the destination in terms of peak rates, the financing markets, as the Fed is likely nearing kind of the destination in terms of peak rates, the financing markets, the financing
and a lot of the business that's kind of clocked into our pipelines will start to print and get delivered and we'll start to see more transactions. So just by reference most of the quarters this year our capital markets revenues were 90 to 100. If you go back to the fourth quarter of 20...
2021 we had 184 million of fees, so roughly double that level. So we thought coming into this year that we'd have much stronger levels of revenue generation. But you know, the good news is we still have a great overall focus on the right sectors in the market. We've got a great team.
And so I think you'll see that start to rev up as we see the market conditions improve. Beyond that, I'm also quite optimistic. We've made a lot of investments in the wealth business. Again, there if you start to see some stability in the asset markets, we should...
get a kind of tailwind from that plus the investments that we've made. So feel confident about that. And then I'd say mortgage is so washed out. I keep thinking it can't go any lower, and it did in the fourth quarter. But I think you're starting to see people
exit the business and capacity coming out of the business. And so, you know, you'll start to see margins expand, and I think volumes will tick up as we go through the year again, linked back to the Fed reaching the destination and some stability on rates. So those would be the big things. I'm happy to pass the horn here. Don, do you want to say anything else?
long and our pipelines are reasonably strong with a very heavy content of private equity who is awash with cash. So there will be transactions. If you don't get regular way transactions you're going to get a lot of restructuring transactions. So there's minority capital, there's a lot of different ways to skin the cat. So we're relatively optimistic about what's ahead of us.
and in the coming year. Yeah, Brendan, anything on consumer? I think you nailed it, excuse me, pretty well. I'd say, you know, well for the year, we're projecting slow and steady continued progress and it's a bit of a hopeful coiled spring when the equity markets really come back, but as long as you're stable, we should see some growth. Thanks to the other bright spotters.
debit and ATM fees that continue to hit records both through customer engagement and primacy and all the investments we made in the health of the franchise that's also translating into our deposit quality. Also some restructure on vendor relationships and such that's giving us a bit of a boost there too. So that should be a continued area of slow and steady progress. On the other side.
That's great. Thank you very much.
Yep. Thank you. Your next question comes from the line of Peter Winter with DA Davidson. Your line is now open.
Good morning. I wanted to ask on credit.
John , you mentioned that most of the increase in non-performing loans was commercial real estate. I was just wondering, was that office-related, and if you can just give a little bit more color on what your outlook is for office.
Yeah, maybe I'll just talk about the coverage levels, you know, just broadly as you may have seen in our materials that the pre-coverage from an allowance standpoint is around 186 basis points, but when you carve out some of the really high quality stuff in multifamily and credit-tenant lease and...
and life sciences, you get to our general office segment where we have very healthy coverage of around 5%. So there are some, we are seeing some trends there that are telling us that we should be putting away some reserves to deal with the back to office trends that are headwind in that space. So you get.
good healthy coverage of around 5%. We are seeing some of that kick into the non-accrual space. I would say more broadly, you know, that'll, even though that goes into non-accrual, our overall three, you know, LTVs are typically around 60%. And so you got to distinguish from non-accruals from actual lost content. And so even though, you know, we're
And we have a very high quality group of investors that we do business with, which are largely institutional. Second is what MSAs are you in and where are you? And we think suburban will do better than urban. And as we said in the comments, we're heavily weighted to suburban. So we're going through every single property in the office portfolio. We'll restructure a lot of them.
Got it. Thank you. And then just as a follow-up, can you just talk about what changed in the updated margin guidance of towards 340 versus the prior guidance of 350? Is it just the higher deposit beta outlook?
Yeah, I'll yeah, just go. I'll go ahead and cover that. I mean, I think more broadly it's it's 2 overall comments. Really the, the just given the pace and speed of rate changes in the impact on. The migration of the deposit mix that we expect as you get into 2023.
is really most in the majority of what we're looking at. So, and that migration manifests itself in two ways. It's really the amount of DDA migration that we see, as well as the cost of our relatively low cost.
deposits that we're seeing not only within our platform but across the industry. So from that perspective, just kind of marking that to market with respect to what we're seeing and the trends in the fourth quarter and the rate and curve outlook that we see going throughout the rest of 23. I would hate to add the...
What's embedded in there, nevertheless, is a transformed deposit platform that, you know, back prior to the pandemic, we would have had DDA percentages that would be in the low 20s compared with a majority of the portfolio being outside of DDA, of course.
But you fast forward to where we are in the fourth quarter and we're at 28% of our deposit franchise is sitting in DDA. That's a significant increase versus pre-pandemic. And we expect to end the year in the mid to high 20s and the DDA space down a little bit from where we are today. But nevertheless, still very high quality. And when you add in
multi-year transformation of the deposit franchise. So I think we're basically just, you know, calibrating what we expect in 2023, which is with the majority of what we saw in terms of the decline from 3.50 to 3.40. I think you could also add in, you know, what's going on with the curve and front book, back book as well.
driver as well. And not only the speed of rates rising, but the inversion of the yield curve is something that is also a headwind to front book, back book. And I think we need to end it with, nevertheless, front book, back book is a positive tailwind.
Over time we're seeing 300 basis point a positive front book back book across Securities and our our fixed rate lending businesses. That's still a tailwind Works that and that's going to be a driver into 2023 with with net interest margins rising But just not by quite as much as we as we thought last quarter
Thanks very much.
Your next question comes from the line of Ken Usden with Jefferies. Your line is now open. Your line is now open.
Thanks Ty, good morning. Wondering, Bruce heard your early comments about you know we're at 130 ACL day one adjusted for the deals in the low 140s now and your comments about 145, 150 year end. I'm just wondering if you can help us you know given that you're slowing loan growth and letting the auto book run out, how do you just help us understand?
And what we've done for the past several quarters is kind of keep looking forward as to what's the macro forecast and are there any particular segments of the portfolio that could come under stress given that the Fed has continued to push higher and...
economic growth has been downgraded. So I think there's, like I read today, that over 60% of the leading economists are projecting a forecast for this year. So the reason that we've been building gradually is just taking that into account. I think at some point you kind of get the cards turned up in 2023 and you'll have
more information and less uncertainty, but we don't see that where we sit today. So I think it's prudent to continue to view the course, likely courses, that the ACL will go up a couple of basis points a quarter like we've done and get into that 145 to 150 range at some point.
then you'll have seen whatever the recessionary impact is and then you'll be looking forward and then you may get to the point where you can release some of those reserves depending on what your charge-off experience is. Clearly, Ken, the slower loan growth plays into that to some degree is mitigating what the...
the build could have been. But anyway, those are the dynamics at play. John , I don't know if you want to add to that. Yeah, I'll add that. I mean just for the last couple of quarters we've had a mild to moderate recession built into the ACL and so you know our peak to trough to GDP decline that we have built into our...
outlook really impact was. So when you think about house prices and used car prices, etc., we've been increasing the amount of decline expected. You've got sort of the low to mid-teens declines now built into our models.
for both house prices and auto prices over the foreseeable kind of period. And so that's really, and that's not really driving a lot of losses, just we've been having a lot of recoveries in the portfolio over the last year or so. And so you might see some lower recoveries and that'll have the, you saw our loss. That's.
wondering how you're thinking about the mix of the dividend versus the buyback going forward yet you obviously moved to 42 cents in the third quarter. Should we also think about that you would be moving the dividend up in line with increased earnings potential as well within that context?
Yeah, I'd say that what we do here is every year we are we're on a cadence where post C car, you know, we, we basically take that as the opportunity to broadly, you know, update our capital return profile over the medium term.
you know, we're looking at 35 to 40 percent dividend payout and you saw that in some of our medium term outlook. We've updated that this is going to be more of a buyback return year in 23 because of the the outlook for RWAs.
But, you know, we take a look at a dividend policy and earnings outlook and update whether there should be a change in the dividend accuracy car. Yeah. And I would, I would just add to that can that.
Clearly, with the uncertainty in the environment, we are being cautious in terms of the lending of kind of risk appetite. And so I think that in and of itself creates some additional capital versus what we've had in prior years.
I also think we still have our plateful integration of existing acquisitions and we haven't seen a whole lot that's attractive at valuation that we're interested in on the acquisition front. I think the combination of operating at very high profitability levels with the
ROTC returns in the high teens, plus more modest loan growth than historical, more modest acquisition activity than historical creates the opportunity. And I think it's appropriate, given the uncertainty and chance for recession, that returning capital shareholders is the right course of action here.
You could expect we would like to raise the dividend during the course of the year, and we'd also like to get close to that 100% return of capital to shareholders.
Got it. Great. Thank you, Bruce and John .
Your next question comes from the line of John Pancari with Evercore. Your line is now open.
Good morning. On the overall deposit dynamics, I know you expect the 2 to 3% year-over-year spot decline. Can you maybe give us one more color on how you expect overall deposit trends to progress through 2023 to get to that 2 to 3% spot decline? Maybe help us with the magnitude of...
declines that you think is reasonable here in the coming quarters as you look at deposit flows.
Yeah sure I'll jump in there. I mean I think... You can start and then maybe pass it to Don and Brendan. Sure yeah that sounds good. Yeah I mean I think overall as I mentioned before you know we're seeing deposit migration in from a DDA perspective as well as from out from some of our lower costs.
But broadly the mix is superior and improved compared to pre-pandemic. I think we're around 28% DDA in 4Q. That's probably going to tick down a bit, call it to maybe 27% or so by the end of the year. That's part of the story. I'd say some of the higher costs are going to be in the next few weeks.
you know deposits in money markets and and and savings will will be part of the runoff as well such that you get to something along the lines of a two to three percent decline spot to spot end of 22 into 23 and so I'd say that you end up with
some again improved mix compared to pre-pandemics, but a little bit of mix softening as you get throughout 23. And I'll just- I would add to that is that, you know, I'd say we did not take in as much surge deposit as many in our peer group.
And where you'd see slight runoff probably is more on the commercial side, where, you know, treasurers have other alternatives besides bank deposits to move some money out. But again, we're relatively protected there because we didn't take in a lot of that money in terms of search deposits. So maybe, Don, you could... There we go. One.
services business, so both specialty deposit offerings, you know, we've got two that we're now in the market with around ESG, green deposits and carbon offsets, and then just the strengthening of our DDA deposits with our Treasury services business gives us more stability than we would have had in prior years, so we feel pretty good about that projection.
And we're, you know, we're in general, we're really managing the balance sheet from a BSO standpoint, and really avoid, we're avoiding most new, new transactions given just a shyness around the credit environment and the uncertainty, and we're moving clients who aren't generating positive returns off the, off the franchise and off the balance sheet. So it gives us a little bit of a…
dynamic that we don't really need to go chase deposits because we're keeping the loan side relatively modestly in terms of how it grows.
Yeah, without being too redundant to what John mentioned, I'd say consumers have been broadly stable on deposits, which is a really good thing, and the story for us is going to be controlling the mix, but all indications are quite positive. We look at a lot of benchmarking data, and we're pretty confident that we're performing in the top quartile of our...
to Bruce's point, we were 45% massive fluent and above five years ago, we're now 60% of our customer base is massive fluent and above. So the quality has been quite good. On the stimulus front, what we're seeing is the bottom two deciles of our customer base.
is essentially back to paycheck to paycheck. So that stimulus has already burned off and is in the rear view mirror. So the stimulus that remains with us tends to be with the more fluent customers, whether that's actual stimulus checks or that's balance parking that happened during COVID from not making mortgage payments and not traveling, et cetera, et cetera. We're not actually seeing that burn off.
group as well as having citizens access to fence off interest-bearing deposits to maintain discipline in the core have all been really big levers for us to manage well and all indications we see so far is that we're right on track with where we want it to be and dramatically outperforming where we were last time in an upgrade cycle and you know at worst in line with peers but some signs that we may be
origination and then do you happen to have refreshed LTV? I know you mentioned that a lot of your deals have sponsor participation, but we're hearing that with sponsors exiting or re-clancing out certain deals that impact the LTV.
So the repressed LCD may be a better read, particularly on the office front. Thanks
Yeah, the office, the 60% was the office LTVs in terms of not the overall, the overall CREE books. So, we think those are still pretty good. We're refreshing the property by property. We haven't gone through and done a total refresh on the entirety of the book yet, but we're kind of working on the maturing quarter by quarter maturities and working with the sponsors to. So, that's it.
either refinance out, inject equity, or adjust the value of the portfolio. And that's what drove the NPL this quarter. It was really one real estate deal.
Okay, sorry, so that's 60% in refresh number on the author side or is it at origination?
So, those are for ad origination.
Okay, all right, thank you.
Your next question comes from the line of Matt O'Connor with Deutsche Bank. Your line is now open.
Hey everyone, this is Nathan Stein on behalf of Matt O'Connor. On capital, so the 9.5% to 10% medium term CPT1 target range, that's well above the regulatory minimum. You've built reserves a lot and it seems like the conversion timeline of ISBC is going really well.
So I guess my question is why hold so much capital down the road given solid reserves and successful deal integration timeline? Yeah, I would say part of it is just the philosophy of you know liking to have a strong balance sheet and So I think nine and a half to ten
is a strong ratio. You've seen over time that we originally had a target of 10 and 10 and a half, and we've been kind of sliding that down as our profitability goes up. And I think the stakeholders gain more confidence that we have a good strategy and we're executing well. So …
It wouldn't surprise me at some point where we start to manage down in that range. I think the time of 2023 today when we're looking at a potential recession to be at the top end of that range makes sense. But once we get to the other side of that to start to...
move that down and maybe manage that closer to the bottom end of that range will provide more leverage. And then at that point I think we could step back and say do we still need nine and a half to ten or can we skinny that down a little bit. So I think that's all in front of us. We thought at this point given the dynamics around 2023 it wouldn't make sense to actually.
move that target range down. Okay, thanks. And, just a second question is just on loans. So, the $3 billion auto runoff will offset growth in other areas this year. What are your expectations for other loan categories in 2023 coming off of a strong 2020?
and historical levels would imply we should be. And so, you know, as you get into the later part of the year, you see some recovery in investments, in inventories and CapEx and possibly M&A, which actually provides financing opportunities. We see lots of opportunities across commercial. And that's really one of the main drivers. When you get into consumer.
And back to the point around that being taking that otherwise RWA that would have been deployed against auto and some other categories with lower risk adjusted returns and giving that back to shareholders.
Your next question comes from the line of Manan Gosalia with Morgan Stanley . Your line is now open. Your line is now open.
Hi, good morning.
I just wanted to follow up on the NIM line of questioning. I think you brought down the floor for NIM from 3.25% to 3.2%. Is that also a function of what you mentioned on the DDA migration and the curve and also the fact that you pushed out the forward swaps? It's the biggest variable on the DDA migration.
now seem to be 340, then your floor is going to also commensurately move lower. The good news is, in a way, is that we've tightened the bottom side of that range. So previously it was 350 down to 320.
So it was 25 basis points and now it's 340 to 320. So it's 20 basis points. So anyway, I think we certainly, John's initial answer on the movement down has been focused more on migration, the DDA and low cost migration.
But then also some of the change the impact from the yield curve on front book back book has been the other Dynamics, so those are the things that we're watching but John you can pick out from there Yeah I'd say the only thing I'd add just to remember we we Constructed we modeled that 320 and there's a lot of assumptions that go into that with respect to what the mix of the balance sheet would be
And what we're assuming is a 200 basis point gradual decline in 2024 that would get you down to that 320. And given that we are still asset sensitive and we haven't closed out that position, you know, that's really what you're seeing in terms of the decline in net interest margin. So you know if you know.
in the context of what's at that time. It's a very dynamic process. So we look and see where the forward curve say rates are going to be. We have our own view of that. We see what the valuations we can get in the hedge market are. And you know, you can be assured. I think we played our hand quite well so far.
and we'll continue to stay really focused on this.
I appreciate that. And then separately just on the TAPA program, can you unpack some of the drivers there of the $100 million in pre-tax benefits and maybe how quickly those can come out from the expense base over the course of the year? Yeah, I'll go ahead and cover that. I'd say the one dynamic to keep in mind is that...
But keep in mind we did the same thing with top seven. So there's a full year effective top seven that comes in. And so when the programs are reasonably similarly sized you can almost use that as an estimate of what the contribution is in any given year. And so you have maybe a combined, you know, $100 million plus contribution from the full year effective top seven hitting 23.
And the in your effective top eight hitting twenty three and so the big drivers of that really are in a couple of places. You've got the traditional areas that we focus on, which is third party costs and vendor cost management, which is an area that we've been.
that's been contributing over the years as well as continuing to optimize the branch network and just being really careful about ensuring that our organizational approaches is as is fit for purpose with respect to what we're trying to accomplish in twenty three. So those are more traditional areas.
The other places we're looking at that have been more recent include maturing our Agile delivery model away from a waterfall approach to Agile. And next-gen technology initiatives continue to contribute as well. We're working towards a data center exit in 2025.
We're looking to migrate to the cloud from our internal applications, and that's contributing in 23 as well. But there's a lot of very strategic initiatives that are built within the TOP8 program, and we're excited about it. It's part of who we are. We're looking to migrate to the cloud from our internal applications, and that's contributing in 23 as well. But there's a lot of very strategic initiatives that are built within the TOP8 program, and
and we're looking forward to deliver against that next year. Great, thanks for taking my questions. Our next question comes from the line of Vivek Jeneha with J.P. Morgan. Your line is now open.
Thanks for taking my questions. A couple of questions for you folks. Firstly, the deposit betas that you expect to get to the high 30s, given the pace of change in the fourth quarter, should we end your expectation for rate hikes?
early in the year and not after that. Should we expect you get to that in Q1? Any color on that, on the pace of it? Especially given how rates have been going up?
Yeah, I mean, I think we will not get there in Q1. That is an over the year expectation in terms of the cumulative growth. I think you'll see the growth in cumulative betas begin to moderate and flatten out. You get the big jumps early in the cycle.
You know, we began, you know, and you go way back to the second quarter of 22, our cumulative data was 6%. And then you get to the fourth quarter, the cumulative data is 29. So you got 23 points just in 22. And then what we're looking for in 23 is another 9 points.
So this is going to, and it'll increase over time. You won't get to 38 in the first quarter. It'll gradually rise. The pauses tend to reprice with a lag. So even after the Fed pauses, you still see a little bit of upward pressure on those betas. That's right. But I would say, OK, but then does that mean Bruce?
income, your guide of about 7 to 9% growth in full year 23 versus 22. How much of that would you expect would come from capital markets or at least what's in your forecast that you're thinking how much comes from capital markets?
Yeah, I think there's a big part of it. I mean, I think, you know, back to the big drivers, you had capital markets, and you heard about card fees from Brendan and wealth from Brendan as well. So those are the three big ones. You see mortgage really potentially rebounding as well. But I think part of it would come from capital markets.
from the underwriting perspective and M&A advisory, just as we may have mentioned in the fourth quarter, we saw some deals push from 4Q into 1Q, so that's gonna support the capital markets business, which by the way, over the years, has really become a very diversified capital markets business itself. I mean, just broadening out.
M&A advisory, underwriting and loan syndication. Those businesses really tend to really diversify our overall fee outlook. A good part of it and a good chunk of the growth in 23 comes from capital markets.
underwriting and loan syndication those those those businesses really tend to really diversify our overall fee outlook but yeah a good part of it and a good chunk of the growth in 23 comes from capital markets. Thank you.
Thank you. There are no further questions in queue. And with that, I'll turn it over to Mr. Van Saun for closing remarks.
Thanks again everyone for dialing in today. We certainly appreciate your interest and support. Have a great day.
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